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Corporate Finance 4th Edition David Hillier - Solutions
Interest You work for jewellers and have sourced a good goldsmith who is able to sell you 100 ounces of gold for £100,000. You approach your two main customers. Mr Noel says he will buy the gold from you in six months for £104,000, whereas Ms Biggs tells you that she will be able to buy the gold
Calculating APR Find the APR for the following five-year loan: a principal of £15,000 with a stated annual interest rate of 7 per cent on the original principal amount to be paid in 60 monthly instalments. The loan has a £250 arrangement fee to be paid as soon as the contract is signed.
Future Value What is the future value in four years of €1,000 invested in an account with a stated annual interest rate of 10 per cent,(a) Compounded annually(b) Compounded semi-annually(c) Compounded monthly(d) Compounded continuously?Why does the future value increase as the compounding period
Growing Perpetuities Oasis Healthtec has been working on a ring that measures blood pressure, heart rate variability and heart rate continuously when worn. It is charged through kinetic energy.The ring has been cleared for manufacture and development. Oasis Healthtec anticipates selling 2,000 units
Unusual Perpetuities You have invested in a project that will pay you £1,000 every two years. If the interest rate is 8 per cent, how much is the project worth today?
Calculating Present Values A three-year annuity of six £5,000 semi-annual payments will begin 10 years from now, with the first payment coming 10.5 years from now. If the discount rate is 10 per cent compounded monthly, what is the value of this annuity five years from now? What is the value three
Balloon Payments On 1 September 2018, Susan Chao bought a motorcycle for £15,000. She paid £1,000 down and financed the balance with a five-year loan at a stated annual interest rate of 9.6 per cent, compounded monthly. She started the monthly payments exactly one month after the purchase (i.e.,
Calculating Annuity Values You are serving on a jury. A plaintiff is suing the city for injuries sustained after a freak doggie poo accident. In the trial, doctors testified that it will be five years before the plaintiff is able to return to work. The jury has already decided in favour of the
You have just started a new company to deliver mail and parcels to rural communities. At the moment, other companies either do not provide a service or are exceptionally expensive. The new company requires an initial investment to purchase a fleet of 20 medium-sized vans. These cost £20,000 each,
You want to pay off the van loan completely and contact your bank for details. The bank has indicated that early completion of your loan will incur a 1 per cent penalty. You have just paid an instalment and have 24 payments left (next payment in one month). How much will you need to pay the bank
Explain how you would modify the present value of an annuity shortcut formula to accommodate an equal payment stream that begins immediately. How would you change the present value of an annuity shortcut formula for an annuity that starts in year 5? How would you answer this question if the payment
How does Max’s age affect his decision to get an MBA?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA would allow him to achieve this goal. After
What other, perhaps non-quantifiable, factors affect Max’s decision to get an MBA?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment banker. He feels that an MBA would allow him
Assuming all salaries are paid at the end of each year, what is the best option for Max – from a strictly financial standpoint?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an investment
Max believes that the appropriate analysis is to calculate the future value of each option. How would you evaluate this statement?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is to become an
What initial salary would Max need to receive to make him indifferent between attending Universität des Geschäfts and staying in his current position?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job, his goal is
Suppose, instead of being able to pay cash for his MBA, Max must borrow the money. The current borrowing rate is 5.4 per cent. How would this affect his decision?Max Gruber graduated from university six years ago with a finance undergraduate degree. Although he is satisfied with his current job,
In Yahoo! Finance, find the closing price for a company in your country. Find the price exactly four years before. What was your annual return over the last four years assuming you purchased the equity at the closing price four years ago? (Assume no dividends were paid.) Using this same return,
Find the share price for a company in your country by visiting Yahoo! Finance. You find an analyst who projects the share price will increase 12 per cent per year for the foreseeable future. Based on the most recent share price, if the projection holds true, when will the share price be 10 times
Definition of a Bond What are the main characteristics of a bond? Provide examples of different types of bonds in terms of coupons, maturity and face value.
Bond Valuation Show how you would value a level coupon bond and a zero coupon bond. How would you value a bond with a changing coupon rate?
Bond Concepts Explain the difference between a coupon rate and a yield to maturity. Show, using examples, how changing the coupon rate and yield to maturity affect the bond price.
