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principles managerial finance

Principles Of Managerial Finance 7th Edition Lawrence J Gitman, Chad J Zutter - Solutions

LG 6 Explain stock splits and the firm’s motivation for undertaking them.
LG 5 Evaluate stock dividends from accounting, shareholder, and company points of view.
LG 4 Review and evaluate the three basic types of dividend policies.
LG 3 Discuss the key factors involved in establishing a dividend policy.
LG 2 Describe the residual theory of dividends and the key arguments with regard to dividend irrelevance and relevance.
LG 1 Understand cash payout procedures, their tax treatment, and the role of dividend reinvestment plans.
P10–19 NPV and IRR Benson Designs has prepared the following estimates for a long-term project it is considering. The initial investment is $18,250, and the project is expected to yield after-tax cash inflows of $4,000 per year for 7 years. The firm has a 10% cost of capital.a. Determine the net
P10–18 IRR, investment life, and cash inflows Oak Enterprises accepts projects earning more than the firm’s 15% cost of capital. Oak is currently considering a 10-year project that provides annual cash inflows of $10,000 and requires an initial investment of $61,450. (Note: All amounts are
P10–17 Long-term investment decision, IRR method Billy and Mandy Jones have $25,000 to invest. On average, they do not make any investment that will not return at least 7.5% per year. They have been approached with an investment opportunity that requires$25,000 up front and has a payout of $6,000
P10–15 Internal rate of return Peace of Mind, Inc. (PMI), sells extended warranties for durable consumer goods such as washing machines and refrigerators. When PMI sells an extended warranty, it receives cash up front from the customer, but later PMI must cover any repair costs that arise. An
P10–13 NPV and EVA A project costs $2,500,000 up front and will generate cash flows in perpetuity of $240,000. The firm’s cost of capital is 9%.a. Calculate the project’s NPV.b. Calculate the annual EVA in a typical year.c. Calculate the overall project EVA and compare to your answer in part
P10–11 Long-term investment decision, NPV method Jenny Jenks has researched the financial pros and cons of entering into a 1-year MBA program at her state university. The tuition and books for the master’s program will have an up-front cost of $50,000. If she enrolls in an MBA program, Jenny
P10–9 NPV and maximum return A firm can purchase new equipment for a $150,000 initial investment.The equipment generates an annual after-tax cash inflow of $44,400 for 4 years.a. Determine the net present value (NPV) of the equipment, assuming that the firm has a 10% cost of capital. Is the
P10–8 NPV Simes Innovations, Inc., is negotiating to purchase exclusive rights to manufacture and market a solar-powered toy car. The car’s inventor has offered Simes the choice of either a one-time payment of $1,500,000 today or a series of five year-end payments of $385,000.a. If Simes has a
P10–6 NPV for varying costs of capital Dane Cosmetics is evaluating a new fragrancemixing machine. The machine requires an initial investment of $24,000 and will generate after-tax cash inflows of $5,000 per year for 8 years. For each of the costs of capital listed, (1) calculate the net present
P10–5 NPV Calculate the net present value (NPV) for the following 15-year projects. Comment on the acceptability of each. Assume that the firm has a cost of capital of 9%.a. Initial investment is $1,000,000; cash inflows are $150,000 per year.b. Initial investment is $2,500,000; cash inflows are
P10–4 Long-term investment decision, payback method Bill Williams has the opportunity to invest in project A that costs $9,000 today and promises to pay annual end-ofyear payments of $2,200, $2,500, $2,500, $2,000, and $1,800 over the next 5 years.Or, Bill can invest $9,000 in project B that
P10–2 Payback comparisons Nova Products has a 5-year maximum acceptable payback period. The firm is considering the purchase of a new machine and must choose between two alternative ones. The first machine requires an initial investment of$14,000 and generates annual after-tax cash inflows of
P10–1 Payback period Jordan Enterprises is considering a capital expenditure that requires an initial investment of $42,000 and returns after-tax cash inflows of $7,000 per year for 10 years. The firm has a maximum acceptable payback period of 8 years.a. Determine the payback period for this
E10–4 Billabong Tech uses the internal rate of return (IRR) to select projects. Calculate the IRR for each of the following projects and recommend the best project based on this measure. Project T-Shirt requires an initial investment of $15,000 and generates cash inflows of $8,000 per year for 4
E10–3 Axis Corp. is considering investment in the best of two mutually exclusive projects.Project Kelvin involves an overhaul of the existing system; it will cost $45,000 and generate cash inflows of $20,000 per year for the next 3 years. Project Thompson involves replacement of the existing
1.. What are the potential risks to a company of unethical behaviors by employees? What are potential risks to the public and to stakeholders? Corporate ethics codes are often faulted for being “window dressing,” for having little or no effect on actual behavior.Financial ethics expert John
10–13 Does the assumption concerning the reinvestment of intermediate cash inflow tend to favor NPV or IRR? In practice, which technique is preferred and why?
