Questions and Answers of Foundations of Finance

How does beta affect the risk premium in the CAPM equation?
Assuming the market is efficient, what is the relationship between a stock’s price and the security market line?
You are considering two investments, X and Y. The distributions of possible returns are shown below:Compute the expected return and standard deviation for each investment. Would you have a preference
Given the following price data for PepsiCo and the S&P 500 Index, compare the returns and the volatility of the returns, and estimate the relationship of the returns for PepsiCo and the S&P
What is the beta of a portfolio if funds are allocated equally between two securities listed in London Stock Exchange (LSE) and Shanghai Stock Exchange (SSE)?
Differentiate between realized and expected returns.
Donna, a chartered financial analyst (CFA), is willing to invest in the Alternative Investments Market (AIM) in the United Kingdom. She collected the information on two different companies (provided
Go to www.moneychimp.com. Select the link Volatility. Complete the retirement planning calculator, making the assumptions that you believe are appropriate for you. Then go to the Monte Carlo
The expected dividends on Estate Lancaster plc. share is £0.17 (around $0.26) in 1 year. Assume you hold this share for a year. Calculate the holding-period dollar gain and return on the share if
Visit the Financial Times Web site and refer to the article “A step-by-step guide to asset allocation” to apply the six main steps on asset allocation on a portfolio of shares of your choice
You are provided data on three companies listed in Alternative Investments Market (AIM) in the United Kingdom. Assume the risk-free rate and the market index return is 3 percent and 5 percent,
The data shared below is extracted from Financial Times website on the betas of four companies listed in the FTSE 100 market index in the UK namely Vodafone, Tesco, British Petroleum, and British
The beta on Marks & Spencer Group plc. as on 19 October, 2015, is 0.9392. Assume that the return on U.K. Treasury bills is 1.94 percent and that the return on FTSE All Share market index is 5
Why do intrinsic and market values vary? At what circumstance they might be equal?
What is the difference between the required and expected rates of return of a common stock?
How do debentures, subordinated debentures, and mortgage bonds differ with regard to their risk? How would investors respond to the varying types of risk?
How is a Eurobond different from a bond issued in Asia that is denominated in dollars?
Why would a convertible bond increase much more in value than a bond that is not convertible?
What are some important features of a bond? Which features determine the cash flows associated with a bond?
What restrictions are typically included in an indenture in order to protect the bondholder?
How does the bond rating affect an investor’s required rate of return? What actions could a firm take to receive a more favorable rating?
Explain the different types of value.
Why should the market value equal the intrinsic value?
What are the three important elements of asset valuation?
What two factors determine an investor’s required rate of return?
How does the required rate of return affect a bond’s value?
What assumption is being made about the length of time a bond is held when computing the yield to maturity?
What does the current yield tell us?
How are the yield to maturity and the current yield different?
Why does a bond sell at a discount when the coupon rate is lower than the required rate of return and vice versa?
As interest rates increase, why does the price of a long-term bond decrease more than that of a short-term bond?
In December 2010, Alpha Technologies Plc. issued coupon bonds with par value £100. The coupon rate is 8 percent annually and the bonds will be redeemed at par value in December 2015. What is the
ITB Plc. has recently issued three alternative coupon bonds with different times to maturity.a. Calculate the market price of each bond, assuming a yield to maturity of 8 percent (face value 5
Nissan issued 20-year bonds with annual coupon rate 8 percent redeemed at par ($1,000). If the current market price of Nissan bonds is $945, what is the yield to maturity?
Assume that Barclays Plc. issued coupon bonds with fixed coupon rate 5 percent redeemed at par (£100) in 5 years. What is the price of Barclays bonds if the market interest rate is 5 percent? What
Alph Plc.’s bonds mature at par in 10 years. The bonds pay annual coupon rate 9 percent. If the current market price of this bond is $1,320, what is the yield to maturity of Alpha’s bonds?
