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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

Use the incremental IRR rule to correctly choose between the investments in Problem 23 when the cost of capital is 7%. At what cost of capital would your decision change?Appendix
You work for an outdoor play structure manufacturing company and are trying to decide between two projects:You can undertake only one project. If your cost of capital is 8%, use the incremental IRR
You are evaluating the following two projects:Use the incremental IRR to determine the range of discount rates for which each project is optimal to undertake. Note that you should also include the
Consider two investment projects, both of which require an up-front investment of $10 million and pay a constant positive amount each year for the next 10 years. Under what conditions can you rank
You are considering a safe investment opportunity that requires a $1000 investment today, and will pay $500 two years from now and another $750 five years from now.a. What is the IRR of this
Facebook is considering two proposals to overhaul its network infrastructure. They have received two bids. The first bid, from Huawei, will require a $20 million up-front investment and will generate
Natasha’s Flowers, a local florist, purchases fresh flowers each day at the local flower market.The buyer has a budget of $1000 per day to spend. Different flowers have different profit margins,
Orchid Biotech Company is evaluating several development projects for experimental drugs.Although the cash flows are difficult to forecast, the company has come up with the following estimates of the
Using the data from Table 12.3, what is the volatility (standard deviation) of a portfolio with equal amounts invested in Apple and Microsoft stock? What is the standard deviation of a portfolio with
Based on historical data, your expected annual return for Target is 6% and for Berkshire Hathaway is 5%. What is the expected return and risk (standard deviation) of your portfolio if you hold only
Suppose the risk-free return is 3% and you measure the market risk premium to be 6%. Apple has a beta of 1.2. According to the CAPM, what is its expected return?
Suppose drug-maker Pfizer (PFE) has a beta of 0.7, whereas the beta of Google (GOOG) is 0.9. If the risk-free interest rate is 3% and the market risk premium is 6%, what is the expected return of
Define correlation. What does the range between +1 and –1 signify?
You buy 200 shares of Tidepool Co. for \($55\) each and 400 shares of Madfish, Inc., for \($25\) each. What are the weights in your portfolio?
Fremont Enterprises has an expected return of 12% and Laurelhurst News has an expected return of 25%. If you put 60% of your portfolio in Laurelhurst and 40% in Fremont, what is the expected return
You have \($85,000\). You put 25% of your money in a stock with an expected return of 18%, \($38,000\) in a stock with an expected return of 25%, and the rest in a stock with an expected return of
Using the spreadsheet from Problem 10 and the fact that Cola Co. and Gas Co. have a correlation of 0.6083, calculate the volatility (standard deviation) of a portfolio that is 55% invested in Cola
Using the data in Table 12.2,a. Compute the annual returns for a portfolio with 25% invested in North Air, 25% invested in West Air, and 50% invested in Texas Oil.b. What is the lowest annual return
Using the data from Table 12.3, what is the volatility of an equally weighted portfolio of Microsoft and Ford stock?
You have a portfolio with a standard deviation of 30% and an expected return of 18%. You are considering adding one of the two stocks in the following table. If after adding the stock you will have
Suppose all possible investment opportunities in the world are limited to the five stocks listed in the following table. What are the market portfolio weights (see MyFinanceLab for the data in Excel
Given $100,000 to invest, construct a value-weighted portfolio of the four stocks listed below (see MyFinanceLab for the data in Excel format). Stock Price/Share ($) Number of Shares Outstanding
You hear on the news that the S&P 500 was down 2% today relative to the risk-free rate (the market’s excess return was –2%). You are thinking about your portfolio and your investments in Zynga
Suppose the risk-free return is 5% and the market portfolio has an expected return of 15% and a standard deviation of 22%. Johnson & Johnson Corporation stock has a beta of 0.98. What is its expected
EJH has a beta of 1.8, CSH has a beta of 0.8, and KMS has a beta of 1.2. If you put 35% of your money in EJH, 25% in CSH, and 40% in KMS, what is the beta of your portfolio?