10–12 How is a net present value profile used to compare projects? What causes conflicts in the ranking of projects via net present value and internal rate of return?
10–11 In addition to using NPV to evaluate projects, most firms also use IRR.Based on the information provided at MFL, use a spreadsheet to rank various projects based on their IRRs.
10–10 Do the net present value (NPV) and internal rate of return (IRR) always agree with respect to accept–reject decisions? With respect to ranking decisions? Explain.
10–9 What are the acceptance criteria for IRR? How are they related to the firm’s market value?
10–8 What is the internal rate of return (IRR) on an investment? How is it determined?
10–7 Almost all firms have to deal with limited financial resources and therefore cannot undertake all positive NPV projects. Based on the information provided at MFL, use a spreadsheet to rank various projects based on their NPVs
10–6 Explain the similarities and differences between NPV, PI, and EVA.
10–5 What are the acceptance criteria for NPV? How are they related to the firm’s market value?
10–4 How is the net present value (NPV) calculated for a project with a conventional cash flow pattern?
10–3 What weaknesses are commonly associated with the use of the payback period to evaluate a proposed investment?
10–2 What is the payback period? How is it calculated?
10–1 What is the financial manager’s goal in selecting investment projects for the firm? Define the capital budgeting process, and explain how it helps managers achieve their goal.
LG 6 Discuss NPV and IRR in terms of conflicting rankings and the theoretical and practical strengths of each approach.
LG 5 Use net present value profiles to compare NPV and IRR techniques.
LG 4 Calculate, interpret, and evaluate the internal rate of return (IRR).
LG 3 Calculate, interpret, and evaluate the net present value (NPV) and economic value added(EVA).
LG 2 Calculate, interpret, and evaluate the payback period.
LG 1 Understand the key elements of the capital budgeting process.
P9–21 ETHICS PROBLEM During the 1990s, General Electric put together a long string of consecutive quarters in which the firm managed to meet or beat the earnings forecasts of Wall Street stock analysts. Some skeptics wondered if GE “managed” earnings to meet Wall Street’s expectations,
P9–20 Weighted average cost of capital American Exploration, Inc., a natural gas producer, is trying to decide whether to revise its target capital structure. Currently, it targets a 50–50 mix of debt and equity, but it is considering a target capital structure with 70% debt. American
P9–16 Cost of capital Edna Recording Studios, Inc., reported earnings available to common stock of $4,200,000 last year. From those earnings, the company paid a dividend of $1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company includes 40% debt, 10%
P9–12 The effect of tax rate on WACC K. Bell Jewelers 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 structure of 40% debt, 10% preferred stock, and 50% common stock. The cost of financing with retained
P9–9 Cost of common stock equity: CAPM J&M Corporation common stock has a beta,b, of 1.2. The risk-free rate is 6%, and the market return is 11%.a. Determine the risk premium on J&M common stock.b. Determine the required return that J&M common stock should provide.
P9–7 Cost of preferred stock Taylor Systems has just issued preferred stock. The stock has a 12% annual dividend and a $100 par value and was sold at $97.50 per share.In addition, flotation costs of $2.50 per share must be paid.a. Calculate the cost of the preferred stock.b. If the firm sells the
P9–6 After-tax cost of debt Bella Wans is interested in buying a new motorcycle. She has decided to borrow money to pay the $25,000 purchase price of the bike. She is in the 25% federal income tax bracket. She can either borrow the money at an interest rate of 5% from the motorcycle dealer, or
P9–2 Cost of debt using both methods Currently, Warren Industries can sell 15-year,$1,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for $1,010 each; flotation costs of$30 per bond will be incurred in this process. The
E9–5 Oxy Corporation uses debt, preferred stock, and common stock to raise capital. The firm’s capital structure targets the following proportions: debt, 55%; preferred stock, 10%; and common stock, 35%. If the cost of debt is 6.7%, preferred stock costs 9.2%, and common stock costs 10.6%, what
E9–4 Weekend Warriors, Inc., has 35% debt and 65% equity in its capital structure. The firm’s estimated after-tax cost of debt is 8% and its estimated cost of equity is 13%.Determine the firm’s weighted average cost of capital (WACC).
