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essentials of management

Essentials Of Financial Management 4th Edition Eugene F. Brigham, Joel F. Houston, Jun-Ming Hsu, Yoon Kee Koong, A. N. Bany-Ariffin - Solutions

Explain why you agree or disagree with this statement: Most investors are risk- averse.
Which of the two stocks graphed in Figure 8.3 is less risky? Why?
Set up an illustrative probability distribution table for an investment with probabilities for different conditions, returns under those conditions, and the expected return.
What does investment risk mean?
Should companies completely avoid high-risk projects? Explain.
What do you think the average investor's risk perception is now? In what types of investments do you think the average investor is investing currently?
Does the average investor's willingness to take on risk vary over time? Explain.
What do the slopes of the risk-return lines illustrated in Figure 8.1 indicate?
Briefly explain the fundamental trade-off between risk and return.
7-19 INFLATION AND INTEREST RATES In late 1980, the U.S. Commerce Department released new data showing inflation was 15%. At the time, the prime rate of interest was 21%, a record high. However, many inves- tors expected the new Reagan administration to be more effective in controlling inflation
7-18 YIELD CURVES Suppose the inflation rate is expected to be 7% next year, 5% the following year, and 3% thereafter. Assume that the real risk-free rate, r', will remain at 2% and that maturity risk premiums on Treasury securities rise from zero on very short-term bonds (those that mature in a
7-17 INTEREST RATE PREMIUMS A 5-year Treasury bond has a 5.2% yield. A 10-year Treasury bond yields 6.4%, and a 10-year corporate bond yields 8.4%. The market expects that inflation will average 2.5% over the next 10 years (IP=2.5%). Assume that there is no maturity risk premium (MRP = 0) and that
7-16 INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. A 6-year security with no maturity, default, or liquidity risk
7-15 EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If a 1-year Treasury bond yield is 5%and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average.
7-14 EXPECTATIONS THEORY AND INFLATION Suppose 2-year Treasury bonds yield 4.5%, while 1-year bonds yield 3%. r' is 1%, and the maturity risk premium is zero.a. Using the expectations theory, what is the yield on a 1-year bond 1 year from now? Calculate the yield using a geometric average.b. What
7-13 DEFAULT RISK PREMIUM The real risk-free rate, 1", is 2.5%. Inflation is expected to average 2.8% a year for the next 4 years, after which time inflation is expected to average 3.75% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yield of 8.3%, which
7-12 MATURITY RISK PREMIUM An investor in Treasury securities expects inflation to be 2.5% in Year 1, 3.2% in Year 2, and 3.6% each year there-after, Assume that the real risk-free rate is 2.75% and that this rate will remain constant. Three-year Treasury securities yield 6.25%, while 5-year
7-11 DEFAULT RISK PREMIUM A company's 5-year bonds are yielding 7.75%per year. Treasury bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate (r*) is 2.3%. The average inflation premium is 2.5%; and the maturity risk premium is estimated to be 0.1 x (t - 1)%, where t
7-10 INFLATION Due to a recession, expected inflation this year is only 3%.However, the inflation rate in Year 2 and thereafter is expected to be constant at some level above 3%, Assume that the expectations theory holds and the real risk-free rate (r") is 2%. If the yield on 3-year Treasury bonds
7-9 EXPECTED INTEREST RATE The real risk-free rate is 3%. Inflation is expected to be 3% this year, 4% next year, and 3.5% thereafter. The matu-rity risk premium is estimated to be 0.05 x (t - 1)%, where t = number of years to maturity. What is the yield on a 7-year Treasury note?
7-8 EXPECTATIONS THEORY Interest rates on 4-year Treasury securities are currently 7%, while 6-year Treasury securities yield 7.5%. If the pure expec-tations theory is correct, what does the market believe that 2-year securities will be yielding 4 years from now? Calculate the yield using a
7-7 EXPECTATIONS THEORY One-year Treasury securities yield 5%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 6%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities? Calculate the yield using a geometric average.
7-6 INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high, As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 5% and inflation is expected to
7-5 MATURITY RISK PREMIUM The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-year Treasury security yields 6.2%. What is the maturity risk premium for the 2-year security?
