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M: Finance ISE 6th Edition Marcia Millon Cornett, Troy Alton Adair Jr, John Nofsinger - Solutions
Which should we expect to be larger: a project’s payback statistic or its discounted payback statistic?
Spreadsheet Problem: Project Cash Flows Your company is contemplating replacing its current fleet of delivery vehicles with Nissan NV vans. You will be replacing five fully depreciated vans, which you think you can sell for $3,000 each and which you could probably use for another two years if you
Spreadsheet Problem: Project Cash Flows Mom’s Cookies, Inc., is considering the purchase of a new cookie oven. The original cost of the old oven was $30,000;it is now five years old and has a current market value of $13,333.33. The old oven is being depreciated over a 10-year life toward a zero
Spreadsheet Problem: Project Cash Flows You are evaluating a project for The Ultimate recreational tennis racket, guaranteed to correct that wimpy backhand.You estimate the sales price of The Ultimate to be $400 per unit and sales volume to be 1,000 units in year 1; 1,250 units in year 2; and 1,325
Project Cash Flows Your highly successful software company is considering adding a new software title to your list. If you add the new product, it will use the full capacity of your disk duplicating machines that you had planned on using for your flagship product, “Battlin’ Bobby.” You had
Operating Cash Flow Continuing the previous problem, what is the operating cash flow for the project in year 2? (LG12-3)
Change in NWC You are evaluating a project for The Farstroke golf club, guaranteed to correct that nasty slice. You estimate the sales price of The Farstroke to be $400 per unit and sales volume to be 1,000 units in year 1; 1,500 units in year 2; and 1,325 units in year 3.The project has a
Spreadsheet Problem: Project Cash Flows You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $60,000. The truck falls into the MACRS three-year class, is not eligible for either bonus depreciation or Section 179 expensing, and
After-Tax Cash Flow from Sale of Assets If the lathe in the previous problem can be sold for $5,000 at the end of year 3, what is the after-tax salvage value? (LG12-4)
Spreadsheet Problem: Depreciation Tax Shield Your firm needs a computerized machine tool lathe that costs $50,000 and requires $12,000 in maintenance for each year of its three-year life. After three years, this machine will be replaced. The machine falls into the MACRS three-year class life
Spreadsheet Problem: Project Cash Flows KADS, Inc., has spent $400,000 on research to develop a new computer game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized and depreciated using bonus
Spreadsheet Problem: EAC Approach You are considering the purchase of one of two machines used in your manufacturing plant. Machine A has a life of two years, costs $80 initially, and then requires $125 per year in maintenance costs.Machine B costs $150 initially, has a life of three years, and
Spreadsheet Problem: EAC Approach You are evaluating two different cookiebaking ovens. The Pillsbury 707 costs $57,000, has a five-year life, and has an annual OCF (after tax) of −$10,000 per year. The Keebler CookieMunster costs$90,000, has a seven-year life, and has an annual OCF (after tax) of
Spreadsheet Problem: EAC Approach You are trying to pick the least-expensive car for your new delivery service. You have two choices: the Kia Rio, which will cost $14,000 to purchase and which will have OCF of −$1,200 annually throughout the vehicle’s expected life of three years as a delivery
Spreadsheet Problem: PV of Depreciation Tax Benefits Your company is considering a new project that will require $1 million of new equipment at the start of the project. The equipment will have a depreciable life of 10 years and will be depreciated to a book value of $150,000 using straight-line
After-Tax Cash Flow from Sale of Assets Suppose you sell a fixed asset for$109,000 when its book value is $129,000. If your company’s marginal tax rate is 21 percent, what will be the effect on cash flows of this sale (i.e., what will be the after-tax cash flow of this sale)? (LG12-3)
Will an increase in flotation costs increase or decrease the initial cash flow for a project? (LG12-8)
How many TVM formulas do you use every time you calculate EAC for a project?(LG12-7)
In a cost-cutting proposal, what might cause you to sometimes have negative EBIT?(LG12-6)
In a replacement problem, will incremental net depreciation always be less than the gross depreciation on the new piece of equipment? (LG12-5)
In a replacement problem, would we ever see changes in NWC? (LG12-5)
Everything else held constant, would you rather depreciate a project with DDB depreciation or deduct it under a Section 179 deduction? (LG12-4)
Everything else held constant, would you rather depreciate a project with straight-line depreciation or with DDB? (LG12-3)
Why does a decrease in NWC result in a cash inflow to the firm? (LG12-3)
Suppose you paid your old college finance professor to evaluate a project for you. If you would pay him regardless of your decision concerning whether to proceed with the project, should his fee for evaluating the project be included in the project’s incremental cash flows? (LG12-2)
How is the pro forma statement we used in this chapter for computing OCF different from an accountant’s income statement? (LG12-1)
What if two alternative assets lasted the same length of time: Would the EAC approach still work?
