Question: Aday Acoustics, Inc., projects unit sales for
Aday Acoustics, Inc., projects unit sales for a new seven-octave voice emulation implant as follows: 
Production of the implants will require $1,500,000 in net working capital to start and additional net working capital investments each year equal to 15 percent of the projected sales increase for the following year. Total fixed costs are $1,850,000 per year, variable production costs are $190 per unit, and the units are priced at $345 each. The equipment needed to begin production has an installed cost of $19,500,000. Because the implants are intended for professional singers, this equipment is considered industrial machinery and thus qualifies as seven-year MACRS property. In five years, this equipment can be sold for about 20 percent of its acquisition cost. The company is in the 35 percent marginal tax bracket and has a required return on all its projects of 18 percent. Based on these preliminary project estimates, what is the NPV of the project? What is the IRR?
Transcribed Image Text:
Year Unit Sales 81,000 2 89,000 3 97,000 4 92,000 77,000
> How does a bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond.
> You are planning to save for retirement over the next 30 years. To save for retirement, you will invest $900 per month in a stock account in real dollars and $300 per month in a bond account in real dollars. The effective annual return of the stock accou
> The Stambaugh Corporation currently has earnings per share of $8.20. The company has no growth and pays out all earnings as dividends. It has a new project that will require an investment of $1.95 per share in one year. The project is only a two-year pro
> Suppose we are thinking about replacing an old computer with a new one. The old one cost us $450,000; the new one will cost $580,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $130,
> In addition to the five factors discussed in the chapter, dividends also affect the price of an option. The Black–Scholes option pricing model with dividends is: All of the variables are the same as the Black–Scholes
> Consider the following information about Stocks I and II: The market risk premium is 7.5 percent, and the risk-free rate is 4 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “
> When Marilyn Monroe died, ex-husband Joe DiMaggio vowed to place fresh flowers on her grave every Sunday as long as he lived. The week after she died in 1962, a bunch of fresh flowers that the former baseball player thought appropriate for the star cost
> Why do we use an aftertax figure for cost of debt but not for cost of equity?
> This one’s a little harder. Suppose the current share price for the firm in the previous problem is $62.40 and all the dividend information remains the same. What required return must investors be demanding on Storico stock? (Hint: Set up the valuation f
> Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment n
> Strudler Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $213 million, but if the project is a failure, the firm will be worth
> Assume a firm is considering a new typical project that requires an initial investment with sales, variable costs and fixed costs over its life. Will the project usually reach the accounting, cash, or financial break-even point first? Which will it reach
> Suppose the risk-free rate is 4.7 percent and the market portfolio has an expected return of 11.2 percent. The market portfolio has a variance of .0382. Portfolio Z has a correlation coefficient with the market of .28 and a variance of .3285. According t
> The following Treasury bond quote appeared in The Wall Street Journal on May 11, 2004: Why would anyone buy this Treasury bond with a negative yield to maturity? How is this possible?
> Storico Co. just paid a dividend of $3.40 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend
> The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price; that is, set the project NPV to zero and solve for the variable in question. a. In
> Brozik Corp. has a zero coupon bond that matures in five years with a face value of $40,000. The current value of the company’s assets is $38,000, and the standard deviation of its return on assets is 50 percent per year. The risk-free rate is 6 percent
> A portfolio that combines the risk-free asset and the market portfolio has an expected return of 8 percent and a standard deviation of 17 percent. The risk-free rate is 4.3 percent, and the expected return on the market portfolio is 11 percent. Assume th
> The Frush Corporation has two different bonds currently outstanding. Bond M has a face value of $30,000 and matures in 20 years. The bond makes no payments for the first six years, then pays $800 every six months over the subsequent eight years, and fina
> Consider the following statement: For the APT to be useful, the number of systematic risk factors must be small. Do you agree or disagree with this statement? Why?
> Most corporations pay quarterly dividends on their common stock rather than annual dividends. Barring any unusual circumstances during the year, the board raises, lowers, or maintains the current dividend once a year and then pays this dividend out in eq
> Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break- even level for the project. Gu
> In our capital budgeting examples, we assumed that a firm would recover all of the working capital it invested in a project. Is this a reasonable assumption? When might it not be valid?