7-4 DEFAULT RISK PREMIUM A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?
7-3 EXPECTED INTEREST RATE The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?
7-2 REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently yielding 5,5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums:.Inflation premium = 3.25%Liquidity premium = 0.6%Maturity
7-10 Suppose you have noticed that the slope of the corporate yield curve has become steeper over the past few months. What factors might explain the change in the slope?
7-9 What does it mean when it is said that the United States is running a trade deficit? What impact will a trade deficit have on interest rates?
7-8 Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company's common stock?
7-7 It is a fact that the federal government (1) encouraged the development of the savings and loan industry, (2) virtually forced the industry to make long-term fixed-interest-rate mortgages, and (3) forced the savings and loans to obtain most of their capital as deposits that were withdrawable on
7-6 Suppose a new and more liberal Congress and administration are elected.Their first order of business is to take away the independence of the Federal Reserve System and to force the Fed to greatly expand the money supply. What effect will this have:a.On the level and slope of the yield curve
7-5 Suppose a new process was developed that could be used to make oil out of seawater. The equipment required is quite expensive; but it would in time lead to low prices for gasoline, electricity, and other types of energy.What effect would this have on interest rates?
7-4 Suppose the population of Area Y is relatively young, and the population of Area O is relatively old, but everything else about the two areas is the same.a. Would interest rates likely be the same or different in the two areas?Explain.b.Would a trend toward nationwide branching by banks and the
7-3 Suppose you believe that the economy is just entering a recession. Your firm must raise capital immediately, and debt will be used. Should you borrow on a long-term or a short-term basis? Why?
7-2 Which fluctuate more-long-term or short-term interest rates? Why?
7-1 Suppose interest rates on residential mortgages of equal risk are 5.5% in California and 7.0% in New York. Could this differential persist? What forces might tend to equalize rates? Would differentials in borrowing costs for businesses of equal risk located in California and New York be more or
ST-3 PURE EXPECTATIONS THEORY The yield on 1-year Treasury securities is 6%, 2-year securities yield 6.2%, 3-year securities yield 6.3%, and 4-year securities yield 6.5%. There is no maturity risk premium. Using expecta-tions theory and geometric averages, forecast the yields on the following
ST-2 INFLATION AND INTEREST RATES The real risk-free rate of interest, It, is 3%; and it is expected to remain constant over time. Inflation is expected to be 2% per year for the next 3 years and 4% per year for the next 5 years.The maturity risk premium is equal to 0.1 x (t - 1)%, where t = the
ST-1 KEY TERMS Define each of the following terms:a. Production opportunities; time preferences for consumption; risk;inflationb. Real risk-free rate of interest, r+; nominal (quoted) risk-free rate of interest, I'c.Inflation premium (IP)a.Default risk premium (DRP)e.Liquidity premium (LP);
Does the Fed have complete control over US. interest rates? That is, can it set rates at any level it chooses? Why or why not?
How does the Fed stimulate the economy? How does the Fed affect interest rates?
Identify some macroeconomic factors that influence interest rates and explain the effects of each.
Assume that the interest rate on a 1-year T-bond is currently 7% and the rate on a 2-year bond is 9%. If the maturity risk premium is zero, what is a reasonable forecast of the rate on a 1-year bond next year? What would the forecast be if the maturity risk premium on the 2-year bond was 0.5%
Most evidence suggests that a positive maturity risk premium exists. How would this affect your calculations when determining interest rates?
According to the pure expectations theory, what would happen if long-term rates were not an average of expected short-term rates?
Assuming that the pure expectations theory is correct, how are expected short- term rates used to calculate expected long-term rates?
What key assumption underlies the pure expectations theory?
Explain why corporate bonds always yield more than Treasury bonds and why BBB-rated bonds always yield more than AA-rated bonds.
Explain why corporate bonds' default and liquidity premiums are likely to increase with their maturity.
If the inflation rate is expected to remain constant at the current level in the future, would the yield curve slope up, slope down, or be horizontal? Consider all factors that affect the yield curve, not just inflation.
If the inflation rate is expected to increase, would this increase or decrease the slope of the yield curve?