The market price of Energy Group Plc. bonds is currently $730. The bonds were issued several years ago with par value ($1,000) and mature in 7 years. The company promises its bond holders to pay
What features of preferred stock are different from bonds?
What provisions are available to protect a preferred stockholder?
What cash flows associated with preferred stock are included in the valuation model equation (8-1)? Why is the valuation model simplified in equation (8-2)? D (1+rps) + D (1+rps) + D% (1 + rps)0 (8-1)
What features of common stock indicate ownership in the corporation versus preferred stock or bonds?
In what two ways does a shareholder benefit from ownership?
How does internal growth versus the infusion of new capital affect the original shareholders?
Describe the process for common stock valuation.
In computing the required rate of return for common stock, why should the growth factor be added to the dividend yield?
Explain the difference between a stockholder’s required and expected rates of return.
How does an efficient market affect the required and expected rates of return?
Deutsche Bank has several preferred stock issues outstanding. One issue, a 7.35 percent preferred stock, was sold at its par value of $25. The stock pays an annual dividend of $1.84. The firm has the
During 2014, Nike’s common stock had been selling for between $73 and $96. Most recently, it was selling at $90 per share. Its most recent earnings per share was $3.50, and the firm was expected to
In Example 8-1, we calculated the value of Deutsche Bank’s preferred stock, where the stock had a par value of $25 and a coupon dividend rate of 7.35 percent, which resulted in a $1.84 dividend. In
In Example 8-2, we valued Nike at $80, given your required rate of return of 15 percent. This answer was based on an anticipated growth rate of 13.6 percent. Also, the stock was expected to pay a
Define the required rate of return on common equity. How is it measured?
What is the difference between dividend yield and capital gain yield?
Queens Park Plc. issued preference shares with par value $100 and annual preferred dividend of 10 percent. What is the price of Queens Park Plc’ preference shares if the appropriate discount rate
Davis Plc. has in its share capital 100,000, $10 preferred shares paying 12 percent dividends. They are currently trading at $40 per share.a. Calculate the cost of preference shares.b. Calculate the
Midwest Energy Group issued preference shares (par value $10) that pay 8 percent dividend annually. If the company’s required rate of return is 15 percent, what is the value of one preference share?
The dividend policy of Scorpio Inc. has been recently changed to payout 40 percent of its earnings to shareholders. The company has just paid dividends of $3 per share.a. Calculate the growth rate of
Bristol Plc. has just paid a dividend of $1.5 per share per year. If the growth rate of dividends is 5 percent, calculate the value of one share if a company of this risk class is required to return
Candy Inc. issued preferred shares with par value of $100 and 5% annual preferred dividends. If the market price of Candy Inc is $35 per share,a. Calculate the cost of preference shares.b. Would you
Donna, a chartered financial analyst (CFA) wants to advise her client about investment in preference shares. The client needs to invest in either Queens Plc. or Royal Plc.’s preferred shares.
The current share price of Victoria Plc. is $49. The company has just paid a dividend of $2.5 per share. Dividends are expected to rise by 5 percent per year indefinitely. The company is in a higher
AC&H Group Plc. has just paid dividends of $2.75 per share. The expected growth rate of dividends is 7 percent annually and the current market price of AC&H is $90 per share. Calculate the cost of
HighTech Inc. was founded by Roger Mortimer last year. The company is developing a new technology that may enhance significantly the speed of the Internet. There has been a debate in the board of
How is an investor’s required rate of return related to an opportunity cost?
How do flotation costs impact the firm’s cost of capital?
Define the costs of debt, preferred equity, and common equity financing.
The cost of common equity financing is more difficult to estimate than the costs of debt and preferred equity. Explain why.
What is the dividend growth model, and how is it used to estimate the cost of common equity financing?
Describe the capital asset pricing model and how it can be used to estimate the cost of common equity financing.
What practical problems are encountered in using the CAPM to estimate common equity capital cost?
