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strategy in practice
Financial Markets And Corporate Strategy 2nd Edition Mark Grinblatt, Sheridan Titman - Solutions
14.5. As owner of 10 percent of ABC Industries, you have control of its capital structure decision. The current corporate tax rate is 34 percent and your personal tax rate is 31 percent. Assume that the returns to stockholders accrue as nontaxable capital gains. ABC currently has no debt and can
14.4. Assume that the real riskless interest rate is zero and the corporate tax rate is 33 percent. IGWT Industries can borrow at the riskless interest rate.It will have an inflation-adjusted EBIT next year of $200 million. It would like to borrow $50 million today. Its only deductions will be
14.3. Suppose the firm in exercise 14.2 unexpectedly announces that it will issue additional debt, with the same seniority as existing debt and a face value of $50. The firm will use the entire proceeds to repurchase some of the outstanding shares.a. What is the market price of the new debt?b. Just
14.2. Consider a single period binomial setting where the riskless interest rate is zero, and there are no taxes. A firm consists of a machine that will produce cash flows of $210 if the economy is good and $80 if the economy is bad. The good and bad states occur with equal risk-neutral
14.1. Suppose rD 12%, 10%, Tc 33%, TD 20%.a. What is the marginal tax rate on stock income TE which would make an investor indifferent in terms of after-tax returns between holding stock or bonds? Assume all betas are zero.b. What is the probability that a firm will not utilize its tax
13.16. Akron, from the last example, is considering an exchange offer where half of Akron’s outstanding debt ($25 million) is retired. The purchase of this debt would be financed by issuing $25 million in equity to the debt holders of Akron. Assuming debt policy that is consistent with the Hamada
13.15. The Akron Company consists of $50 million in perpetual riskless debt and $50 million in equity.The current market value of its assets is $100 million and the beta of its equity return is 1.2.Assume the risk-free rate is 8 percent, the expected return of the market portfolio is 13 percent per
13.14. SL, Inc., is currently an all equity-firm with a beta of equity of 1. The risk-free rate is 5 percent and the market risk premium is 8 percent. Assume the CAPM is true and that there are no taxes. What is the company’s weighted average cost of capital? If management levers the company at a
13.13. Applied Micro Devices (AMD) currently spends$213,333 a year leasing office space in Austin.Because lease payments are tax deductible at a 25 percent corporate tax rate, the firm spends about$160,000 per year [5 $213,333 3 (1 2 .25)] on an after-tax basis to lease the building. The firm has
13.12. Use the risk-neutral valuation method to directly show that the risk-neutral discounted value of the existing debt of Unitron is $636,000 higher if the project in Example 13.17 is adopted.
13.11. Compute the net present value of the mold in Example 13.4, assuming that the debt capacity of the project is zero.
13.10. The HTT Company is considering a new product.The new product has a five-year life. Sales and net income after taxes for the new product are estimated in the following table:The equipment to produce the new product costs $500,000. The $500,000 would be borrowed at a risk-free interest rate of
13.9. GT Associates have plans to start a widget company financed with 60 percent debt and 40 percent equity. Other widget companies are financed with 25 percent debt and 75 percent equity and have equity betas of 1.5. GT’s borrowing costs will be 14 percent, the risk-free rate is 8 percent, and
13.15. If they are not the same, you made a mistake.
13.8. Compute the WACC of Marriott’s restaurant division in Example 13.15 by doing the following:a. Compute the E of Marriott’s restaurant division using equation (13.6).b. Apply the CAPM’s risk expected return equation to obtain the restaurant , assuming a risk-free rate of 4 percent and a
13.7. Apply the APV method. First, compute the value of the unlevered assets of the Hughes acquisition.Next, compute the present value of the tax shield.Finally, add the two numbers.
13.6. Compute the value of Hughes if the WACC of GM at its existing leverage ratio is used instead of the WACC computed from the comparison firms (see exercise 13.4).
13.5. Compute the value of Hughes with the WACC from exercise 13.4.
13.4. Compute the WACC for the Hughes acquisition.
13.3. Compute the E for the Hughes acquisition at the target debt level.
13.2. Compute UA, the beta of the unlevered assets of the Hughes acquisition, by taking the average of the betas of the unlevered assets of Lockheed and Northrop.
13.1. Analyze the Hughes acquisition by first computing the betas of the comparison firms, Lockheed and Northrop, as if they were all equity financed. Hint:Use equation (13.7) to obtain UA from E.
