Questions and Answers of Foundations Financial Management

John Churchill, instead of taking a job with a large company on graduation, had started his own chain of muffin shops. The menu featured different varieties of freshly baked muffins, along with
Pabst Dental Supplies is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of occurrence are given.a. What is the expected value of unit sales for
The Phillips Toy Company was considering the advisability of adding a new product line. Ike Barnes, a marketing major who had joined the company right out of business school three years previously,
Sam Sung is evaluating a new advertising program that could increase electronic sales. Possible outcomes and probabilities of the outcomes are shown below. Compute the coefficient of variation.
Five investment alternatives have the following returns and standard deviations of returns.Rank the five alternatives from lowest risk to highest risk using the coefficient of variation. Alternative
In the previous problem, if you were to choose between Alternative Band Conly, would you need to use the coefficient of variation? Why?Previous ProblemFive investment alternatives have the following
Why use certainty equivalents in a capital budgeting analysis?
Why must one be careful when using sensitivity analysis?
Another five investment alternatives have the following returns and standard deviations ofreturns.Rank the five alternatives from lowest risk to highest risk using the coefficient of variation.
Digital Technology wishes to determine its coefficient of variation as a company over time. The firm projects the following data (in millions of dollars).a. Compute the coefficient of variation (V)
Why might an analyst set up a decision tree in attempting to make a decision?
Tom Fears is highly risk adverse while Sonny Outlook actually enjoys taking a risk.a. Which of the four investments should Tom choose and why?b. Which of the four investments should Sonny choose and
Tomcat Oil Company was set up to take large risks and is willing to take the largest risk possible. HiC Construction Company is more typical of the average corporation and is risk averse.a. Which of
Possible outcomes for three investment alternatives and their probabilities of occurrence are given below.Rank the three alternatives in terms of risk. Alternative 2 Alternative 3 Alternative 1
From a corporate perspective is unique risk (σ) or beta risk (β) the more important consideration? Does it matter?
Mary Beth Clothes is considering opening an additional suburban outlet. An aftertax cash flow of $100 per day (expected value) is projected for each of the two locations being evaluated. Which of
Westurn Dynamite Company is evaluating two new methods of blowing up buildings for commercial purposes over the next five years. Method 1 (implosion) is relatively low in risk for this business and
Larry's Athletic Lounge is considering an expansion program to increase the sophistication of the exercise equipment. The equipment will cost $20,000 and has an estimated life of five years. Larry is
Canadian Metal, Mining, and Petroleum Company are analyzing two projects for possible investment. Only one investment will be made. The first project is an oildrilling project in Alberta at a cost of
Mr. John Backster, a retired executive, desires to invest a portion of his assets in rental property. He has narrowed his choices to two apartment complexes, Windy Acres and Hillcrest Apartments. The
Referring to the previous problem, Mr. Backster is likely to hold the apartment complex of his choice for about 10 years and will use this period for decision-making purposes. Either apartment can be
Wardrobe Clothing Manufacturers is preparing a strategy for the fall season. One strategy is to go to a highly imaginative, new, four-gold-button sports coat. The all-wool product would be available
Astrid has the following two investments in her portfolio:a. Which investment is riskier by itself and in a portfolio sense? b. What is the expected return of the portfolio?c. With a correlation
Assume a corporation has earnings before amortization and taxes (EBAT) of $100,000 and amortization of $50,000, and it has a 34 percent tax rate. Compute its cash flow.
As she headed toward her boss's office, Emily Hamilton, chief operating officer for the Aerocomp Corporation-a computer services firm that specialized in airborne support-wished she could remember
a. In the previous problem, how much would cash flow be if there was only $10,000 in amortization? All other factors are the same.b. How much cash flow is lost due to the reduced amortization between
As the three division managers of Galaxy Systems Inc. entered the central headquarters meeting room, each felt under pressure. They were there to meet with Marlene Davidson, the senior vice-president
Assume a firm has EBAT of $200,000, and no amortization. It is in a 25 percent tax bracket.a. Compute its cash flow.b. Assume it has $200,000 in amortization. Recompute its cash flow.c. How large a
Blink 281 Corporation is considering an investment that will cost $120,000 and last for five years. The investment will be amortized on a straight-line basis over that period. Earnings generated by
AI Quick, president of a Toronto Stock Exchange-listed firm , is very short-term oriented and interested in the immediate consequences of his decisions. Assume Mr. Quick is considering a project that
Pluto Corporation is considering an investment that will cost $210,000 and last for three years. The investment will be amortized on a straight-line basis over that period. Earnings generated by the
What is the NPV profile? What three points (characteristics) should be determined to create the profile?
