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principles corporate finance

Corporate Finance 6th Edition Jonathan Berk, Peter DeMarzo - Solutions

Suppose Intel’s stock has an expected return of 26% and a volatility of 50%, while Coca-Cola’s has an expected return of 6% and volatility of 25%. If these two stocks were perfectly negatively correlated (i.e., their correlation coefficient is −1),a. Calculate the portfolio weights that
Calculate (a) the expected return and (b) the volatility (standard deviation) of a portfolio that is equally invested in Johnson & Johnson’s and Walgreens’s stock.suppose Johnson & Johnson and Walgreens Boots Alliance have expected returns and volatilities shown below, with a
For the portfolio in Problem 23, if the correlation between Johnson & Johnson’s and Walgreens’s stock were to increase,a. Would the expected return of the portfolio rise or fall?b. Would the volatility of the portfolio rise or fall?suppose Johnson & Johnson and Walgreens Boots Alliance
Calculate (a) the expected return and (b) the volatility (standard deviation) of a portfolio that consists of a long position of $10,000 in Johnson & Johnson and a short position of $2000 in Walgreens.suppose Johnson & Johnson and Walgreens Boots Alliance have expected returns and
Using the same data as for Problem 23, calculate the expected return and the volatility (standard deviation) of a portfolio consisting of Johnson & Johnson’s and Walgreens’s stocks using a wide range of portfolio weights. Plot the expected return as a function of the portfolio
A hedge fund has created a portfolio using just two stocks. It has shorted $35,000,000 worth of Oracle stock and has purchased $85,000,000 of Intel stock. The correlation between Oracle’s and Intel’s returns is 0.65. The expected returns and standard deviations of the two stocks are given in
Consider the portfolio in Problem 27. Suppose the correlation between Intel and Oracle’s stock increases, but nothing else changes. Would the portfolio be more or less risky with this change?Appendix
Fred holds a portfolio with a 30% volatility. He decides to short sell a small amount of stock with a 40% volatility and use the proceeds to invest more in his portfolio. If this transaction reduces the risk of his portfolio, what is the minimum possible correlation between the stock he shorted and
You have $10,000 to invest. You decide to invest $20,000 in Google and short sell $10,000 worth of Yahoo! Google’s expected return is 15% with a volatility of 30% and Yahoo!’s expected return is 12% with a volatility of 25%. The stocks have a correlation of 0.9. What is the expected return and
You expect HGH stock to have a 20% return next year and a 30% volatility. You have $25,000 to invest, but plan to invest a total of $50,000 in HGH, raising the additional $25,000 by shorting either KBH or LWI stock. Both KBH and LWI have an expected return of 10% and a volatility of 20%. If KBH has
Suppose you have $100,000 in cash, and you decide to borrow another $15,000 at a 4% interest rate to invest in the stock market. You invest the entire $115,000 in a portfolio J with a 15%expected return and a 25% volatility.a. What is the expected return and volatility (standard deviation) of your
You have $100,000 to invest. You choose to put $150,000 into the market by borrowing $50,000.a. If the risk-free interest rate is 5% and the market expected return is 10%, what is the expected return of your investment?b. If the market volatility is 15%, what is the volatility of your
You currently have $100,000 invested in a portfolio that has an expected return of 12% and a volatility of 8%. Suppose the risk-free rate is 5%, and there is another portfolio that has an expected return of 20% and a volatility of 12%.a. What portfolio has a higher expected return than your
Assume the risk-free rate is 4%. You are a financial advisor, and must choose one of the funds below to recommend to each of your clients. Whichever fund you recommend, your clients will then combine it with risk-free borrowing and lending depending on their desired level of risk.Appendix Expected
Assume all investors want to hold a portfolio that, for a given level of volatility, has the maximum possible expected return. Explain why, when a risk-free asset exists, all investors will choose to hold the same portfolio of risky stocks.Appendix
You have noticed a market investment opportunity that, given your current portfolio, has an expected return that exceeds your required return. What can you conclude about your current portfolio?Appendix
The Optima Mutual Fund has an expected return of 20%, and a volatility of 20%. Optima claims that no other portfolio offers a higher Sharpe ratio. Suppose this claim is true, and the risk-free interest rate is 5%.a. What is Optima’s Sharpe Ratio?b. If eBay’s stock has a volatility of 40% and an