12.12. In Example 12.11, assuming that the stock per share and the firm’s operations do not change as a consequence of the leveraged recapitalizationa. Identify the dividend yield both before and after the leveraged recapitalization.b. Identify after the leveraged recapitalization.c. Identify g
12.11. Solve the unlevered price/earnings ratio, A/X, by rearranging equation (12.1).
12.10. Porter and Spence (1982) pointed out that firms may want to overinvest in production capacity to show a commitment to maintain their market share to competitors. In their model, excess plant capacity would not be a positive net present value project if the cash flow calculations take the
12.9. Example 12.9 illustrates how an increase in leverage can affect Micro Technologies’price/earnings ratio. If the interest rate on the new debt was 2 percent rather than 6 percent, would the firm’s price/earnings ratio increase or decrease?
12.8. Although there is no empirical evidence to strongly support this hypothesis, some financial journalists have claimed that American managers are shortsighted and overly risk averse, preferring to take on relatively safe projects that pay off quickly instead of taking on longer-term projects
12.7. Compute the risk-neutral probabilities attached to the two states—high demand and low demand—in Example 12.2. Show that applying these probabilities to value the mine provides the same answer for valuing the outcomes in scenarios 1 and 2 as given in Example 12.2.
12.6. Assume that the futures closing prices on the New York Mercantile Exchange at the end of August 2002 specify that futures prices per barrel for light sweet crude oil delivered monthly from mid-October 2002 through mid-December 2004 are, respectively, $21.56, $21.08, $20.63, $20.23,$19.88,
12.5. Widget production and sales take place over a oneyear cycle. For simplicity, assume that all costs(revenues) are paid (received) at the end of the one-year cycle.A factory with a life of three years (from today)has a capacity to produce 1 million widgets each year (which are to be sold at the
12.4. A silver mine has reserves of 25,000 troy ounces of silver. For simplicity, assume the following schedule for extraction, ore purification, and sale of the silver ore:Also assume the following:• The mine, which will exhaust its supply of silver ore in two years, is assumed to have no
12.3. Vacant land has been zoned for either one 10,000-square-foot five-unit condominium or two single-family homes, each with 3,000 square feet.The cost of constructing the single-family homes is $100 per square foot and the cost of constructing the condominium is $120 per square foot. If the real
12.2. The XYZ firm can invest in a new DRAM chip factory for $425 million. The factory, which must be invested in today, has cash flows two years from now that depend on the state of the economy.The cash flows when the factory is running at full capacity are described by the following tree
12.1. Maytag merges with Whirlpool. Assume that Maytag’s price/earnings ratio is 20 and Whirlpool’s is 15. If Maytag accounts for 60 percent of the earnings of the merged firm, and if there are no synergies between the two merged firms, what is the price/earnings ratio of the merged firm?
11.16. Risk-free rates at horizons of one year, two years, and three years are 6.00 percent per year, 6.25 percent per year, and 6.75 percent per year, respectively. The manager of the space shuttle at Rockwell International forecasts respective cash flows of $200 million, $250 million, and $300
11.15. In a two-factor APT model, Dell Computer has a factor beta of 1.15 on the first factor portfolio, which is highly correlated with the change in GDP, and a factor beta of .3 on the second factor portfolio, which is highly correlated with interest rate changes. If the risk-free rate is 5
11.14. Compute the value of Hughes if GM’s cost of capital is used as a discount rate instead of the cost of capital computed from the comparison firms.
11.13. Compute the value of Hughes with the cost of capital estimated in exercise 11.12.
11.12. Compute the cost of capital for the Hughes acquisition, assuming no taxes.
11.11. Compute the beta of the assets of the Hughes acquisition, assuming no taxes, by taking the average of the asset betas of Lockheed and Northrop.
11.10. Analyze the Hughes acquisition (which took place) by first computing the betas of the comparison firms, Lockheed and Northrop, as if they were all equity financed. Assume no taxes.
11.9. Explain intuitively why the certainty equivalent of a cash flow with a negative beta exceeds the cash flow’s expected value.
11.8. In Section 11.3’s illustration, asset values increased 10 percent from 2001 to 2002, from$100 million to $110 million.a. Compute the percentage increase in the value of equity if the firm is financed with $50 million in debt.b. Compute the leverage ratio of this firm in 2002.
