Questions and Answers of Essentials Corporate Finance

Fama’s Llamas has a WACC of 11.20 percent. The company’s cost of equity is 15 percent, and its cost of debt is 8 percent. The tax rate is 35 percent. What is Fama’s target debt-equity ratio?
Rainbow in the Dark Manufacturing has a target debt-equity ratio of .65. Its cost of equity is 13 percent, and its cost of debt is 8 percent. If the tax rate is 35 percent, what is the
Mullineaux Corporation has a target capital structure of 60 percent common stock, 5 percent preferred stock, and 35 percent debt. Its cost of equity is 12.5 percent, the cost of preferred stock is
For the firm in Problem 7, suppose the book value of the debt issue is $90 million. In addition, the company has a second debt issue, a zero coupon bond with 10 years left to maturity; the book value
Peyton’s Colt Farm issued a 30-year, 7 percent semiannual bond 7 years ago. The bond currently sells for 94 percent of its face value. The company’s tax rate is 35 percent.a. What is the pretax
ICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 108 percent of face value. The issue makes semiannual
Sixth Fourth Bank has an issue of preferred stock with a $5.50 stated dividend that just sold for $97 per share. What is the bank’s cost of preferred stock?
Suppose Matta Ltd. just issued a dividend of $2.46 per share on its common stock. The company paid dividends of $1.96, $2.03, $2.20, and $2.30 per share in the last four years. If the stock currently
Stock in CDB Industries has a beta of 0.90. The market risk premium is 7 percent, and T-bills are currently yielding 4 percent. CDB’s most recent dividend was $1.90 per share, and dividends are
Bohannon Corporation’s common stock has a beta of 1.10. If the risk-free rate is 4.5 percent and the expected return on the market is 12 percent, what is the company’s cost of equity capital?
Betancourt International has operations in Arrakis. The balance sheet for this division in Arrakeen Solaris shows assets of 20,000 solaris, debt in the amount of 6,000 solaris, and equity of 14,000
According to purchasing power parity, if a Big Mac sells for $3.29 in the United States and kronur 127.49 in Iceland, what is the kronur/$ exchange rate?
The £ trades at $1.4934 in London and $ 1.4872 in New York. How much profit could you earn on each trade with $10,000?
Suppose the spot exchange rate for the Hungarian forint is HUF 221. Interest rates in the United States are 3.2 percent per year. They are 5.1 percent in Hungary, (a) What do you predict the
Suppose the spot and three-month forward rates for the yen are ¥102.16 and ¥101.23, respectively.a. Is the yen expected to get stronger or weaker?b. What would you estimate is the difference
Suppose the spot and six-month forward rates on the South Korean won are SKW 1,304.81 and SKW 1,315.16, respectively. The annual risk-free rate in the United States is 5 percent, and the annual
Suppose your company imports computer motherboards from Singapore. The exchange rate is given in Figure 18.1. You have just placed an order for 30,000 motherboards at a cost to you of 230.75
The treasurer of a major U.S. firm has $30 million to invest for three months. The interest rate in the United States is .47 percent per month. The interest rate in Great Britain is .51 percent per
Suppose the Japanese yen exchange rate is ¥106 = $1, and the British pound exchange rate is £1 = $1.51.a. What is the cross-rate in terms of yen per pound?b. Suppose the cross-rate is ¥165 =
The Trektronics store begins each month with 950 phasers in stock. This stock is depleted each month and reordered. If the carrying cost per phaser is $32 per year and the fixed order cost is $540,
Vang, Inc., has an average collection period of 28 days. Its average daily investment in receivables is $87,000. What are annual credit sales? What is the receivables turnover?
A firm offers terms of 2/15, net 40. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to
Two Doors Down, Inc., has weekly credit sales of $38,600, and the average collection period is 34 days. What is TDD’s average accounts receivable figure?