Explain how the EAC approach turns uneven cash flows for infinitely repeated asset purchases into perpetuities.
Would it ever be possible to have a project that generated net positive cash flows across all years of a project’s life just by buying and depreciating assets?
Explain why, in Example 12-2, the investment in operating capital in the last year of the project was positive instead of negative.
If the IRS wanted to encourage businesses to invest in certain types of assets, would it put them into shorter or longer MACRS life-class categories?
Explain why, under MACRS,“five-year” depreciation is actually spread over six years, six-year depreciation spreads into seven years, and so forth.
Will OCF typically be larger or smaller than net income?Why?
Explain why an increase in NWC is treated as a cash outflow rather than as an inflow.
Could a new product have both substitutionary and complementary effects on existing products?
Suppose that your manager will be devoting half of her time to a new project, with the other half devoted to currently existing projects.How would you reflect this in your calculation of the incremental cash flows of the project?
Spreadsheet Problem: Divisional WACCs Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.6, 1.0, 1.3, and 1.6, respectively. If all current and future projects will be
Spreadsheet Problem: Firmwide versus Project-Specific WACCs An all-equity firm is considering the projects shown below. The T-bill rate is 4 percent and the market risk premium is 7 percent. If the firm uses its current WACC of 12 percent to evaluate these projects, which project(s), if any, will
Flotation Cost A firm is considering a project that will generate perpetual after-tax cash flows of $15,000 per year beginning next year. The project has the same risk as the firm’s overall operations and must be financed externally. Equity flotation costs 14 percent and debt issues cost 4
Spreadsheet Problem: Flotation Cost Suppose that Brown-Murphies’ common shares sell for $19.50 per share, that the firm is expected to set their next annual dividend at $0.57 per share, and that all future dividends are expected to grow by 4 percent per year, indefinitely. If Brown-Murphies faces
Spreadsheet Problem: WACC Weights BetterPie Industries has 3 million shares of common stock outstanding, 2 million shares of preferred stock outstanding, and 10,000 bonds. If the common shares are selling for $47 per share, the preferred shares are selling for $24.50 per share, and the bonds are
Spreadsheet Problem: WACC Johnny Cake Ltd. has 10 million shares of stock outstanding selling at $23 per share and an issue of $50 million in 9 percent annual coupon bonds with a maturity of 17 years, selling at 93.5 percent of par. If Johnny Cake’s weighted average tax rate is 21 percent, it
WACC Suppose that MNINK Industries’ capital structure features 63 percent equity, 7 percent preferred stock, and 30 percent debt. If the before-tax component costs of equity, preferred stock, and debt are 11.60 percent, 9.5 percent, and 9 percent, respectively, what is MNINK’s WACC if the firm
WACC Suppose that TapDance, Inc.’s, capital structure features 65 percent equity and 35 percent debt, and that its before-tax cost of debt is 8 percent, while its cost of equity is 13 percent. If the appropriate weighted average tax rate is 21 percent and TapDance estimates it cannot make any use
Spreadsheet Problem: Weight of Preferred Stock FarCry Industries, a maker of telecommunications equipment, has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10,000 bonds. If the common shares sell for $27 per share, the preferred shares sell for
Spreadsheet Problem: Weight of Debt FarCry Industries, a maker of telecommunications equipment, has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10,000 bonds. If the common shares are selling for $27 per share, the preferred shares are selling
Spreadsheet Problem: Weight of Equity FarCry Industries, a maker of telecommunications equipment, has 2 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 10,000 bonds. If the common shares are selling for $27 per share, the preferred shares are selling
Cost of Preferred Stock ILK has preferred stock selling for 97 percent of par that pays an 8 percent annual coupon. What would be ILK’s component cost of preferred stock? (LG11-3)