Calculate the Sharpe ratio of each of the three portfolios in Problem 41. What portfolio weight in Hannah stock maximizes the Sharpe ratio?Appendix
Returning to Problem 38, assume you follow your broker’s advice and put 50% of your money in the venture fund.a. What is the Sharpe ratio of the Tanglewood Fund?b. What is the Sharpe ratio of your new portfolio?c. What is the optimal fraction of your wealth to invest in the venture fund?Appendix
When the CAPM correctly prices risk, the market portfolio is an efficient portfolio. Explain why.Appendix
Your investment portfolio consists of $15,000 invested in only one stock—Amazon. Suppose the risk-free rate is 5%, Amazon stock has an expected return of 12% and a volatility of 40%, and the market portfolio has an expected return of 10% and a volatility of 18%. Under the CAPM assumptions,a. What
Suppose you group all the stocks in the world into two mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the following characteristics:The risk-free
Suppose the risk-free return is 4% and the market portfolio has an expected return of 10% and a volatility of 16%. Merck & Co. (Ticker: MRK) stock has a 20% volatility and a correlation with the market of 0.06.a. What is Merck’s beta with respect to the market?b. Under the CAPM assumptions, what
Consider a portfolio consisting of the following three stocks:The volatility of the market portfolio is 10% and it has an expected return of 8%. The risk-free rate is 3%.a. Compute the beta and expected return of each stock.b. Using your answer from part (a), calculate the expected return of the
Suppose Autodesk stock has a beta of 2.16, whereas Costco stock has a beta of 0.69. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10%, what is the expected return of a portfolio that consists of 60% Autodesk stock and 40% Costco stock, according to the
What is the risk premium of a zero-beta stock? Does this mean you can lower the volatility of a portfolio without changing the expected return by substituting out any zero-beta stock in a portfolio and replacing it with the risk-free asset?Appendix
Suppose Pepsico’s stock has a beta of 0.73. If the risk-free rate is 3% and the expected return of the market portfolio is 8%, what is Pepsico’s equity cost of capital?Appendix
Suppose the market portfolio has an expected return of 10% and a volatility of 20%, while Microsoft’s stock has a volatility of 30%.a. Given its higher volatility, should we expect Microsoft to have an equity cost of capital that is higher than 10%?b. What would have to be true for Microsoft’s
Aluminum maker Alcoa has a beta of about 1.89, whereas Hormel Foods has a beta of 0.16.If the expected excess return of the marker portfolio is 5%, which of these firms has a higher equity cost of capital, and how much higher is it?Appendix
Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table below. What does the market portfolio consist of (what are the portfolio weights)?Appendix Stock Price/Share ($) Number of Shares Outstanding (millions) A 10 10 B 20 12 C 8 3 D 50 1 E 45 20
Using the data in Problem 4, suppose you are holding a market portfolio, and have invested$12,000 in Stock C.a. How much have you invested in Stock A?b. How many shares of Stock B do you hold?c. If the price of Stock C suddenly drops to $4 per share, what trades would you need to make to maintain a
Suppose Best Buy stock is trading for $75 per share for a total market cap of $15 billion, and Walt Disney has 1.82 billion shares outstanding. If you hold the market portfolio, and as part of it hold 100 shares of Best Buy, how many shares of Walt Disney do you hold?Appendix
Standard and Poor’s also publishes the S&P Equal Weight Index, which is an equally weighted version of the S&P 500.a. To maintain a portfolio that tracks this index, what trades would need to be made in response to daily price changes?b. Is this index suitable as a market proxy?Appendix
Suppose that in place of the S&P 500, you wanted to use a broader market portfolio of all U.S.stocks and bonds as the market proxy. Could you use the same estimate for the market risk premium when applying the CAPM? If not, how would you estimate the correct risk premium to use?Appendix
From the start of 1999 to the start of 2009, the S&P 500 had a negative return. Does this mean that in 2009 the market risk premium we should have used in the CAPM was negative?Appendix
Go to Chapter Resources in MyLab Finance and use the data in the spreadsheet provided to estimate the beta of Nike (NKE) and HP (HPQ) stock based on their monthly returns from 2011–2021. (Hint : You can use the slope( ) function in Excel.)
Using the same data as in Problem 11, estimate the alpha of Nike and HP stock, expressed as %per month. (Hint : You can use the intercept( ) function in Excel.)