Miyagi Data, Inc., sells earnings forecasts for Japanese securities. Its credit terms are 1/10, net 30. Based on experience, 65 percent of all customers will take the discount.a. What is the average
The Johnson Corporation has annual credit sales of $31 million. The average collection period is 33 days. What is the average investment in accounts receivable as shown on the balance sheet?
Essence of Skunk Fragrances, Ltd., sells 5,000 units of its perfume collection each year at a price per unit of $380. All sales are on credit with terms of 1/10, net 30. The discount is taken by 35
Each business day, on average, a company writes checks totaling $32,000 to pay its suppliers. The usual clearing time for the checks is four days. Meanwhile, the company is receiving payments from
In a typical month, the Tanner Corporation receives 100 checks totaling $78,000. These are delayed three days on average. What is the average daily float? Assume 30 days in a month.
You place an order for 900 units of Good X at a unit price of $46. The supplier offers terms of 1/20, net 35.a. How long do you have to pay before the account is overdue? If you take the full period,
Kings of Leon, Inc., has a book value of equity of $62,000. Longterm debt is $55,000. Net working capital, other than cash, is $21,800. Fixed assets are $91,600. How much cash does the company have?
We are evaluating a project that costs $1,350,000, has a six-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected
Automatic Transmissions, Inc., has the following estimates for its new gear assembly project: price = $1,070 per unit; variable cost = $290 per unit; fixed costs = $4.8 million; quantity = 70,000
In the previous problem, suppose your required return on the project is 10 percent and your pretax cost savings are $190,000 per year. Will you accept the project? What if the pretax cost savings are
A major college textbook publisher has an existing finance textbook. The publisher is debating whether or not to produce an “essentialized” version, meaning a shorter (and lower-priced) book.
For the company in the previous problem, what is the dividend yield? What is the expected capital gains yield?Previous problemThe next dividend payment by Mosby, Inc., will be $2.45 per share. The
In 2007, baseball player Alex Rodriguez signed a contract reported to be worth $275 million. The contract called for $2 million immediately and $27 million in 2008. The remaining $246 million was to
You want to borrow $58,000 from your local bank to buy a new sailboat. You can afford to make monthly payments of $1,200, but no more. Assuming monthly compounding, what is the highest rate you can
You’re prepared to make monthly payments of $175, beginning at the end of this month, into an account that pays 10 percent interest compounded monthly. How many payments will you have made when
What is the relationship between the value of an annuity and the level of interest rates? Suppose you just bought a 10-year annuity of $15,000 per year at the current interest rate of 10 percent per
You’re trying to choose between two different investments, both of which have up-front costs of $85,000. Investment G returns $150,000 in six years. Investment H returns $270,000 in 13 years. Which
Peter Lynchpin wants to sell you an investment contract that pays equal $12,000 amounts at the end of each of the next 20 years. If you require an effective annual return of 9 percent on this
You have an investment that will pay you 1.27 percent per month. How much will you have per dollar invested in one year? In two years?
You are saving to buy a $175,000 house. There are two competing banks in your area, both offering certificates of deposit yielding 6 percent. How long will it take your initial $92,000 investment to
You receive a credit card application from Shady Banks Savings and Loan offering an introductory rate of 2.1 percent per year, compounded monthly for the first six months, increasing thereafter to 17
You want to buy a new sports car from Muscle Motors for $43,000. The contract is in the form of a 60-month annuity due at a 6.25 percent APR. What will your monthly payment be?
If the appropriate discount rate for the following cash flows is 9.29 percent per year, what is the present value of the cash flows? Cash Flow Year $1,900 2,300 4,500 5,100 3
If you put up $25,000 today in exchange for a 7.9 percent, 12-year annuity, what will the annual cash flow be?