> McLemore Industries has a zero coupon bond issue that matures in two years with a face value of $75,000. The current value of the company’s assets is $46,000, and the standard deviation of the return on assets is 60 percent per year. a. Assume the risk-f
> Beginning with the cost of capital equation—that is: show that the cost of equity capital for a levered firm can be written as follows: RAce =B + SR, B R. + B+SR, WACC R, = R, + GR, – R,) R.)
> The market portfolio has an expected return of 11 percent and a standard deviation of 19 percent. The risk-free rate is 4.3 percent. a. What is the expected return on a well-diversified portfolio with a standard deviation of 9 percent? b. What is the sta
> The YTM on a bond is the interest rate you earn on your investment if interest rates don’t change. If you actually sell the bond before it matures, your realized return is known as the holding period yield (HPY). a. Suppose that today you buy a bond with
> The Cornchopper Company is considering the purchase of a new harvester. Cornchopper has hired you to determine the break-even purchase price in terms of present value of the harvester. This break-even purchase price is the price at which the project’s NP
> Consider four different stocks, all of which have a required return of 14 percent and a most recent dividend of $3.50 per share. Stocks W, X, and Y are expected to maintain constant growth rates in dividends for the foreseeable future of 7 percent, 0 per
> A proposed cost-saving device has an installed cost of $710,000. The device will be used in a five-year project but is classified as three-year MACRS property for tax purposes. The required initial net working capital investment is $65,000, the marginal
> An investor is said to take a position in a “collar” if she buys the asset, buys an out-of-the-money put option on the asset, and sells an out-of-the-money call option on the asset. The two options should have the same time to expiration. Suppose Marie w
> Classify the following events as mostly systematic or mostly unsystematic. Is the distinction clear in every case? a. Short-term interest rates increase unexpectedly. b. The interest rate a company pays on its short-term debt borrowing is increased by it
> Suppose a firm’s business operations mirror movements in the economy as a whole very closely—that is, the firm’s asset beta is 1.0. Use the result of the previous problem to find the equity beta for this firm for debt–equity ratios of 0, 1, 5, and 20. Wh
> Under what two assumptions can we use the dividend growth model presented in the chapter to determine the value of a share of stock? Comment on the reasonableness of these assumptions.
> Milano Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt–equity ratio of 40 percent and makes interest payments of $41,000 at the end of each year. The cost of the firm’s levered equity is 19 perce
> You have been provided the following data about the securities of three firms, the market portfolio, and the risk-free asset: a. Fill in the missing values in the table. b. Is the stock of Firm A correctly priced according to the capital asset pricing
> Bond P is a premium bond with a coupon of 8.5 percent. Bond D has a coupon of 5.5 percent and is selling at a discount. Both bonds make annual payments, have a YTM of 7 percent, and have 10 years to maturity. What is the current yield for Bond P? For Bon
> M.V.P. Games, Inc., has hired you to perform a feasibility study of a new video game that requires an initial investment of $8 million. M.V.P. expects a total annual operating cash flow of $1.5 million for the next 10 years. The relevant discount rate is
> Fincher Manufacturing has projected sales of $135 million next year. Costs are expected to be $76 million and net investment is expected to be $15 million. Each of these values is expected to grow at 14 percent the following year, with the growth rate de
> Some people argue that the efficient market hypothesis cannot explain the 1987 market crash or the high price-to-earnings ratios of Internet stocks during the late 1990s. What alternative hypothesis is currently used for these two phenomena?
> McKeekin Corp. has a project with the following cash flows: What is the IRR of the project? What is happening here? Year Cash Flow $20,000 | -26,000 2 13,000
> Pricing Model Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $1,380 per ounce, the firm would go bankrupt. The current price of
> Assume a firm’s debt is risk-free, so that the cost of debt equals the risk-free rate, Rf . Define βA as the firm’s asset beta—that is, the systematic risk of the firm’s assets. Define βS to be the beta of the firm’s equity. Use the capital asset pricing
> Suppose the expected returns and standard deviations of Stocks A and B are E(RA) = .11, E(RB) = .13, α A = .39, and αB = .76. a. Calculate the expected return and standard deviation of a portfolio that is composed of 35 percent A and 65 percent B when th
> Given that Transocean was down by about 63 percent for 2014, why did some investors hold the stock? Why didn’t they sell out before the price declined so sharply?
> As a shareholder of a firm that is contemplating a new project, would you be more concerned with the accounting break-even point, the cash break-even point (the point at which operating cash flow is zero), or the financial break-even point? Why?