General Electric has just issued a callable (at par) 10-year, 6% coupon bond with annual coupon payments. The bond can be called at par in one year or anytime thereafter on a coupon payment date. It has a price of $102.a. What is the bond’s yield to maturity?b. What is its yield to call?c. What
Why would managers In one Industry choose different capital structures from those in another industry?
Shown below is the income statement for E. C. Builders (ECB). Given its marginal corporate tax rate of 35%, what is the amount of the interest tax shield for ECB in years 2010 through 2013? 1 ECB Income Statement ($ million) 2010 2011 2012 2013 2 Total sales $3369 $3706 $4077 $4432 3 Cost of sales
Suppose ECB from Example 16.3 borrows $2 billion by issuing 10-year bonds. ECB’s cost of debt is 6%, so it will need to pay $120 million in interest each year for the next 10 years, and then repay the principal of $2 billion in year 10. ECB’s marginal tax rate will remain 35% throughout this
Which of the following industries have low optimal debt levels according to the tradeoff theory? Which have high optimal levels of debt?a. Tobacco firmsb. Accounting firmsc. Established restaurant chainsd. Lumber companiese. Cell phone manufacturers
You are an entrepreneur starting a biotechnology firm. If your research is successful, the technology can be sold for \($30\) million. If your research is unsuccessful, it will be worth nothing. To fund your research, you need to raise \($2\) million. Investors are willing to provide you with
Suppose Microsoft has no debt and a WACC of 9.2%. The average debt-to-value ratio for the software industry is 5%. What would be its cost of equity if it took on the average amount of debt for its industry at a cost of debt of 6%?
Describe the different mechanisms available to a firm for the repurchase of shares.
Why is an announcement of a share repurchase considered a positive signal?
After looking at the projections of the HomeNet project, you decide that they are not realistic.It is unlikely that sales will be constant over the four-year life of the project. Furthermore, other companies are likely to offer competing products, so the assumption that the sales price will remain
Cellular Access, Inc. is a cellular telephone service provider that reported net income of $250 million for the most recent fiscal year. The firm had depreciation expenses of $100 million, capital expenditures of $200 million, and no interest expenses. Working capital increased by $10 million.
Elmdale Enterprises is deciding whether to expand its production facilities. Although long-term cash flows are difficult to estimate, management has projected the following cash flows for the first two years (in millions of dollars):a. What are the incremental earnings for this project for years 1
You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant’s report on your desk, and complains, “We owe these consultants $1 million for this report, and I am not sure their
Using the assumptions in part (a) of Problem 5 (assuming no cannibalization nor lost rent),a. Calculate HomeNet’s net working capital requirements (that is, reproduce Table 8.4 under the assumptions in Problem 5(a)).b. Calculate HomeNet’s FCF (that is, reproduce Table 8.3 under the same
One year ago, your company purchased a machine used in manufacturing for $110,000.You have learned that a new machine is available that offers many advantages; you can purchase it for $150,000 today. It will be depreciated on a straight-line basis over 10 years, after which it has no salvage value.
Your firm is considering a project that would require purchasing $7.5 million worth of new equipment. Determine the present value of the depreciation tax shield associated with this equipment if the firm’s tax rate is 20% using the alternative depreciation methods below. Note that because the
Bay Properties is considering starting a commercial real estate division. It has prepared the following four-year forecast of free cash flows for this division:Assume cash flows after year 4 will grow at 3% per year, forever. If the cost of capital for this division is 14%, what is the continuation
Your firm would like to evaluate a proposed new operating division. You have forecasted cash flows for this division for the next five years, and have estimated that the cost of capital is 12%.You would like to estimate a continuation value. You have made the following forecasts for the last year
In September 2008, the IRS changed tax laws to allow banks to utilize the tax loss carryforwards of banks they acquire to shield up to 100% of their future income from taxes (prior law restricted the ability of acquirers to use these credits). Suppose Fargo Bank acquired Covia Bank and with it
Using the FCF projections in part (b) of Problem 11, calculate the NPV of the HomeNet project assuming a cost of capital ofa. 10%.b. 12%.c. 14%.What is the IRR of the project in this case?Appendix
For the assumptions in part (a) of Problem 5, assuming a cost of capital of 12%, calculate the following:a. The break-even annual sales price decline.b. The break-even annual unit sales increase.Appendix
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $2.75 million. Unfortunately, installing this machine will take several months and will partially disrupt production. The firm has just completed a $50,000
Growth Company’s current share price is \($20\) and it is expected to pay a \($1\) dividend per share next year. After that, the firm’s dividends are expected to grow at a rate of 4% per year.a. What is an estimate of Growth Company’s cost of equity?b. Growth Company also has preferred stock
RiverRocks realizes that it will have to raise the financing for the acquisition of Raft Adventures (described in Problem 20) by issuing new debt and equity. The firm estimates that the direct issuing costs will come to $7 million. How should it account for these costs in evaluating the project?
