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principles managerial finance
Principles Of Managerial Finance 7th Edition Lawrence J Gitman, Chad J Zutter - Solutions
P5–15 Time value and discount rates You just won a lottery that promises to pay you$1,000,000 exactly 10 years from today. Because the $1,000,000 payment is guaranteed by the state in which you live, opportunities exist to sell the claim today for an immediate single cash payment.a. What is the
P5–14 Time value An Iowa state savings bond can be converted to $100 at maturity 6 years from purchase. If the state bonds are to be competitive with U.S. savings bonds, which pay 8% annual interest (compounded annually), at what price must the state sell its bonds? Assume no cash payments on
P5–13 Time value Jim Nance has been offered an investment that will pay him $500 three years from today.a. If his opportunity cost is 7% compounded annually, what value should he place on this opportunity today?b. What is the most he should pay to purchase this payment today?c. If Jim can
P5–12 Present value concept Answer each of the following questions.a. What single investment made today, earning 12% annual interest, will be worth$6,000 at the end of 6 years?b. What is the present value of $6,000 to be received at the end of 6 years if the discount rate is 12%?c. What is the
P5–9 Single-payment loan repayment A person borrows $200 to be repaid in 8 years with 14% annually compounded interest. The loan may be repaid at the end of any earlier year with no prepayment penalty.a. What amount will be due if the loan is repaid at the end of year 1?b. What is the repayment
P5–8 Time value Misty needs to have $15,000 at the end of 5 years to fulfill her goal of purchasing a small sailboat. She is willing to invest a lump sum today and leave the money untouched for 5 years until it grows to $15,000, but she wonders what sort of investment return she will need to earn
P5–7 Time value You can deposit $10,000 into an account paying 9% annual interest either today or exactly 10 years from today. How much better off will you be at the end of 40 years if you decide to make the initial deposit today rather than 10 years from today?
P5–6 Time value As part of your financial planning, you wish to purchase a new car exactly 5 years from today. The car you wish to purchase costs $14,000 today, and your research indicates that its price will increase by 2% to 4% per year over the next 5 years.a. Estimate the price of the car at
P5–5 Time value You have $1,500 to invest today at 7% interest compounded annually.a. Find how much you will have accumulated in the account at the end of(1) 3 years, (2) 6 years, and (3) 9 years.b. Use your findings in part a to calculate the amount of interest earned in (1) the first 3 years
P5–3 Future value You have $100 to invest. If you can earn 12% interest, about how long does it take for your $100 investment to grow to $200? Suppose that the interest rate is just half that, at 6%. At half the interest rate, does it take twice as long to double your money? Why or why not? How
P5–1 Using a time line The financial manager at Starbuck Industries is considering an investment that requires an initial outlay of $25,000 and is expected to result in cash inflows of $3,000 at the end of year 1, $6,000 at the end of years 2 and 3,$10,000 at the end of year 4, $8,000 at the end
E5–6 Jack and Jill have just had their first child. If college is expected to cost $150,000 per year in 18 years, how much should the couple begin depositing annually at the end of each year to accumulate enough funds to pay the first year’s tuition at the beginning of the nineteenth year?
E5–5 Joseph is a friend of yours. He has plenty of money but little financial sense. He received a gift of $12,000 for his recent graduation and is looking for a bank in which to deposit the funds. Partners’ Savings Bank offers an account with an annual interest rate of 3% compounded
E5–3 Gabrielle just won $2.5 million in the state lottery. She is given the option of receiving a total of $1.3 million now, or she can elect to be paid $100,000 at the end of each of the next 25 years. If Gabrielle can earn 5% annually on her investments, from a strict economic point of view
E5–2 If Bob and Judy combine their savings of $1,260 and $975, respectively, and deposit this amount into an account that pays 2% annual interest, compounded monthly, what will the account balance be after 4 years?
E5–1 Assume that a firm makes a $2,500 deposit into its money market account. If this account is currently paying 0.7% (yes, that’s right, less than 1%!), what will the account balance be after 1 year?
ST5–4 Deposits needed to accumulate a future sum Judi Janson wishes to accumulate$8,000 by the end of 5 years by making equal, annual, end-of-year deposits over the next 5 years. If Judi can earn 7% on her investments, how much must she deposit at the end of each year to meet this goal?
