Questions and Answers of Principles Managerial Finance

The income statement and balance sheet are the primary reports that a firm constructs for use by management and for distribution to stockholders, regulatory bodies, and the general public. They are
Zona Estates has just issued a 12-year, 10% coupon rate, €1,000-par bond that pays interest annually. The required return is currently 12%, and the company is certain it will remain at 12% until
Why is debt usually the cheapest finance source?
What are the conditions under which the WACC is an appropriate hurdle rate for a firm’s investments?
We learned that Facebook acquired GIPHY for a sum of $400 million. Facebook has historically maintained its WACC at around 8%. Assume that Facebook acquired another app this year for $500 million and
Vaso Tools Gmbh uses debt, preferred stock, and common stock to raise capital. The firm’s capital structure targets the following proportions: debt, 55%; preferred stock, 20%; and common stock,
Creek Manufacturing is in the process of analyzing its investment decision-making procedures. Two projects, namely Nord and Lucas, evaluated by the firm recently involved building new facilities in
Flotation costs and the cost of debt In March of 2020 PepsiCo, Inc. (PEP) sold $750 million worth of 40-year 3.875% coupon bonds that pay semi-annual interest. At the time the bonds were issued, the
After-tax cost of debt For each of the following £1,000-par-value bonds, assuming annual interest payment and a 20% tax rate, calculate the after-tax cost of debt. Bond A B C D E Life (years) 15 16
For each of the following $1,000-par-value bonds paying semi-annual interest payments, calculate the before- and after-tax cost of debt. Use the 21% corporate tax rate. Issuer Name AT&T Boeing CVS
Charles Fabrics wishes to measure its cost of common stock equity. The firm’s stock is currently selling for €64.50. The firm just recently paid a dividend of €4. The firm has been increasing
The effect of tax rate on WACC Rayyan Games, an IT firm, wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital
Carnival Corporation (CCL) recently sold new bonds at a discount price of $990. The bonds have a short three-year maturity, have an 11.5% coupon rate, and pay interest semi-annually. In addition to
After careful analysis, Rumi Builders has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table.The cost of debt is 5%,
Chevron Corporation (CVX) has 1,865,864,238 shares of common stock outstanding selling at $92.22 per share. Chevron also has 28,247,195 bonds outstanding with a 3.078% coupon rate, maturing in 30
Parry Instruments has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital (WACC). The WACC is to be measured by using the
Xia Trading Limited is based in Beijing, China. The firm is interested in measuring its overall cost of capital. A current investigation has gathered the following data. The firm is in the 25% tax
BlackRock, Inc. (BLK) has a capital structure that consists of common stock equity and debt. The market capitalization of its equity is $77.004 billion and its debt has a market value of $4,967
How is a project’s net present value (NPV) calculated?
In theory and in practice, which method is better, NPV or IRR?
Viva Gold’s investment opportunity has an NPV of $20.3 million and an IRR of 22%. From those two facts alone, what can you conclude about Viva’s cost of capital?
Sweet Taters Corporation is considering the acquisition of a new cooking machine. The initial investment (CF0) estimate is $2.52 million. The machine purchased will have a five-year life with no
Soviet Services has a five-year maximum acceptable payback period. The firm is considering purchasing a new washing machine and must choose between two alternatives. The first machine, IntelWash,
As a financial analyst for your company, you have been asked to calculate the discounted payback period for the following projects and recommend whether your firm should accept or reject each
Using a 8% cost of capital, calculate the net present value for each of the independent projects shown in the following table, and indicate whether each is acceptable. Year 0 1 2 WN 3 4 5 6 78 9 10
Kamal Enterprises Ltd., a garment manufacturer in Mumbai, India, is negotiating to purchase a fully automated sewing machine. This machine can be programmed to sew and is expected to reduce
Insos Corporation has three projects under consideration. The cash flows for each project appear in the following table. The cost of capital for Insos is 14%.a. Calculate each project’s payback
NPV and EVA For the following investment opportunities the only investment required is the initial outlay, the investment capital will be evenly depreciated over the six-year investment life, and the
Multiple IRRs Consider investment projects L through O and answer the following questions.a. What is the maximum number of IRRs for each project? Why?b. Draw an NPV profile for Project L by
Maple Industries accepts projects earning more than the firm’s 13% cost of capital. Maple is currently considering a 12-year project that provides annual cash inflows of £18,000 and requires an
Rhine Tools Ltd., a renowned tool maker for sculpting, is considering four projects. Because of the company’s risk profile, it has a high cost of capital.a. Calculate the NPV of each project, using
All techniques, conflicting rankings Baloma Engineering Ltd. in Hong Kong is considering two mutually exclusive projects that both cost HKD 450,000. The company’s board of directors has set a
Jackson Limited is considering two mutually exclusive projects. The firm, which has a 14% cost of capital, has estimated its cash flows as shown in the following table.a. Calculate the NPV of each
Decision among mutually exclusive investments Jami’s Hospitality is planning to open a new restaurant in the Netherlands. It has identified three different locations in Rotterdam and needs to pick
Bright Tiles Limited (BTL) has been expanding very rapidly in recent years, making its shareholders rich in the process. The average annual rate of return on the stock in the past few years has been
Antonio is discussing an investment opportunity with his friend, Vincenzo. It has the following projected cash flows.a. Calculate the investment’s net present value (NPV) at each of the following
Why is the cost of financing not reflected in a project’s cash flows?
