Questions and Answers of Foundations of Finance

Consider the following investment proposal:If the required rate of return is 15 percent, should this project be accepted? Initial outlay FCF in year 1 FCF in year 2 FCF in year 3 FCF in year 4
Let’s look at an example of a project with a 3-year life and a required rate of return of 10 percent, assuming the following cash flows are associated with it:Determine the MIRR of the project.
Suppose a firm is considering two mutually exclusive projects, A and B; both have required rates of return of 10 percent. Project A involves a $200 initial outlay and a cash inflow of $300 at the end
Suppose a firm with a required rate of return or cost of capital of 10 percent and with no capital constraint is considering the two mutually exclusive projects illustrated in Table 10-9. How do we
Suppose a firm with a 10 percent required rate of return must replace an aging machine and is considering two replacement machines, one with a 3-year life and one with a 6-year life. The relevant
What are mutually exclusive projects and what kind of difficulties may be associated with their ranking?
What is the unequal lives problem in ranking mutually exclusive projects?How do managers deal with it?
Strada Company is considering purchasing new machinery for its business line. This investment required an initial outlay of $200,000 and will generate free cash inflow of $20,000 per year for 15
TBC Bank is considering purchasing a new building for newly opened branch in region. Required rate of return for the project is 10 percent, and it will generate the following cash flows; cash inflows
(IRR) Ives Roche, a perfume and cosmetics store, is considering a new project, which costs $1,000,000 and is expected to last 15 years. The project will produce $150,000 cash flows per year. The
Ace publishing company needs new equipment for a new branch in the region. According to prior estimates, the following positive cash flow will be generated during 5 years:Estimated pay-back period
Alfa Company is considering a new project which requires $300,000 initial investment and an additional $100,000 cash outflow on the last year of the project. The project will last 7 years and will
Ariel company decided to invest $10 million in new machinery. The investment will generate $3,000,000 net cash inflow during the next 7 years. Calculate MIRR fora. 10 percent required rate of
Kurta Company Ltd. has a budget of $10 million for new projects. The projects are independent and have the following costs and profitability indexes associated with them:a. Make your selection under
Industrial Zone Group, which operates in building industry in South Caucasus, is considering making investments in regional projects. The CEO of the group was offered two projects regarding
Microfinance Company Alfa Cash Capital had financial problems recently. According to independent auditors’ report, the main sources of the problems were a shortage of financial analyses and
What is an incremental cash flow? What is a sunk cost? Why must you account for opportunity costs?
If Ford introduces a new auto line, might some of the cash flows from that new car line be diverted from existing product lines? How should you deal with this?
In general, a project’s cash flows will fall into one of three categories. What are these categories?
What is a free cash flow? How do we calculate it?
Although depreciation is not a cash flow item, it plays an important role in the calculation of cash flows. How does depreciation affect a project’s cash flows?
Give an example of an option to delay a project. Why might this be of value?
Give an example of an option to expand a project. Why might this be of value?
Give an example of an option to abandon a project. Why might this be of value?
Is a project’s standing-alone-risk the appropriate level of risk for capital budgeting? Why or why not?
What problems are associated with using systematic risk as the measure for risk in capital budgeting?
What is the most commonly used method for incorporating risk into the capital-budgeting decision? How is this technique related to Principle 3: Risk Requires a Reward?
Explain how simulations work.
What is a scenario analysis? What is a sensitivity analysis? When would you perform a sensitivity analysis?
Assume that a new project will annually generate additional revenues of $1 million and additional fixed and variable costs of $500,000, while increasing depreciation by $150,000 per year. If the
You are considering expanding your product line that currently consists of Lee’s Press-on Nails to take advantage of the fitness craze. The new product you are considering introducing is Press-on
A toy manufacturer is considering introducing a line of fishing equipment with an expected life of 5 years. In the past, the firm has been quite conservative in its investment in new products,
SCOP TI is considering introducing a variation of its current breakfast tea, Earl Grey 1336. The new tea bags will be similar to the old with the exception that it will contain small caramel-flavored
Metal Winds Ltd is considering a new project that involves the introduction of a new technology for developing small-sized wind mills. Given the uncertain future of this particular technology, it has
Memphis Restaurants has come up with a new fast casual restaurant combining some of the features consumers like in Delicatessen, Quick, and Hippopotamus, but it is not quite sure how the public in
Why do managers care about the volatility of their firms’ earnings?
What are the three determinants of the volatility of a firm’s earnings?
Describe the sources of business risk.
What is the determinant of a firm’s operating risk?
Distinguish among fixed costs, variable costs, and semi-variable costs.
When is it useful or sometimes necessary to compute the break-even point in terms of sales dollars rather than units of output?
How can we identify when a firm has operating leverage?
What is the effect of operating leverage on the volatility of a firm’s EBIT in response to changing sales?
What creates financial leverage in a firm’s capital structure?
How does financial leverage affect the volatility of firm earnings in response to changes in EBIT?
If the ratio of the percent change in earnings per share to the corresponding percent change in EBIT were 2, what percent change in earnings would you expect to follow a 15 percent decline in EBIT?
How do operating and financial leverage interact to affect the volatility of a firm’s earnings per share?
What is the basic controversy surrounding capital structure theory?
Explain the independence hypothesis as it relates to capital structure management.
Explain the moderate view of the relationship between a firm’s financing mix and its average cost of capital.