How do maturity risk premiums affect the yield curve?
If the interest rates on 1-, 5-, 10-, and 30-year bonds are 4%, 5%, 6%, and 7%, respectively, how would you describe the yield curve? If the rates were reversed, how would you describe it?
Distinguish among the shapes of a "normal" yield curve, an "abnormal" curve, and a "humped" curve.
What is a yield curve, and what information would you need to draw this curve?
How do investors deal with inflation when they determine interest rates in the financial markets?
Distinguish between the real risk-free rate of interest, r", and the nominal, or quoted, risk-free rate of interest,
Write an equation for the nominal interest rate on any security.
If inflation during the last 12 months was 2% and the interest rate during that period was 5%, what was the real rate of interest? If inflation is expected to average 4% during the next year and the real rate is 3%, what should the current interest rate be? (3%; 7%)
How does risk affect interest rates?
How does the price of capital tend to change during a boom? During a recession?
What happens to market-clearing, or equilibrium, interest rates in a capital market when the supply of funds declines? What happens when expected inflation increases or decreases?
What role do interest rates play in allocating capital to different potential borrowers?
How do risk and inflation impact interest rates in the economy?
Which factor determines how much will be saved at different interest rates?
Which factor sets an upper limit on how much can be paid for savings?
What four fundamental factors affect the cost of money?
What are the two items whose sum is the cost of equity?
What is the price paid to borrow debt capital called?
5. How has Abercrombie's stock performed this year relative to the S&P 500?
4. Within the last year, have Abercrombie's reported quarterly earnings generally met, exceeded, or fallen short of analysts' forecasted earnings?
3. Have analysts made any significant changes to their forecasted earnings for Abercrombie & Fitch in the past few months? Explain.
2. Based on analysts' forecasts, what is the expected long-term (5-year) growth rate in earnings?
1. What are the mean and median forecasts for Abercrombie's earnings per share over the next fiscal year?
6-15 FORECASTING FINANCIAL STATEMENTS Use a spreadsheet model to forecast the financial statements in problems 6-13 and 6-14.
6-14 EXCESS CAPACITY Krogh Lumber's 2015 financial statements are shown here.a. Assume that the company was operating at full capacity in 2015 with regard to all items except fixed assets; fixed assets in 2015 were being utilized to only 75% of capacity. By what percentage could 2016 sales increase
$ 6-13 ADDITIONAL FUNDS NEEDED Morrissey Technologies Inc.'s 2015 finan-cial statements are shown here.Suppose that in 2016, sales increase by 10% over 2015 sales. The firm currently has 100,000 shares outstanding. It expects to maintain its 2015 dividend payout ratio and believes that its assets
6-12 EXCESS CAPACITY Edney Manufacturing Company has 52 billion in sales and $0.6 billion in fixed assets. Currently, the company's fixed assets are operating at 80% of capacity.a. What level of sales could Edney have obtained if it had been oper-ating at full capacity?b. What is Edney's target
6-11 REGRESSION AND INVENTORIES Charlie's Cycles Inc. has $110 million in sales. The company expects that its sales will increase 5% this year.Charlie's CFO uses a simple linear regression to forecast the company's inventory level for a given level of projected sales. On the basis of recent
Given the estimated sales forecast and the estimated relationship between receivables and sales, what are your forecasts of the company's year-end balance for receivables and its year end days sales outstanding (DSO) ratio? Assume that DSO is calculated on the basis of a 365-day year.
6-10 REGRESSION AND RECEIVABLES Edwards Industries has $320 million in sales. The company expects that its sales will increase 12% this year.Edwards' CFO uses a simple linear regression to forecast the compa-ny's receivables level for a given level of projected sales. On the basis of recent
6-9 SALES INCREASE Pierce Furnishings generated $2 million in sales during 2015, and its year-end total assets were $1.5 million. Also, at year-end 2015, current liabilities were $500,000, consisting of $200,000 of notes payable,$200,000 of accounts payable, and $100,000 of accrued liabilities.
