Questions and Answers of Fundamentals Of Financial Management

Sullivan-Swift Mining Company must install new machinery in its Nevada mine. It can obtain a bank loan for 100% of the after-tax cost of the machinery.Alternatively, a Nevada investment banking firm
In the summer of 2021, the Gallatin Company was planning to finance an expansion with a convertible security. It considered a convertible debenture but feared the burden of fixed interest charges if
As part of its overall plant modernization and cost reduction program, the management of Tanner-Woods Textile Mills has decided to install a new automated weaving loom. In the capital budgeting
Storm Software wants to issue $100 million in new capital to fund new opportunities. If Storm raised the $100 million of new capital in a straight-debt 20-year bond offering, Storm would have to
Martha Millon, financial manager for Fish & Chips Inc., has been asked to perform a lease-versus-buy analysis on a new computer system. The computer system has an after-tax cost of$975,000, and if it
Define synergy. Is synergy a valid rationale for mergers? Describe several situations that might produce synergistic gains.
Give two examples of how tax considerations can motivate mergers.
Suppose your firm could purchase another firm for only half its replacement value.Would that be a sufficient justification for the acquisition? Explain.
Discuss the pros and cons of diversification as a rationale for mergers.
What is breakup value?
What are the four economic types of mergers?
What are some reasons for the current merger wave?
What is the difference between an operating merger and a financial merger?
Describe the way post-merger cash flows are estimated in a DCF analysis.What is the basis for the discount rate in a DCF analysis? Describe how this rate might be estimated.
Describe the market multiple approach.
What are some factors that acquiring firms consider when they set a bid price?
How do control issues affect mergers?
Assuming the following facts, what is the value of XYZ Corporation to JKL Enterprises?XYZ’s post-merger cash flows in Years 1–3 are estimated to be $7 million, $10 million, and $12 million,
What role did junk bonds play in the merger wave of the 1980s?
Explain how researchers can study the effects of mergers on shareholder wealth.Do mergers create value? If so, who profits from this value?Do the research results discussed in this section seem
What is an LBO? What actions do companies typically take to meet the large debt burdens resulting from LBOs?
Identify and briefly explain the four types of divestitures.
Define each of the following terms:a. Synergy; mergerb. Horizontal merger; vertical merger; congeneric merger; conglomerate mergerc. Friendly merger; hostile merger; defensive merger; tender offer;
Pizza Place, a national pizza chain, is considering purchasing a smaller chain, Western Mountain Pizza. Pizza Place’s analysts project that the merger will result in incremental cash flows of $1.5
We looked at the determinants of market interest rates. The following questions are designed to aid with your understanding of interest rates. Here, we will access The New York Times Bonds Market
Define floating-rate bonds, zero coupon bonds, callable bonds, putable bonds, income bonds, convertible bonds, and inflation-indexed bonds (TIPS).
Which is riskier to an investor, other things held constant—a callable bond or a putable bond? Explain.
In general, how is the rate on a floating-rate bond determined?
What are the two ways sinking funds can be handled? Which alternative will be used if interest rates have risen? If interest rates have fallen?
A bond that matures in 8 years has a par value of $1,000 and an annual coupon payment of $70; its market interest rate is 9%. What is its price?
A bond that matures in 12 years has a par value of $1,000 and an annual coupon rate of 10%; the market interest rate is 8%. What is its price?
Which of those two bonds is a discount bond, and which is a premium bond? Explain.
Explain the difference between yield to maturity (YTM) and yield to call (YTC).
Halley Enterprises’s bonds currently sell for $975. They have a 7-year maturity, an annual coupon of $90, and a par value of $1,000. What is their yield to maturity?
The Henderson Company’s bonds currently sell for $1,275. They pay a $120 annual coupon, have a 20-year maturity, and a par value of $1,000, but they can be called in 5 years at $1,120. What are
What is meant by the terms new issue and seasoned issue?
Last year a firm issued 20-year, 8% annual coupon bonds at a par value of $1,000.a. Suppose that 1 year later the going market interest rate drops to 6%. What is the new price of the bonds, assuming
Why do the prices of fixed-rate bonds fall if expectations for inflation rise?
Describe how the annual payment bond valuation formula is changed to evaluate semiannual coupon bonds, and write the revised formula.
Hartwell Corporation’s bonds have a 20-year maturity, an 8% semiannual coupon, and a face value of $1,000. The going nominal annual interest rate (rd) is 7%. What is the bond’s price?
Differentiate between price risk and reinvestment risk.
To which type of risk are holders of long-term bonds more exposed? Short-term bondholders?
What type of security can be used to minimize both price risk and reinvestment risk for an investor with a fixed investment horizon? Does this security protect the real payoff? Explain.
Differentiate between mortgage bonds and debentures.
Name the major rating agencies, and list some factors that affect bond ratings.
Why are bond ratings important to firms and investors?
Do bond ratings adjust immediately to changes in credit quality? Explain.
Why do most bond trades occur in the over-the-counter (OTC) market?
How is accrued interest calculated?
It is now January 1, 2021, and you are considering the purchase of an outstanding bond that was issued on January 1, 2019. It has an 8% annual coupon and had a 30-year original maturity. (It matures
We looked at how interest rates impact bond valuation. The following questions are designed to help you understand how bond values are affected by different interest rate levels. Here, we will access
Briefly explain the fundamental trade-off between risk and return.
What do the slopes of the risk-return lines illustrated in Figure 8.1 indicate? FIGURE 8.1 Panel a: The Individual Investor's Perspective Investment Return The Trade-Off between Risk and Return Good
Does the average investor’s willingness to take on risk vary over time? Explain.