You have $35,400 on deposit with no outstanding checks or uncleared deposits. One day you write a check for $4,700 and then deposit a check for $6,300. What are your disbursement, collection, and net
You have $13,200 on deposit with no outstanding checks or uncleared deposits. If you deposit a check for $4,800, does this create a disbursement float or a collection float? What is your available
You have $145,000 on deposit with no outstanding checks or uncleared deposits. One day you write a check for $39,000. Does this create a disbursement float or a collection float? What is your
In the chapter opening, we discussed the cash positions of several companies. Automobile manufacturers also have enormous cash reserves. At the beginning of 2009, Ford Motor Co. had $28.2 billion in
Come and Go Bank offers your firm an 8 percent discount interest loan for up to $20 million, and in addition requires you to maintain a 3 percent compensating balance against the face amount
In exchange for a $400 million fixed commitment line of credit, your firm has agreed to do the following:1. Pay 1.8 percent per quarter on any funds actually borrowed.2. Maintain a 4 percent
Piano Man, Inc., has a 40-day average collection period and wants to maintain a minimum cash balance of $25 million, which is what the company currently has on hand. The company currently has a
A bank offers your firm a revolving credit arrangement for up to $75 million at an interest rate of 1.34 percent per quarter. The bank also requires you to maintain a compensating balance of 4
You’ve worked out a line of credit arrangement that allows you to borrow up to $60 million at any time. The interest rate is .573 percent per month.In addition, 4 percent of the amount that you
The Coba Company has projected the following quarterly sales amounts for the coming year:a. Accounts receivable at the beginning of the year are $3,700. The company has a 45-day collection period.
Here are some important figures from the budget of Red Barchetta, Inc., for the second quarter of 2010:The company predicts that 5 percent of its credit sales will never be collected, 35 percent of
The Bruin Corporation’s purchases from suppliers in a quarter are equal to 75 percent of the next quarter’s forecast sales. The payables period is 60 days. Wages, taxes, and other expenses are 30
Confusion Products has projected the following sales for the coming year:Sales in the year following this one are projected to be 15 percent greater in each quarter.a. Calculate payments to suppliers
Your firm has an average collection period of 47 days. Current practice is to factor all receivables immediately at a 2 percent discount. What is the effective cost of borrowing in this case? Assume
Consider the following financial statement information for the Keenan Corporation:Assume all sales are on credit. Calculate the operating and cash cycles. How do you interpret your answer? Ending
The Maynard Company has projected the following quarterly sales amounts for the coming year:a. Accounts receivable at the beginning of the year are $240. Maynard has a 45-day collection period.
Kane Manufacturing, Inc., has recently installed a justin- time (JIT) inventory system. Describe the effect this is likely to have on the company’s carrying costs, shortage costs, and operating
The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield
Flashback Corporation is evaluating an extra dividend versus a share repurchase. In either case, $16,320 would be spent. Current earnings are $3.10 per share, and the stock currently sells for $85
In the previous problem, suppose the company instead decides on a two for-one stock split. The firm’s 42-cent-per-share cash dividend on the new (postsplit) shares represents an increase of 10
The company with the common equity accounts shown here has declared a 10 percent stock dividend at a time when the market value of its stock is $64 per share. What effects on the equity accounts will
The market value balance sheet for Tidwell Manufacturing is shown here. Tidwell has declared a 20 percent stock dividend. The stock goes ex-dividend tomorrow (the chronology for a stock dividend is
In the previous problem, suppose the company has announced it is going to repurchase $30,000 worth of stock instead of paying a dividend. What effect will this transaction have on the equity of the
The balance sheet for Price Cut, Inc., is shown here in market value terms. There are 25,000 shares of stock outstanding.The company has declared a dividend of $1.20 per share. The stock goes
Bermuda Triangle Corporation (BTC) currently has 500,000 shares of stock outstanding that sell for $83 per share. Assuming no market imperfections or tax effects exist, what will the share price be
The owners' equity accounts for Trans World International are shown here:a. If Trans World stock currently sells for $42 per share and a 10 percent stock dividend is declared, how many new shares
Palmer, Inc., has declared a $5.80 per share dividend. Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be withheld at the time the
Your portfolio is 180 shares of Sunny Morning, Inc. The stock currently sells for $88 per share. The company has announced a dividend of $1.90 per share with an ex-dividend date of April 19. Assuming
During 2008, only 21 companies went public with common stock offerings, raising a combined total of $22.8 billion. Relatively few of these 21 companies involved paid cash dividends. Why do you think
Explain the life-cycle theory of dividend payments. How does it explain corporate dividend payments that are seen in the stock market?
