Questions and Answers of Foundations Financial Management

Lost Time Watch (LTW) Company manufactures watches that are sold for $200 each. Fixed operating costs are $640,000 and variable costs are $120 per watch. (a) What is LTW’s operating breakeven
Canyon Eatery’s common stock, which is currently selling for $50 per share, has a beta coefficient equal to 0.75. Canyon has paid a dividend equal to $6 per share since it has been in business,
Energetic Engines is trying to estimate its cost of retained earnings. The company has outstanding bonds that pay $20 interest every six months. The bonds, which have a $1,000 face value and mature
Suppose the current risk-free rate of return is 5 percent and the expected market risk premium is 7 percent. Using this information, estimate the cost of retained earnings for a company with a beta
Suppose the current risk-free rate of return is 3.5 percent and the expected market return is 9 percent. Fashion Faux-Pas’ common stock has a beta coefficient equal to 1.4. Using the CAPM
Jumbo Juice’s preferred stock pays a constant dividend equal to $4.75 per share. The firm’s marginal tax rate is 40 percent. Jumbo Juice incurs a 5 percent flotation cost each time it issues
Buoyant Cruises plans to issue preferred stock with a $120 par value and a 5 percent dividend. Even though the current market value of its preferred stock is $80 per share, Buoyant expects to net
Notable Nothings plans to issue new bonds with the same yield as its existing bonds. The existing bonds have a coupon rate of interest equal to 5.6 percent (semiannual interest payments), 12 years
Global Products plans to issue long-term bonds to raise funds to finance its growth. The company has existing bonds outstanding that are similar to the new bonds it expects to issue. The existing
The CFO of Bogey Golf has been given the following information about two mutually exclusive investments: The CFO normally uses a risk-adjusted required rate of return to evaluate such investments.
Following are three independent projects Peanut/Pecan Processing (PPP) is evaluating: PPP generally considers risk when examining projects by adjusting its average required rate of return, r, which
After completing a scenario analysis for a prospective investment, the CFO of a company reported to the CEO that there is a 60 percent chance the investment will provide the firm with a net present
Qualil evaluated a project using scenario analysis. His results indicate that the project normally will generate a net present value (NPV) equal to $19,800, which will occur 70 percent of the time.
Logic Legal Leverage (LLL) is evaluating a project that has a beta coefficient equal to 1.3. The risk-free rate is 3 percent and the market risk premium is 6 percent. The project, which requires an
Quiet Quilts is considering adding another division that requires a cash outlay of $29,500, and is expected to generate $6,250 in after-tax cash flows each year for seven years. The CFO has
Otter Outside Gear must decide whether to replace a 10 year-old packing machine with a new one that costs $153,800. Replacing the old machine will increase net operating income (excluding
Emotion Cosmetics is considering whether to replace one of its manufacturing machines with a new one that will increase operating income (excluding depreciation) by $14,300 per year for the next
Artistic Adobes is considering growing its business by adding a paint machine that costs $90,000. The machine will generate an additional $29,800 in before-tax operating income (excluding
Four years ago Progressive Products purchased a machine for $25,000. The machine’s current book value is $6,000. Later today, Progressive plans to sell the machine for $4,000. The company’s
Towers Elevator Company plans to sell one of its machines to another company for $102,000. The book value of the machine is $90,000. Compute(a) The gain (loss) on the sale of the machine (b) The
Cool Cat Cabinets (CCC) is evaluating whether to replace an aging machine. The existing machine is being depreciated at $40,000 per year, whereas the depreciation for a new machine is expected to be
Gator Bicycles just bought a new brake calibration machine that is expected to generate $30,000 in new revenues each of the next four years without increasing cash operating costs. The machine falls
Chiefland Campers is evaluating a project that will not affect revenues, but it will save the firm $110,000 per year in before-tax operating costs, excluding depreciation. The project’s depreciable
Western Textiles is trying to determine whether to purchase a new weaving machine that costs $214,000. It would cost another $26,000 to install the machine. Western plans to use the machine for four