The Present Value of Equity Explain why the share price depends on dividends and capital gains.
The Dividend Growth Model Under what two assumptions can we use the dividend growth model to determine the share price? Comment on the reasonableness of these assumptions.
Growth Opportunities In the context of the dividend growth model, is it true that the growth rate in dividends and the growth rate in the share price are identical?
Net Present Value of Growth Opportunities Explain what is meant by NPVGO. In what circumstances is calculating the NPVGO better than other methods of share valuation?
Price–Earnings Ratio What are the three factors that determine a company’s price–earnings ratio?Explain the possible reasons why the PE ratios vary between firms within the same sector, and between firms in different sectors.
Stock Market Reporting What information might a financial analyst need when valuing a company’s prospects? Comment on the usefulness of this information.
Firm Valuation Explain how you would undertake a multiples valuation. Is this approach consistent with other valuation models that use discounted cash flow? Explain.REGULAR
Valuing Bonds A 30-year gilt is issued with face value of £100, paying interest of £20 per year. If market yields increase shortly after the bond is issued, what happens to the:(a) Coupon rate(b) Price(c) Yield to maturity(d) Current yield?
Share Values Your manager has obtained the following information on comparable stocks A and B, both of which are estimated to have a discount rate of 15 per cent:Stock A Stock B Return on equity 15% 10%Earnings per share £2.00 £1.50 Dividends per share £ 1.00 £1.00 Calculate the dividend payout
Share Values A2A SpA is an Italian utility firm. Its most recent dividend was €0.013 per share. In the past year, the company has experienced financial difficulties and the share price has dropped by more than 20 per cent. However, long-term growth in dividends is anticipated to be 7 per cent for
Share Values ABC plc pays dividends that are expected to grow at 5 per cent each year. These will stop in year 5, at which point the company will pay out all its earnings as dividends. Next year’s dividend is £0.87 and its EPS at the time will be £2.02. If the appropriate discount rate on ABC
Growth Opportunities If your company were to distribute all its earnings, it could maintain a level dividend stream of £0.67 per share. How much is the market actually paying per share for growth opportunities?
Equity Valuation XYZ plc will pay a dividend next year of 40p per share, and it is estimated that XYZ’s dividend will increase by 4 per cent per year for ever. Investors in XYZ require a rate of return of 10 per cent. What is the share price of XYZ plc?
Bond Price Movements Define each of the following terms:(i) Treasury bill(ii) Pure discount bond(iii) Index-linked bond.
Bond Returns The UK government issues a five-year bond, which makes annual coupon payments of 5 per cent and offers a yield of 3 per cent annually compounded. Suppose that, one year later, the bond still yields 3 per cent. What return has the bondholder earned over the 12-month period? Now suppose
Valuing Preference Shares Mark Bank has just issued some new preference shares. The issue will pay a£5 annual dividend in perpetuity, beginning four years from now. If the market requires an 8 per cent return on this investment, how much do preference shares cost today?
Non-constant Growth The return on equity (ROE) of Child SA is 14 per cent and it has a payout ratio of €0.5. Current book value per share is €50 and the book value will grow as the firm reinvests earnings.Assume that the ROE and payout ratio stay constant for the next four years. After that,
Semi-annual Dividends The Belgian food group Delhaize has just paid a dividend of €1.08. If the annual discount rate on Delhaize shares is 8 per cent and the dividend is expected to grow at 3 per cent per year, what is the current share price of Delhaize?
Finding the Required Return Regenboog NV earned €68 million for the fiscal year ending yesterday.The firm also paid out 25 per cent of its earnings as dividends yesterday. The firm will continue to pay out 25 per cent of its earnings as annual, end-of-year dividends. The remaining 75 per cent of
Price–Earnings Ratio The market consensus is that Pinto plc has an ROE of 9 per cent and plans to maintain its plowback ratio of 0.67. This year’s earnings per share was €3. The discount rate on Pinto plc is 10 per cent. What is the current PE ratio for the company? What is the prospective PE
Growth Opportunities For Pinto plc in question 24 above, what is the present value of growth opportunities?