11.6. Explain why the answer to exercise 11.5 differs from the answer in Example 11.2.11.7. Start with the risk-adjusted discount rate formula.Derive the certainty equivalent formula by rearranging terms and noting that b PV.
11.5. Discount your answer in exercise 11.4 at a riskfree rate of 4 percent per year to obtain the present value.
11.4. Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, find the certainty equivalent of the year 1 cash flow. What are the advantages and disadvantages of using such historical data for market
11.3. Find the covariance of the cash flow with the market return and its cash flow beta.
11.2. Compute the expected year 1 restaurant cash flow for Marriott.
11.1. A project has an expected cash flow of $1 million one year from now. The standard deviation of this cash flow is $250,000. If the expected return of the market portfolio is 10 percent, the risk-free rate is 5 percent, the standard deviation of the market return is 5 percent, and the
10A.3. Compute spot yields and annuity yields for years 1, 2, 3, and 4 if par yields for years 1, 2, 3, and 4 are, respectively, 4.5 percent, 5 percent, 5.25 percent, and 5.25 percent. Assume annual compounding for all rates and annual payments for all bonds.
10A.2. Compute annuity yields and par yields for years 1, 2, and 3 if spot yields for years 1, 2, and 3 are respectively 4.5 percent, 5 percent, and 5.25 percent. Assume annual compounding for all rates and annual payments for all bonds.
10A.1. A zero-coupon bond maturing two years from now has a yield to maturity of 8 percent (annual compounding). Another zero-coupon bond with the same maturity date has a yield to maturity of 10 percent (annual compounding). Both bonds have a face value of $100.a. What are the prices of the
10.9. Investco, a West Coast research company, must decide on the level of computer technology it will buy for its analysis department. Package A, a midlevel technology, would cost $2.5 million for firmwide installation, while package B, a higherlevel technology, would cost $3.5 million.Equipped
10.8. ABC Metalworks wants to determine which model sheetcutter to purchase. Three choices are available,(1) machine 1 costs the least but must be replaced the most frequently, (2) machine 2 has average cost and average lifespan, and (3) machine 3 costs the most but needs only infrequent
10.7. As a regional managing director of Finco, a U.S.-based investment company, your mandate is to scour the Midwest in search of promising investment opportunities and to recommend one project to corporate headquarters in Los Angeles.Your analysts have screened thousands of prospective ventures
10.6. Consider the cash flows associated with undertaking project X.a. Is this an early or later cash flow stream?b. Based on the term structure of interest rates in exercise 10.5, what is the hurdle rate? What does such a hurdle rate represent?c. Calculate the IRR for project X.d. Based on the
10.5. Let Bt price per $100 of face value of a zerocoupon bond maturing at year t. Then, if B1 $94.00, B2 $88.20, B3 $81.50, B4 $76.00, and B5 $73.00, implying that the term structure of interest rates is no longer flat:a. Determine zero-coupon rates for years 1 through 5 to the nearest
10.4. Describe the equivalent tracking portfolio for project X, giving long and short positions and amounts, under a flat term structure of 8 percent, compounded annually. Conceptually, why are we interested in tracking project X’s cash flows with a portfolio of marketable securities?
10.3. Respond to parts a through d.a. What are the incremental cash flows associated with Small Corp.’s undertaking project X? Are these inflows or outflows, costs or revenue?b. What is the PV of project X under a flat term structure of 8 percent, compounded annually, irrespective of maturity?c.
10.2. The Wheatena Company is considering the purchase of a new milling machine. What purchase price makes the NPV of the project zero? Base your analysis on the following facts:• The new milling machine will reduce operating expenses by exactly $20,000 per year for 10 years. Each of these cash
10.1. Your firm has recently reached an expansion phase and is seeking possible new geographic regions to market the newly patented chemical compound Glupto. The five regional projections are as follows:a. Which regions would be profitable to the firm?Which of the five is the most profitable?b. If
9.29 Compute ExxonMobil’s unlevered cash flow from its most recent financial statements.
9.28 Using the assumptions of exercise 9.26, provide inflation-adjusted figures for Exhibit 9.1.a. Compute the real discount rate if the nominal discount rate is 10 percent.b. Discount the inflation-adjusted unlevered cash flows of the hydrogenerator at the real discount rate to obtain their
9.27 Find the present value of the hydrogenerator’s unlevered cash flows for the revised exhibit you constructed in exercise 9.26. Assume a discount rate of 10 percent.