Underwater Swimwear recently purchased a new machine for $350,000. It cost $20,000 to ship the machine to Underwater’s facility, and it cost another $50,000 to get it installed. Purchase of the new
Dave’s Devilish Dogs (3D) expects to generate $92,000 in sales in the long term. 3D’s operating costs, excluding depreciation, are 75 percent of sales. The company has only one asset, a machine
Canadian Wilderness Company (CWC) just bought a machine that is expected to generate $25,000 in operating income before depreciation expenses each year. The machine, which has a depreciable basis
The CFO of Horatio?s Hotels gave three college interns three different independent projects to evaluate. Following are the results of their analyses: The CFO agrees with the final accept/reject
Following is information about two independent projects that a company is evaluating: (a) Which project(s) should be chosen? Explain why. (b) What can be concluded about the company?s required rate
Following are the estimated after-tax cash flows for two mutually exclusive projects: The company?s required rate of return is 16 percent. What is the internal rate of return (IRR) of the
Compute the (a) Net present value, (b) Internal rate of return (IRR), (c) Modified internal rate of return (MIRR), (d) Discounted payback period (DPB) for each of the following projects. The
Compute the (a) Net present value, (b) Internal rate of return (IRR), (c) Discounted payback period (DPB) for each of the following projects. The firm?s required rate of return is 14
Pick a day within the past week and construct a yield curve for that day. Pick a day approximately a year ago and construct a yield curve for that day. How are interest rates different? The Globe and
How has Abercrombie’s stock performed this year relative to the S&P 500?Access the Thomson ONE problems through the ThomsonNOW Web site. Use the Thomson ONE—Business School Edition online
Historically, have Abercrombie’s reported earnings generally met, exceeded, or fallen short of analysts’ forecasted earnings?Access the Thomson ONE problems through the ThomsonNOW Web site. Use
Have analysts made any significant changes to their forecasted earnings for Abercrombie & Fitch in the past few months?Access the Thomson ONE problems through the ThomsonNOW Web site. Use the
Based on analysts’ forecasts, what is the expected long-term growth rate in earnings?Access the Thomson ONE problems through the ThomsonNOW Web site. Use the Thomson ONE—Business School Edition
What are the mean and median forecasts for Abercrombie’s earnings per share over the next fiscal year?Access the Thomson ONE problems through the ThomsonNOW Web site. Use the Thomson ONE—Business
Refer back to the FULL COMPANY REPORT and scroll down to the “5 Yr Annual Balance Sheet” section. Does it appear that MSFT has been repurchasing any stock, or has it been issuing new stock?Access
Investors are more concerned with future dividends than historical dividends, so go to ESTIMATES and scroll down to the “Consensus Estimates” section. Click on the “Available Measures” menu
In the “Interim Financial Data” section of the FULL COMPANY REPORT, identify the dividend declared date, ex date, and pay date. Explain the significance of these dates. Go back to “Overview,”
Refer back to the FULL COMPANY REPORT used in Question 1. Manually, plot earnings and dividends over time. In the text we point out that dividends are often much more stable than earnings. Do you see
Compare this with other firms in the same industry. To see how MSFT stacks up against its peers, select PEERS>OVERVIEWS>PER SHARE DATA to get MSFT’s peers’ last annual dividends. Accessing
To get information about MSFT’s dividend policy, enter its ticker and select OVERVIEW>FULL REPORTS>WORLDSCOPE FULL REPORTS>FULL COMPANY REPORT. Click on STOCK & EARNINGS DATA and
From the submenu just above the list of firms, you may choose a number of options. “List” displays a list of the firms and allows you to access a firm report. “Profiles” provides key
You can also use Thomson One to search for companies with either very large or very small debt ratios. For example, if you want to find the top 50 companies with the highest debt ratio select: SEARCH
The financial ratios investigated thus far are based on book values of debt and equity. Determine whether using the market value of equity (market capitalization found on the OVERVIEW page) makes a
Repeat this procedure for the other 3 auto companies. Do you find similar capital structures for each of the 4 companies? Do you find that the capital structures have moved in the same direction over
