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principles corporate finance

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

Sunnyfield Industries will lease a new rock crusher for $30,000 per year for 5 years, paid at the end of each year. These lease terms are consistent with an annual interest rate of 6%. How will the lease affect Sunnyfield’s EBIT and net income in the first year if the lease is classified as (a)
What is the firm’s cash cycle? How does it differ from the operating cycle?
Describe “just-in-time” inventory management.
Use the financial statements supplied on the next page for International Motor Corporation (IMC) to answer the following questions.a. Calculate the cash conversion cycle for IMC for both 2018 and 2019. What change has occurred, if any? All else being equal, how does this change affect IMC’s need
What is the difference between the factor rate and the holdback rate?
Hand-to-Mouth (H2M) is currently cash-constrained and must decide whether to delay paying one of its suppliers or take out a loan. They owe the supplier \($10,000\) with terms of 2.2/10 Net 40, so the supplier will give them a 2.2% discount if they pay today (when the discount period expires).
Which of the following one-year $1000 bank loans offers the lowest effective annual rate?a. A loan with an APR of 6.1%, compounded monthly.b. A loan with an APR of 6.1%, compounded annually, that also has a compensating balance requirement of 10.1% (on which no interest is paid).c. A loan with an
Your firm has expected annual sales of \($2.0\) million, and has been offered a merchant cash advance of \($440,000\) with a factor rate of 1.25 and a holdback rate of 20%.a. When do you expect the loan will be repaid, expressed in days?b. What is the implied interest rate on the loan, expressed as
You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company. UnderWater’s stock price is \($25,\) and it has 2 million shares outstanding. You believe that if you buy the company and replace its management, its value will increase by 35%. You are planning on
What is corporate governance?
What is a say-on-pay vote?
What is an activist hedge fund?
Suppose the current exchange rate is \($1.78/£\) the interest rate in the United States is 5.37%, the interest rate in the United Kingdom is 3.92%, and the volatility of the \($/£\) exchange rate is 9.8%. Use the Black-Scholes formula to determine the price of a six-month call option on the
How can you identify a real option in a decision tree?
In what circumstances does the real option add value?
How do you use a decision tree to make the best investment decision?
Why can staging investment decisions add value?
The current price of Estelle Corporation stock is \($25.\) In each of the next two years, this stock price will either go up by 20% or go down by 20%. The stock pays no dividends. The one-year risk-free interest rate is 6% and will remain constant. Using the Binomial Model, calculate the price of a
Suppose Caterpillar, Inc., has 653 million shares outstanding with a share price of $75.14, and $25.99 billion in debt. If in three years, Caterpillar has 710 million shares outstanding trading for $86.58 per share, how much debt will Caterpillar have if it maintains a constant debt-equity ratio?
In 2022, Costco Wholesale Corporation had a market capitalization of \($238\) billion, debt of \($6.5\) billion, cash of \($12\) billion, and EBIT of about \($8\) billion. If Costco were to increase its debt by \($1\) billion and use the cash for a share repurchase, which market imperfections would
Suppose Goodyear Tire and Rubber Company has an equity cost of capital of 9%, a debt cost of capital of 7.5%, a marginal corporate tax rate of 45%, and a debt-equity ratio of 2.7.Suppose Goodyear maintains a constant debt-equity ratio.a. What is Goodyear’s WACC?b. What is Goodyear’s unlevered
You are a consultant who was hired to evaluate a new product line for Markum Enterprises. The upfront investment required to launch the product line is $13 million. The product will generate free cash flow of $760,000 the first year, and this free cash flow is expected to grow at a rate of 5% per
Consider Alcatel-Lucent’s project in Problem 6.a. What is the free cash flow to equity for this project?b. What is its NPV computed using the FTE method? How does it compare with the NPV based on the WACC method?Data from problem 6 6. Suppose Alcatel-Lucent has an equity cost of capital of 10%,
Amarindo, Inc. (AMR), is a newly public firm with 9.5 million shares outstanding. You are doing a valuation analysis of AMR. You estimate its free cash flow in the coming year to be $14.97 million, and you expect the firm’s free cash flows to grow by 3.7% per year in subsequent years.Because the
