Questions and Answers of Financial Management Theory

Draw a graph similar to the one shown in exhibit 13.4 and explain its implications.Exhibit 13.4 EXHIBIT 13.4 Bayside Memorial Hospital: Corporate and Project Costs of Capital Project Cost of Capital
Consider the project contained in problem 14.7 in chapter 14.a. Perform a sensitivity analysis to see how NPV is affected by changes in the number of procedures per day, average collection amount,
University Health Center has three divisions: Real Estate, with an 8 percent cost of capital; Health Services, with a 10 percent cost of capital; and Managed Care, with a 12 percent cost of capital.
Refer to the table developed in problem 15.5 for University Health Center. Assume the Managed Care Division is evaluating a project with the net cash flows and probabilities shown in the table
Components Manufacturing Corporation (CMC) has 1 million shares of stock outstanding. CMC has a target capital structure with 60% equity and 40% debt. The company projects net income of $5 million
Burns & Kennedy Corporation (BK) has a value of operations equal to $2,100, short-term investments of $100, debt of $200, and 100 shares of stock.a. What is BK’s estimated intrinsic stock price?b.
Vanderheiden Press Inc. and the Herrenhouse Publishing Company had the following balance sheets as of December 31, 2013 (thousands of dollars):Earnings before interest and taxes for both firms are
Blue Coral Breweries (BCB) is planning an IPO. Its underwriters have said the stock will sell at $20 per share. The direct costs (legal fees, printing, etc.) will be $800,000. The underwriters will
Menendez Corporation forecasts free cash flow of $100 at Year 1 and $120 at Year 2; after Year 2, the FCF is expected to grow at a constant rate of 4%. The company has a tax rate of 40% and $500 in
Red Valley Breweries is considering an acquisition of Flagg Markets. Flagg currently has a cost of equity of 10%; 25% of its financing is in the form of 6% debt, and the rest is in common equity. Its
The Pennington Corporation issued a new series of bonds on January 1, 1990. The bonds were sold at par ($1,000), had a 12% coupon, and matured in 30 years on December 31, 2019. Coupon payments are
Current and projected free cash flows for Radell Global Operations are shown below.Growth is expected to be constant after 2015, and the weighted average cost of capital is 11%. What is the horizon
Molteni Motors Inc. recently reported $6 million of net income. Its EBIT was $13 million, and its tax rate was 40%. What was its interest expense? (Write out the headings for an income statement, and
Using Rhodes Corporation’s financial statements (shown below), answer the following questions.a. What is the net operating profit after taxes (NOPAT) for 2013?b. What are the amounts of net
a. What is an opportunity cost rate?b. How is this rate used in time value analysis?c. Is this rate a single number that is used in all situations?
What is the difference between a lump sum, an annuity, and an unequal cash flow stream?
Great Lakes Health Network’s net income increased from $3.2 million in 2010 to $6.4 million in 2020. The total growth rate over the ten years is 100 percent, while the annual growth rate is only
The present value of a perpetuity is equal to the payment divided by the opportunity cost (interest) rate: PV = PMT ÷ I. What is the future value of a perpetuity?
When a loan is amortized, what happens over time to the size of the total payment, interest payment, and principal payment?
Explain the difference between the stated rate, periodic rate, and effective annual rate.
What are three techniques for solving time value problems?
Explain the concept of return on investment (ROI) and the two different approaches to measuring it.
Find the following values for a lump sum assuming annual compounding:a. The future value of $500 invested at 8 percent for one yearb. The future value of $500 invested at 8 percent for five yearsc.
Repeat problem 9.1, but assume the following compounding conditions:a. Semiannualb. QuarterlyProblem 9.1Find the following values for a lump sum assuming annual compounding:• The future value of
What is the effective annual rate (EAR) if the stated rate is 8 percent and compounding occurs semiannually? Quarterly?