E9–3 Duke Energy has been paying dividends steadily for 20 years. During that time, dividends have grown at a compound annual rate of 7%. If Duke Energy’s current stock price is $78 and the firm plans to pay a dividend of $6.50 next year, what is Duke’s cost of common stock equity?
E9–2 Your firm, People’s Consulting Group, has been asked to consult on a potential preferred stock offering by Brave New World. This 15% preferred stock issue would be sold at its par value of $35 per share. Flotation costs would total $3 per share.Calculate the cost of this preferred stock.
E9–1 A firm raises capital by selling $20,000 worth of debt with flotation costs equal to 2% of its par value. If the debt matures in 10 years and has a coupon interest rate of 8%, what is the bond’s YTM?
1.. Why don’t firms generally use both short- and long-run weighted average costs of capital? As U.S. financial markets experienced and recovered from the 2008 financial crisis and 2009 “great recession,” firms struggled to keep track of their weighted average cost of capital. The individual
9-15 Describe the logic underlying the use of target weights to calculate the WACC, and compare and contrast this approach with the use of historical weights. What is the preferred weighting scheme?
9-14 What is the relationship between the firm’s target capital structure and the weighted average cost of capital (WACC)?
9-13 What is the weighted average cost of capital (WACC), and how is it calculated?
9–12 Why is the cost of financing a project with retained earnings less than the cost of financing it with a new issue of common stock?
9–11 How do the constant-growth valuation model and capital asset pricing model methods for finding the cost of common stock differ?
9–10 What premise about share value underlies the constant-growth valuation(Gordon growth) model that is used to measure the cost of common stock equity, rs?
9-9 How would you calculate the cost of preferred stock?
9-8 The interest expense on debt provides a tax deduction for the issuer so any calculation of a firm’s net cost of debt should reflect this benefit.
9-7 How is the before-tax cost of debt converted into the after-tax cost?
9-6 What methods can be used to find the before-tax cost of debt?
9-5 What are the net proceeds from the sale of a bond? What are flotation costs, and how do they affect a bond’s net proceeds?
9–4 What are the typical sources of long-term capital available to the firm?
9–3 What does the firm’s capital structure represent?
9–2 What role does the cost of capital play in the firm’s long-term investment decisions? How does it relate to the firm’s ability to maximize shareholder wealth?
9–1 What is the cost of capital?
LG 6 Calculate the weighted average cost of capital(WACC), and discuss alternative weighting schemes.
LG 5 Calculate the cost of common stock equity, and convert it into the cost of retained earnings and the cost of new issues of common stock.
LG 4 Determine the cost of preferred stock.
LG 3 Determine the cost of long-term debt, and explain why the after-tax cost of debt is the relevant cost of debt.
LG 2 Explain what is meant by the marginal cost of capital.
LG 1 Understand the basic concept and sources of capital associated with the cost of capital.
P5–62 ETHICS PROBLEM A manager at a “Check Into Cash” business defends his business practice as simply “charging what the market will bear.” “After all,” says the manager,“we don’t force people to come in the door.” How would you respond to this ethical defense of the
P5–61 Time to repay installment loan Mia Salto wishes to determine how long it will take to repay a loan with initial proceeds of $14,000 where annual end-of-year installment payments of $2,450 are required.a. If Mia can borrow at a 12% annual rate of interest, how long will it take for her to
P5–59 Time to accumulate a given sum Manuel Rios wishes to determine how long it will take an initial deposit of $10,000 to double.a. If Manuel earns 10% annual interest on the deposit, how long will it take for him to double his money?b. How long will it take if he earns only 7% annual
P5–56 Interest rate for an annuity Anna Waldheim was seriously injured in an industrial accident. She sued the responsible parties and was awarded a judgment of$2,000,000. Today, she and her attorney are attending a settlement conference with the defendants. The defendants have made an initial
P5–54 Rate of return: Annuity What is the rate of return on an investment of $10,606 if the company will receive $2,000 each year for the next 10 years?