You are evaluating a project that requires an investment of \($94\) today and provides a single cash flow of \($123\) for sure one year from now. You decide to use 100% debt financing, that is, you will borrow \($94.\) The risk-free rate is 5% and the tax rate is 36%. Assume that the investment is
You are on your way to an important budget meeting. In the elevator, you review the project valuation analysis you had your summer associate prepare for one of the projects to be discussed:Looking over the spreadsheet, you realize that while all of the cash flow estimates are correct, your
Arden Corporation is considering an investment in a new project with an unlevered cost of capital of 9.1%. Arden’s marginal corporate tax rate is 35%, and its debt cost of capital is 4.7%.a. Suppose Arden adjusts its debt continuously to maintain a constant debt-equity ratio of 50%. What is the
Gartner Systems has no debt and an equity cost of capital of 10.7%. Gartner’s current market capitalization is $98 million, and its free cash flows are expected to grow at 3.1% per year.Gartner’s corporate tax rate is 34%. Investors pay tax rates of 35% on interest income and 21%on equity
Revtek, Inc., has an equity cost of capital of 12% and a debt cost of capital of 6%. Revtek maintains a constant debt-equity ratio of 0.5, and its tax rate is 25%.a. What is Revtek’s WACC given its current debt-equity ratio?b. Assuming no personal taxes, how will Revtek’s WACC change if it
Use your answers from Problems 17 and 18 to infer the value today of the projected improvements in working capital under the assumptions that Ideko’s market share will increase by 0.5% per year and that investment, financing, and depreciation will be adjusted accordingly.Data from in Question
Table 19.20 shows the sensitivity analysis for KKP’s investment in Ideko. Given this information, do you recommend the acquisition of Ideko? TABLE 19.20 SPREADSHEET Sensitivity Analysis for KKP's Investment in Ideko Exit EBITDA Multiple Implied Long-Run Growth Rate Ideko Enterprise Value (in $
Explain put-call parity.
Below is an option quote on IBM from the CBOE Web site showing options expiring in March and April 2022.a. Which option contract had the most trades on that day?b. Which option contract is being held the most overall?c. Suppose you purchase one March 125 Call option. How much will you need to pay
Consider the IBM call and put options in Problem 3. Ignoring any interest you might earn over the remaining few days’ life of the options:a. Compute the break-even IBM stock price for each option (i.e., the stock price at which your total profit from buying and then exercising the option would be
It is February 21, 2022, and you own IBM stock. You would like to insure that the value of your holdings will not fall significantly. Using the data in Problem 3, and expressing your answer in terms of a percentage of the current value of your portfolio:a. What will it cost to insure that the value
Dynamic Energy Systems stock is currently trading for \($31\) per share. The stock pays no dividends. A one-year European put option on Dynamic with a strike price of \($41\) is currently trading for \($10.24.\) If the risk-free interest rate is 3% per year, what is the price of a one-year European
Consider the IBM call and put options in Problem 3. IBM paid a dividend on February 10, 2022, and was not scheduled to pay another dividend until May 2022. Ignoring the negligible interest you might earn on T-bills over the remaining few days’ life of the options, show that there is no arbitrage
In mid-July 2018, European-style options on the S&P 100 index (OEX) expiring in December 2019 were priced as follows:Given an interest rate of 0.38% for a December 2019 maturity (17 months in the future), use put-call parity (with dividends) to determine:a. The price of a December 2019 OEX put
Suppose Amazon stock is trading for $2000 per share, and Amazon pays no dividends.a. What is the maximum possible price of a call option on Amazon?b. What is the maximum possible price of a put option on Amazon with a strike price of $2250?c. What is the minimum possible value of a call option on
Consider the data for IBM options in Problem 3. Suppose a new American-style put option on IBM is issued with a strike price of $130 and an expiration date of April 1st.a. What is the maximum possible price for this option?b. What is the minimum possible price for this option?Data from in problem
Consider an American put option on XAL stock with a strike price of \($49\) and one year to expiration. Assume XAL pays no dividends, XAL is currently trading for \($5\) per share, and the one-year interest rate is 10%. If it is optimal to exercise this option early:a. What is the price of a
Suppose the S&P 500 is at \($889,\) and a one-year European call option with a strike price of \($429\) has a negative time value. If the interest rate is 6%, what can you conclude about the dividend yield of the S&P 500? (Assume all dividends are paid at the end of the year.)