A firm’s capital structure and its target capital structure proportions are important determinants of a firm’s weighted average cost of capital. Explain.
Explain in words the calculation of a firm’s weighted average cost of capital. What exactly are we averaging, and what do the weights represent?
What are the implications for a firm’s capital investment decisions of using a companywide cost of capital when the firm has multiple operating divisions that have unique risk attributes and
If a firm has decided to move from a situation in which it uses a company-wide cost of capital to divisional costs of capital, what problems is it likely to encounter?
Synopticom Inc. plans a bond issue for the near future and wants to estimate its current cost of debt capital. After talking with the firm’s investment banker, the firm’s chief financial officer
San Antonio Edison has a preferred stock issue outstanding on which it pays an annual dividend of $4.25 per share. On August 24, 2011, the stock price was $58.50 per share. If the firm were to sell a
The Talbot Corporation’s common shareholders anticipate receiving a $2.20 per share dividend next year, based on the fact that they received $2 last year and expect dividends to grow 10 percent
The Talbot Corporation’s beta coefficient is estimated to be 1.40. Furthermore, the risk-free rate of interest is currently 3.75 percent, and the expected rate of return on a diversified portfolio
Ash Inc.’s capital structure and estimated capital costs are found in Table 9-2. Note that the sum of the capital structure weights must equal 100 percent if we have properly accounted for all
In early 2016, Alfa Corporation issued new common stock at a market price of $30. Dividends last year were $2.00 and are expected to grow at an annual rate of 3 percent forever. Floatation costs will
LLC International is issuing a $2,000 par value bond that pays 8 percent annual interest and matures in 10 years. Investors are willing to pay $1,800 for the bond. Floatation costs will be 4 percent
The preferred stock of LLC International sells for $35 and pays 5 percent dividends. The net price of the stock is $30. What is the cost of capital for the preferred stock?
Corporation Beta sells common stock for $50. The floatation cost for new issue of stocks will be 5 percent. The company pays 50 percent of its earnings in dividends, and a $4 dividend was recently
Microfinance Company needs to raise $800,000 to improve the position of cash. It has decided to issue a $1,000 par value bond with 15 percent annual coupon rate and 5-year maturity. The investors
The capital structure for the ABC Corporation is provided hereThe company plans to keep its debt structure in the future. The after-tax cost of debt is 7 percent, 12.5 percent is the cost of
Alfa trading operates a quite successful chain of milk products and tea houses across the South Caucasus, Alfa plans to expand in Ukraine and Moldova, so it needs to raise some funds. The Company’s
Socar Corporation is an integrated oil company which is based in Baku, Azerbaijan, which has large operations in nearby regions. For a long period of time Socar used to be the main one in South
Star Corporation is a provider of computer software and IT services in two large regions of Easter Europe. The company uses 12 percent to evaluate investments; however, due to latest developments it
TBC Bank, based in Georgia, is growing rapidly since 2010, it introduced regional branches in South Caucasus, has been rated as the best corporate bank in region and listed on London international
Why is it so difficult to find an exceptionally profitable project?
Why is the search for new profitable projects so important?
Provide an intuitive definition of an internal rate of return for a project.
What does a net present value profile tell you, and how is it constructed?
What is the difference between the IRR and the MIRR?
Why do the net present value and profitability index always yield the same accept/reject decision for any project?
How might capital rationing conflict with the goal of maximizing shareholders’ wealth?
What are mutually exclusive projects? How might they complicate the capital-budgeting process?
Ski-Doo is considering new machinery that would reduce manufacturing costs associated with its Mach Z snowmobile, for which the free cash flows are shown in Table 10-3. If the firm has a 12 percent
A firm is considering the purchase of a new computer system, which will cost $30,000 initially, to aid in credit billing and inventory management. The free cash flows resulting from this project are
A firm with a 10 percent required rate of return is considering investing in a new machine with an expected life of 6 years. The free cash flows resulting from this investment are given in Table

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