Explain how to calculate the terminal cash flow for finite-lived projects and for projects with infinite lives.
If the Institute of Modeling for Businesses (IMB), an Albanian firm that develops software for enterprises, reimburses employees who earn an Oracle Certification and who agree to remain with the firm
Biophore Corporation, an Indian pharmaceutical company, is considering replacing a labeling machine in one of its factories.The replacement will reduce operating expenses (i.e., increase earnings
Operating cash inflows MSC Cruises provides cruise lines for tourist destinations all around the world. It is considering replacing one of its cruise ships with a new model. The existing cruise ship
Project cash flows for a marketing campaign Barilla Group, a manufacturer of pasta and other similar food products, has maintained stable sales and profits over the last few years. Although the
Antonio and his wife Alessia are considering the purchase of a new car and have decided that estimating its cash flows will help them in their decision process. They expect to have a disposable
Determining and evaluating project cash flows for a home solar system You are keen on the use of solar power and have decided to evaluate investing in a solar system for your home. After consulting
Due to an increase in copper prices to MNT 7,744 per pound (MNT stands for Tughrik, the official currency of Mongolia), Tian Poh Resources, a Singapore-based company with coal and copper assets in
Describe how each of the following techniques help managers better understand project risk: (a) sensitivity analysis, (b) scenario analysis, and (c) simulation.
What is a risk-adjusted discount rate (RADR) and when should a firm use one rather than its cost of capital to calculate an investment’s NPV?
How are RADRs related to the capital asset pricing model (CAPM)? What is an asset beta? What is a pure play firm?
Explain why managers need not diversify the firms they run.
TikTok’s investment in India was affected due to political events that led to the app being banned in the country. If you were a financial analyst at TikTok, how might you use scenario analysis to
Antonio wishes to evaluate a business opportunity that requires an initial investment of €70,000 and is expected to bring positive cash flows for five years. What minimum amount of annual cash
McDavid’s is the nation’s leading fast-food chain, but senior leaders of the company believe that they should diversify by investing in the aerospace business. They have collected data on a pure
Sensitivity analysis The Kay Rona Cypress Company believes that by investing $10 million to modernize its manufacturing facilities, it can sell an additional 60,000 units of its product in each of
Scenario analysis For De Beers, one of the biggest companies in the business of diamond exploration, mining, and trading, when the market price of a single 1 carat round-cut diamond is R59,220 (R
Risk-adjusted discount rates Facebook has come under intense pressure in recent years from privacy advocates and, in the United States, from people concerned about the accuracy of political content
Godiva Chocolatier is considering one of three mutually exclusive projects for opening a chocolate factory in Bruges, Gent, or Liege. The firm plans to use a 10% cost of capital to evaluate these
Dyno Corporation has two projects that it would like to undertake. However, due to capital restraints, the two projects—Alpha and Beta—must be treated as mutually exclusive. Both projects are
Eco Media Limited is a medium-sized firm specializing in print and digital marketing. It is privately owned and has a client base that is spread across Europe. It specializes in high quality
What is an unlevered versus a levered firm?
What tradeoffs do managers face when they consider changing a firm’s capital structure?
Explain what M&M Propositions One and Two have in common and how they are different.
What is meant by the terms levered and unlevered equity? Suppose an investor in Paypal Holdings, an unlevered firm, wanted the company to borrow more. What could they do that would be equivalent to
It is possible to separate whole milk into two products—skim milk and cream. Apply Proposition One thinking to the question of whether separating whole milk into two products can fundamentally
In perfect capital markets, what is the impact of using financial leverage on a firm’s value and cost of capital? Explain your answer.
Explain the impact of corporate and personal taxes on the M&M Propositions.