Suppose the S&P 500 is at 2700, and it will pay a dividend of $90 at the end of the year.Suppose also that the interest rate is 2%. If a one-year European put option has a negative time value, what is the lowest possible strike price it could have?
Wesley Corp. stock is trading for $27/share. Wesley has 20 million shares outstanding and a market debt-equity ratio of 0.49. Wesley’s debt is zero-coupon debt with a 5-year maturity and a yield to maturity of 11%.a. Describe Wesley’s equity as a call option. What is the maturity of the call
RFC Corp. has announced a \($1.58\) dividend. If RFC’s price last price cum-dividend is \($17.78,\) what should its first ex-dividend price be (assuming perfect capital markets)?
EJH Company has a market capitalization of \($1.6\) billion and 25 million shares outstanding. It plans to distribute \($120\) million through an open market repurchase. Assuming perfect capital markets:a. What will the price per share of EJH be right before the repurchase?b. How many shares will
KMS Corporation has assets with a market value of $500 million, $50 million of which are cash.It has debt of $200 million, and 10 million shares outstanding. Assume perfect capital markets.a. What is its current stock price?b. If KMS distributes $50 million as a dividend, what will its share price
Natsam Corporation has \($250\) million of excess cash. The firm has no debt and 350 million shares outstanding, with a current market price of \($20\) per share. Natsam’s board has decided to pay out this cash as a one-time dividend.a. What is the ex-dividend price of a share in a perfect
Now suppose Natsam Corporation has \($275\) million of excess cash. The firm has no debt and 500 million shares outstanding with a current market price of \($19\) per share. The board decided to do the share repurchase in Problem 7, part b, but you, as an investor, would have preferred to receive a
Suppose that all capital gains are taxed at a 26% rate, and that the dividend tax rate is 34%.Arbuckle Corp. is currently trading for \($37\) and is about to pay a \($5\) special dividend.a. Absent any other trading frictions or news, what will its share price be just after the dividend is
Clovix Corporation has \($50\) million in cash, 10 million shares outstanding, and a current share price of \($30.\) Clovix is deciding whether to use the \($50\) million to pay an immediate special dividend of \($5\) per share or to retain and invest it at the risk-free rate of 10% and use
Berkshire Hathaway’s A shares are trading at \($120,000.\) What split ratio would it need to bring its the stock price down to \($50?\)
What is the “tradeoff” in the tradeoff theory?
Why would a firm with excessive leverage not immediately reduce it?
Consider the differences in leverage across industries shown in Figure 15.7. To what extent can you account for these differences?
Kohwe Corporation plans to issue equity to raise \($40\) million to finance a new investment. After making the investment, Kohwe expects to earn free cash flows of \($10\) million each year. Kohwe currently has 5 million shares outstanding, and it has no other assets or opportunities. Suppose the
Marpor Industries has no debt and expects to generate free cash flows of \($15\) million each year. Marpor believes that if it permanently increases its level of debt to \($45\) million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its
Dynron Corporation’s primary business is natural gas transportation using its vast gas pipeline network. Dynron’s assets currently have a market value of \($150\) million. The firm is exploring the possibility of raising \($50\) million by selling part of its pipeline network and investing the
Zymase is a biotechnology start-up firm. Researchers at Zymase must choose one of three different research strategies. The payoffs (after-tax) and their likelihood for each strategy are shown below. The risk of each project is diversifiable.a. Which project has the highest expected payoff ?b.
You own your own firm, and you want to raise \($40\) million to fund an expansion. Currently, you own 100% of the firm’s equity, and the firm has no debt. To raise the \($40\) million solely through equity, you will need to sell two-thirds of the firm. However, you would prefer to maintain at
According to the managerial entrenchment theory, managers choose capital structures so as to preserve their control of the firm. On the one hand, debt is costly for managers because they risk losing control in the event of default. On the other hand, if they do not take advantage of the tax shield
If investors are holding optimal portfolios, how will the portfolios of a more risk averse and a more risk-tolerant investor differ?