To get more details about the companies’ capital structures over the past five years, select FINANCIALS > FUNDAMENTAL RATIOS > THOMSON RATIOS. From here you can select ANNUAL RATIOS and/or 5
To get an overall picture of each company’s capital structure it is helpful to see a chart that summarizes the company’s capital structure over the past decade. To obtain this chart, choose a
Putting all this information together, what is your estimate of MMM’s WACC? How confident are you in this estimate? Explain your answer.Access the Thomson ONE problems though the ThomsonNOW Web
Next, we need to calculate MMM’s cost of debt. Unfortunately, Thomson One doesn’t provide a direct measure of the cost of debt. However, we can use different approaches to estimate it. One
Once again, we can use the CAPM to estimate MMM’s cost of equity. Thomson One provides various estimates of beta—select the measure that you believe is best and combine this with your estimates
Finally, you can also use the information in Thomson One to value the entire corporation. This approach requires that you estimate XOM’s annual free cash flows. Once you estimate the value of the
On the basis of the dividend history you uncovered in question 5 and your assessment of XOM’s future dividend payout policies, do you think it is reasonable to assume that the constant growth model
It is often useful to perform a sensitivity analysis, where you show how your estimate of intrinsic value varies according to different estimates of D1, rs, and g. To do so, recalculate your
The required return on equity, rs, is the final input needed to estimate intrinsic value. For our purposes you can either assume a number (say, 8 or 9 percent), or you can use the CAPM to calculate
In the text, we discussed using the dividend growth model to estimate a stock’s intrinsic value. To keep things as simple as possible, let’s assume at first that XOM’s dividend is expected to
Now to see how XOM’s P/E ratio has varied over time—return back to the COMPANY OVERVIEW page. Next click FINANCIALS—GROWTH RATIOS and then select WORLDSCOPE—INCOME STATEMENT RATIOS. Is
To provide a starting point for gauging a company’s relative valuation, analysts often look at a company’s price-to-earnings (P/E) ratio. Returning to the COMPANY OVERVIEW page, you can see
Click on the “NEWS” tab to see the recent news stories for the company. Have there been any recent events impacting the company’s stock price, or have things been relatively quiet?Access the
For purposes of this exercise, let’s take a closer look at the stock of ExxonMobil Corporation (XOM). Looking at the COMPANY OVERVIEW we can immediately see the company’s current stock price and
Repeat the same exercise for each of the 3 remaining companies. Do the reported betas confirm your earlier intuition? In general, do you find that the higher-beta stocks tend to do better in up
Select a beta estimate that you believe is best. (If you are not sure, you may want to consider an average of the given estimates.) Assume that the risk-free rate is 5 percent and the market risk
What is the estimated beta on this page? What is the source of the estimated beta? Why might different sources produce different estimates of beta?Access the Thomson ONE problems though the
Click on the tab labeled PRICES. What is the company’s current dividend yield? What has been its total return to investors over the past 6 months? Over the past year? Over the past 3 years?
Return to the overview page for the stock you selected. If you scroll down the page you should see an estimate of the company’s beta. What is the company’s beta? What was the source of the
Assume that the risk-free rate is 5 percent and the market risk premium is 6 percent. What is the expected return for the overall stock market? What is the required rate of return on a stock with a
Select one of the four stocks listed in question 2 by selecting COMPANIES, entering the company’s ticker symbol, and clicking on GO. On the overview page, you should see a chart that summarizes how
Required rate of return Assume that the risk-free rate is 6 percent and the expected return on the market is 13 percent. What is the required rate of return on a stock with a beta of 0.7?Access the
Now let’s take a closer look at the stocks of four companies: Colgate Palmolive (Ticker CL), Gillette (G), Merrill Lynch (MER), and Microsoft (MSFT). Before looking at the data, which of these
Begin by taking a look at the historical performance of the overall stock market. If you want to see, for example, the performance of the S&P 500, select INDICES and enter S&PCOMP. Click on
Construct a simple Du Pont analysis for Ford and its peers. What are Ford’s strengths and weaknesses relative to its competitors?In Chapter 3, we took a look at Starbucks’ financial statements.
