Questions and Answers of Essentials Of Corporate Finance

What is the payback period for the following set of cash flows? Year 0 1 2 3 4 Cash Flow -$7,700 1,900 3,000 2,300 1,700
a. What are the relevant cash flows for valuing a share of common stock?b. Does the value of a share of stock depend on how long you expect to keep it?c. What is the value of a share of stock when
a. What is a proxy?b. What rights do stockholders have?c. Why is preferred stock called preferred?
a. What is the difference between a securities broker and a securities dealer?b. Which is bigger, the bid price or the ask price? Why?c. What are the three types of license holders of the New
Based on the dividend growth model, what are the two components of the total return on a share of stock? Which do you think is typically larger?
If a project with conventional cash flows has a payback period less than its life, can you definitively state the algebraic sign of the NPV? Why or why not?
a. What is the net present value rule?b. If we say an investment has an NPV of $1,000, what exactly do we mean?
a. In words, what is the payback period? The payback period rule?b. Why do we say that the payback period is, in a sense, an accounting break-even measure?
a. What are the most commonly used capital budgeting procedures?b. If NPV is conceptually the best tool for capital budgeting, why do you think multiple measures are used in practice?
a. What is an average accounting rate of return, or AAR?b. What are the weaknesses of the AAR rule?
An investment has an installed cost of $827,450. The cash flows over the four-year life of the investment are projected to be $319,745, $304,172, $245,367, and $229,431. If the discount rate is zero,
a. What are the relevant incremental cash flows for project evaluation?b. What is the stand-alone principle?
a. What is a sunk cost? An opportunity cost?b. Explain what erosion is, and why it is relevant.c. Explain why interest paid is not a relevant cash flow for project evaluation
a. What is the definition of project operating cash flow? How does this differ from net income?b. In the shark attractant project, why did we add back the firm’s net working capital investment
a. Why is it important to consider changes in net working capital in developing cash flows? What is the effect of doing so?b. How is depreciation calculated for fixed assets under current tax law?
Suppose a financial manager is quoted as saying, “Our firm uses the stand-alone principle. Because we treat projects like minifirms in our evaluation process, we include financing costs because
a. What is forecasting risk? Why is it a concern for the financial manager?b. What are some potential sources of value in a new project?
“When evaluating projects, we’re only concerned with the relevant incremental after tax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when
a. What are scenario and sensitivity analyses?b. What are the drawbacks to what-if analyses?
a. Why do we say that our standard discounted cash flow analysis is static?b. What are managerial options in capital budgeting? Give some examples.c. What is capital rationing? What types are there?
Shue Music Company is considering the sale of a new sound board used in recording studios. The new board would sell for $27,300, and the company expects to sell 1,500 per year. The company currently
A co-worker claims that looking at all this marginal this and incremental that is a bunch of nonsense and states: “Listen, if our average revenue doesn’t exceed our average cost, then we will
a. What are the two parts of total return?b. Why are unrealized capital gains or losses included in the calculation of returns?c. What is the difference between a dollar return and a percentage
a. With 20-20 hindsight, what was the best investment for the period 1926–1935?b. Why doesn’t everyone buy only small stocks as investments?c. What was the smallest return observed over the 95
You purchased 275 shares of a particular stock at the beginning of the year at a price of $89.73. The stock paid a dividend of $1.42 per share, and the stock price at the end of the year was $96.18.
a. What do we mean by excess return and risk premium?b. What was the real (as opposed to nominal) risk premium on the common stock portfolio?c. What was the nominal risk premium on corporate bonds?
a. If you want to forecast what the stock market is going to do over the next year, should you use an arithmetic or geometric average?b. If you want to forecast what the stock market is going to do
a. What is an efficient market?b. What are the forms of market efficiency?
You bought a share of 3.4 percent preferred stock for $96.82 last year. The market price for your stock is now $98.34. What is your total return for last year?
You bought a stock three months ago for $48.21 per share. The stock paid no dividends. The current share price is $51.06. What is the APR of your investment? The EAR?
a. How do we calculate the expected return on a security?b. In words, how do we calculate the variance of the expected return?
a. What is a portfolio weight?b. How do we calculate the expected return on a portfolio?c. Is there a simple relationship between the standard deviation on a portfolio and the standard
a. What are the two basic parts of a return?b. Under what conditions will an announcement have no effect on common stock prices?