Firm Valuation The ABC plc statement of cash flows for the latest financial year is given below. The appropriate discount and growth rates are 14 per cent and 4 per cent, respectively. Assume the marginal corporate tax rate is 23 per cent. What is the value of the firm?Year Ended 31 March £m Notes
Growth Opportunities The annual earnings of Avalanche Skis will be 6 Swedish kroner per share in perpetuity if the firm makes no new investments. Under such a situation the firm would pay out all of its earnings as dividends. Assume the first dividend will be received exactly one year from
Firm Valuation Your company’s net income was €4.456 million, EPS was €73.56 and the dividend payout ratio was 23.7 per cent. The return on equity of the firm was 17.83 per cent and its debt to equity ratio is 1.31.The appropriate discount rate is 18 per cent. What is the value of the firm’s
Components of Bond Returns Bond P is a premium bond with a 10 per cent coupon. Bond D is a 7 per cent coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 9 per cent, and have five years to maturity. What is the current yield for Bond P? For Bond D? If
Discount Rate Wonte is a German commercial vehicle manufacturer. Its DPS and EPS for last year were€2 and €4.62, respectively. The ROE of the firm was 11.85 per cent and the share price is €99.63. How would you calculate the appropriate discount rate for the firm’s equity?
Valuing Bonds Mallory plc has two different bonds currently outstanding. Bond M has a face value of£20,000 and matures in 20 years. The bond makes no payments for the first six years, then pays £1,200 every six months over the subsequent eight years, and finally pays £1,500 every six months over
Equity Valuation Most corporations pay semi-annual rather than annual dividends on their equity.Barring any unusual circumstances during the year, the board raises, lowers or maintains the current dividend once a year and then pays this dividend out in equal biannual instalments to its
Growth Opportunities Nakamura has earnings of £10 million and is projected to grow at a constant rate of 5 per cent for ever because of the benefits gained from the learning curve. Currently all earnings are paid out as dividends. The company plans to launch a new project two years from now that
Equity Valuation Rando’s share price is €56.99. You wish to value the company’s equity and compare your valuation to the share price. The dividend that has just been paid is €1.78 and the earnings per share is€7.96. The return on equity for the firm is 18.66 per cent. There are a number
Kalvin SA pays dividends that are expected to grow at 7 per cent each year. These will stop in year 5, at which point the company will pay out all its earnings as dividends. Next year’s dividend is €10 and its EPS at the time will be €15. If the appropriate discount rate on Kalvin shares is 9
If Kalvin SA were to distribute all its earnings, it could maintain a level dividend stream of €15 per share.How much is the market actually paying per share for growth opportunities? (20 marks)
A six-year government bond makes annual coupon payments of 4 per cent and offers a yield of 8 per cent annually compounded. Suppose that, one year later, the bond still yields 8 per cent. What return has the bondholder earned over the 12-month period? Now suppose that the bond yields 6 per cent at
How would you value a firm that pays no dividends? Explain, using a quantitative example to illustrate your answer. (40 marks)
Assuming Ecorenewable Energy continues its current growth rate, what is the share price of the company’s equity?Ecorenewable Energy is a renewable wave energy firm that was established in 2016 by two finance graduates. The company manufactures and installs wave energy converters through a point
You have been hired to verify the share price valuation, and have been given information on Ecorenewable Energy and its three closest competitors. You believe that although Ecorenewable Energy has a technological advantage from the point absorber buoy, your research indicates that the firm’s
What is the industry average price–earnings ratio? What is Ecorenewable Energy’s price–earnings ratio? Comment on any differences and explain why they may exist.Ecorenewable Energy is a renewable wave energy firm that was established in 2016 by two finance graduates. The company manufactures
Assume the company’s growth rate declines to the industry average after five years. What percentage of the equity’s value is attributable to growth opportunities?Ecorenewable Energy is a renewable wave energy firm that was established in 2016 by two finance graduates. The company manufactures
Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply?Ecorenewable Energy is a renewable wave energy firm that was established in 2016 by two finance graduates. The company manufactures and installs wave energy converters
Both shareholders of Ecorenewable Energy wish to increase the value of the company equity but want to retain control of the company. They will not sell shares to outside investors and believe the company’s debt is at a manageable level. They also do not wish to borrow more money. What steps can
Dividend Discount Model Choose any large company from your country and download its most recent statement of financial position and statement of profit and loss. Using the financial figures in the accounts, calculate the sustainable growth rate for your company. Now go to Yahoo! Finance or any
Growth Opportunities Assume that investors require an 8 per cent return on the company you studied for question 1. Using this share price and the EPS for the most recent year, calculate the NPVGO for your company. What is the appropriate PE ratio for your company using these calculations? What is
Net Present Value What is meant by a project’s NPV, and what is the decision rule? List the main strengths of the net present value method. What do you think are the weaknesses of NPV in practical capital budgeting analysis?
