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financial management

Practical Financial Management 5th Edition William R. Lasher - Solutions

1. The Glendale Corp. is considering a real estate development project that will cost$5 million to undertake and is expected to produce annual inflows between $1 million and $4 million for two years. Management feels that if the project turns out really well the inflows will be $3 million in the
4. In evaluating the situation presented in the previous problem, you’ve found a pure play company in the proposed industry whose beta is 2.5. The rate of return on short-term treasury bills is currently 8% and a typical stock investment returns 14%. Explain how this information might affect the
3. Charlie Henderson, a senior manager in the Bartok Company, is known for taking risks. He recently proposed that the company expand its operations into a new and untried field. He put together a set of cash flow projections and calculated an IRR of 25% for the project. The firm’s cost of
2. Might Ed’s case in the preceding problem be helped by a real option? If so, what kind? How would it help?
1. Ed Draycutt is the engineering manager of Airway Technologies, a firm that makes computer systems for air traffic control installations at airports. He has proposed a new device whose success depends on two separate events. First the Federal Aviation Administration (FAA) must adopt a recent
6. Evaluate the conceptual merits of applying CAPM theory to the problem of determining risk-adjusted interest rates for capital budgeting purposes. Form your own opinion based on your study of CAPM (Chapter 9) and the knowledge of capital budgeting you’re now developing. The issue is concisely
5. Rationalize the appropriateness of using the cost of capital to analyze normally risky projects and higher rates for those with more risk.
4. Why is it desirable to construct capital budgeting rules so that higher-risk projects become less acceptable than lower-risk projects?
3. One of the problems of using simulations to incorporate risk in capital budgeting is related to the idea that the probability distributions of successive cash flows usually are not independent. If the first period’s cash flow is at the high end of its range, for example, flows in subsequent
2. A “random variable” is defined as the outcome of one or more chance processes.Imagine that you’re forecasting the cash flows associated with a new business venture.List some of the things that come together to produce cash flows in future periods. Describe how they might be considered to
1. In 1983 the Bell telephone system, which operated as AT&T, was broken up, resulting in the creation of seven regional telephone companies. AT&T stockholders received shares of the new companies and the continuing AT&T, which handled long distance services. Prior to the breakup, telephone service
22. The Paxton Homes Co. is a successful builder of moderate to high-priced houses.The firm is currently considering an expansion into light commercial construction in which it would build shopping centers and small office buildings. Management considers the idea a new venture because of the major
21. Do a cash flow sensitivity analysis on some problems of your choice at the end of the chapter. (You can download the spreadsheet template for Microsoft ExcelTM on this Web page.) The spreadsheet template can be customized to meet your needs. For additional information, click on the link for
20. Segwick Corp. manufactures men’s shoes, which it sells through its own chain of retail stores. The firm is considering adding a line of women’s shoes.Management considers the project a new venture because there are substantial differences in marketing and manufacturing processes between
19. The Ebitts Field Corp. manufactures baseball gloves. Charlie Botz, the company’s top salesman, has recommended expanding into the baseball bat business. He has put together a project proposal including the following information in support of his idea.• New production equipment will cost
18. Blackstone Inc. manufactures western boots and saddles. The company is considering replacing an outmoded leather processing machine with a new, more efficient model. The old machine was purchased for $48,000 six years ago and was expected to have an eight-year life. It has been depreciated on a
17. The Catseye Marble Co. is thinking of replacing a manual production process with a machine. The manual process requires three relatively unskilled workers and a supervisor. Each worker makes $17,500 a year and the supervisor earns $24,500.The new machine can be run with only one skilled
16. Olson-Jackson Corp. (OJC) is considering replacing a machine that was purchased only two years ago because of dramatic improvements in new models. The old machine has been depreciated straight line anticipating a 10-year life based on a cost of $240,000 and an expected salvage value of $20,000.
15. Shelton Pharmaceuticals Inc. is planning to develop and introduce a new drug for pain relief. Management expects to sell 3 million units in the first year at $8.50 each and anticipates 10% growth in sales per year thereafter. Operating costs are estimated at 70% of revenues. Shelton will invest
14. Assume that Meade Metals Inc. of the previous problem is replacing an old truck with a new one instead of replacing an outside delivery service. The old truck was purchased eight years ago for $120,000. It has been depreciated straight line based on a 10-year life and a $20,000 salvage value.