> Suppose the returns on long-term corporate bonds and T-bills are normally distributed. Based on the historical record, use the NORMDIST function in Excel ® to answer the following questions: a. What is the probability that in any given year, the return o
> Suppose your company needs to raise $50 million and you want to issue 30-year bonds for this purpose. Assume the required return on your bond issue will be 6 percent, and you’re evaluating two issue alternatives: A semiannual coupon bond with a 6 percent
> Consider the following project for Hand Clapper, Inc. The company is considering a four-year project to manufacture clap-command garage door openers. This project requires an initial investment of $15 million that will be depreciated straight-line to zer
> Prospectors, Inc., is a publicly traded gold prospecting company in Alaska. Although the firm’s searches for gold usually fail, the prospectors occasionally find a rich vein of ore. What pattern would you expect to observe for Prospectors’ cumulative abn
> Darin Clay, the CFO of MakeMoney.com, has to decide between the following two projects: The expected rate of return for either of the two projects is 12 percent. What is the range of initial investment (I o) for which Project Billion is more financiall
> Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be $975,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine
> Pricing Model Rob wishes to buy a European put option on BioLabs, Inc., a non-dividend-paying common stock, with a strike price of $50 and six months until expiration. The company’s common stock is currently selling for $45 per share, and Rob expects tha
> Assuming a world of corporate taxes only, show that the cost of equity, RS , is as given in the chapter by MM Proposition II with corporate taxes.
> Security F has an expected return of 10 percent and a standard deviation of 49 percent per year. Security G has an expected return of 14 percent and a standard deviation of 73 percent per year. a. What is the expected return on a portfolio composed of 30
> What is the intrinsic value of a call option? Of a put option? How do we interpret these values?
> Which has greater interest rate risk, a 30-year Treasury bond or a 30-year BB corporate bond?
> Tesla Corporation needs to raise funds to finance a plant expansion, and it has decided to issue 25-year zero coupon bonds to raise the money. The required return on the bonds will be 5.4 percent. a. What will these bonds sell for at issuance? b. Using t
> In Problem 26, suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity o
> FFDP Corp. has yearly sales of $42 million and costs of $13 million. The company’s balance sheet shows debt of $64 million and cash of $21 million. There are 1,750,000 shares outstanding and the industry EV/EBITDA multiple is 6.8. What is the company’s e
> Ramsay Corp. currently has an EPS of $3.10, and the bench-mark PE for the company is 21. Earnings are expected to grow at 6 percent per year. a. What is your estimate of the current stock price? b. What is the target stock price in one year? c. Assuming
> Assume that markets are efficient. During a trading day American Golf, Inc., announces that it has lost a contract for a large golfing project that, prior to the news, it was widely believed to have secured. If the market is efficient, how should the sto
> In the previous problem, what is the probability that the return is less than 2100 percent? (Think.) What are the implications for the distribution of returns?
> Consider two streams of cash flows, A and B. Stream A’s first cash flow is $11,600 and is received three years from today. Future cash flows in Stream A grow by 4 percent in perpetuity. Stream B’s first cash flow is 2$13,000, is received two years from t
> Pricing Model Ken is interested in buying a European call option written on Southeastern Airlines, Inc., a non-dividend-paying common stock, with a strike price of $65 and one year until expiration. Currently, the company’s stock sells for $62 per share.
> Cost of Capital In a world of corporate taxes only, show that the R WACC can be written as R WACC = R0 x [1 - tC (B/V )].
> We are evaluating a project that costs $588,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 70,000 units per year. Price per unit is $36, variab
> Based on the following information, calculate the expected return and standard deviation for each of the following stocks. What are the covariance and correlation between the returns of the two stocks? Probability of State of Economy State of Return
> An investment project provides cash inflows of $790 per year for eight years. What is the project payback period if the initial cost is $3,200? What if the initial cost is $4,800? What if it is $7,300?
> You’ve just found a 10 percent coupon bond on the market that sells for par value. What is the maturity on this bond?
> Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,700,000 investment in threading equipment to get the project started; the project will last for five years. The accoun
> Office Automation, Inc., must choose between two copiers, the XX40 or the RH45. The XX40 costs $1,499 and will last for three years. The copier will require a real aftertax cost of $120 per year after all relevant expenses. The RH45 costs $2,399 and will
> Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $630,000. Without new projects, both firms will continue to generate earnings of $630,000 in perpetuity. Assume that all earnings are paid as dividends and that
> The efficient market hypothesis implies that all mutual funds should obtain the same expected risk-adjusted returns. Therefore, we can simply pick mutual funds at random. Is this statement true or false? Explain.