What do you think the average investor’s risk perception is now? In what types of investments do you think the average investor is investing currently?
Should companies completely avoid high-risk projects? Explain.
What does investment risk mean? Set up an illustrative probability distribution table for an investment with probabilities for different conditions, returns under those conditions, and the expected
Which of the two stocks graphed in Figure 8.3 is less risky? Why? Identify the three measures of stand-alone risk discussed in this section. Briefly explain what each measure indicates.Figure 8.3
How does risk aversion affect rates of return?An investment has a 50% chance of producing a 20% return, a 25% chance of producing an 8% return, and a 25% chance of producing a 212% return. What is
What is meant by perfect positive correlation, perfect negative correlation, and zero correlation?Explain the statement: An asset held as part of a portfolio is generally less risky than the same
What is an average-risk stock? What is the beta of such a stock?An investor has a two-stock portfolio with $25,000 invested in Stock X and $50,000 invested in Stock Y. X’s beta is 1.50, and Y’s
Why is it argued that beta is the best measure of a stock’s risk?An investor has a two-stock portfolio with $25,000 invested in Stock X and $50,000 invested in Stock Y. X’s beta is 1.50, and
Differentiate between a stock’s expected rate of return (r⁄), required rate of return (r), and realized, after-the-fact historical return (r). Which would have to be larger to induce you to buy
What is meant by the term, positive alpha? Negative alpha?
What happens to the SML graph when risk aversion increases or decreases?
What would the SML look like if investors were indifferent to risk, that is, if they had zero risk aversion?
How can a firm influence the size of its beta?
A stock has a beta of 1.2. Assume that the risk-free rate is 4.5%, and the market risk premium is 5%. What is the stock’s required rate of return?
Have there been any studies that question the validity of the CAPM? Explain.
How does the correlation between returns on a project and returns on the firm’s other assets affect the project’s risk?The stand-alone risk of an individual corporate project may be quite high,
What are some important concepts for individual investors to consider when evaluating the risk and returns of various investments?The stand-alone risk of an individual corporate project may be quite
Define each of the following terms using graphs or equations to illustrate your answers whenever feasible: a. Risk; stand-alone risk; probability distribution b. Expected rate of return, c. Standard
Stocks A and B have the following historical returns:a. Calculate the average rate of return for each stock during the period 2016 through 2020. Assume that someone held a portfolio consisting of 50%
ECRI Corporation is a holding company with four main subsidiaries. The percentage of its capital invested in each of the subsidiaries(and their respective betas) is as follows:a. What is the holding
Assume that the risk-free rate is 5.5% and the required return on the market is 12%. What is the required rate of return on a stock with a beta of 2?
Assume that the risk-free rate is 3.5% and the market risk premium is 4%. What is the required return for the overall stock market?What is the required rate of return on a stock with a beta of 0.8?
Stocks A and B have the following probability distributions of expected future returns: Probability 0.1 0.2 0.4 0.2 0.1 A (10%) 2 12 20 38 B (35%) 0 20 25 45
Bartman Industries’s and Reynolds Inc.’s stock prices and dividends, along with the Winslow 5000 Index, are shown here for the period 2015–2020. The Winslow 5000 data are adjusted to include
Chapter 8 discussed the basic trade-off between risk and return. In the capital asset pricing model (CAPM) discussion, beta was identified as the correct measure of risk for diversified
What is the preemptive right, and what are the two primary reasons for its existence?Identify some actions that companies have taken to make takeovers more difficult.
What are some reasons a company might use classified stock?
What is the difference between a stock’s price and its intrinsic value?
Why do investors and managers need to understand how to estimate a firm’s intrinsic value?
What are two commonly used approaches for estimating a stock’s intrinsic value?How do they differ in their focus?
What are the two parts of most stocks’ expected total return?Whereas a bond contains a promise to pay interest, a share of common stock typically provides an expectation of but no promise of
If D1 5 $2.00, g 5 6%, and P0 5 $40.00, what are the stock’s expected dividend yield, capital gains yield, and total expected return for the coming year?Whereas a bond contains a promise to pay
Is it necessary for all investors to have the same expectations regarding a stock for the stock to be in equilibrium?Whereas a bond contains a promise to pay interest, a share of common stock
What would happen to a stock’s price if the “marginal investor” examined a stock and concluded that its intrinsic value was greater than its current market price?Whereas a bond contains a
Write out and explain the valuation formula for a constant growth stock.
Describe how the formula for a zero growth stock can be derived from the formula for a normal constant growth stock.
Firm A is expected to pay a dividend of $1.00 at the end of the year. The required rate of return is rs = 11%. Other things held constant, what would the stock’s price be if the growth rate was 5%?
Firm B has a 12% ROE. Other things held constant, what would its expected growth rate be if it paid out 25% of its earnings as dividends? 75%?
If Firm B had a 75% payout ratio but then lowered it to 25%, causing its growth rate to rise from 3% to 9%, would that action necessarily increase the price of its stock?Why or why not?
Explain how one would find the value of a nonconstant growth stock.
Explain what is meant by horizon (terminal) date and horizon (continuing)value.
Write out the equation for free cash flows and explain it.
Why might someone use the corporate valuation model for companies that have a history of paying dividends?
What steps are taken to find a stock price using the corporate valuation model?
Why might the calculated intrinsic value differ from the stock’s current market price?Which would be “correct,” and what does “correct” mean?
Is the equation used to value preferred stock more like the one used to value a bond or the one used to value a “normal” constant growth common stock? Explain.Explain the following statement:

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