Payback Period What is a project’s payback period? Discuss the advantages and disadvantages of the payback period method. If a project has a payback period less than the lifetime of the project, can we know for sure whether the NPV will be positive or negative?
Discounted Payback Period Why would a manager use discounted payback period? Can the discounted payback ever be longer than the conventional payback?
Average Accounting Return Average accounting return is a popular method with accountants. Review the main strengths and weaknesses of the methodology for practical capital budgeting.
Internal Rate of Return In many countries, internal rate of return is the most popular capital budgeting technique, yet in almost all academic textbooks, NPV is put forward as the best method. Why do you think this is the case?
Problems with IRR Review the main problems that arise when one uses only IRR to evaluate potential projects. In spite of these pitfalls, why do many managers use IRR instead of NPV to evaluate projects?
Profitability Index What is the profitability index, and how is it calculated? Discuss the main applications of the profitability index in capital budgeting. When is it most useful and what are its weaknesses? What is its relationship with NPV?
MIRR In which situations would you use MIRR instead of IRR? Explain your answer using a practical example.
Margin of Safety Although margin of safety is used by many investors, explain the method’s major criticisms. Do you agree with these? Explain.10 The Practice of Capital Budgeting Why do you think certain capital budgeting techniques are used more often in some countries than in others? If NPV is
Calculating Payback Period and NPV Shire plc has the following mutually exclusive projects:Year Project A (£) Project B (£)0 –14,000 –6,000 1 4,000 4,500 2 5,500 2,200 3 8,000 200(a) Suppose Shire’s payback period cut-off is two years. Which of these two projects should be chosen?(b)
Investment Criteria Which of the following statements is correct?(a) The NPV and the IRR always result in the same accept/reject decisions.(b) The NPV cannot rank mutually exclusive projects.(c) The IRR cannot rank mutually exclusive projects.(d) The NPV cannot be used in cases of multiple IRRs.
Discounted Payback and Discount Rates A project has annual cash flows of –€45,000, €35,000, €15,000 and €5,000. What is the payback period for this project? What is the maximum discount rate that would result in a positive NPV?
Average Accounting Return Your firm is considering purchasing a machine that requires an annual investment of €16,000. Depreciation is calculated using 20 per cent reducing balance (i.e. instead of depreciating the machine by the same amount each year, we depreciate the residual value of the
Average Accounting Return Vedanta Resources has invested £8 million in a new mining project lasting three years. Depreciation is charged on a straight-line basis to zero over the course of the project.The project generates pre-tax income of £2 million each year. The pre-tax income already
Calculating NPV Calculate the NPV of the following project for discount rates of 5, 12 and 19 per cent.Year 0 1 2 Cash flow −£77,000 +£55,000 +£320,000
Calculating IRR and MIRR Marielle Machinery Works is considering a project that has an initial investment of £10,000 and expected cash flows of £0 in year 1, £7,500 in year 2 and £8,500 in year 3. The company uses the IRR rule to accept or reject projects, and has asked for your assessment on
Calculating Profitability Index What is the profitability index for a project with an initial investment of€14,000, which has cash flows of €7,300 in year 1, €6,900 in year 2 and €5,700 in year 3? Should the project be accepted or rejected if the discount rate is 14 per cent?