You work in Walt Disney Company’s corporate finance and treasury department and have been assigned to the team estimating Disney’s WACC. You must estimate this WACC in preparation for a team meeting later today. You quickly realize that the information you need is readily available online.1. Go
Do underwriters face the most risk from a best-efforts IPO, a firm commitment IPO, or an auction IPO?
Margóles Publishing recently completed its IPO. The stock was offered at \($14\) per share. On the first day of trading, the stock closed at \($19\) per share.a. What was the initial return on Margóles?b. Who benefited from this underpricing? Who lost, and why?
If Margóles Publishing from Problem 11 paid an underwriting spread of 7% for its IPO and sold 10 million shares, what was the total cost (exclusive of underpricing) to it of going public?
If all of the shares sold are primary shares, how much will the firm raise? What will be your percentage ownership of the firm after the IPO?The firm you founded currently has 12 million shares, of which you own 7 million. You are considering an IPO where you would sell 2 million shares for $20
If all of the shares sold are from your holdings, how much will the firm raise? What will be your percentage ownership of the firm after the IPO?The firm you founded currently has 12 million shares, of which you own 7 million. You are considering an IPO where you would sell 2 million shares for $20
Consider the following potential events that might have taken place at Global Conglomerate on December 30, 2022. For each one, indicate which line items in Global’s balance sheet would be affected and by how much. Also indicate the change to Global’s book value of equity. (In all cases, ignore
Quisco Systems has 6.5 billion shares outstanding and a share price of $18. Quisco is considering developing a new networking product in house at a cost of $500 million. Alternatively, Quisco can acquire a firm that already has the technology for $900 million worth (at the current price) of Quisco
Suppose your firm receives a $5 million order on the last day of the year. You fill the order with$2 million worth of inventory. The customer picks up the entire order the same day and pays$1 million up front in cash; you also issue a bill for the customer to pay the remaining balance of $4 million
Suppose security C has a payoff of $600 when the economy is weak and $1800 when the economy is strong. The risk-free interest rate is 4%.a. Security C has the same payoffs as which portfolio of the securities A and B in Problem A.1?b. What is the no-arbitrage price of security C?c. What is the
You work for Innovation Partners and are considering creating a new security. This security would pay out $1000 in one year if the last digit in the closing value of the Dow Jones Industrial index in one year is an even number and zero if it is odd. The one-year risk-free interest rate is 5%.
Suppose Hewlett-Packard (HPQ) stock is currently trading on the NYSE with a bid price of$28.00 and an ask price of $28.10. At the same time, a Nasdaq dealer posts a bid price for HPQ of $27.85 and an ask price of $27.95.a. Is there an arbitrage opportunity in this case? If so, how would you exploit
You have decided to take your daughter skiing in Utah. The best price you have been able to find for a round-trip air ticket is $359. You notice that you have 20,000 frequent flier miles that are about to expire, but you need 25,000 miles to get her a free ticket. The airline offers to sell you
Your computer manufacturing firm must purchase 10,000 keyboards from a supplier. One supplier demands a payment of $100,000 today plus $10 per keyboard payable in one year. Another supplier will charge $21 per keyboard, also payable in one year. The risk-free interest rate is 6%.a. What is the
Your bank is offering you an account that will pay 20% interest in total for a two-year deposit.Determine the equivalent discount rate for a period length ofa. Six months.b. One year.c. One month.Appendix
Which do you prefer: a bank account that pays 5% per year (EAR) for three years ora. An account that pays 2½% every six months for three years?b. An account that pays 7½% every 18 months for three years?c. An account that pays ½% per month for three years?Appendix
Many academic institutions offer a sabbatical policy. Every seven years a professor is given a year free of teaching and other administrative responsibilities at full pay. For a professor earning$70,000 per year who works for a total of 42 years, what is the present value of the amount she will
You have found three investment choices for a one-year deposit: 10% APR compounded monthly, 10% APR compounded annually, and 9% APR compounded daily. Compute the EAR for each investment choice. (Assume that there are 365 days in the year.)Appendix
You are considering moving your money to a new bank offering a one-year CD that pays an 8%APR with monthly compounding. Your current bank’s manager offers to match the rate you have been offered. The account at your current bank would pay interest every six months. How much interest will you need