13. Meade Metals Inc. plans to start doing its own deliveries instead of using an outside service for which it has been paying $150,000 per year. To make the change, Meade will purchase a $200,000 truck that will depreciate straight line over 10 years to a $40,000 salvage value. Annual operating
12. Harrington Inc. is introducing a new product in its line of household appliances.Household products generally have 10-year life cycles and are viewed as capital budgeting projects over that period. Harrington’s working capital forecast for the project is as follows:• $1.0 million will be
11. The Leventhal Baking Company is thinking of expanding its operations into a new line of pastries. The firm expects to sell $350,000 of the new product in the first year and $500,000 each year thereafter. Direct costs including labor and materials will be 60% of sales. Indirect incremental costs
10. Sam Dozier, a very bright computer scientist, has come up with an idea for a new product. He plans to form a corporation to develop the idea and market the resulting product. He has estimated that it will take him and one employee about a year to develop a prototype and another year to bring a
9. Harry and Flo Simone are planning to start a restaurant. Stoves, refrigerators, other kitchen equipment, and furniture are expected to cost $50,000, all of which will be depreciated straight line over five years. Construction and other costs of getting started will be $30,000. The Simones expect
8. Resolve the previous problem assuming Voxland uses the five-year Modified Accelerated Cost Recovery System (MACRS) with no salvage value to depreciate the computer. Continue to assume the machine is sold after five years for $1,000.(Hint: Apply the MACRS rules for computers on pages 468–469 to
7. Voxland Industries purchased a computer for $10,000, which it will depreciate straight line over five years to a $1,000 salvage value. The computer will then be sold at that price. The company’s marginal tax rate is 40%. Calculate the cash flows associated with the computer from its purchase
6. A four-year project has cash flows before taxes and depreciation of $12,000 per year. The project requires the purchase of a $50,000 asset that will be depreciated over five years straight line. At the end of the fourth year the asset will be sold for$18,000. The firm’s marginal tax rate is
5. The Olson Company plans to replace an old machine with a new one costing$85,000. The old machine originally cost $55,000 and has 6 years of its expected 11-year life remaining. It has been depreciated straight line assuming zero salvage value and has a current market value of $24,000. Olson’s
4. Tomatoes Inc. is planning a project that involves machinery purchases of$100,000. The new equipment will be depreciated over five years straight line. It will replace old machinery that will be sold for an estimated $36,000 and has a book value of $22,000. The project will also require hiring
3. Flextech Inc. is considering a project that will require new equipment costing$150,000. It will replace old equipment with a book value of $35,000 that can be sold on the secondhand market for $75,000. The company’s marginal tax rate is 35%. Calculate the project’s initial outlay.
2. Auburn Concrete Inc. is considering the purchase of a new concrete mixer to replace an inefficient older model. If purchased, the new machine will cost$90,000 and is expected to generate savings of $40,000 per year for five years at the end of which it will be sold for $20,000. The mixer will be
1. A project that is expected to last six years will generate a profit and cash flow contribution before taxes and depreciation of $23,000 per year. It requires the initial purchase of equipment costing $60,000, which will be depreciated over four years. The relevant tax rate is 25%. Calculate the
6. Wilson Petroleum is a local distributor of home heating oil. The firm also installs and services furnaces and heating systems in homes and small commercial buildings.The customer service department maintains sales and service records on current customers, who number about 400. Detailed customer
5. The Capricorn Company is launching a new venture in a field related to but separate from its present business. Management is proposing that financing for the new enterprise be supplied by a local bank, which it has approached for a loan.Capricorn’s finance department has done a capital
4. Webley Motors, a manufacturer of small gas engines, has been working on a new design for several years. It’s now considering going into the market with the new product, and has projected future sales and cash flows. The marketing and finance departments are putting together a joint
3. Creighton Inc. is preparing a bid to sell a large telephone communications system to a major business customer. It is characteristic of the telephone business that the vendor selling a system gets substantial follow-on business in later years by making changes and alterations to that system. The
2. Most top executives are graded primarily on their results in terms of net income rather than net cash flow. Why, then, is capital budgeting done with incremental cash flows rather than with incremental net income?