You own a portfolio that is 15 percent invested in Stock X, 35 percent in Stock Y, and 50 percent in Stock Z. The expected returns on these three stocks are 9 percent, 15 percent, and 12 percent,
a. What are the two basic types of risk?b. What is the distinction between the two types of risk?
a. What happens to the standard deviation of return for a portfolio if we increase the number of securities in the portfolio?b. What is the principle of diversification?c. Why is some risk
a. What is the systematic risk principle?b. What does a beta coefficient measure?c. How do you calculate a portfolio beta?d. True or false: The expected return on a risky asset depends on that
You have a portfolio with the following: What is the expected return of your portfolio? Stock W X Y N Number of Shares 475 840 475 650 Price $43 29 94 51 Expected Return 10% 15 11 14
a. What is the fundamental relationship between risk and return in well-functioning markets?b. What is the security market line? Why must all assets plot directly on it in a well-functioning
a. If an investment has a positive NPV, would it plot above or below the SML? Why?b. What is meant by the term cost of capital?
You have $250,000 to invest in a stock portfolio. Your choices are Stock H, with an expected return of 12.3 percent, and Stock L, with an expected return of 10.2 percent. If your goal is to create a
a. What is the primary determinant of the cost of capital for an investment?b. What is the relationship between the required return on an investment and the cost of capital associated with that
a. What do we mean when we say that a corporation’s cost of equity capital is 16 percent?b. What are two approaches to estimating the cost of equity capital?
a. How can the cost of debt be calculated?b. How can the cost of preferred stock be calculated?c. Why is the coupon rate a bad estimate of a firm’s cost of debt?
a. How is the WACC calculated?b. Why do we multiply the cost of debt by (1 – TC) when we compute the WACC?c. Under what conditions is it correct to use the WACC to determine NPV?
a. Why do we adjust a firm’s taxes when we do a firm valuation?b. Why do you think we might prefer to use a ratio when calculating the terminal value when we value a firm?
Fama’s Llamas has a WACC of 8.4 percent. The company’s cost of equity is 11 percent, and its pretax cost of debt is 5.8 percent. The tax rate is 25 percent. What is the company’s target
Occam Industrial Machines issued 225,000 zero coupon bonds five years ago. The bonds originally had 30 years to maturity with a yield to maturity of 5.2 percent. Interest rates have recently
a. What is the relationship between the WACC and the value of the firm?b. What is an optimal capital structure?
a. What is the impact of financial leverage on stockholders?b. What is homemade leverage?c. Why is Trans Am’s capital structure irrelevant?
a. What does M&M Proposition I state?b. What are the three determinants of a firm’s cost of equity? c. The total systematic risk of a firm’s equity has two parts. What are they?
a. What is the relationship between the value of an unlevered firm and the value of a levered firm once we consider the effect of corporate taxes?b. If we only consider the effect of taxes, what is
a. What are direct bankruptcy costs?b. What are indirect bankruptcy costs?
a. Can you describe the trade-off that defines the static theory of capital structure?b. What are the important factors in making capital structure decisions?
a. Do U.S. corporations rely heavily on debt financing?b. What regularities do we observe in capital structures?
a. What is the APR (in connection with bankruptcy proceedings)?b. What is the difference between liquidation and reorganization?
Farmington Co. can borrow at 6.3 percent. The company currently has no debt, and the cost of equity is 12.9 percent. The current value of the firm is $685,000. What will the value be if the company
Vonte Co. has a 22 percent tax rate. Its total interest payment for the year just ended was $15.7 million. What is the interest tax shield? How do you interpret this amount?
Garcia Co. has no debt. Its cost of capital is 9.4 percent. Suppose the company converts to a debt-equity ratio of 1.0. The interest rate on the debt is 5.3 percent. Ignoring taxes, what is the
What is the cost of capital for a firm that is 100 percent debt financed? What is the value of the firm?
Your portfolio is 300 shares of Sabrina, Inc. The stock currently sells for $86 per share. The company has announced a dividend of $1.27 per share with an ex-dividend date of April 19. Assuming no
a. What are the different types of cash dividends?b. What are the mechanics of the cash dividend payment?c. How should the price of a stock change when the stock goes ex dividend?
a. Are dividends irrelevant?b. What are some of the reasons for a low payout?c. What are the implications of dividend clienteles for payout policies?
a. Why might a stock repurchase make more sense than an extra cash dividend?b. What is the effect of a stock repurchase on a firm’s EPS? Its PE?
a. What is the effect of a stock split on stockholder wealth?b. What is a reverse split?