ST5–2 Future values of annuities Ramesh Abdul wishes to choose the better of two equally costly cash flow streams: annuity X and annuity Y. X is an annuity due with a cash inflow of $9,000 for each of 6 years. Y is an ordinary annuity with a cash inflow of$10,000 for each of 6 years. Assume that
ST5–1 Future values for various compounding frequencies Delia Martin has $10,000 that she can deposit in any of three savings accounts for a 3-year period. Bank A compounds interest on an annual basis, bank B compounds interest twice each year, and bank C compounds interest each quarter. All
5-30 As a savvy finance major you realize that you can quickly estimate your retirement age by knowing how much you need to retire, how much you can contribute each month to your retirement account, and what rate of return you can earn on your retirement investment and solving for the number of
5-29 You want to buy a new car as a graduation present for yourself, but before finalizing a purchase you need to consider the monthly payment amount. Based on the information provided at MFL, find the monthly payment amount for the car you are considering.
5-28 How can you determine the unknown number of periods when you know the present and future values—single amount or annuity—and the applicable rate of interest?
5-27 Describe the procedure used to amortize a loan into a series of equal periodic payments.
5-26 How can you determine the size of the equal, annual, end-of-period deposits necessary to accumulate a certain future sum at the end of a specified future period at a given annual interest rate?
5-25 Rather than comparing future values, you often compare the effective annual rates of various investment opportunities with differing compounding frequencies. Based on the information provided at MFL, solve for the effective annual rates of several investment opportunities with different
5-24 What if your short term investments provide continuous compounding?Based on the information provided at MFL, determine the future value of an investment opportunity based on continuous compounding.
5-23 You are responsible for managing your company’s short term investments and you know that the compounding frequency of investment opportunities is quite important. Based on the information provided at MFL, calculate the future value of an investment opportunity based on various compounding
5-22 Differentiate between a nominal annual rate and an effective annual rate (EAR). Define annual percentage rate (APR) and annual percentage yield (APY).
5-21 How does the future value of a deposit subject to continuous compounding compare to the value obtained by annual compounding?
5-20 What effect does compounding interest more frequently than annually have on (a) future value and (b) the effective annual rate (EAR)? Why?
5-19 To give yourself a financial head start after college you have decided to work summer jobs and invest the money you earn until after graduation.You expect that your earnings each summer will vary depending on the job you get. Based on the information provided at MFL, find the value of your
5-18 How is the future value of a mixed stream of cash flows calculated?How is the present value of a mixed stream of cash flows calculated?
5-17 Rather than making contributions to an IRA at the end of each year, you decide to make equal contributions at the beginning of each year. Based on the information provided at MFL, solve for the future value of beginning-of-year annual IRA contributions grown until retirement.
5-16 You have just graduated from college, begun your new career, and now it is time to buy your first home. Based on the information provided at MFL, determine how much you can spend for your new dream home.
5-15 Since tax time comes around every year you smartly decide to make equal contributions to your IRA at the end of every year. Based on the information provided at MFL, calculate the future value of annual IRA contributions grown until retirement.
5-14 What is a perpetuity? Why is the present value of a perpetuity equal to the annual cash payment divided by the interest rate?
5-13 How can the formula for the present value of an ordinary annuity be modified to find the present value of an annuity due?
5-12 How can the formula for the future value of an annuity be modified to find the future value of an annuity due?
5-11 What are the most efficient ways to calculate the present value of an ordinary annuity?
5-10 What is the difference between an ordinary annuity and an annuity due?Which is more valuable? Why?
5–9 It is never too soon to begin investing for a child’s college education.Based on the information provided at MFL, determine the present value you would need to invest today to ensure that your child gets the college education she deserves.
5–8 It is tax time and you would like to make a tax deductible contribution to an Individual Retirement Account (IRA). Based on the information provided at MFL, find the future value of an IRA contribution grown until retirement.
5–7 How are present value and future value calculations related?
5–6 What effect does increasing the required return have on the present value of a future amount? Why?
5–5 What is meant by “the present value of a future amount”? What is the general equation for present value?
5–4 What effect would a decrease in the interest rate have on the future value of a deposit? What effect would an increase in the holding period have on future value?
5–3 How is the compounding process related to the payment of interest on savings? What is the general equation for future value?
5–2 Define and differentiate among the three basic patterns of cash flow:(1) a single amount, (2) an annuity, and (3) a mixed stream.
5–1 What is the difference between future value and present value? Which approach is generally preferred by financial managers? Why?
LG 6 Describe the procedures involved in (1)determining deposits needed to accumulate a future sum, (2) loan amortization, (3) finding interest or growth rates, and (4) finding an unknown number of periods.