1. You are a new financial analyst at Belvedere Corp., a large manufacturing firm that is currently looking into diversification opportunities. The vice president of marketing is particularly interested in a venture that is only marginally connected with what the firm does now. Other managers have
1. The typical cash flow pattern for business projects involves cash outflows first, and then inflows. However, it’s possible to imagine a project in which the pattern is reversed. For example, we might receive inflows now in return for guaranteeing to make payments later. Would the payback, NPV,
30. The Tallahassee Motor Company is thinking of automating one of its production facilities. The equipment required will cost a total of $10 million and is expected to last 10 years. The company’s cost of capital is 9%. The project’s benefits include labor savings and a quality improvement
29. Write a spreadsheet program to calculate the NPV of a project with an irregular pattern of cash flows for up to 10 periods without using the spreadsheet software’s NPV function. Essentially, the task is to program equation 10.1 with n 10.First input the interest rate (k) in a single
28. For a brief discussion of the rationale behind capital budgeting, go to http://www.netmba.com/finance/capital/budgeting/ and read about the relationship between the process and pleasing shareholders. Write a summary of the reason(s) why the author emphasizes NPV over other methods of analysis.
27. Griffin-Kornberg is reviewing the following projects for next year’s capital program.Projects A and B are mutually exclusive and so are Projects D and E. Griffin-Kornberg has a 9% cost of capital and a maximum of $14 million to spend on capital projects next year. Use capital rationing to
26. Zuker Distributors handles the warehousing of perishable foods and is considering replacing one of its primary cold storage units. One supplier has offered a unit for$250,000 with an expected life of 10 years. The unit is projected to reduce electricity costs by $50,000 per year. However, it
25. Cassidy and Sons is reviewing a project with an initial cash outflow of $250,000.An additional $100,000 will have to be invested after the first year, followed by an additional investment of $50,000 at the end of the second year. Beginning at the end of year 3, the project is expected to
24. Haley Motors is considering a maintenance contract for its heavy equipment. One firm has offered Haley a four-year contract for $100,000. Another firm has offered an eight-year contract for $165,000. Haley will be able to save $34,000 per year under either contract because its employees will no
23. Kneelson and Botes Inc. (K&B) is a construction company that does road and bridge work for the state highway authority. The state government solicits bids on construction projects from private contractors. The winning contractor is chosen based on its bid price as well as its perceived
22. Consider two mutually exclusive projects, A and B. Project A requires an initial cash outlay of $100,000 followed by five years of $30,000 cash inflows. Project B requires an initial cash outlay of $240,000 with cash inflows of $40,000 in the first two years, $80,000 in the next two years, and
21. Huron Valley Homes is considering a project requiring a $1 million initial investment.Expected cash inflows will be $25,000 in the first year, $100,000 in the second year, and $200,000 per year for the next six years.a. Calculate the project’s IRR and the NPV assuming an 8% cost of capital.b.
20. Calculate IRRs for the projects in the previous problem.
19. Provide the missing information for the following projects. Initial Length Annual Project Investment (in years) Cash Flow Cost of Capital NPV A $100,000 5 $35,000 8% ? B 200,000 4 ? 13 $35,000 CDE C 300,000 50,000 ? 15,000 400,000 ? 56,098 9 20,000 E ? 6 75,000 10 25,000
18. Tutak Industries is considering a project requiring an initial investment of$200,000 followed by annual cash inflows of $45,000 for the next six years. A second six-year project has an initial outlay of $325,000.a. How much would the second project have to generate in annual cash flows to have
17. Callaway Associates, Inc. is considering the following mutually exclusive projects.Callaway’s Cost of capital is 12%.a. Calculate each project’s NPV and IRR.b. Which project should be undertaken? Why? Year Project A Project B 01234 ($80,000) $44,000 $34,000 $14,000 4 $14,000 ($80,000)
16. Bagel Pantry Inc. is considering two mutually exclusive projects with widely differing lives. The company’s cost of capital is 12%. The project cash flows are summarized as follows.Project A Project B C0 $(25,000) $(23,000)C1 14,742 6,641 C2 14,742 6,641 C3 14,742 6,641 C4 6,641 C5 6,641 C6
15. Grand Banks Mining Inc. plans a project to strip-mine a wilderness area. Setting up operations and initial digging will cost $5 million. The first year’s operations are expected to be slow and to net a positive cash flow of only $500,000. Then there will be four years of $2 million cash flows
14. Calculate the NPV at 12% and the IRR for the following projects. Find IRRs to the nearest whole percent.a. An initial outflow of $5,000 followed by three inflows of $2,000.b. An initial outflow of $5,000 followed by inflows of $1,000, $2,000, and $3,000.c. An initial outflow of $5,000 followed
13. Calculate the NPV at 9% and the IRR for the following projects.a. An initial outlay of $69,724 and an inflow of $15,000 followed by four consecutive inflows of $17,000.b. An initial outlay of $25,424 followed by two zero cash years and then four years of inflows at $10,500.c. An outlay of
12. Calculate the IRR for the following projects.a. An initial outflow of $15,220 followed by inflows of $5,000, $6,000, and$6,500.b. An initial outflow of $47,104 followed by inflows of $16,000, $17,000, and$18,000.