How do agency costs and free cash flow relate to capital structure management?
Explain the meaning of the EBIT-EPS indifference point.
How are various leverage ratios and industry norms used in capital structure management?
Identify several factors that influence the decision to issue debt.
Why is capital structure design both an art and a science?
Even though Pierce Grain Company manufactures several different products, it has observed over a lengthy period that its product mix is rather constant. This allows management to conduct its
Assume that plan B presented earlier in Table 12-4 is the existing capital structure for the Pierce Grain Company. Furthermore, the asset structure of the firm is such that EBIT is expected to be
Which of the following sources of new earnings volatility represents the effect of business versus financial risk (discuss the rationale for your decisions):a. Pajala AB in Sweden is considering
Tenny Inc. is planning to sell 50,000 units of its products next year. Fixed costs will total €6 million, and the variable costs are planned to be 60 percent of the sales.a. The firm wants to
King Inc. is a health wine company in China. The average selling price of its finished product is 38 Chinese Yuan Renminbi (RMB) per bottle (500 ml/bottle). The variable cost of the same bottle of
Define the EBIT-EPS indifference point.
Imagine that you were a new CFO of Beily Inc., a children’s bicycle manufacturer. The president, Mr. Zhao, started the business 2 years ago. The firm manufactures two types of products, bicycles
Top Performance has been operating for several years in the outskirts of Ostersund, Sweden, and is a new manufacturer of a top-of-the-line outdoor jacket. You are starting an internship as assistant
Provide a financial executive with a useful definition of the term dividend payout ratio.
Summarize the position that a dividend policy may be irrelevant with regard to the firm’s stock price.
What is meant by the bird-in-the-hand dividend theory?
Why are cash dividend payments thought to be more certain than capital gains?
How might personal taxes affect both the firm’s dividend policy and its share price?
Distinguish between the residual dividend theory and the clientele effect.
Identify some practical considerations that affect a firm’s payout policy.
Identify and explain three different dividend policies. (Hint: One of these is a constant dividend payout ratio.)
What is the typical frequency with which cash dividends are paid to investors?
Distinguish among the(a) declaration date,(b) date of record, (c) ex-dividend date.
What managerial logic might lie behind a stock split or a stock dividend?
Identify three reasons why a firm might buy back its own common stock shares.
What financial relationships must hold for a stock repurchase to be a perfect substitute for a cash dividend payment to stockholders?
Within the context of a stock repurchase, what is meant by a tender offer?
Telink, Inc. is planning to pay $4 million ($4 per share) in dividends to its common stockholders. The following earnings and market price information are provided for Telink:In a recent meeting,
In Europe, why do most bank loans include restrictions on dividend payments during the amortization of the loans? Is this restriction appropriate in the case of small firms?
European and Asian firms often have concentrated ownership by a few major shareholders. What impact do these factors have on the payment of dividends?
Phosphorus Technologies earned €3 million in net income last year and for the first time ever paid its common stockholders a cash dividend of €1.12 per share. The firm has 1 million shares
The Daher Trucking Company needs to expand its fleet by 20 percent to meet the demands of two major contracts it just received to transport aeronautic equipment from manufacturing facilities
The General Meeting of Remy Cointreau SA, listed on Euronext Paris, held in July 2015, set the overall dividend at €1.53 per share. The Meeting decided to grant every shareholder payment of the
TOTAL Group recently declared a 4-for-1 stock split for its common shares. Before the split the firm’s share price had risen to € 200 per share and the firm’s CFO felt that this high stock
The debt and equity section of the TOTAL Group balance sheet is shown here (in million euros). The current market price of the common shares is €200. Reconstruct the financial statement assuming
If we cannot predict the future perfectly, then why do firms engage in financial forecasting?
Why are sales forecasts so important to developing a firm’s financial plans?
What are some examples of spontaneous and discretionary sources of financing?
What is the distinction between discretionary financing needs (DFN) and external financing needs (EFN)?
What, in words, is the fundamental relationship (equation) used in making percent of sales forecasts?
Under what circumstances does a firm violate the basic relationship underlying the percent of sales forecast method?
What is a cash budget?
How is a cash budget used in financial planning?
Hotel Gudauri is operating in Georgia, South Caucasus, and is located in the Ski and Skate resort area. It became quite popular in recent years. Do you think that seasonal variations may affect
Star Supermarket is evaluating its financial needs for the year 2017. The company’s CFO suggests that the relationship between sales, operating expenses, current liabilities, and total assets will
Door Company sells products in cash and in credit as follows: cash sales are 60 percent of total sales, and credit sales are 40 percent. 10 percent of the credit sales are collected in the month of
Beta Corporation is making plans for the next fiscal year. Beta’s current sales are $3.5 million, expected to increase to $5 million, based on current assets of $2.4 million and fixed assets of
Rainbow Company’s balance sheet is as follows:Current level of sales is $450,000 and is expected to grow up to $600,000a. Develop a proforma balance sheet for the firm if net fixed assets, bonds
Garr Company estimates its investment to be $0.25 in assets for each dollar of new sales. By each dollar of additional sales $0.04 profits will be produced and $0.01 can be reinvested in the
Scion Company wants to plan inventories for the year 2017 based on average of the past 5 years data. Scion’s CEO, Radha Kar, believes that it is a good idea to use the average percent of sales

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