Calculating Profitability Index Suppose the following two independent investment opportunities are available to Greenplain Ltd. The appropriate discount rate is 10 per cent.(a) Compute the profitability index for each of the two projects.(b) Which project(s) should Greenplain accept based on the
Problems with IRR Suppose you are offered £5,000 today but must make the following payments:Year Cash Flows (£)0 5,000 1 –2,500 2 –2,000 3 –1,000 4 –1,000(a) What is the IRR of this offer?(b) If the appropriate discount rate is 10 per cent, should you accept this offer?(c) If the
NPV versus IRR Consider the following cash flows on two mutually exclusive projects for Tomatina Recreation SA. Both projects require an annual return of 15 per cent.Year Deepwater Fishing (€) New Submarine Ride (€)0 –600,000 –1,800,000 1 270,000 1,000,000 2 350,000 700,000 3 300,000
Capital Budgeting Tools Consider the following cash flows:Year 0 1 2 3 4 5 Cash flow −£15,000 £4,000 £5,000 −£2,000 £7,000 £7,000(a) What is the payback period for the above project? Assume the cash flows are received continuously throughout each year.(b) If the discount rate is 10 per
Comparing Investment Criteria Software games company Avalanche Entertainment is considering expanding its highly successful online game franchise to the board game or trading card environment. The company has decided that it will invest in one project but not both. Consider the following cash flows
Capital Budgeting Sandy Grey Ltd is in the process of deciding whether or not to revise its line of mobile phones, which it manufactures and sells. Its sole market is large corporations and it has not as yet focused on the retail sector. It has estimated that the revision will cost £220,000. Cash
Comparing Investment Criteria Pinto plc is considering spending €10,000 on insulating its office, which will save it €1,000 per year in heating expenses in perpetuity.(a) What is the NPV of the investment when the cost of capital is 8 per cent?(b) What is the IRR of the investment?(c) What is
Comparing Investment Criteria The treasurer of Amaro Canned Fruits has projected the cash flows of projects A, B and C as follows.Year Project A (€) Project B (€) Project C (€)0 −100,000 −200,000 −100,000 1 70,000 130,000 75,000 2 70,000 130,000 60,000 Suppose the relevant discount rate
Comparing Investment Criteria Consider the following cash flows of two mutually exclusive projects for Tadcaster Rubber Company. Assume the discount rate for Tadcaster Rubber Company is 10 per cent.Year Dry Prepreg (€) Solvent Prepreg (€)0 −800,000 −600,000 1 500,000 400,000 2 300,000
Comparing Investment Criteria You are a senior manager at Airbus and have been authorized to spend up to €200,000 for projects. The three projects you are considering have the following characteristics:Project A: Initial investment of €150,000. Cash flow of €50,000 at year 1 and €100,000 at
Project Valuation The financial manager of Solsken is evaluating a proposal to purchase a new solar machine unit that has a lifetime of 10 years. The new machine would allow the company to make cost savings of SKr4 million per annum. The new fully solar machine would cost SKr9 million and have a
Payback and NPV An investment under consideration has a payback of seven years and a cost of£483,000. If the required return is 12 per cent, what is the worst-case NPV? What is the best-case NPV?Explain. Assume the cash flows are conventional.
Multiple IRRs This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? (Hint: Search between 20 per cent and 70 per cent.) When should we take this project?Year Project Million Project
Calculating IRR Moshi Mining is set to open a gold mine in northern Tanzania. The mine will cost 6 million rand to open and will have an economic life of 12 years. It will generate a cash inflow of 1 million rand at the end of the first year, and the cash inflows are projected to grow at 10 per
IRR and NPV You are out having dinner with your two colleagues who are also studying finance. John, who loves the IRR method, tells you that ranking projects by IRR is fine as long as each project’s cash flows can be reinvested at the project’s IRR. Your other friend, Beverley, is confused and
Investment Appraisal Many companies have a set of appraisal methods that they recommend their managers use when considering new project investments. Assume that your company uses three methods:NPV (discount rate of 20 per cent on all new projects); payback period (two to three years maximum);and
Calculating Incremental Cash Flows Darin Clay, the CFO of MakeMoney.com, has to decide between the following two projects:
Multiple IRRs This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? (Hint: Search between 20 per cent and 70 per cent.) When should we take this project?Year Project Million Project
Assume you are the new financial manager of the bed mattress firm Fairy Tale Lullaby Ltd. The firm has always used payback period and accounting rate of return to appraise new investments. With your trusty copy of Corporate Finance to hand, you believe that other methods may be more appropriate for
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