Suppose Intel stock has a beta of 1.8, whereas Boeing stock has a beta of 1.2. If the risk-free interest rate is 5% and the expected return of the market portfolio is 15%, according to the CAPM,a.
You are thinking of buying a stock priced at \($103\) per share. Assume that the risk-free rate is about 5.5% and the market risk premium is 9%. If you think the stock will rise to \($122\) per share
You are analyzing a stock that has a beta of 2.4. The risk-free rate is 3% and you estimate the market risk premium to be 8%. If you expect the stock to have a return of 15% over the next year,
You have risen through the ranks of a coffee company, from the lowly green-apron barista to the coveted black apron, and all the way to CFO. A quick Internet check shows you that your company’s
At the beginning of 2013, Apple’s beta was 1.2 and the risk-free rate was about 3%. Apple’s price was \($75\). Apple’s price at the end of 2013 was \($80\). If you estimate the market risk
When evaluating a project in a new line of business, which assumptions for the WACC method are most likely to be violated?
Assuming that you can borrow all the funding to finance your expansion project at 8%, does it mean that 8% would be your cost of capital for the project? What is the cost of capital measured by WACC?
Book Co. has 2 million shares of common equity with a par (book) value of \($5\), retained earnings of \($30\) million, and its shares have a market value of \($25\) per share. It also has debt with
Avicorp has a \($15\) million debt issue outstanding, with an 8% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in eight years. It is
Laurel, Inc., has debt outstanding with a coupon rate of 10% and a yield to maturity of 8%. Its tax rate is 40%. What is Laurel’s effective (after-tax) cost of debt?
Dewyco has preferred stock trading at \($80\) per share. The next preferred dividend of \($5\) is due in one year. What is Dewyco’s cost of capital for preferred stock?
Steady Company’s stock has a beta of 1.80. If the risk-free rate is 5% and the market risk premium is 9%, what is an estimate of Steady Company’s cost of equity?
HighGrowth Company has a stock price of \($50\). The firm will pay a dividend next year of \($2.5\), and its dividend is expected to grow at a rate of 3% per year thereafter. What is your estimate of
Slow ’n Steady, Inc., has a stock price of \($80\), will pay a dividend next year of \($5\), and has expected dividend growth of 4% per year. What is your estimate of Slow ’n Steady’s cost of
CoffeeCarts has a cost of equity of 18%, has an effective cost of debt of 7%, and is financed 60% with equity and 40% with debt. What is this firm’s WACC?
Pfd Company has debt with a yield to maturity of 8%, a cost of equity of 18%, and a cost of preferred stock of 12%. The market values of its debt, preferred stock, and equity are \($12\) million,
RiverRocks’ purchase of Raft Adventures (from Problem 19) will cost \($100\) million, and will generate cash flows that start at \($15\) million in one year and then grow at 4% per year forever.
Your company has two divisions: One division sells software and the other division sells computers through a direct sales channel, primarily taking orders over the Internet. You have decided that
Find the most recent financial statements for Starbucks Corporation (SBUX) using the following sources:a. From the company’s Web page www.starbucks.com. (Hint: Search for “investor
In early 2022, Abercrombie & Fitch (ANF) had a book equity of $826 million, a price per share of $39.00, and 50.4 million shares outstanding. At the same time, The Gap (GPS) had a book equity of
At the end of 2021, Apple had cash and short-term investments of $62.64 billion, accounts receivable of $26.28 billion, current assets of $134.84 billion, and current liabilities of $125.48
See Table 2.5 showing financial statement data and stock price data for Mydeco Corp.a. By how much did Mydeco increase its debt from 2019 to 2023?b. What was Mydeco’s EBITDA/Interest coverage ratio
Use the data in Problem 8 to determine the change, from 2018 to 2022, in Ford’sa. book debt-equity ratio.b. market debt-equity ratio.
