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principles corporate finance

Principles Of Corporate Finance 10th Global Edition Richard Brealey - Solutions

15. In Section 25-5 we listed four circumstances in which there are potential gains from leasing.Check them out by conducting a sensitivity analysis on the Greymare Bus Lines lease, assuming that Greymare does not pay tax. Try, in turn, (a) a lessor tax rate of 50% (rather than 35%), ( b )
17. A lease with a varying rental schedule is known as a structured lease. Try structuring the Greymare Bus Lines lease to increase value to the lessee while preserving the value to the lessor.Assume that Greymare does not pay tax. ( Note: In practice the tax authorities will allow some structuring
18. Nodhead College needs a new computer. It can either buy it for $250,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments (prepaid) of$62,000. Nodhead pays no tax. Compulease pays tax at 35%. Compulease can depreciate the computer for tax purposes over
19. The Safety Razor Company has a large tax-loss carryforward and does not expect to pay taxes for another 10 years. The company is therefore proposing to lease $100,000 of new machinery. The lease terms consist of eight equal lease payments prepaid annually. The lessor can write the machinery off
21. How would the lessee in Figure 25.1 evaluate the NPV of the lease? Sketch the correct valuation procedure. Then suppose that the equity lessor wants to evaluate the lease. Again sketch the correct procedure. ( Hint: APV. How would you calculate the combined value of the lease to lessee and
22. Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm one-year contract with the mining company and expects that the contract will be renewed for the five-year duration of the exploration program. If the
3. Yesterday you sold six-month futures on the German DAX stock market index at a price of 4,820. Today the DAX closed at 4,800 and DAX futures closed at 4,840. You get a call from your broker, who reminds you that your futures position is marked to market each day. Is she asking you to pay money,
12.a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is concerned about increasing volatility in interest rates. He decides to hedge using bond futures contracts. Should he buy or sell such contracts?b. The treasurer of Zeta Corporation plans to issue bonds in
18. If you buy a nine-month T-bill future, you undertake to buy a three-month bill in nine months’ time. Suppose that Treasury bills and notes currently offer the following yields:Months to Maturity Annual Yield 3 6%6 6.5 9 7 12 8 What is the value of a nine-month bill future?
19. Table 26.4 contains spot and six-month futures prices for several commodities and financial instruments. There may be some money-making opportunities. See if you can find them, and explain how you would trade to take advantage of them. The interest rate is 14.5%, or 7% over the six-month life
20. The following table shows 2009 gold futures prices for varying contract lengths. Gold is predominantly an investment good, not an industrial commodity. Investors hold gold because it diversifies their portfolios and because they hope its price will rise. They do not hold it for its convenience
22. Securities A, B, and C have the following cash flows:Period 1 Period 2 Period 3 A $ 40 $40 $ 40 B $120 — —C $ 10 $10 $110a. Calculate their durations if the interest rate is 8%.b. Suppose that you have an investment of $10 million in A. What combination of B and C would immunize this
23. What is meant by “delta” ( ␦ ) in the context of hedging? Give examples of how delta can be estimated or calculated.
27. In Section 26-6, we stated that the duration of Potterton’s lease equals the duration of its debt.a. Show that this is so.b. Now suppose that the interest rate falls to 3%. Show how the value of the lease and the debt are now affected by a .5% rise or fall in the interest rate. What would
29. Consider the commodities and financial assets listed in Table 26.5 . The risk-free interest rate is 6% a year, and the term structure is flat.a. Calculate the six-month futures price for each case.b. Explain how a magnoosium producer would use a futures market to lock in the selling price of a
30. Is a total return swap on a bond the same as a credit default swap (see Section 23-1)? Why or why not?
31. “Speculators want futures contracts to be incorrectly priced; hedgers want them to be correctly priced.” Why?
32. Your investment bank has an investment of $100 million in the stock of the Swiss Roll Corporation and a short position in the stock of the Frankfurter Sausage Company. Here is the recent price history of the two stocks:Percentage Price Change Month Frankfurter Sausage Swiss Roll January ⫺10
33. Phillip’s Screwdriver Company has borrowed $20 million from a bank at a floating interest rate of 2 percentage points above three-month Treasury bills, which now yield 5%. Assume that interest payments are made quarterly and that the entire principal of the loan is repaid after five
1. The Web sites of the major commodities exchanges provide futures prices. Calculate and plot (as in Figure 26.2) the annualized net convenience yield for a commodity of your choice. ( Note: You may need to use the futures price of a contract that is about to mature as your estimate of the current
3. You can find spot and futures prices for a variety of equity indexes on www.wsj.com . Pick one and check whether it is fairly priced. You will need to do some detective work to find the dividend yield on the index and the interest rate.