Using the data from Table 11.3, what is the covariance between the stocks of Alaska Air and Southwest Airlines? Alaska Southwest Ford General Microsoft HP Air Airlines Motor Kellogg Mills Volatility (Standard Deviation) 31% 35% 37% 32% 46% 19% 17% Correlation with Microsoft 1.00 0.39 0.19 0.21
Suppose Wesley Publishing’s stock has a volatility of 55%, while Addison Printing’s stock has a volatility of 20%. If the correlation between these stocks is 30%, what is the volatility of the following portfolios of Addison and Wesley:(a) 100% Addison,(b) 75% Addison and 25% Wesley, and(c) 50%
Suppose Ford Motors stock has an expected return of 15% and a volatility of 42%, and Molson Coors Brewing has an expected return of 11% and a volatility of 32%. If the two stocks are uncorrelated,a. What is the expected return and volatility of a portfolio consisting of 73% Ford Motor stock and 27%
Suppose Target’s stock has an expected return of 17% and a volatility of 35%, Hershey’s stock has an expected return of 15% and a volatility of 30%, and these two stocks are uncorrelated.a. What is the expected return and volatility of an equally weighted portfolio of the two stocks?Consider a
You have \($9800\) to invest. You decide to invest \($19,000\) in Google and short sell \($9200\) worth of Yahoo! Google’s expected return is 14% with a volatility of 27% and Yahoo!’s expected return is 14% with a volatility of 27%. The stocks have a correlation of 0.92. What is the expected
You have \($175,000\) to invest. You choose to put \($225,000\) into the market by borrowing \($50,000.a. If the risk-free interest rate is 6% and the market expected return is 7%, what is the expected return of your investment?b. If the market volatility is 15%, what is the volatility of your
The Optima Mutual Fund has an expected return of 19.1% and a volatility of 21.5%. Optima claims that no other portfolio offers a higher Sharpe ratio. Suppose this claim is true, and the risk-free interest rate is 4.7%.a. What is Optima’s Sharpe Ratio?b. If eBay’s stock has a volatility of 38.9%
Your investment portfolio consists of $13,000 invested in only one stock—Amazon. Suppose the risk-free rate is 6%, Amazon stock has an expected return of 11% and a volatility of 39%, and the market portfolio has an expected return of 10% and a volatility of 16%. Under the CAPM assumptions,a. What
Suppose the risk-free return is 2.3% and the market portfolio has an expected return of 7.2% and a volatility of 13.8%. Merck & Co. (Ticker: MRK) stock has a 18.2% volatility and a correlation with the market of 0.051.a. What is Merck’s beta with respect to the market?b. Under the CAPM
Suppose Autodesk stock has a beta of 2.40, whereas Costco stock has a beta of 0.73. If the risk-free interest rate is 6% and the expected return of the market portfolio is 11.5%, what is the expected return of a portfolio that consists of 65% Autodesk stock and 35% Costco stock, according to the
Suppose Pepsico’s stock has a beta of 0.72. If the risk-free rate is 2% and the expected return of the market portfolio is 6%, what is Pepsico’s equity cost of capital?
Using the same data as in Problem 11, estimate the alpha of Nike and HP stock, expressed as % per month.Data from in problem 11Go 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
Harrison Holdings, Inc. (HHI) is publicly traded, with a current share price of \($30\) per share.HHI has 23 million shares outstanding, as well as \($70\) million in debt. The founder of HHI, Harry Harrison, made his fortune in the fast food business. He sold off part of his fast food empire and
Unida Systems has 32 million shares outstanding trading for \($9\) per share. In addition, Unida has \($85\) million in outstanding debt. Suppose Unida’s equity cost of capital is 13%, its debt cost of capital is 9%, and the corporate tax rate is 32%.a. What is Unida’s unlevered cost of
What risk model is most consistent with investors’ choices in their mutual fund investments?
In early 2018, Qualcomm Inc. had \($15\) billion in debt, total equity capitalization of \($88\) billion, and an equity beta of 1.33 (as reported on Yahoo! Finance). Included in Qualcomm’s assets was \($24\) billion in cash and risk-free securities. Assume that the risk-free rate of interest is
Indell stock has a current market value of \($170\) million and a beta of 1.80. Indell currently has risk-free debt as well. The firm decides to change its capital structure by issuing \($35.96\) million in additional risk-free debt, and then using this \($35.96\) million plus another \($13\)
For which types of investors is there a personal tax disadvantage of debt?