In the United States, interest income received by corporate bondholders has been taxed at ordinary income rates, whereas capital gains and dividends received by shareholders have often been taxed at
Holding other factors constant, how do you think corporate capital structures might change if the corporate income tax were abolished?
Over time, institutional investors—especially pension funds, which are effectively untaxed on their investment income—have held an increasing percentage of common stock. What do you think this
Does a firm’s debt policy matter and is there an optimal capital structure?
What does an optimal capital structure imply for a firm’s value and cost of capital?
Managers of an all-equity firm must believe that the cost of debt is very high. How high would that have to be to explain the decision to avoid debt entirely?
Managers are sometimes accused of being too conservative. If a firm does not borrow as much as it should to reach its optimal capital structure, what market forces might pressure management to use
Suppose an all-equity firm is sufficiently profitable that the likelihood of it experiencing a loss in the near future is close to zero. For this firm, what does the marginal benefit curve of debt
If the tax law granted firms a tax rebate when they lost money, even when they had not previously earned a profit, then would the marginal benefit curve for debt still decline as debt increased?
What impact do direct and indirect bankruptcy costs have on a firm’s capital structure decision?
Revisit Example 13.4 for Lo Road and Hi Road companies. The required returns on equity and debt are higher for Hi than for Lo. How can the cost of capital for both firms be 12%?Data from Example 13.4
Suppose a commercial bank suffers loan losses so severe that it approaches insolvency. What kinds of asset substitution problems might arise? How might bank regulators act to prevent these problems?
Another type of agency problem is overinvestment, in which managers invest in negative-NPV projects to increase the size of the firm (as measured by sales or assets). Explain how debt constrains this
If a firm has to sell new shares of stock to the public to raise the financing necessary to invest in a project with a small positive NPV, should it do it?
If you ask senior corporate executives whether their firms’ stock prices are overvalued, undervalued, or fairly valued, which do you think would be the most common response? What does this have to
Use a “signaling” argument to explain why students return to school to pursue an MBA and why the market rewards individuals who obtain an MBA with higher salaries.
How might cash dividend payments serve as an effective signal of corporate profitability?
Use the table to answer the questions that follow.a. Assume that Emirates decides to use the proceeds from the bond issue to repurchase shares. How would you expect this decision to impact total
Parker Investments has interest expense of $6,000, and preferred dividends of $5,000. If it pays taxes at a rate of 37%, what is Parker’s degree of financial leverage (DFL) at a base level of EBIT
Optimal capital structure Hawaiian Macadamia Nut Company competes in an industry where the required return on assets rA, is 10%. Under M&M Proposition Two, what is the firm’s cost of equity,
Two firms, Secure Inc. and Gamble Corp. are identical except that they have different capital structures. Both companies expect to generate a net operating profit of$100,000 per year in perpetuity.
A firm with no debt expects to generate pretax net operating profit of $100,000 per year in perpetuity. The required return on assets for this firm is 10%, and it faces a corporate tax of 21%.a. What
How are the gains from leverage affected by a difference in the personal tax rates on stock versus interest income?
How do bankruptcy and agency costs alter the effect of financial leverage on firm value?
Is there a difference between direct and indirect bankruptcy costs? If yes, what is the difference?
Explain the pecking-order theory and its underlying assumptions.
According to the signaling model of capital structure, how should leverage affect firm value?
RC Media Inc. plans to issue debt and retire stock in order to lever up its currently unlevered financing. The recapitalization proposal is to issue $20,000,000 worth of new debt with a 5.0% interest
Recapitalization A proposed recapitalization plan for Focus Corporation would change its current all-equity capital structure to a leveraged capital structure. The proposal is for Focus to sell
Your corporation is currently all-equity financed with 400,000 shares of common stock selling for $32 a share. Currently your firm generates $4,000,000 in EBIT annually and has a 29% dividend payout
LexMart maintains a debt-to-equity ratio of 1.0 at all times. At the present time LexMart has $1,000 par value bonds outstanding that pay 9% annual interest. The firm also has 2.5 million shares of
Premier Stonework’s shareholders believe that paying off the company’s debt of $10 million with a new stock issue will improve their EPS. Premier’s EPS is currently $7.40. There are 1.6 million
An institutional investor believes that the company he has invested in should increase its leverage to improve the return on its stock. Currently the investor earns a return of 12% on a $7 million
At the beginning of the year you invest $40,000 of your own money plus $40,000 that you borrowed at 6% interest to purchase $80,000 worth of GoFast stock, which earns a return of 13%. You pay taxes
You operate an all-equity financed company in perfect markets and generate a net operating profit of $450,000. Your firm has just sold $1.8 million worth of 4% coupon rate bonds and plans to use the

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