4. The following table shows interest rates and exchange rates for the U.S. dollar and the Philippine peso in 2007. The spot exchange rate is 47.46 pesos $1. Complete the missing entries:1 Month 3 Months 1 Year Dollar interest rate (annually compounded) 5.3 5.3 ?Peso interest rate (annually
5. An importer in the United States is due to take delivery of clothing from Mexico in six months. The price is fixed in Mexican pesos. Which of the following transactions could eliminate the importer’s exchange risk?a. Sell six-month call options on pesos.b. Buy pesos forward.c. Sell pesos
6. A U.S. company has committed to pay 10 million kronor to a Swedish company in one year. What is the cost (in present value) of covering this liability by buying kronor forward?The Swedish interest rate is .6%, and exchange rates are shown in Table 27.1 . Briefly explain.
9. It is the year 2018 and Pork Barrels Inc. is considering construction of a new barrel plant in Spain. The forecasted cash flows in millions of euros are as follows:C0 C1 C2 C3 C4 C5 80 10 20 23 27 25 The spot exchange rate is $1.2 €1. The interest rate in the United States is 8% and the euro
10. Table 27.1 shows the 90-day forward rate on the South African rand.a. Is the dollar at a forward discount or premium on the rand?b. What is the annual percentage discount or premium?c. If you have no other information about the two currencies, what is your best guess about the spot rate on the
11. Look at Table 27.1 . If the three-month interest rate on dollars is 0.2%, what do you think is the three-month interest rate on South African rand? Explain what would happen if the rate were substantially above your figure.
15. A Ford dealer in the United States may be exposed to a devaluation of the yen if this leads to a cut in the price of Japanese cars. Suppose that the dealer estimates that a 1% decline in the value of the yen would result in a permanent decline of 5% in the dealer’s profits.How should she
18. Table 27.5 above shows the annual interest rate (annually compounded) and exchange rates against the dollar for different currencies. Are there any arbitrage opportunities? If so, how would you secure a positive cash flow today, while zeroing out all future cash flows?
19. “Last year we had a substantial income in sterling, which we hedged by selling sterling forward. In the event sterling appreciated. So our decision to sell forward cost us a lot of money. I think that in the future we should either stop hedging our currency exposure or just hedge when we
20. Carpet Baggers, Inc., is proposing to construct a new bagging plant in a country in Europe.The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants are as follows:C0 C1 C2 C3 C4 C5 C6 IRR(%)Germany (millions of euros) 60 10 15 15 20 20 20 18.8
1. Find the foreign exchange rate tables in the online versions of The Wall Street Journal( www.wsj.com ) or the Financial Times ( www.ft.com ).a. How many U.S. dollars are worth one Canadian dollar today?b. How many Canadian dollars are worth one U.S. dollar today?c. Suppose that you arrange today
2. Find the foreign exchange rate tables in the online versions of The Wall Street Journal( www.wsj.com ) or the Financial Times ( www.ft.com ). How many Swiss francs can you buy for $1? How many Hong Kong dollars can you buy? What rate do you think a Swiss bank would quote for buying or selling
2. Table 28.11 on the following page gives abbreviated balance sheets and income statements for Estée Lauder Companies. Calculate the following ratios:a. Return on assets.b. Operating profit margin.c. Sales-to-assets ratio.d. Inventory turnover.e. Debt–equity ratio.f. Current ratio.g. Quick ratio