> Butler International Limited is evaluating a project in Erewhon. The project will create the following cash flows: All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has de
> A company has a single zero coupon bond outstanding that matures in 10 years with a face value of $10 million. The current value of the company’s assets is $9.05 million, and the standard deviation of the return on the firm’s assets is 39 percent per yea
> Williamson, Inc., has a debt–equity ratio of 2.3. The firm’s weighted average cost of capital is 10 percent, and its pretax cost of debt is 6 percent. The tax rate is 35 percent. a. What is the company’s cost of equity capital? b. What is the company’s u
> Why is underpricing not a great concern with bond offerings?
> Based on the following information, calculate the expected return and standard deviation of each of the following stocks. Assume each state of the economy is equally likely to happen. What are the covariance and correlation between the returns of the two
> Assuming that the returns from holding small-company stocks are normally distributed, what is the approximate probability that your money will double in value in a single year? Triple in value?
> Repeat parts (a) and (b) in Problem 1 assuming the company has a tax rate of 35 percent. Problem 1: Music City, Inc., has no debt outstanding and a total market value of $295,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if
> What are the direct and indirect costs of bankruptcy? Briefly explain each.
> Suppose the following bond quote for IOU Corporation appears in the financial page of today’s newspaper. Assume the bond has a face value of $1,000, semiannual coupon payments, and the current date is April 15, 2015. What is the yield t
> Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value is $2.8 million. Its current book value is $1.6 million. If not sold, the old machine will require maintenance costs of $855,000 at the end of the year for t
> Imagine that a particular macroeconomic variable that influences your firm’s net earnings is positively serially correlated. Assume market efficiency. Would you expect price changes in your stock to be serially correlated? Why or why not?
> The Utah Mining Corporation is set to open a gold mine near Provo, Utah. According to the treasurer, Monty Goldstein, “This is a golden opportunity.” The mine will cost $2,700,000 to open and will have an economic life of 11 years. It will generate a cas
> You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1 million in anticipation of using it as a toxic
> On Tuesday, December 8, Hometown Power Co.’s board of directors declares a dividend of 75 cents per share payable on Wednesday, January 17, to shareholders of record as of Wednesday, January 3. When is the ex-dividend date? If a shareholder buys stock be
> Suppose Sunburn Sunscreen and Frostbite Thermalwear in the previous problems have decided to merge. Because the two companies have seasonal sales, the combined firm’s return on assets will have a standard deviation of 29 percent per year. a. What is the
> Green Manufacturing, Inc., plans to announce that it will issue $1.8 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity company worth $5.
> This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm tha
> You have $100,000 to invest in a portfolio containing Stock X and Stock Y. Your goal is to create a portfolio that has an expected return of 12.9 percent. If Stock X has an expected return of 11.2 percent and a beta of 1.30 and Stock Y has an expected re
> An election is being held to fill three seats on the board of directors of a firm in which you hold stock. The company has 17,400 shares outstanding. If the election is conducted under cumulative voting and you own 300 shares, how many more shares must y
> Suppose the returns on long-term government bonds are normally distributed. Based on the historical record, what is the approximate probability that your return on these bonds will be less than 23.7 percent in a given year? What range of returns would yo
> Erna Corp. has 9 percent coupon bonds making annual payments with a YTM of 7.81 percent. The current yield on these bonds is 8.42 percent. How many years do these bonds have left until they mature?
> Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 15 units per year at $275,000 net cash flow per unit for the next five years. The enginee
> Four years ago, Bling Diamond, Inc., paid a dividend of $1.51 per share. The company paid a dividend of $1.87 per share yesterday. Dividends will grow over the next five years at the same rate they grew over the last four years. Thereafter, dividends wil
> Suppose the market is semistrong form efficient. Can you expect to earn excess returns if you make trades based on: a. Your broker’s information about record earnings for a stock? b. Rumors about a merger of a firm? c. Yesterday’s announcement of a succe
> You are determining whether your company should undertake a new project and have calculated the NPV of the project using the WACC method when the CFO, a former accountant, notices that you did not use the interest payments in calculating the cash flows o
> The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $315,000 for the firm during the first year, and the c