Safeco Inc. has no debt, and maintains a policy of holding \($10\) million in excess cash reserves, invested in risk-free Treasury securities. If Safeco pays a corporate tax rate of 21%, what is the cost of permanently maintaining this \($10\) million reserve? (Hint : What is the present value of
Rogot Instruments makes fine violins and cellos. It has \($1.1\) million in debt outstanding, equity valued at \($2.2\) million, and pays corporate income tax at a rate of 40%. Its cost of equity is 12% and its cost of debt is 6%.a. What is Rogot’s pretax WACC?b. What is Rogot’s (effective
Rumolt Motors has 13 million shares outstanding with a price of \($17\) per share. In addition, Rumolt has issued bonds with a total current market value of \($313\) million. Suppose Rumolt’s equity cost of capital is 15%, and its debt cost of capital is 10%.a. What is Rumolt’s pretax weighted
Suppose Microsoft has 8.15 billion shares outstanding and pays a marginal corporate tax rate of 37%. If Microsoft announces that it will payout $52 billion in cash to investors through a combination of a special dividend and a share repurchase, and if investors had previously assumed Microsoft
PMF, Inc., can deduct interest expenses next year up to 30% of EBIT. This limit is equally likely to be \($10\) million, \($15\) million, or \($20\) million. Its corporate tax rate is 35%, and investors pay a 15% tax rate on income from equity and a 35% tax rate on interest income.a. What is the
Krell Industries has a share price of \($21.44\) today. If Krell is expected to pay a dividend of \($0.78\) this year, and its stock price is expected to grow to \($24.63\) at the end of the year, what is Krell’s dividend yield and equity cost of capital?
NoGrowth Corporation currently pays a dividend of $1.36 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year?
In mid-2018, some analysts recommended that General Electric (GE) suspend its dividend payments to preserve cash needed for investment. Suppose you expected GE to stop paying dividends for two years before resuming an annual dividend of $1 per share, paid 3 years from now, growing by 3% per year.
Cooperton Mining just announced it will cut its dividend from \($4.27\) to \($2.67\) per share and use the extra funds to expand. Prior to the announcement, Cooperton’s dividends were expected to grow at a 2.9% rate, and its share price was \($49.06.\) With the new expansion, Cooperton’s
Suppose Amazon.com, Inc. pays no dividends but spent $2.98 billion on share repurchases last year. If Amazon’s equity cost of capital is 7.6%, and if the amount spent on repurchases is expected to grow by 6.5% per year, estimate Amazon’s market capitalization. If Amazon has 474 million shares
Benchmark Metrics, Inc. (BMI), an all-equity financed firm, reported EPS of \($4.52\) in 2016.Despite the economic downturn, BMI is confident regarding its current investment opportunities.But due to the financial crisis, BMI does not wish to fund these investments externally.The Board has
IDX Technologies is a privately held developer of advanced security systems based in Chicago.As part of your business development strategy, in late 2016 you initiate discussions with IDX’s founder about the possibility of acquiring the business at the end of 2016. Estimate the value of IDX per
Consider the following data for the airline industry for July 2018. Discuss the potential challenges of using multiples to value an airline. Company Name Market Capitalization Enterprise Forward Value (EV) EV/Sales EV/EBITDA EV/EBIT P/E P/E Alaska Air (ALK) 7,286 8,207 1.02x 5.1x 6.7x 7.7x 12.5x
For an investment horizon from 1926 to 2021, which of the following investments had the highest return: the S&P 500, small stocks, world portfolio, corporate bonds, or Treasury bills? Which had the lowest return?
For an investment horizon of just one year, which of these investments was the most variable? Which was the least variable?
What are the two most common measures of risk, and how are they related to each other?
How do we calculate the average annual return of an investment?
We have 96 years of data on the S&P 500 returns, yet we cannot estimate the expected return of the S&P 500 very accurately. Why?
What is the excess return?
Do expected returns of well-diversified large portfolios of stocks appear to increase with volatility?

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