Tax Rate Suppose that LilyMac Photography expects EBIT to be approximately$200,000 per year for the foreseeable future, and that it has 1,000 10-year, 9 percent annual coupon bonds outstanding. What would the appropriate tax rate be for use in the calculation of the debt component of LilyMac’s
Spreadsheet Problem: Cost of Debt Oberon, Inc., has a $20 million (face value)10-year bond issue selling for 97 percent of par that pays an annual coupon of 8.25 percent. What would be Oberon’s before-tax component cost of debt? (LG11-3)
Cost of Equity Diddy Corp. stock has a beta of 1.2, the current risk-free rate is 5 percent, and the expected return on the market is 13.5 percent. What is Diddy’s cost of equity? (LG11-3)
Suppose a new project was going to be financed partially with retained earnings. What flotation costs should you use for retained earnings? (LG11-8)
When will the subjective approach to forming divisional WACCs be better than using the firmwide WACC to evaluate all projects? (LG11-7)
Explain why the divisional cost of capital approach may cause problems if new projects are assigned to the wrong division. (LG11-6)
Suppose your firm wanted to expand into a new line of business quickly, and that management anticipated that the new line of business would constitute over 80 percent of your firm’s operations within three years. If the expansion was going to be financed partially with debt, would it still make
Why do we use market-based weights instead of book-value-based weights when computing the WACC? (LG11-4)
Could you calculate the component cost of equity for a stock with nonconstant expected growth rates in dividends if you didn’t have the information necessary to compute the component cost using the CAPM? Why or why not? (LG11-3)
Under what situations would you want to use the CAPM approach for estimating the component cost of equity? The constant-growth model? (LG11-3)
Expressing WACC in terms of iE, iP, and iD, what is the theoretical minimum for the WACC? (LG11-2)
How would you handle calculating the cost of capital if a firm were planning to issue two different classes of common stock? (LG11-1)
Explain how we should go about computing the WACC for a project that uses both retained earnings and a new equity issue.
Why should we expect the flotation costs for debt to be significantly lower than those for equity?
Explain why, in Example 11-7, using objectively computed divisional WACCs still resulted in an incorrect accept/reject decision for project D.
Divisions of a corporation are not usually formed based explicitly on differences in risk between the projects in different divisions. Rather, they are normally formed along product-type or geographic differences. Explain how this division scheme may still result in divisions that do differ among
Explain why, in Example 11-7, using objectively computed divisional WACCs still resulted in an incorrect accept/reject decision for project D.
Divisions of a corporation are not usually formed based explicitly on differences in risk between the projects in different divisions. Rather, they are normally formed along product-type or geographic differences. Explain how this division scheme may still result in divisions that do differ among
It is usually much easier to find proxy firms that are engaged in multiple lines of business than it is to find pure-play proxies. Explain how such firms can be used to estimate the beta for a new project.
For computing a project WACC, why do we take some component costs from the firm but compute others that are specific for the project being considered?
How would we compute iD if a company had multiple bond issues outstanding?
Explain why we multiply the component cost of debt by a factor containing the marginal tax rate, TD , but don’t do so for the component costs of equity or preferred stock.
Spreadsheet Problem Build a spreadsheet that automatically computes the expected market return and risk for different assumptions about the state of the economy.(LG10-1)a. First, create a spreadsheet like the one shown below and compute the expected return and standard deviation.b. Compute the
Spreadsheet Problem As discussed in the text, beta estimates for one firm will vary depending on various factors such as the time over which the estimation is conducted, the market portfolio proxy, and the return intervals. You will demonstrate this variation using returns for Microsoft. (LG10-4)a.