11. Calculate the NPV for the following projects.a. An outflow of $7,000 followed by inflows of $3,000, $2,500, and $3,500 at oneyear intervals at a cost of capital of 7%.b. An initial outlay of $35,400 followed by inflows of $6,500 for three years and then a single inflow in the fourth year of
3. Calculate an IRR for the project in the previous problem using an iterative technique.(Hint: Start by guessing 15%.)
13. Show that the profitability index (PI), the initial outlay (C0), and the net present value (NPV) of a project are related by the following equation.NPV C0(1 PI)(Hint: State both the NPV and the PI in terms of C0 and the sum of all other cash flows.)
12. Why is the profitability index more appropriately described as a variation on the NPV technique than as a variation on the IRR technique?
7. Suppose the present value of cash ins and outs is very close to balanced for a project to build a new $50 million factory, so that the NPV is $25,000. The same company is thinking about buying a new trailer truck for $150,000. The NPV of projected cash flows associated with the truck is also
3. Relate the idea of cost of capital to the opportunity cost concept (page 226). Is the cost of capital the opportunity cost of project money?
33. In this exercise we’ll explore beta, portfolio theory’s measure of risk, and its theoretical impact on stock prices.Enter Thomson ONE for each of the five companies we’ve been working with, Sherwin Williams (SHW), General Motors (GM), Harley-Davidson (HOG), Starbucks (SBUX), and Microsoft
32. Write a spreadsheet program to calculate the expected return and beta for a portfolio of 10 stocks given the expected returns and betas of the stocks in the portfolio and their dollar values.The calculation involves taking a weighted average of the individual stocks’expected returns and betas
31. Problem 23 in Chapter 8 concerned the Rollins Metal Company, which is engaged in long-term planning. The firm is trying to choose among several strategic options that imply different future growth rates and risk levels. Reread that problem on pages 366–367 now.The CAPM gives some additional
30. Learn a little about investing in general and mutual funds in particular from the website of Vanguard, one of the largest fund companies in the world. Go to http://www.vanguard.com. Click on personal investors and then click on the planning and education tab. Notice the six education options
26. Weisman Electronics from the previous problem is considering acquiring an unrelated business. Management thinks the move could change the firm’s stock price by moving its beta up or down and decreasing its growth rate. A consultant has estimated that Weisman’s beta after the acquisition
15. The return on Holland-Wilson Inc. (HWI) stock over the last three years is shown below along with the market’s return for the same period.Year HWI Market 1 4.0% 3.0%2 9.0 6.0 3 12.0 10.0 Plot HWI’s return against that of the market in each of the three years. Make three estimates of HWI’s
14. A four-stock portfolio is made up as follows.Stock Current Value Beta A $4,500 .8 B 2,900 .6 C 6,800 1.3 D 1,200 1.8 Calculate the portfolio’s beta.
10. A portfolio consists of the following four stocks.What is the expected return of the portfolio? Stock ABCD Current Market Value $ 180,000 Expected Return 8% 145,000 10 452,000 12 223,000 25 $1,000,000
9. Imagine making choices in the following situation to test your degree of risk aversion.Someone offers you the choice between the following game and a sure thing.The game: A coin is tossed. If it turns up heads, you get a million dollars.If tails, you get nothing.The sure thing: You’re given
6. The probability distribution of the return on an investment in Omega Inc.’s common stock follows.Return Probability 5% .05 8 .25 10 .40 12 .25 15 .05 Graph the probability distribution. Calculate the expected return, the standard deviation of the return, and the coefficient of variation.