You are analyzing the leverage of two firms and you note the following (all values in millions of dollars):a. What is the market debt-to-equity ratio of each firm?b. What is the book debt-to-equity
In early 2022, United Airlines (UAL) had a market capitalization of $14.3 billion, debt of $39.4 billion, and cash of $18.4 billion. United also had annual revenues of $24.6 billion. Southwest
For fiscal year 2021, Costco Wholesale Corporation (COST) had a net profit margin of 2.60%, asset turnover of 3.24, and a book equity multiplier of 3.28.a. Use this data to compute Costco’s ROE
For fiscal year 2021, Walmart Inc. (WMT) had total revenues of $572.75 billion, net income of$13.67 billion, total assets of $244.86 billion, and total shareholder’s equity of $83.25 billion.a.
WorldCom reclassified $3.85 billion of operating expenses as capital expenditures. Explain the effect this reclassification would have on WorldCom’s cash flows. (Hint : Consider taxes.)WorldCom’s
The table here shows the no-arbitrage prices of securities A and B that we calculated.a. What are the payoffs of a portfolio of one share of security A and one share of security B?b. What is the
Suppose a risky security pays an expected cash flow of $80 in one year. The risk-free rate is 4%, and the expected return on the market index is 10%.a. If the returns of this security are high when
Consider a portfolio of two securities: one share of Johnson and Johnson ( JNJ ) stock and a bond that pays $100 in one year. Suppose this portfolio is currently trading with a bid price of$211.65
Honda Motor Company is considering offering a $2000 rebate on its minivan, lowering the vehicle’s price from $30,000 to $28,000. The marketing group estimates that this rebate will increase sales
You are an international shrimp trader. A food producer in the Czech Republic offers to pay you 2 million Czech koruna today in exchange for a year’s supply of frozen shrimp. Your Thai supplier
Suppose the current market price of corn is $3.75 per bushel. Your firm has a technology that can convert 1 bushel of corn to 3 gallons of ethanol. If the cost of conversion is $1.60 per bushel, at
Suppose your employer offers you a choice between a $5000 bonus and 100 shares of the company stock. Whichever one you choose will be awarded today. The stock is currently trading for$63 per share.a.
Suppose the risk-free interest rate is 4%.a. Having $200 today is equivalent to having what amount in one year?b. Having $200 in one year is equivalent to having what amount today?c. Which would you
You have an investment opportunity in Japan. It requires an investment of $1 million today and will produce a cash flow of ¥114 million in one year with no risk. Suppose the risk-free interest rate
Your firm has a risk-free investment opportunity where it can invest $160,000 today and receive$170,000 in one year. For what level of interest rates is this project attractive?Appendix
You run a construction firm. You have just won a contract to construct a government office building. It will take one year to construct it, requiring an investment of $10 million today and$5 million
Your firm has identified three potential investment projects. The projects and their cash flows are shown here:Suppose all cash flows are certain and the risk-free interest rate is 10%.a. What is the
Suppose Bank One offers a risk-free interest rate of 5.5% on both savings and loans, and Bank Enn offers a risk-free interest rate of 6% on both savings and loans.a. What arbitrage opportunity is
Throughout the 1990s, interest rates in Japan were lower than interest rates in the United States.As a result, many Japanese investors were tempted to borrow in Japan and invest the proceeds in the
An American Depositary Receipt (ADR) is security issued by a U.S. bank and traded on a U.S.stock exchange that represents a specific number of shares of a foreign stock. For example, Nokia
The promised cash flows of three securities are listed here. If the cash flows are risk-free, and the risk-free interest rate is 5%, determine the no-arbitrage price of each security before the first
An Exchange-Traded Fund (ETF) is a security that represents a portfolio of individual stocks.Consider an ETF for which each share represents a portfolio of two shares of Hewlett-Packard(HPQ), one
Consider two securities that pay risk-free cash flows over the next two years and that have the current market prices shown here:a. What is the no-arbitrage price of a security that pays cash flows
Suppose a security with a risk-free cash flow of $150 in one year trades for $140 today. If there are no arbitrage opportunities, what is the current risk-free interest rate?Appendix
You have just taken out a five-year loan from a bank to buy an engagement ring. The ring costs$5000. You plan to put down $1000 and borrow $4000. You will need to make annual payments of $1000 at the