P5–50 Monthly loan payments Tim Smith is shopping for a used car. He has found one priced at $4,500. The dealer has told Tim that if he can come up with a down payment of $500, the dealer will finance the balance of the price at a 12% annual rate over 2 years (24 months).a. Assuming that Tim
P5–49 Loan interest deductions Liz Rogers just closed a $10,000 business loan that is to be repaid in three equal, annual, end-of-year payments. The interest rate on the loan is 13%. As part of her firm’s detailed financial planning, Liz wishes to determine the annual interest deduction
P5–48 Loan amortization schedule Joan Messineo borrowed $15,000 at a 14% annual rate of interest to be repaid over 3 years. The loan is amortized into three equal, annual, end-of-year payments.a. Calculate the annual, end-of-year loan payment.b. Prepare a loan amortization schedule showing the
P5–46 Inflation, time value, and annual deposits While vacationing in Florida, John Kelley saw the vacation home of his dreams. It was listed with a sale price of$200,000. The only catch is that John is 40 years old and plans to continue working until he is 65. Still, he believes that prices
P5–45 Deposits to create a perpetuity You have decided to endow your favorite university with a scholarship. It is expected to cost $6,000 per year to attend the university into perpetuity. You expect to give the university the endowment in 10 years and will accumulate it by making equal annual
P5–44 Accumulating a growing future sum A retirement home at Deer Trail Estates now costs $185,000. Inflation is expected to cause this price to increase at 6%per year over the 20 years before C. L. Donovan retires. How large an equal, annual, end-of-year deposit must be made each year into an
P5–43 Creating a retirement fund To supplement your planned retirement in exactly 42 years, you estimate that you need to accumulate $220,000 by the end of 42 years from today. You plan to make equal, annual, end-of-year deposits into an account paying 8% annual interest.a. How large must the
P5–41 Annuities and compounding Janet Boyle intends to deposit $300 per year in a credit union for the next 10 years, and the credit union pays an annual interest rate of 8%.a. Determine the future value that Janet will have at the end of 10 years, given that end-of-period deposits are made and
P5–40 Comparing compounding periods René Levin wishes to determine the future value at the end of 2 years of a $15,000 deposit made today into an account paying a nominal annual rate of 12%.a. Find the future value of René’s deposit, assuming that interest is compounded(1) annually, (2)
P5–39 Compounding frequency and time value You plan to invest $2,000 in an individual retirement arrangement (IRA) today at a nominal annual rate of 8%, which is expected to apply to all future years.a. How much will you have in the account at the end of 10 years if interest is compounded (1)
P5–36 Changing compounding frequency Using annual, semiannual, and quarterly compounding periods for each of the following, (1) calculate the future value if $5,000 is deposited initially, and (2) determine the effective annual rate (EAR).a. At 12% annual interest for 5 years.b. At 16% annual
P5–32 Value of a mixed stream Harte Systems, Inc., a maker of electronic surveillance equipment, is considering selling to a well-known hardware chain the rights to market its home security system. The proposed deal calls for the hardware chain to pay Harte $30,000 and $25,000 at the end of years
P5–27 Creating an endowment On completion of her introductory finance course, Marla Lee was so pleased with the amount of useful and interesting knowledge she gained that she convinced her parents, who were wealthy alumni of the university she was attending, to create an endowment. The endowment
P5–25 Value of an annuity versus a single amount Assume that you just won the state lottery.Your prize can be taken either in the form of $40,000 at the end of each of the next 25 years (that is, $1,000,000 over 25 years) or as a single amount of $500,000 paid immediately.a. If you expect to be
P5–24 Funding your retirement You plan to retire in exactly 20 years. Your goal is to create a fund that will allow you to receive $20,000 at the end of each year for the 30 years between retirement and death (a psychic told you that you would die exactly 30 years after you retire). You know that
P5–23 Value of a retirement annuity An insurance agent is trying to sell you an immediate retirement annuity, which for a single amount paid today will provide you with$12,000 at the end of each year for the next 25 years. You currently earn 9% on low-risk investments comparable to the retirement
P5–22 Retirement planning Hal Thomas, a 25-year-old college graduate, wishes to retire at age 65. To supplement other sources of retirement income, he can deposit $2,000 each year into a tax-deferred individual retirement arrangement (IRA). The IRA will earn a 10% return over the next 40 years.a.
P5–21 Time value: Annuities Marian Kirk wishes to select the better of two 10-year annuities, C and D. Annuity C is an ordinary annuity of $2,500 per year for 10 years. Annuity D is an annuity due of $2,200 per year for 10 years.a. Find the future value of both annuities at the end of year 10
P5–18 Calculating deposit needed You put $10,000 in an account earning 5%. After 3 years, you make another deposit into the same account. Four years later (that is, 7 years after your original $10,000 deposit), the account balance is $20,000. What was the amount of the deposit at the end of year

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