Baker Corporation expects an EBIT of $43,000 every year forever. Baker currently has no debt, and its cost of equity is 13 percent. The company can borrow at 8 percent. If the corporate tax rate is
Kunitz Co. has no debt. Its cost of capital is 9.3 percent. Suppose Kunitz converts to a debt-equity ratio of 1.0. The interest rate on the debt is 6.4 percent. Ignoring taxes, what is the
M&M. Guerin Enterprises has no debt. Its current total value is $70 million. Ignoring taxes, what will the company’s value be if it sells $32 million in debt? Suppose now that the company’s
Fleury Co. has a 38 percent tax rate. Its total interest payment for the year just ended was $32 million. What is the interest tax shield? How do you interpret this amount?
Cede & Co. can borrow at 9 percent. Cede currently has no debt, and the cost of equity is 15 percent. The current value of the firm is $625,000. What will the value be if Cede borrows $210,000
Malkin Corp. has no debt but can borrow at 7 percent. The firm’s WACC is currently 12 percent, and there is no corporate tax.a. What is Malkin’s cost of equity?b. If the firm converts to 30
Staal Enterprises is considering a change from its current capital structure. Staal currently has an all-equity capital structure and is considering a capital structure with 25 percent debt. There
Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 30 percent debt. Currently, there are 6,100 shares outstanding and the
Blue Stripes Co. is comparing two different capital structures. Plan I would result in 8,500 shares of stock and $313,500 in debt. Plan II would result in 12,000 shares of stock and $198,000 in debt.
Suppose you observe the following situation:a. Calculate the expected return on each stock.b. Assuming the capital asset pricing model holds and stock A’s beta is greater than stock B’s beta
You have $100,000 to invest in either Stock D, Stock F, or a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an expected return of 10.5 percent. If D
You have a portfolio with the following:What is the expected return of your portfolio? Number of Expected Return Price Stock Shares 700 600 $45 12% 22 16 350 14 58 43 575 15
Stock J has a beta of 1.20 and an expected return of 13.16 percent, while Stock K has a beta of .75 and an expected return of 10.10 percent. You want a portfolio with the same risk as the market.
You have $250,000 to invest in a stock portfolio. Your choices are Stock H, with an expected return of 14 percent, and Stock L, with an expected return of 10.1 percent. If your goal is to create a
Stock Y has a beta of 1.30 and an expected return of 13 percent. Stock Z has a beta of .75 and an expected return of 10.5 percent. If the risk free rate is 4.5 percent and the market risk premium
Asset W has an expected return of 13 percent and a beta of 1.25. If the risk-free rate is 4.5 percent, complete the following table for portfolios of Asset W and a risk-free asset. Illustrate the
A stock has a beta of 1.2 and an expected return of 11.8 percent. A risk-free asset currently earns 3.8 percent.a. What is the expected return on a portfolio that is equally invested in the two
A stock has an expected return of 11.90 percent and a beta of 1.15, and the expected return on the market is 10.90 percent. What must the risk-free rate be?
A stock has an expected return of 11 percent, its beta is .85, and the risk-free rate is 5.5 percent. What must the expected return on the market be?
A stock has an expected return of 14.2 percent, the risk-free rate is 5.5 percent, and the market risk premium is 6.9 percent. What must the beta of this stock be?
A stock has a beta of 1.25, the expected return on the market is 11.7 percent, and the risk-free rate is 4.5 percent. What must the expected return on this stock be?
You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.31 and the total portfolio is equally as risky as the market, what must the beta be for
You own a stock portfolio invested 25 percent in Stock Q, 20 percent in Stock R, 45 percent in Stock S, and 10 percent in Stock T. The betas for these four stocks are .85, .91, 1.31, and 1.76,

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