LG 5 Understand the effect that compounding interest more frequently than annually has on future value and on the effective annual rate of interest.
LG 4 Calculate both the future value and the present value of a mixed stream of cash flows.
LG 3 Find the future value and the present value of both an ordinary annuity and an annuity due, and find the present value of a perpetuity.
LG 2 Understand the concepts of future value and present value, their calculation for single amounts, and the relationship between them.
LG 1 Discuss the role of time value in finance, the use of computational tools, and the basic patterns of cash flow.
P8–31 ETHICS PROBLEM Risk is a major concern of almost all investors. When shareholders invest their money in a firm, they expect managers to take risks with those funds. What do you think are the ethical limits that managers should observe when taking risks with other people’s money?
P8–29 Shifts in the security market line Assume that the risk-free rate, RF, is currently 8%;the market return, rm, is 12%; and asset A has a beta, bA, of 1.10.a. Draw the security market line (SML) on a set of “nondiversifiable risk (x axis)–required return (y axis)” axes.b. Use the CAPM
P8–28 Security market line (SML) Assume that the risk-free rate, RF, is currently 9% and that the market return, rm, is currently 13%.a. Draw the security market line (SML) on a set of “nondiversifiable risk (x axis)–required return (y axis)” axes.b. Calculate and label the market risk
P8–26 Manipulating CAPM Use the basic equation for the capital asset pricing model(CAPM) to work each of the following problems.a. Find the required return for an asset with a beta of 0.90 when the risk-free rate and market return are 8% and 12%, respectively.b. Find the risk-free rate for a firm
P8–25 Beta coefficients and the capital asset pricing model Katherine Wilson is wondering how much risk she must undertake to generate an acceptable return on her portfolio.The risk-free return currently is 5%. The return on the overall stock market is 16%. Use the CAPM to calculate how high the
P8–22 Betas and risk rankings You are considering three stocks—A, B, and C—for possible inclusion in your investment portfolio. Stock A has a beta of 0.80, stock B has a beta of 1.40, and stock C has a beta of -0.30.a. Rank these stocks from the most risky to the least risky.b. If the return
P8–20 Interpreting beta A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20.a. If the market return increased by 15%, what impact would this change be expected to have on the asset’s return?b. If the market return decreased by 8%, what impact
P8–16 International investment returns Joe Martinez, a U.S. citizen living in Brownsville, Texas, invested in the common stock of Telmex, a Mexican corporation. He purchased 1,000 shares at 20.50 pesos per share. Twelve months later, he sold them at 24.75 pesos per share. He received no dividends
P8–12 Normal probability distribution Assuming that the rates of return associated with a given asset investment are normally distributed; that the expected return, r, is 18.9%;and that the coefficient of variation, CV, is 0.75; answer the following questions.a. Find the standard deviation of
P8–1 Rate of return Douglas Keel, a financial analyst for Orange Industries, wishes to estimate the rate of return for two similar-risk investments, X and Y. Douglas’s research indicates that the immediate past returns will serve as reasonable estimates of future returns. A year earlier,
E8–6a. Calculate the required rate of return for an asset that has a beta of 1.8, given a risk-free rate of 5% and a market return of 10%.b. If investors have become more risk-averse due to recent geopolitical events and the market return rises to 13%, what is the required rate of return for the
E8–4 Your portfolio has three asset classes. U.S. government T-bills account for 45% of the portfolio, large-company stocks constitute another 40%, and small-company stocks make up the remaining 15%. If the expected returns are 3.8% for the T-bills, 12.3% for the large-company stocks, and 17.4%
E8–3 The expected annual returns are 15% for investment 1 and 12% for investment 2. The standard deviation of the first investment’s return is 10%; the second investment’s return has a standard deviation of 5%. Which investment is less risky based solely on standard deviation? Which
E8–2 Four analysts cover the stock of Fluorine Chemical. One forecasts a 5% return for the coming year. The second expects the return to be negative 5%. The third predicts a 10% return. The fourth expects a 3% return in the coming year. You are relatively confident that the return will be
E8–1 An analyst predicted last year that the stock of Logistics, Inc., would offer a total return of at least 10% in the coming year. At the beginning of the year, the firm had a stock market value of $10 million. At the end of the year, it had a market value of $12 million even though it
ST8–2 Beta and CAPM Currently under consideration is an investment with a beta,b, of 1.50. At this time, the risk-free rate of return, RF, is 7%, and the return on the market portfolio of assets, rm, is 10%. You believe that this investment will earn an annual rate of return of 11%.a. If the
8–14 What impact would the following changes have on the security market line and therefore on the required return for a given level of risk? (a)An increase in inflationary expectations. (b) Investors become less riskaverse.