Repeat problem 9.4, but assume the annuities are annuities due.Problem 9.4Find the following values assuming a regular, or ordinary, annuity:a. The present value of $400 per year for ten years at 10
Consider the following uneven cash flow stream:a. What is the present (year 0) value if the opportunity cost (discount) rate is 10 percent?b. Add an outflow (or cost) of $1,000 at year 0. What is the
Consider another uneven cash flow stream:a. What is the present (year 0) value of the cash flow stream if the opportunity cost rate is 10 percent?b. What is the future (year 5) value of the cash flow
What is the present value of a perpetuity of $100 per year if the appropriate discount rate is 7 percent? Suppose that interest rates doubled in the economy and the appropriate discount rate is now
Assume that you just won $35 million in the Florida lottery, and hence the state will pay you 20 annual payments of $1.75 million each beginning immediately. If the rate of return on securities of
An investment that you are considering promises to pay $2,000 semiannually for the next two years, beginning six months from now. You have determined that the appropriate opportunity cost(discount)
Everly Healthcare has just borrowed $1,000,000 on a five-year, annual payment term loan at a 15 percent rate. The first payment is due one year from now. Construct the amortization schedule for this
Assume that $10,000 was invested in the stock of General Medical Corporation with the intention of selling after one year. The stock pays no dividends, so the entire return will be based on the price
County Hospital is planning to purchase a new piece of medical equipment with a list price of $3,000,000. The medical equipment supplier has been experiencing low sales volume and is currently
Assume a large healthcare system has just approved a $355,000 annual (per year) bonus to retain its top cardiac surgeon. Assume that$355,000 will be paid to the surgeon as a bonus at the end of each
Give an example of financial risk.
What is stand-alone risk?
Are risk and return separate attributes of an investment? Explain.
Does the amount of money at risk affect the riskiness of an investment? Explain.
Define and explain the most common measure of stand-alone risk.
What is a well-diversified portfolio?
What happens to the risk of a single asset when it is held as part of a portfolio of assets?
When considering stand-alone risk, the return distribution of a less risky investment is more peaked (“tighter”) than that of a riskier investment. What shape would the return distribution have
Stock A has an expected rate of return of 8 percent, a standard deviation of 20 percent, and a market beta of 0.5. Stock B has an expected rate of return of 12 percent, a standard deviation of 15
a. What is risk aversion?b. Why is risk aversion so important to financial decision-making?
Explain why holding investments in portfolios has such a profound impact on the concept of financial risk.
Assume that two investments are combined in a portfolio.a. In words, what is the expected rate of return on the portfolio?b. What condition must be present for the portfolio to have lower risk than
What are the implications of portfolio theory for investors?
a. What are the two types of portfolio risk?b. How is each type defined?c. How is each type measured?
Under what circumstances is stand-alone and market risk most relevant?
a. What is the capital asset pricing model (CAPM)? The security market line (SML)?b. What are the weaknesses of the CAPM?c. What is the value of the CAPM?
Consider the following probability distribution of returns estimated for a proposed project that involves a new ultrasound machine:a. What is the expected rate of return on the project?b. What is the
Refer to exhibit 10.2.a. Construct an equal-weighted (50/50) portfolio of investments B and C. What are the expected rate of return and standard deviation of the portfolio? Explain your results.b.
Suppose that the risk-free rate, RF, is 8 percent and the required rate of return on the market, R(RM), is 14 percent.a. Write out the security market line (SML) equation, and explain each term.b.
Several years ago, the Value Line Investment Survey reported the following market betas for the stocks of selected healthcare providers:At the time these betas were developed, reasonable estimates
Suppose that Apple Health Services has four different projects.These projects are listed below, along with the amount of capital invested and the market betas:a. What is the overall market beta of
Assume that Community Health Systems is evaluating the feasibility of building a new hospital in an area not currently served by the company. The company’s analysts estimate a market beta of 1.1
Yahoo Finance reported the following market betas for the stocks of selected health insurers:Assume that the risk-free rate, RF, and required rate of return on the market, R(RM), are 2.0 percent and
Assume that Everly Healthcare, a provider of skilled nursing facility services, is evaluating the feasibility of building a new facility to replace one of its aging facilities in a small, low-volume
Describe the primary features of the following long-term debt securities:a. Term loanb. Bondc. First mortgage bondd. Junior mortgagee. Debenturef. Municipal bond
What are the key differences between a private placement and a public issue?