3. Wayne Merritt drives from Cleveland to Chicago frequently and has noticed that traffic and weather make a big difference in the time it takes to make the trip. As a result, he has a hard time planning activities around his arrival time. To better plan his business, Wayne wants to calculate his
2. The Rapscallion Company’s stock is selling for $43.75. Dave Jones has done some research on the firm and its industry, and he thinks it will pay dividends of $5 next year and $7 the following year. After those two years Dave thinks its market price will peak at $50. His strategy is to buy now,
19. Is the CAPM a true and accurate representation of the securities world?
17. How is risk aversion reflected in the SML?
16. How does the SML determine the price of a security?
14. Describe the concept of beta. Include what it measures and how it’s developed.
11. Define and discuss the idea of separating risk into two parts. Describe each part carefully.
9. Analyze the shape of the probability distribution for a high-risk stock versus that of a low-risk stock. (Hint: Think in terms of where the area under the curve lies.)
6. The following definition applies to both investing and gambling: putting money at risk in the hope of earning more money. In spite of this similarity, society has very different moral views of the two activities.a. Develop an argument reconciling the differences and similarities between the two
5. Define risk aversion in words without reference to probability distributions. If people are risk averse, why are lotteries so popular? Why are trips to Las Vegas popular? (Hint: Think in terms of the size of the amount risked and entertainment value.)
28. We can also use a stock’s price earnings ratio (P/E) to gauge whether it is over or under valued. Reread the Insights box on page 341, and make a chart listing the companies we’ve been working with down the left side along with column headings for the current P/E, six years of history, and
27. We can use Thomson ONE to value stocks with the Gordon Model. We’ll illustrate with Sherwin Williams (SHW), a stable paint manufacturer.Access Sherwin in Thomson ONE and calculate growth rates for dividends, earnings per share, and revenues. Select a rate you think reflects the company’s
26. Program a model for three years of super normal growth.
25. Program your own two-stage growth model for two years of super normal growth(g1) followed by normal growth (g2) lasting forever. Treat both growth rates, the last dividend (D0), and the required rate of return (k) as inputs. Here’s how to do it. (Refer to Figure 8.2 and Example 8.5 on pages
24. Suppose the strategic options available to the Rollins company in the last problem result in temporarily enhanced growth. Each option can be associated with a super normal growth rate that lasts for some period after which growth returns to the firm’s normal 5%. Further suppose the duration
23. The Rollins Metal Company is engaged in a long-term planning process and is trying to choose among several strategic options that imply different future growth rates for the company. Management feels that the main benefit of higher growth is that it enhances the firm’s current stock price.
22. The Sara Lee Corporation provides an excellent five-year summary of financial data at http://www.saralee.com. Use the constant growth model to estimate the value of Sara Lee. You can get the most recent dividend and the dividend growth rate (use the five-year rate) from the Web site. Use a 14%
10 years ago. The shares are currently selling at $60. What return are they earning for investors who buy them today?
18. Fox Woodworking Inc. issued preferred shares at a face value of $50 to yield 9%
13. How would you advise clients about Softek stock as an investment under the following conditions? Give reasons for your advice. (No calculations.)a. Softek is currently selling at a price very near that calculated in part (a) of Problem 11.b. It is selling near the price calculated in Problem
12. Calculate a price for Softek assuming Alpha is successful and Beta is also successful but doesn’t do quite as well as Alpha. Assume Softek grows at 25% for two years and then at 18% for two more. After that it continues to grow at 6%.(Hint: Don’t be confused by the fact that there are now
You are an investment analyst for a brokerage firm and have been asked to develop a recommendation about Softek for the firm’s clients. You’ve studied the fundamentals of the industry and the firm, and are now ready to determine what the stock should sell for based on the present value of
14. Is investing in options really investing, or is it more like gambling?
12. What does the efficient market hypothesis say? What is its implication for stock analysis?
11. Compare fundamental analysis and technical analysis. Which makes more sense to you?

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