8–13 Explain the meaning of each variable in the capital asset pricing model(CAPM) equation. What is the security market line (SML)?
8–12 What risk does beta measure? How can you find the beta of a portfolio?
8–11 How are total risk, nondiversifiable risk, and diversifiable risk related?Why is nondiversifiable risk the only relevant risk?
8–10 How does international diversification enhance risk reduction? When might international diversification result in subpar returns? What are political risks, and how do they affect international diversification?
8–9 Why is the correlation between asset returns important? How does diversification allow risky assets to be combined so that the risk of the portfolio is less than the risk of the individual assets in it?
8–8 What is an efficient portfolio? How can the return and standard deviation of a portfolio be determined?
8–7 What does the coefficient of variation reveal about an investment’s risk that the standard deviation does not?
8–6 What relationship exists between the size of the standard deviation and the degree of asset risk?
8–5 What does a plot of the probability distribution of outcomes show a decision maker about an asset’s risk?
8–4 Explain how the range is used in scenario analysis.
8-3 Compare the following risk preferences: (a) risk averse, (b) risk neutral, and (c) risk seeking. Which risk preference is most common among financial managers?
8-2 Define return, and describe how to find the rate of return on an investment.
8-1 What is risk in the context of financial decision making?
1.. What are some hazards of allowing investors to pursue claims based on their most recent account statements? For many years, investors around the world clamored to invest with Bernard Madoff. Those fortunate enough to invest with “Bernie” might not have understood his secret trading system,
LG 6 Explain the capital asset pricing model (CAPM), its relationship to the security market line (SML), and the major forces causing shifts in the SML.
LG 5 Review the two types of risk and the derivation and role of beta in measuring the relevant risk of both a security and a portfolio.
LG 4 Understand the risk and return characteristics of a portfolio in terms of correlation and diversification and the impact of international assets on a portfolio.
LG 3 Discuss the measurement of return and standard deviation for a portfolio and the concept of correlation.
LG 2 Describe procedures for assessing and measuring the risk of a single asset.
LG 1 Understand the meaning and fundamentals of risk, return, and risk preferences.
1.. You are interested in purchasing the common stock of Azure Corporation. The firm recently paid a dividend of $3 per share. It expects its earnings—and hence its dividends—to grow at a rate of 7% for the foreseeable future. Currently, similar-risk stocks have required returns of 10%.TO DOa.
P7–24 ETHICS PROBLEM Melissa is trying to value Generic Utility, Inc.’s, stock, which is clearly not growing at all. Generic declared and paid a $5 dividend last year. The required rate of return for utility stocks is 11%, but Melissa is unsure about the financial reporting integrity of
P7–21 Integrative: Risk and valuation Given the following information for the stock of Foster Company, calculate the risk premium on its common stock.Current price per share of common $50.00 Expected dividend per share next year $ 3.00 Constant annual dividend growth rate 9%Risk-free rate of
P7–20 Management action and stock value REH Corporation’s most recent dividend was$3 per share, its expected annual rate of dividend growth is 5%, and the required return is now 15%. A variety of proposals are being considered by management to redirect the firm’s activities. Determine the
P7–15 Common stock value: All growth models You are evaluating the potential purchase of a small business currently generating $42,500 of after-tax cash flow(D0 = $42,500). On the basis of a review of similar-risk investment opportunities, you must earn an 18% rate of return on the proposed
P7–14 Common stock value: Variable growth Lawrence Industries’ most recent annual dividend was $1.80 per share (D0 = $1.80), and the firm’s required return is 11%.Find the market value of Lawrence’s shares when:a. Dividends are expected to grow at 8% annually for 3 years, followed by a
P7–13 Common stock value: Variable growth Home Place Hotels, Inc., is entering into a 3-year remodeling and expansion project. The construction will have a limiting effect on earnings during that time, but when it is complete, it should allow the company to enjoy much improved growth in earnings
P7–12 Common stock value: Variable growth Newman Manufacturing is considering a cash purchase of the stock of Grips Tool. During the year just completed, Grips earned $4.25 per share and paid cash dividends of $2.55 per share (D0 5 2.55).Grips’ earnings and dividends are expected to grow at 25%
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