You currently have a four-year-old mortgage outstanding on your house. You make monthly payments of $1500. You have just made a payment. The mortgage has 26 years to go (i.e., it had an original term
Calculate the future value of $2000 ina. Five years at an interest rate of 5% per year.b. Ten years at an interest rate of 5% per year.c. Five years at an interest rate of 10% per year.d. Why is the
What is the present value of $10,000 receiveda. Twelve years from today when the interest rate is 4% per year?b. Twenty years from today when the interest rate is 8% per year?c. Six years from today
Your brother has offered to give you either $5000 today or $10,000 in 10 years. If the interest rate is 7% per year, which option is preferable?Appendix
Consider the following alternatives:i. $100 received in one year ii. $200 received in five years iii. $300 received in ten yearsa. Rank the alternatives from most valuable to least valuable if the
Suppose you invest $1000 in an account paying 8% interest per year.a. What is the balance in the account after three years? How much of this balance corresponds to “interest on interest”?b. What
Your daughter is currently eight years old. You anticipate that she will be going to college in 10 years. You would like to have $100,000 in a savings account to fund her education at that time. If
You are thinking of retiring. Your retirement plan will pay you either $250,000 immediately on retirement or $350,000 five years after the date of your retirement. Which alternative should you choose
Your grandfather put some money in an account for you on the day you were born. You are now 18 years old and are allowed to withdraw the money for the first time. The account currently has $3996 in
Suppose you receive $100 at the end of each year for the next three years.a. If the interest rate is 8%, what is the present value of these cash flows?b. What is the future value in three years of
You have just received a windfall from an investment you made in a friend’s business. He will be paying you $10,000 at the end of this year, $20,000 at the end of the following year, and $30,000 at
You have a loan outstanding. It requires making three annual payments at the end of the next three years of $1000 each. Your bank has offered to restructure the loan so that instead of making the
You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1500 two years from now, and $10,000 10 years from now.a. What is the NPV
Marian Plunket owns her own business and is considering an investment. If she undertakes the investment, it will pay $4000 at the end of each of the next three years. The opportunity requires an
Your buddy in mechanical engineering has invented a money machine. The main drawback of the machine is that it is slow. It takes one year to manufacture $100. However, once built, the machine will
How would your answer to Problem 16 change if the machine takes one year to build?Appendix
The British government has a consol bond outstanding paying £100 per year forever. Assume the current interest rate is 4% per year.a. What is the value of the bond immediately after a payment is
What is the present value of $1000 paid at the end of each of the next 100 years if the interest rate is 7% per year?Appendix
You are head of the Schwartz Family Endowment for the Arts. You have decided to fund an arts school in the San Francisco Bay area in perpetuity. Every five years, you will give the school$1 million.
You are 25 years old and decide to start saving for your retirement. You plan to save $5000 at the end of each year (so the first deposit will be one year from now), and will make the last deposit
Your grandmother has been putting $1000 into a savings account on every birthday since your first (that is, when you turned one). The account pays an interest rate of 3%. How much money will be in
A rich relative has bequeathed you a growing perpetuity. The first payment will occur in a year and will be $1000. Each year after that, on the anniversary of the last payment you will receive a
You are thinking of building a new machine that will save you $1000 in the first year. The machine will then begin to wear out so that the savings decline at a rate of 2% per year forever. What is
You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last 17 years. You expect that the drug’s profits will be $2 million in its first year and that this
Your oldest daughter is about to start kindergarten at a private school. Tuition is $10,000 per year, payable at the beginning of the school year. You expect to keep your daughter in private school
A rich aunt has promised you $5000 one year from today. In addition, each year after that, she has promised you a payment (on the anniversary of the last payment) that is 5% larger than the last
You are running a hot Internet company. Analysts predict that its earnings will grow at 30% per year for the next five years. After that, as competition increases, earnings growth is expected to slow

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