Your bank account pays interest with an EAR of 5%. What is the APR quote for this account based on semiannual compounding? What is the APR with monthly compounding?Appendix
Suppose the interest rate is 8% APR with monthly compounding. What is the present value of an annuity that pays $100 every six months for five years?Appendix
You can earn $50 in interest on a $1000 deposit for eight months. If the EAR is the same regardless of the length of the investment, determine how much interest you will earn on a$1000 deposit fora. 6 months.b. 1 year.c. 1½ years.Appendix
Suppose you invest $100 in a bank account, and five years later it has grown to $134.39.a. What APR did you receive, if the interest was compounded semiannually?b. What APR did you receive if the interest was compounded monthly?Appendix
You make monthly payments on your mortgage. It has a quoted APR of 5% (monthly compounding).What percentage of the outstanding principal do you pay in interest each month?Appendix
Capital One is advertising a 60-month, 5.99% APR motorcycle loan. If you need to borrow$8000 to purchase your dream Harley Davidson, what will your monthly payment be?Appendix
Oppenheimer Bank is offering a 30-year mortgage with an EAR of 5⅜%. If you plan to borrow$150,000, what will your monthly payment be?Appendix
You have decided to refinance your mortgage. You plan to borrow whatever is outstanding on your current mortgage. The current monthly payment is $2356 and you have made every payment on time. The original term of the mortgage was 30 years, and the mortgage is exactly four years and eight months
You have just sold your house for $1,000,000 in cash. Your mortgage was originally a 30-year mortgage with monthly payments and an initial balance of $800,000. The mortgage is currently exactly 18½ years old, and you have just made a payment. If the interest rate on the mortgage is 5.25% (APR),
You have just purchased a home and taken out a $500,000 mortgage. The mortgage has a 30-year term with monthly payments and an APR of 6%.a. How much will you pay in interest, and how much will you pay in principal, during the first year?b. How much will you pay in interest, and how much will you
You have an outstanding student loan with required payments of $500 per month for the next four years. The interest rate on the loan is 9% APR (monthly). You are considering making an extra payment of $100 today (that is, you will pay an extra $100 that you are not required to pay). If you are
Consider again the setting of Problem 18. Now that you realize your best investment is to prepay your student loan, you decide to prepay as much as you can each month. Looking at your budget, you can afford to pay an extra $250 per month in addition to your required monthly payments of $500, or
Oppenheimer Bank is offering a 30-year mortgage with an APR of 5.25% based on monthly compounding. With this mortgage your monthly payments would be $2,000 per month. In addition, Oppenheimer Bank offers you the following deal: Instead of making the monthly payment of $2,000 every month, you can
You need a new car and the dealer has offered you a price of $20,000, with the following payment options: (a) pay cash and receive a $2000 rebate, or (b) pay a $5000 down payment and finance the rest with a 0% APR loan over 30 months. But having just quit your job and started an MBA program, you
You have credit card debt of $25,000 that has an APR (monthly compounding) of 15%. Each month you pay the minimum monthly payment only. You are required to pay only the outstanding interest. You have received an offer in the mail for an otherwise identical credit card with an APR of 12%. After
In 1975, interest rates were 7.85% and the rate of inflation was 12.3% in the United States.What was the real interest rate in 1975? How would the purchasing power of your savings have changed over the year?Appendix
If the rate of inflation is 5%, what nominal interest rate is necessary for you to earn a 3% real interest rate on your investment?Appendix
Can the nominal interest rate available to an investor be significantly negative? (Hint : Consider the interest rate earned from saving cash “under the mattress.”) Can the real interest rate be negative? Explain.Appendix
Consider a project that requires an initial investment of $100,000 and will produce a single cash flow of $150,000 in five years.a. What is the NPV of this project if the five-year interest rate is 5% (EAR)?b. What is the NPV of this project if the five-year interest rate is 10% (EAR)?c. What is
Using the term structure in Problem 29, what is the present value of an investment that pays$100 at the end of each of years 1, 2, and 3? If you wanted to value this investment correctly using the annuity formula, which discount rate should you use?Appendix

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