LONG-TERM FINANCING NEEDED At year-end 2015, total assets for Ambrose Inc. were $1.2 million and accounts payable were $375,000. Sales, which in 2015 were $2.5 million, are expected to increase by 25% in 2016. Total assets and accounts payable are proportional to sales, and that relationship will
5 6-7 PRO FORMA INCOME STATEMENT At the end of last year, Roberts Inc.reported the following income statement (in millions of dollars):Looking ahead to the following year, the company's CFO has assembled this information.Year-end sales are expected to be 10% higher than the $3 billion in sales
6-6 REGRESSION AND INVENTORIES Jasper Furnishings has $300 million in sales. The company expects that its sales will increase 12% this year.Jasper's CFO uses a simple linear regression to forecast the company's inventory level for a given level of projected sales. On the basis of recent history,
6-5 EXCESS CAPACITY Walter Industries has $5 billion in sales and $1.7 billion in fixed assets. Currently, the company's fixed assets are operating at 90%of capacity.a. What level of sales could Walter Industries have obtained if it had been operating at full capacity?b. What is Walter's target
6-4 PRO FORMA INCOME STATEMENT Austin Grocers recently reported the following 2015 income statement (in millions of dollars):For the coming year, the company is forecasting a 25% increase in sales, and it expects that its year-end operating costs, including depreciation, will equal 70% of sales.
6-3 AFN EQUATION Refer to problem 6-1 and assume that the company had 53 million in assets at the end of 2015. However, now assume that the company pays no dividends. Under these assumptions, what additional funds would be needed for the coming year? Why is this AFN different from the one you found
6-2 AFN EQUATION Refer to problem 6-1. What additional funds would be needed if the company's year-end 2015 assets had been $4 million? Assume that all other numbers are the same. Why is this AFN different from the one you found in problem 6-17 Is the company's "capital intensity" the same or
6-1 AFN EQUATION Carter Corporation's sales are expected to increase from$5 million in 2015 to $6 million in 2016, or by 20%. Its assets totaled$3 million at the end of 2015. Carter is at full capacity, so its assets must grow in proportion to projected sales, At the end of 2015, current
6-5 Suppose a firm makes the following policy changes. If the change means that external nonspontaneous financial requirements (AFN) will increase, indicate this with a (+); indicate a decrease with a (-); and indicate an indeterminate or negligible effect with a (0). Think in terms of the
6 4 Certain liability and net worth items generally increase spontaneously with increases in sales. Put a check mark (+ ) next to those items that typi-cally increase spontaneously,Accounts payable Notes payable to banks Accrued wages Accrued taxes Mortgage bonds Common stock Retained earnings
6-3 Would you agree that computerized corporate planning models were a fad during the 1990s but that because of a need for flexibility in corporate planning, they are no longer used by most firms? Explain.
6-2 Assume that an average firm in the office supply business has a 6%profit margin, a 40% total liabilities/assets ratio, a total assets turnover of 2 times, and a dividend payout ratio of 40%. Is it true that if such a firm is to have any sales growth (g > 0), it will be forced to borrow or to
6-1 What are the key factors on which external financing depends, as indi-cated in the AFN equation?
ST-3 ADDITIONAL FUNDS NEEDED Suppose Weatherford's financial consultants report (1) that the inventory turnover ratio is Sales/Inventory = 3 times versus an industry average of 4 times and (2) that Weatherford can reduce inventories and thus raise its turnover to 4 without affecting sales, the
ST-2 SUSTAINABLE GROWTH RATE Weatherford Industries Inc. has the following ratios: A,"/S, = 1.6; L,"/S. = 0.4; profit margin = 0.10; and payout ratio = 0.45, or 45%. Sales last year were $100 million. Assuming that these ratios will remain constant, use the AFN equation to determine the maximum
ST-1 KEY TERMS Define each of the following terms:a. Mission statement; corporate scope; statement of corporate objectives; corporate strategies b.Operating plan; financial planc. Spontaneously generated fundsd. Additional Funds Needed (AFN); AFN equatione. Capital intensity ratio; sustainable
5-43 REQUIRED ANNUITY PAYMENTS A father is now planning a savings program to put his daughter through college. She is 13, plans to enroll at the university in 5 years, and should graduate 4 years later. Currently, the annual cost (for everything-food, clothing, tuition, books, transpor- tation, and

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