9.26 Assume that the analyst who developed Exhibit 9.1 simply forgot about inflation. Redo Exhibit 9.1 assuming 2 percent inflation per year, and 2 percent growth due to inflation in EBITDA, in column (c).Show how columns (a)–(g) change and explain why column (b) does not change.
9.25 The Allied Corporation typically allocates expenses for CEO pay to each of its existing projects, with the percentage allocation based on the percentage of book assets that each project represents. Super secret project X, under consideration, will, if adopted, constitute 10 percent of the
9.24. Assume that a homeowner takes on a 30-year,$100,000 floating-rate mortgage with monthly payments. Assume that the floating rate is 7.0 percent at the initiation of the mortgage, 7.125 percent is the reset rate at the end of the first month, and 7.25 percent is the reset rate at the end of the
9.23. You are considering a new business venture and want to determine the present value of seasonal cash flows. Historical data suggest that quarterly flows will be $3,000 in quarter 1, $4,000 in quarter 2, $5,000 in quarter 3, and $6,000 in quarter 4. The annualized rate is 10 percent, compounded
9.22. Your financial planner has advised you to initiate a retirement account while you are still young. Today is your 35th birthday and you are planning to retire at age 65. Actuarial tables show that individuals in your age group have a life expectancy of about 75.If you want a $50,000 annuity
9.21. You have just had a baby boy and you want to ensure the funding of his college education. Tuition today is $15,000, and it is growing at 4 percent per year. In 18 years, your son will enter a four-year undergraduate program with tuition payments at the beginning of each year.a. At the rate of
9.20. Your rich uncle has recently passed away and left you an inheritance in the form of a varying perpetuity. You will receive $2,000 per year from year 3 through year 14, $5,000 per year from year 15 through year 22, and $3,000 per year thereafter.At a rate of 7 percent compounded annually, what
9.19. You need to insure your home over the next 20 years. You can either pay beginning-of-year premiums with today’s premium of $5,000 and future premiums growing at 4 percent per year, or prepay a lump sum of $67,500 for the entire 20 years of coverage.a. With a rate of 9 percent compounded
9.18. You have just won the California state lottery! As the winner, you have a choice of three payoff programs. Assume the interest rate is 9 percent compounded annually: (1) a lump sum today of$350,000 plus a lump sum 10 years from now of$25,000; (2) a 20-year annuity of $42,500 beginning next
9.17. If the future value of $10,000 today is $13,328, and the interest rate is 9 percent compounded annually:a. What is the holding period t (in years)?b. How does t change if the interest rate is 9 percent compounded semiannually?c. How does t change if the interest rate is 11 percent compounded
9.16. Jones Inc. is considering a prospective project with the following future cash inflows: $9,000 at the end of year 1, $9,500 at the end of 15 months, $10,500 at the end of 30 months, and $11,500 at the end of 38 months.a. What is the PV of these cash flows at 7.5 percent compounded annually?b.
9.15. Daniela, a junior in high school, is considering a delivery program for a local grocery store to earn extra money for college. Her idea is to buy a used car and deliver groceries after school and on weekends. She estimates the following revenues and expenses.• Start-up costs of $1,000 for
9.14. The treasurer of Small Corp. is considering the purchase of a T-bill maturing in seven months. At a rate of 9 percent compounded annually:a. Calculate the present value of the $10,000 face value T-bill.b. If you wanted to purchase a seven-month T-bill 30 months from now, what amount must you
9.13. Which of the following rates would you prefer:8.50 percent compounded annually, 8.33 percent compounded semiannually, 8.25 percent compounded quarterly, or 8.16 percent compounded continuously? Why?
9.12. A nine-month T-bill with a face value of $10,000 currently sells for $9,600. Calculate the annualized simple interest rate.
9.11. Bob invests $1,000 in a simple interest account.Thirty months later, he finds the account has accumulated to $1.212.50.a. Compute the annualized simple interest rate.b. Compute the equivalent annualized rate compounded (1) annually, (2) semiannually,(3) quarterly, (4) monthly, and (5)
9.10. A 35-year-old employee, who expected to work another 30 years, is injured in a plant accident and will never work again. His wages next year will be$40,000. A study of wages across the plant found that every additional year of seniority tends to add 1 percent to the wages of a worker, other
9.9. The value of a share of stock is the present value of its future dividends. If the next dividend, occurring one year from now, is $2 per share and dividends, paid annually, are expected to grow at 3 percent per year, what is the value of a share of stock if the discount rate is 7 percent?