Assume a $50,000 investment and the following cash flows for two alternatives:Which of the alternatives would you select under the payback method? Year Investment B Investment A $10,000 $20,000
What else, besides the forecast IRR and NPV, might top management consider in making capital budgeting decisions?
Referring to the previous problem, if the inflow in the fifth year for Investment A were $30,000,000 instead of $30,000, would your answer change under the payback method? Previous Problem Year
Generally, what effect does the CCA system have on the timing of CCA tax shield benefits?
Again referring to problem 7, analyze the two investment alternatives under the net present value method using a 15 percent discount rate. Would your answer change? Previous Problem Year Investment
What is the ITC? How does it affect the capital budgeting decision?
The Short-Line Railroad is considering a $100,000 investment in either of two companies. The cash flows are as follows:a. Using the payback method, what decision should be made?b. Explain why the
How would you modify your capital budgeting analysis (NPV methodology) to account for expected inflation?
Britney Javelin Company is considering two investments, both of which cost $15,000. The cash flows are as follows:a. Which of the two projects should be chosen based on the payback method?b. Which of
What implications does an efficient market (Chapter 14) have for NPV calculations?
A firm buys a new piece of equipment for $24,907 and will receive a cash flow of $4,500 per year for eight years. What is the IRR?
Hand Salsa buys a new piece of equipment for $11,778 and will receive a cash flow of $2,000 per year for 10 years. What is the IRR?
King's Department Store is considering the purchase of a new machine at a cost of $13,869. The machine will provide $3,000 per year in cash flow for six years. King's has a cost of capital is 12
Elgin Restaurant Supplies is analyzing the purchase of manufacturing equipment that will cost $20,000. The annual cash inflows are as follows.Year ..............Cash flow1 ..................$10,0002
Twelve Inch Toes Corp. will invest $175,000 in a project that will not begin to produce returns until the third year. From the end of the third year until the end of the tenth year (8 periods), the
DeBarry Corporation makes an investment of $50,000 which yields the following cash flows:Year ............Cash flow1 ..................$10,0002 ....................10,0003 ....................16,0004
The Green Goddess Company is considering the purchase of a new machine that would increase the speed of manufacturing tires and save money. The net cost of the new machine is $45,000. The annual cash
You are asked to evaluate the following two projects for Boring Corporation using the NPV method combined with the PI approach, which project would you select? Use a discount rate of 10 percent.
Turner Video will invest $48,500 in a project. The firm's discount rate (cost of capital) is 9 percent. The investment will provide the following inflows:1 .............$10,0002
The Last Century Corporation uses the MIRR. The firm has a cost of capital of 7 percent. The project being analyzed has a $25,000 initial investment and is expected to produce the following cash
Murchie's is considering diversification by way of acquisition to reduce its reliance on its volatile core business. Mad Max, the CEO, has asked for your calculation of a discount rate to be used to
Trois-Rivieres Manufacturing has 10,000 bonds (face value of $1,000 each) with a 10 percent coupon maturing in 8 years. Its preferred (100,000 shares) have a face value of $25 and pay a 7.5 percent
Island Capital has the following capital structure:Bonds ........................ ......................$20,000,000Perpetuals (preferred shares)...............4,000,000Common shares ...............
A Dozen Monkeys Ltd. has the following right-hand side of its balance sheet:Debt: 8% coupon, 12 years to maturity...........$8,000,000Preferred shares: 5% dividend ............
Eaton International Corporation has the following capital structure:a. If the firm has $19.5 million in retained earnings, at what size capital structure will the firm run out of retained
Western Electric Utility Company faces increasing needs for capital. Fortunately it has an A credit rating. The corporate tax rate is 39 percent. Western's treasurer is trying to determine the
McNabb Construction Company is trying to calculate its cost of capital for use in making a capital budgeting decision. Mr. Reid, the vice-president of finance, has given you the following
Valvano Publishing Company is trying to calculate its cost of capital for use in a capital budgeting decision. Mr. Washburn, the vice-president of finance, has given you the following information
Given the following information, calculate the weighted average cost of capital for Puppet Corporation.Percent of capital structure:Debt..............................................55%Preferred
Given the following information, calculate the weighted average cost of capital for Hadley Corporation. Line up the calculations in the order shown in Table 11-1.Percent of capital
Given the following information, calculate the weighted average cost of capital for Genex Corporation. Line up the calculations in the order shown in Table 11-1.Percent of capital
As an alternative to the capital structure shown in the previous problem for Tyler Oil Company, an outside consultant has suggested the following modifications.Debt. ................. .