During 2020, 163 companies went public with common stock offerings, raising a combined total of $29.7 billion. Relatively few of these 163 companies involved paid cash dividends. Why do you think
a. What is venture capital?b. Why is venture capital often provided in stages?
a. Why is an initial public offering necessarily a cash offer?b. What is the difference between a rights offer and a cash offer?
a. What do underwriters do?b. What is the Green Shoe provision?
a. Why is underpricing a cost to the issuing firm?b. Suppose a stockbroker calls you up out of the blue and offers to sell you “all the shares you want” of a new issue. Do you think the issue
The 908 Devices IPO was underpriced by about 145 percent. Should 908 Devices be upset at Cowen and Company over the underpricing?
a. What are some possible reasons the price of a stock drops on the announcement of a new equity issue?b. Explain why we might expect a firm with a positive NPV investment to finance it with debt
In the previous problem, if the SEC filing fee and associated administrative expenses of the offering are $1.5 million, how many shares need to be sold now?Data in previous problem,The Elkmont
a. What are the different costs associated with security offerings?b. What lessons do we learn from studying issue costs?
a. What is the difference between private and public bond issues?b. A private placement is likely to have a higher interest rate than a public issue. Why?
a. What is shelf registration?b. What are the arguments against shelf registration?
a. What is the difference between net working capital and cash?b. Will net working capital always increase when cash increases?c. List five potential uses of cash.d. List five potential sources
a. What does it mean to say that a firm has an inventory turnover ratio of 4?b. Describe the operating cycle and cash cycle. What are the differences?c. Explain the connection between a firm’s
Cori’s Corp., has a book value of equity of $14,735. Long-term debt is $8,300. Net working capital, other than cash, is $2,850. Fixed assets are $18,440. How much cash does the company have? If
a. What considerations determine the optimal size of the firm’s investment in current assets?b. What considerations determine the optimal compromise between flexible and restrictive net working
a. What are the two basic forms of short-term financing?b. Describe two types of secured loans.
a. What is the transaction motive for holding cash?b. What is the cost to the firm of holding excess cash?c. Which of these would a firm be more interested in reducing:Collection float or
You have $83,000 on deposit with no outstanding checks or uncleared deposits. One day you write a check for $24,400. Does this create a disbursement float or a collection float? What is your
a. What is a lockbox? What purpose does it serve?b. What is a concentration bank? What purpose does it serve?c. Is maximizing disbursement float a sound business practice?d. What are some types
You have $19,700 on deposit with no outstanding checks or uncleared deposits. One day you write a check for $4,300 and then deposit a check for $4,600. What are your disbursement, collection, and net
You have $11,700 on deposit with no outstanding checks or uncleared deposits. If you deposit a check for $2,400, does this create a disbursement float or a collection float? What is your available
a. What are the basic components of credit policy?b. Explain what terms of “3/45, net 90” mean. What is the effective interest rate?c. What are the five Cs of credit?
a. What are the different types of inventory?b. What are three things to remember when examining inventory types?c. What is the basic goal of inventory management?
In the chapter opening, we discussed the cash positions of several companies. Automobile manufacturers also have enormous cash reserves. In the middle of 2021, Ford Motor Co. had about $49.9 billion
a. What does the EOQ model determine for the firm?b. Which cost component of the EOQ model does JIT inventory minimize?
If a company moves to a JIT inventory management system, what will happen to inventory turnover? What will happen to total asset turnover? What will happen to return on equity, ROE?
a. What are the differences between a Eurobond and a foreign bond?b. What are Eurodollars?
a. What does absolute PPP say? Why might it not hold for many types of goods?b. According to relative PPP, what determines the change in exchange rates?
a. What is interest rate parity?b. Do you expect that interest rate parity will hold more closely than purchasing power parity? Why?
a. What are the different types of exchange rate risk?b. How can a firm hedge short-run exchange rate risk? Long-run exchange rate risk?
a. What is political risk?b. What are some ways of hedging political risk?
The British pound trades at $1.1248 in London and $1.1241 in New York. How much profit could you earn on each trade with $10,000?
According to purchasing power parity, if a Big Mac sells for $4.89 in the United States and krona 42.50 in Iceland, what is the krona/$ exchange rate?
For each of the following annuities, calculate the annuity payment. Future Value $ 25,600 1,250,000 535,000 104,600 Years Interest Rate 8 40 25 13 5% 7 8 4
a. Describe how to calculate the future value of a series of cash flows.b. Describe how to calculate the present value of a series of cash flows.c. Unless we are explicitly told otherwise, what do we

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