Spreadsheet Problem: Required Return Using the information in the table, compute the required return for each company using both CAPM and the constant-growth model. Compare and discuss the results. Assume that the market portfolio will earn 11 percent and the risk-free rate is 4 percent. (LG10-3,
Required Return Using the information in the table, compute the required return for each company using both CAPM and the constant-growth model. Compare and discuss the results. Assume that the market portfolio will earn 12 percent and the risk-free rate is 3.5 percent. (LG10-3, LG10-7) Price
Portfolio Beta and Required Return You hold the positions in the following table.What is the beta of your portfolio? If you expect the market to earn 12 percent and the risk-free rate is 3.5 percent, what is the required return of the portfolio?(LG10-3) Price Shares Beta Amazon.com $40.80 100 3.8
Risk Premiums You own $10,000 of Dennys Corp. stock that has a beta of 2.9. You also own $15,000 of Qwest Communications (beta = 1.5) and $5,000 of Southwest Airlines (beta = 0.7). Assume that the market return will be 11.5 percent and the risk-free rate is 4.5 percent. What is the market risk
Expected Return and Risk Compute the expected return and standard deviation given these four economic states, their likelihoods, and the potential returns:(LG10-1) Economic State Probability Return Fast growth 0.30 60% Slow growth 0.50 13 Recession Depression 0.15 -15 0.05 -45
Spreadsheet Problem: Portfolio Beta and Return You own the portfolio of five stocks shown below. Given the amount owned of each stock and their respective betas, what is the beta of your portfolio? If the market return is expected to be 9.5 percent and the risk-free rate is 2 percent, what is the
Spreadsheet Problem: Expected Return and Risk For the following economic state probability distribution, determine the expected return and the standard deviation of the expected return. (LG10-1) A B C 1 Probability Return 23365 Fast growth 0.08 38% Slow growth 0.40 14% 4 No growth 0.34 6% Recession
Portfolio Beta You own $10,000 of Olympic Steel stock that has a beta of 2.2. You also own $7,000 of Rent-a-Center (beta = 1.5) and $8,000 of Lincoln Educational(beta = 0.5). What is the beta of your portfolio? (LG10-3)
Undervalued/Overvalued Stock A manager believes his firm will earn a 14 percent return next year. His firm has a beta of 1.5, the expected return on the market is 12 percent, and the risk-free rate is 4 percent. Compute the return the firm should earn given its level of risk and determine whether
Expected Return Risk For the same economic state probability distribution in problem 10-1, determine the standard deviation of the expected return. (LG10-1) Economic State Probability Fast growth Slow growth 0.3 0.4 Recession Return 40% 10 0.3 -25
Spreadsheet Problem: Portfolio Beta You have a portfolio of six stocks. The portfolio weights of each stock and each stock’s beta are shown below. What is your portfolio beta? (LG10-3) A B C 1 2 Wingbat Beta Weight 1.22 21% 3 Flow Exchange 0.95 16% 4 Mega Metalurgy 0.58 13% 199 5 Fly by Cart 1.15
Required Return Paccars’ current stock price is $48.20, and it is likely to pay an$0.80 dividend next year. Because analysts estimate Paccar will have an 8.8 percent growth rate, what is its required return? (LG10-7)
Stock Market Bubble The NASDAQ stock market bubble peaked at 4,816 in 2000.Two and a half years later it had fallen to 1,000. What was the percentage decline?(LG10-5)
Portfolio Beta You have a portfolio with a beta of 1.35. What will be the new portfolio beta if you keep 85 percent of your money in the old portfolio and 15 percent in a stock with a beta of 0.78? (LG10-3)
Company Risk Premium Netflix, Inc., has a beta of 3.61. If the market return is expected to be 13 percent and the risk-free rate is 3 percent, what is Netflix’s risk premium? (LG10-3)
CAPM Required Return Hastings Entertainment has a beta of 0.65. If the market return is expected to be 11 percent and the risk-free rate is 4 percent, what is Hastings’ required return? (LG10-3)
Risk Premium The average annual return on the S&P 500 Index from 1986 to 1995 was 15.8 percent. The average annual T-bill yield during the same period was 5.6 percent. What was the market risk premium during these 10 years? (LG10-2)
Required Return If the risk-free rate is 3 percent and the risk premium is 5 percent, what is the required return? (LG10-2)
Expected Return Compute the expected return given these three economic states, their likelihoods, and the potential returns: (LG10-1) Economic State Probability Return Fast growth 0.3 40% Slow growth 0.4 10 Recession 0.3 -25
How should you handle a case where required return computations from CAPM and the constant-growth model are very different? (LG10-7)
Compare and contrast the assumptions that need to be made to compute a required return using CAPM and the constant-growth model. (LG10-7)
If stock prices are not strong-form efficient, what might be the price reaction to a firm announcing a stock buyback? Explain. (LG10-6)
Describe a stock market bubble. Can a bubble occur in a single stock? (LG10-5)
Why do most investment scams conducted over the Internet and e-mail involve penny stocks instead of S&P 500 Index stocks? (LG10-5)
Determine what level of market efficiency is consistent with each of the following events: (LG10-5)a. Immediately after an earnings announcement, the stock price jumps and then stays at the new level.b. The CEO buys 50,000 shares of his company and the stock price does not change.c. The stock price
Explain how the concept of a positive risk–return relationship breaks down if you can systematically find stocks that are overvalued and undervalued. (LG10-5)
If you were to compute beta yourself, what choices would you make regarding the market portfolio, the holding period for the returns (daily, weekly, etc.), and the number of returns? Justify your choices. (LG10-4)
Find a beta estimate from three different sources for General Electric (GE). Compare these three values. Why might they be different? (LG10-4)
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