9.8. Graph the relation between the annually compounded interest rate and the present value of a zero-coupon bond paying $100 five years from today. Graph the relation between present value and years to maturity of a zero-coupon bond with an interest rate of 8 percent compounded annually.
9.7. An investor is comparing a 30-year fixed-rate mortgage with a 15-year fixed-rate mortgage. The 15-year mortgage has a considerably lower interest rate. If the annualized interest rate on the 30-year mortgage is 10 percent, compounded monthly, what rate, compounded monthly on the 15-year
9.6. If r is the annually compounded interest rate, what is the present value of a deferred perpetuity with annual payments of C beginning t years from now?
9.5. A self-employed investor who has just turned 35 wants to save for his retirement with a Keogh account. He plans to retire on his 65th birthday and wants a monthly income, beginning the month after his 65th birthday, of $2,000 (after taxes) until he dies.• He has budgeted conservatively,
9.4. What is the annualized interest rate, compounded daily, that is equivalent to 10 percent interest compounded semiannually? What is the daily compounded rate that is equivalent to 10 percent compounded continuously?
9.3. A30-year fixed-rate mortgage has monthly payments of $1,500 per month and a mortgage interest rate of 9 percent per year compounded monthly. If a buyer purchases a home with the cash proceeds of the mortgage loan plus an additional 20 percent down, what is the purchase price of the home?
9.2. How long will it take your money to double at an annualized interest rate of 8 percent compounded semiannually? How does your answer change if the interest rate is compounded annually?
9.1. Let PV be the present value of a growing perpetuity(the “time 1 perpetuity”) with an initial payment of C beginning one period from now and a growth rate of g. If we move all the cash flows back in time one period, the present value becomes PV (1 r).Note that this is the present value
8.16. A nondividend-paying stock has a current price of$30 and a volatility of 20 percent per year.(a) Use the Black-Scholes equation to value a European call option on the stock above with a strike price of $28 and time to maturity of three months.(b) Without performing calculations, state whether
8.15. The following tree diagram outlines the price of a stock over the next two periods:The risk-free rate is 12 percent from date 0 to date 1 and 15 percent from date 1 to date 2. A European call on this stock (1) expires in period 2 and (2) has a strike price of $8.(a) Calculate the risk-neutral
8.14. Callable bonds appear to have market values that are determined as if the issuing corporation optimally exercises the call option implicit in the bond. You know, however, that these options tend to get exercised past the optimal point. Write up a nontechnical presentation for your boss, the
8.13. Describe what happens to the amount of stock held in the tracking portfolio for a call (put) as the stock price goes up (down). Hint: Prove this by looking at delta.
8.12. In the chapter’s opening vignette, Chrysler Corporation argued that there was little risk in the government guarantee of Chrysler’s debt because Chrysler also was offering a senior claim of Chrysler’s assets to the government. In light of this, Chrysler’s warrants appear to have been
8.11. FSA is a privately held firm. As an analyst trying to determine the value of FSA’s common stock and bonds, you have estimated the market value of the firm’s assets to be $1 million and the standard deviation of the asset return to be .3. The debt of FSA, which consists of zero-coupon bank
8.10. Steady Corp. has a share value of $50. At-themoney American call options on Steady Corp. with nine months to expiration are trading at $3. Sure Corp. also has a share value of $50. At-the-money American call options on Sure Corp. with nine months to expiration are trading at $3. Suddenly, a
8.9. The present price of an equity share of Strategy Inc.is $50. The stock follows a binomial process where each period the stock either goes up 10 percent or down 10 percent. Compute the fair market value of an American put option on Strategy Inc. stock with a strike price of $50 and two periods
8.8. Consider a position of two purchased calls (AT&T, three months, K = 30) and one written put (AT&T, three months, K = 30). What position in AT&T stock will show the same sensitivity to price changes in AT&T stock as the option position described above? Express your answer algebraically as a
8.7. Suppose you observe a European call option on a stock that is priced at less than the value of So-PV(K) - PV(div). What type of transaction should you execute to achieve arbitrage? (Be specific with respect to amounts and avoid using puts in this arbitrage.)
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