3. Look again at Table 28.11 . Calculate a common-size balance sheet and income statement for Estée Lauder.
4. Look again at Table 28.11 . At the end of fiscal 2008 Estée Lauder had 195 million shares outstanding 20 with a share price of $45.50. The company’s weighted-average cost of capital was about 10%. Calculatea. Market value added.b. Market-to-book ratio.c. Economic value added.d. Return on
6. True or false?a. A company’s debt–equity ratio is always less than 1.b. The quick ratio is always less than the current ratio.c. The return on equity is always less than the return on assets.Tangible fixed assets Property, plant, and equipment Less accumulated depreciation Assets Balance
10. Consider this simplified balance sheet for Geomorph Trading:Current assets $100 $ 60 Current liabilities Long-term assets 500 280 Long-term debt 70 Other liabilities 190 Equity$600 $600a. Calculate the ratio of debt to equity.b. What are Geomorph’s net working capital and total long-term
13. On average, it takes Microlimp’s customers 60 days to pay their bills. If Microlimp has annual sales of $500 million, what is the average value of unpaid bills?INTERMEDIATE
14. This question reviews some of the difficulties encountered in interpreting accounting numbers.a. Give four examples of important assets, liabilities, or transactions that may not be shown on the company’s books.b. How does investment in intangible assets, such as research and development,
16. Discuss alternative measures of financial leverage. Should the market value of equity be used or the book value? Is it better to use the market value of debt, the book value, or the book value discounted at the risk-free interest rate? How should you treat off-balance-sheet obligations such as
18. How would the following actions affect a firm’s current ratio?a. Inventory is sold.b. The firm takes out a bank loan to pay its suppliers.c. The firm arranges a line of credit with a bank that allows it to borrow at any time to pay its suppliers.d. A customer pays its overdue bills.e. The
19. Sara Togas sells all its output to Federal Stores. The following table shows selected financial data, in millions, for the two firms:Sales Interest Payment Net Income Assets at Start of Year Federal Stores $100 $4 $10 $50 Sara Togas 20 1 4 20 Calculate the sales-to-assets ratio, the operating
20. As you can see, someone has spilled ink over some of the entries in the balance sheet and income statement of Transylvania Railroad ( Table 28.12 ). Can you use the following information to work out the missing entries?• Debt ratio: .4.• Times-interest-earned: 6.25.• Current ratio:
21. Here are some data for five companies in the same industry:Company Code A B C D E EBIT 10 30 100 3 80 Interest expense 5 15 50 2 1 You have been asked to calculate a measure of times-interest-earned for the industry. Discuss the possible ways that you might calculate such a measure. Does
22. How would rapid inflation affect the accuracy and relevance of a manufacturing company’s balance sheet and income statement? Does your answer depend on how much debt the firm has issued?
23. Suppose that you wish to use financial ratios to estimate the risk of a company’s stock.Which of those that we have described in this chapter are likely to be helpful? Can you think of other accounting measures of risk?
24. Look up some firms that have been in trouble. Plot the changes over the preceding years in the principal financial ratios. Are there any patterns?December 2009 December 2008 Balance Sheet Cash 20 Accounts receivable 34 Inventory 26 Total current assets 80 Fixed assets, net 110 Total 190 Notes
26. Sometimes analysts use the average of capital at the start and end of the year to calculate return on capital. Provide some examples to illustrate when this does and does not make sense. ( Hint: Start by assuming that capital increases solely as a result of retained earnings.)
27. Take another look at Geomorph Trading’s balance sheet in Problem 10 and consider the following additional information:Current Assets Current Liabilities Other Liabilities Cash $15 Payables $35 Deferred tax $32 Inventories 35 Taxes due 10 Unfunded pensions 22 Receivables 50 Bank loan 15 R&R
1. Find financial ratios for five different industries. Can you account for some of the differences between industries?
2. Select two companies that are in a similar line of business and find their simplified balance sheets and income statements. Then draw up common-size statements for each company and compute the principal financial ratios. Compare and contrast the companies based on these data.
3. Here is a forecast of sales by National Bromide for the first four months of 2010 (figures in$ thousands):Month 1 Month 2 Month 3 Month 4 Cash sales 15 24 18 14 Sales on credit 100 120 90 70 On the average 50% of credit sales are paid for in the current month, 30% are paid in the next month, and
4. Dynamic Futon forecasts the following purchases from suppliers:Jan. Feb. Mar. Apr. May Jun.Value of goods ($ millions) 32 28 25 22 20 20a. Forty percent of goods are supplied cash-on-delivery. The remainder are paid with an average delay of one month. If Dynamic Futon starts the year with
5. Each of the following events affects one or more tables in Sections 29-2 to 29-3 . Show the effects of each event by adjusting the tables listed in parentheses:a. Dynamic repays only $10 million of short-term debt in 2009. ( Tables 29.2 and 29.3 )b. Dynamic issues an additional $40 million of
7. Table 29.11 on the next page summarizes the 2011 income statement and end-year balance sheet of Drake’s Bowling Alleys. Drake’s financial manager forecasts a 10% increase in sales and costs in 2009. The ratio of sales to average assets is expected to remain at .40. Interest is forecasted at
8. Abbreviated financial statements for Archimedes Levers are shown in Table 29.12 on the next page. If sales increase by 10% in 2011 and all other items, including debt, increase correspondingly, what must be the balancing item? What will be its value?Income Statement Sales $1,000 (40% of average
9. What is the maximum possible growth rate for Archimedes (see Problem 8 ) if the payout ratio is set at 50% and ( a ) no external debt or equity is to be issued? (b) the firm maintains a fixed debt ratio but issues no equity?INTERMEDIATE
10. Table 29.13 (on the next page) lists data from the budget of Ritewell Publishers. Half the company’s sales are for cash on the nail; the other half are paid for with a one-month delay.The company pays all its credit purchases with a one-month delay. Credit purchases in January were $30, and
12. Which items in Table 29.6 would be affected by the following events?a. There is a rise in interest rates.b. Suppliers demand interest for late payment.c. Dynamic receives an unexpected bill in the third quarter from the Internal Revenue Service for underpayment of taxes in previous years.