The Tyler Oil Company's capital structure is as follows:Debt..........................................................35%Preferred stock .... .. ........ . . . .. .. . ....... .15Common
What is the justification for using market value weightings rather than book value weightings?
What limitations are there in using the dividend valuation model to determine the cost of equity capital?
Ellington Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.50 per share, and the current price of its common
The treasurer of Sutton Security Systems is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is
Identify other variables (ratios) besides the debt-to-equity ratio that influence a company's cost of capital.
Schuss Inc. can sell preferred shares for $60 with an estimated flotation cost of $3.00. The preferred stock is anticipated to pay $7 per share in dividends.a. Compute the cost of preferred stock for
The Meredith Company issued $100 par value preferred shares 10 years ago. The shares provided an 8 percent yield at the time of issue. Each preferred share is now selling for $75. What is the
Shaw Communications is planning to issue debt that will mature in the year 2039. In many respects the issue is similar to currently outstanding debt of the corporation. Using Table 11-2 in the
Orbit Corp. has the following balance sheet:Today's market is subject to different supply and demand factors and underlying economic events than when Orbit's capital structure was put in place. This
For Russell Container Company, described in the previous problem, assume the yield on the bonds goes up by one percentage point and that the tax rate is now 34 percent.a. What is the new aftertax
Huron Ltd. has the following capital structure:16% Debentures, due in 14 years.....................$30,000,000Preferreds (8% dividend, 40,000 shares)..............3,000,000Common shares: 3,600,000
Russell Container Company has a $1,000 par value bond outstanding with 20 years to maturity. The bond carries an annual interest payment of $95, and is currently selling for $920. Russell is in a 25
Austen Sensibles Ltd. has the following capital structure, which it expects to maintain into the foreseeable future:Debt. ......... . ......................35%Preferreds ......... .
Octopus Transit has a $1,000 par value bond outstanding with 10 years to maturity. The bond carries an annual interest payment of $75, payable semiannually, and is currently selling for $1,092.
The risk-free rate is projected to be 5 percent for the upcoming year. Investor expectations concerning the market portfolio reveal expected excess returns of 8 percent during the same period. You
Why do you think the CAPM is or is not useful to the financial manager?
Waste Disposal Systems has an aftertax cost of debt of 6 percent. With a tax rate of 33 percent, what can you assume the yield on the debt is?
You have invested in a stock with some systematic risk. It has a beta of 1.05. The current anticipated market portfolio return for the upcoming year is 16 percent, and the anticipated market risk
Why would an efficient market be an important assumption for the development of the CAPM?
Calculate the aftertax cost of debt on a bond issue yielding 10 percent. The issuing company pays tax at a rate of 34 percent and will incur distribution costs of 1 percent on this bond issue.
Currently, Treasury bills yield 4.75 percent and the market prices risk at 6.90 percent. You have invested in a stock efficiently priced by the CAPM with a beta of 1.15 that will pay an expected
If an individual stock lay above the SML, what would be an appropriate investment strategy? Why?
Calculate the aftertax cost of debt under each of the following conditions. Yield Corporate tax rate 8.0% 22% 14.0% 36% 11.5% 42%
How do corporate taxes and bankruptcy considerations change the initial M&M approach? What is the net effect?
The risk-free interest rate on one-year debt is 7 percent and the return on the market is expected to be 13 percent. A stock with a beta of 1.2 pays no dividends over the next year. If it is
Pogo Petroleum Company can issue debt yielding 9 percent. The company is paying at a 25 percent tax rate. What is the aftertax cost of debt?
Under the initial M&M approach, does the use of debt affect the cost of capital? Explain.
For the preceding problem, assume an increase in interest rates changes Rf to 7.0 percent; also assume that the market premium (Rm - Rf) changes to 6.5 percent.Compute Kf for the three betas
Why does Ke approximate Kj, or why does D1/(P0 - g) approximate Rf + βf/Rm -Rf)?
Royal Petroleum Co. can buy a piece of equipment that is anticipated to provide a 9 percent return and can be financed at 6 percent with debt. Later in the year, the firm turns down an opportunity to
What is the difference between the net income (NI) approach, the net operating income (NOI) approach, and the traditional approach?
Assume Rf = 4 percent and Rm = 8 percent. Compute Kf for the following betas, using formula 11A-2.a. 0.7b. 1.4c. 1.7
What is the difference in dividend payments between Bombardier and TELUS nonvoting shares and their voting common shares? How do you explain the difference in their trading values?
Diploma Mills has $30 million in earnings, pays $4.25 million in interest to bondholders, and $2.95 million in dividends to preferred shareholders.a. What are the common shareholders' residual claims
Why do corporations use special categories in issuing common stock?

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