Take a look at Ford’s inventory turnover ratio. How does this ratio compare with its peers? Have there been any interesting changes over time in this measure? Do you consider Ford’s inventory
What has happened to Ford’s liquidity position over the past 3 years? How does Ford’s liquidity compare with its peers?In Chapter 3, we took a look at Starbucks’ financial statements. Now we
Over the past few years, has there been a strong correlation between stock price performance and reported earnings?Over the past decade, Starbucks coffee shops have become an increasingly familiar
Komfy Karz is evaluating a project that costs $365,000 and is expected to generate $260,000 and $175,000, respectively, during the next two years. If Komfy’s required rate of return is 13 percent,
Compute the traditional payback period (PB) for a project that costs $64,000 if it is expected to generate $16,000 per year for six years? If the firm’s required rate of return is 12 percent, what
Compute both the traditional payback period (PB) and the discounted payback period (DPB) for a project that costs $270,000 if it is expected to generate $75,000 per year for five years. The
Rascal Clothing is evaluating a new weaving machine that costs $90,000. It is expected that the machine will generate after-tax cash flows equal to $54,000 per year for two years. Rascal’s required
What is the internal rate of return (IRR) for a project that costs $5,500 and is expected to generate $1,800 per year for the next four years? If the firm’s required rate of return is 8 percent,
Construct an NPV profile for a capital budgeting project that costs $64,000 and is expected to generate $18,200 per year for five years. Using the NPV profile, determine the project’s internal
Kansas Furniture Corporation (KFC) is evaluating a capital budgeting project that costs $34,000 and is expected to generate after-tax cash flows equal to $14,150 per year for three years. KFC’s
Piping Hot Food Services (PHFS) is evaluating a capital budgeting project that costs $75,000. The project is expected to generate after-tax cash flows equal to $26,000 per year for four years.
What is the internal rate of return (IRR) of a project that costs $74,000 if it is expected to generate $16,500 per year for six years?
The CFO of HairBrain Stylists is evaluating a project that costs $42,000. The project will generate $11,000 each of the next five years. If HairBrain’s required rate of return is 9 percent, should
Conventional Corporation is evaluating a capital budgeting project that will generate $600,000 per year for the next 10 years. The project costs $3.6 million, and Conventional’s required rate of
Zebra Fashions is evaluating a capital budgeting project that should generate $104,400 per year for four years.(a) If its required rate of return is 16 percent, what is the value of the project to
Wandering RV is evaluating a capital budgeting project that is expected to generate $36,950 per year during its six-year life. If its required rate of return is 10 percent, what is the value of the
High Energy (HE) Company recently paid a $2 per share dividend, which is expected to grow at a constant rate forever. HE’s stock, which has a beta coefficient equal to 1.1, is selling for $37.50
Suppose the risk-free rate of return is 3.5 percent and the market risk premium is 7 percent. Stock U, which has a beta coefficient equal to 0.9, is currently selling for $28 per share. The company
Recently, Kellie determined that the required rate of return for Stock Q is 11 percent. In her analysis, she determined that the risk-free rate of return, rRF, is 4 percent and that the required
Stock V has a beta coefficient of 2.0, and Stock W has a beta of 0.5. The expected rate of return on an average stock is 11 percent, and the risk-free rate of return is 5 percent. By how much does
ZR Corporation’s stock has a beta coefficient equal to 0.8 and a required rate of return equal to 11 percent. If the expected return on the market is 12.5 percent, what is the risk-free rate of
Suppose the risk-free rate of return, rRF, is 4 percent, and the market return, rM, is expected to be 12 percent. What is the required rate of return for a stock with a beta coefficient, b, equal to
The current risk-free rate of return, rRF, is 3 percent and the market risk premium, RPM, is 6 percent. If the beta coefficient associated with a firm’s stock is 1.5, what should be the stock’s
Sharon’s portfolio, which is valued at $200,000, contains six stocks and has a beta coefficient equal to 1.5. Later today, Sharon is going to sell one of the stocks in her portfolio for $40,000.
Willis currently has $120,000 invested in a four-stock portfolio with a beta coefficient equal to 0.8. Willis plans to sell one of the stocks in his portfolio for $48,000, which will increase the
Pete’s investment portfolio contains five stocks that have a total value equal to $40,000. The beta coefficient of this portfolio is 1.2. Pete wants to invest an additional $10,000 in a stock that
Of the $60,000 invested in a two-stock portfolio, 40 percent is invested in Stock S and 60 percent is invested in Stock X. If Stock S has a beta coefficient equal to 1.5 and the beta of the

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