Describe the following debt contract features:a. Bond indentureb. Restrictive covenantc. Trusteed. Call provision
What are the three major rating agencies?
How do bond ratings affect the cost of debt to the issuing firm?
Why are callable bonds riskier for investors than similar bonds without a call provision?
Briefly describe the following types of debt:a. Term loanb. Bondc. Mortgage bondd. Senior debt; junior debte. Debenturef. Municipal bond
a. What is interest rate risk?b. What is price risk?c. What is reinvestment rate risk?
Twin Oaks Health Center has a bond issue outstanding with a coupon rate of 7 percent and four years remaining until maturity. The par value of the bond is $1,000, and the bond pays interest
Tideview Home Health Care, Inc., has a bond issue outstanding with eight years remaining to maturity, a coupon rate of 10 percent with interest paid annually, and a par value of $1,000. The current
Homecare Inc. has three bond issues outstanding. All three bonds pay $100 in annual interest plus $1,000 at maturity. Bond S has a maturity of five years, bond M has a 15-year maturity, and bond L
Turndale Health System has bonds outstanding that have four years remaining to maturity, a coupon interest rate of 9 percent paid annually, and a $1,000 par value.a. What is the yield to maturity on
Jane Smith, MD, has had a great year in her pediatrics practice, and she has cash that she wants to invest. Her financial adviser suggests she buy a seven-year, $1,500 par value bond with an annual
Orange District Hospital issued a 30-year, 10 percent annual coupon bond (par value $1,000) two years ago. The bond now has 28 years remaining to maturity and sells for $1,400. The bond has a call
How do common stock investors usually receive returns?
What is meant by classified stock?
Give one reason for using classified stock.
What are the sources of equity (i.e., fund capital) available to not-for-profit firms?
Are not-for-profit corporations at a disadvantage when it comes to raising equity capital? Explain your answer.
What are three approaches to valuing common stocks, and when does each apply?
Does the holding period matter when using the dividend valuation model?
Write out and explain the valuation model for a constant growth stock.
Show the constant growth model in the form of its expected rate of return.
Explain the risk/return trade-off.
a. What is the preemptive right?b. Why is it important to shareholders?
Why might an investor-owned firm choose to issue different classes of common stock?
Describe the primary means by which investor-owned firms raise new equity capital.
What are the similarities and differences between equity capital in investor-owned firms and fund capital in not-for-profit firms?
What is the general approach for valuing a share of stock of a dividend-paying company?
Two investors are evaluating the stock of Beverly Enterprises for possible purchase. They agree on the stock’s risk and on expectations about future dividends. However, one investor plans to hold
Evaluate the following statement: One of the assumptions of the constant growth model is that the required rate of return must be greater than the expected dividend growth rate. Because of this
a What is the efficient markets hypothesis (EMH)?b. What are its implications for investors and managers?
a. What is meant by risk/return trade-off?b. Does this trade-off hold in all markets?
An investor is considering buying the stock of two home health companies that are similar in all respects except the proportion of earnings paid out as dividends. Both companies are expected to earn
Assume the risk-free rate is 6 percent and the market risk premium is 6 percent. The stock of Clinicians Care Alliance (PCA) has a beta of 1.5. The last dividend paid by PCA (D0) was $2 per share.a.
Jane’s sister-in-law, a stockbroker at Invest, Inc., is trying to get Jane to buy the stock of HealthWest, a regional HMO. The stock has a current market price of $25, its last dividend (D0) was
St. John Medical, a surgical equipment manufacturer, has been hit hard by increased competition. Analysts predict that earnings and dividends will decline at a rate of 5 percent annually into the
Humana Inc.’s last dividend (D0) was $1.12, and its earnings and dividends are expected to increase at a constant growth rate of 12 percent. Humana’s (www.humana.com) market beta is 1.16. If the
You are considering investing in the stock of Encompass Health (formerly HealthSouth). You do some market research and learn that the company’s last dividend was $0.84 and the company’s market
What is a business’s capital structure?
What are some questions relevant to the capital structure decision?

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