13. Table 29.15 (on the next page) shows Dynamic Mattress’s year-end 2007 balance sheet, and Table 29.16 (on page 754) shows its income statement for 2008. Work out the statement of cash flows for 2008. Group these items into sources of cash and uses of cash.
14. Work out a short-term financing plan for Dynamic Mattress Company, assuming the limit on the line of credit is raised from $100 to $120 million. Otherwise keep to the assumptions used in developing Table 29.6 (on page 741).
15. Dynamic Mattress decides to lease its new mattressstuffing machines rather than buy them. As a result, capital expenditure in the first quarter is reduced by$50 million, but the company must make lease payments of $2.5 million for each of the four quarters.Assume that the lease has no effect on
19. Construct a new model for Dynamic Mattress based on your answer to Problem 18 . Does your model generate a feasible financial plan for 2010? ( Hint: If it doesn’t, you may have to allow the firm to issue stock.)
20.a. Use the Dynamic Mattress model ( Tables 29.8 – 29.10 ) and the “live” spreadsheets on the book’s Web site at www.mhhe.com/bma to produce pro forma income statements, balance sheets, and statements of cash flows for 2010 and 2011. Assume business as usual except that now sales and
21. The financial statements of Eagle Sport Supply are shown in Table 29.17 (on the next page). For simplicity, “Costs” include interest. Assume that Eagle’s assets are proportional to its sales.a. Find Eagle’s required external funds if it maintains a dividend payout ratio of 60% and plans
22.a. What is the internal growth rate of Eagle Sport (see Problem 21 ) if the dividend payout ratio is fixed at 60% and the equity-to-asset ratio is fixed at two-thirds?b. What is the sustainable growth rate?
23. Bio-Plasma Corp. is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 20%. Its plowback ratio is 40%.a. What is the internal growth rate?b. What is the firm’s need for external financing this year?c. By how much would the firm
6. Look back at the discussion in Section 30-2 of credit decisions with repeat orders. If p 1 ⫽ .8, what is the minimum level of p 2 at which Cast Iron is justified in extending credit?
12. In October 2008, six-month (182-day) Treasury bills were issued at a discount of 1.4%.What is the annual yield?
17. Listed below are some common terms of sale. Can you explain what each means?a. 2/30, net 60.b. 2/5, EOM, net 30.c. COD.
18. Some of the items in Problem 17 involve a cash discount. For each of these, calculate the rate of interest paid by customers who pay on the due date instead of taking the cash discount.
19. Phoenix Lambert currently sells its goods cash-on-delivery. However, the financial manager believes that by offering credit terms of 2/10 net 30 the company can increase sales by 4%, without significant additional costs. If the interest rate is 6% and the profit margin is 5%, would you
20. As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6%. He believes that imposing a more stringent credit policy might reduce sales by 5% and reduce the bad debt ratio to 4%. If the cost of goods sold is 80% of
21. Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on a scale of 1 to 4. During the past five years, the
22. Look again at Problem 21 . Suppose (a) that it costs $95 to classify each new credit applicant and (b) that an almost equal proportion of new applicants falls into each of the four categories.In what circumstances should Mr. Khana not bother to undertake a credit check?
23. Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed its terms to 2/10, EOM, net 60. The initial effect of the changed terms is as follows:Average
24. Look back at Problem 23 . Assume that the change in credit terms results in a 2% increase in sales. Recalculate the effect of the changed credit terms.
25. Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $180 million annually. First National, Knob’s principal bank, offers to establish a new concentration banking system for a flat fee of $100,000 per year. The bank
27. A parent company settles the collection account balances of its subsidiaries once a week.(That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire transfer is $10. A check costs $.80. Cash transferred by wire is available the same day, but the
29. A three-month Treasury bill and a six-month bill both sell at a discount of 10%. Which offers the higher annual yield?
34. The IRS prohibits companies from borrowing money to buy tax-exempts and deducting the interest payments on the borrowing from taxable income. Should the IRS prohibit such activity? If it didn’t, would you advise the company to borrow to buy tax-exempts?
36. You need to borrow $10 million for 90 days. You have the following alternatives:a. Issue high-grade commercial paper, with a backup line of credit costing .3% a year.b. Borrow from First Cookham Bank at an interest rate of .25% over LIBOR.c. Borrow from the Test Bank at prime.Given the rates
37. Suppose that you are a banker responsible for approving corporate loans. Nine firms are seeking secured loans. They offer the following assets as collateral:a. Firm A, a heating oil distributor, offers a tanker load of fuel in transit from the Middle East.b. Firm B, a wine wholesaler, offers
38. Reliant Umbrellas has been approached by Plumpton Variety Stores of Nevada. Plumpton has expressed interest in an initial purchase of 5,000 umbrellas at $10 each on Reliant’s standard terms of 2/30, net 60. Plumpton estimates that if the umbrellas prove popular with customers, its purchases
39. Galenic, Inc., is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed a numerical credit scoring system based on a small number of key ratios.This has resulted in a bad
40. Axle Chemical Corporation’s treasurer has forecasted a $1 million cash deficit for the next quarter. However, there is only a 50% chance this deficit will actually occur. The treasurer estimates that there is a 20% probability the company will have no deficit at all and a 30%probability that
41. Term loans usually require firms to pay a fluctuating interest rate. For example, the interest rate may be set at “1% above prime.” The prime rate sometimes varies by several percentage points within a single year. Suppose that your firm has decided to borrow $40 million for five years. It
1. The Dun and Bradstreet Web site ( www.dnb.com ) contains a sample comprehensive report on a small business. Would you extend credit to the firm? Why or why not?
2. The three main credit bureaus maintain useful Web sites with examples of their business and consumer reports. Log on to www.equifax.com and look at the sample report on a small business. What information do you think would be most useful if you were considering granting credit to the firm?
3. Log on to the Federal Reserve site at www.federalreserve.gov and look up current moneymarket interest rates. Suppose your business has $7 million set aside for an expenditure in three months. How would you choose to invest it in the meantime? Would your decision be different if there were some
4. The Federal Reserve Bulletin publishes the results of a quarterly survey of bank lending(see www.federalreserve.gov/releases/E2 ). Use the latest survey to describe the pattern of lending by domestic banks. Examine, for example, whether most loans are secured and whether they are made under
2. Which of the following motives for mergers make economic sense?a. Merging to achieve economies of scale.b. Merging to reduce risk by diversification.c. Merging to redeploy cash generated by a firm with ample profits but limited growth opportunities.d. Merging to combine complementary
3. Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce marketing and administrative costs by $500,000
5. True or false?a. Sellers almost always gain in mergers.b. Buyers usually gain more than sellers.c. Firms that do unusually well tend to be acquisition targets.d. Merger activity in the United States varies dramatically from year to year.e. On the average, mergers produce large economic gains.f.
6. Briefly define the following terms:a. Purchase accountingb. Tender offerc. Poison pilld. Golden parachutee. Synergy INTERMEDIATE
11. Suppose you obtain special information—information unavailable to investors—indicating that Backwoods Chemical’s stock price is 40% undervalued. Is that a reason to launch a takeover bid for Backwoods? Explain carefully.
12. As treasurer of Leisure Products, Inc., you are investigating the possible acquisition of Plastitoys.You have the following basic data:Leisure Products Plastitoys Earnings per share $ 5.00 $ 1.50 Dividend per share $ 3.00 $ .80 Number of shares 1,000,000 600,000 Stock price $90 $20 You estimate
13. The Muck and Slurry merger has fallen through (see Section 31-2 ). But World Enterprises is determined to report earnings per share of $2.67. It therefore acquires the Wheelrim and Axle Company. You are given the following facts:World Enterprises Wheelrim and Axle Merged Firm Earnings per share
3. What are the government’s motives in a privatization?

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