Gemini, Inc., an all-equity firm, is considering a $1.7 million investment that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate earnings before taxes and depreciation of $595,000 per year for four years. The investment will not change the risk level of the firm. The company can obtain a four-year, 9.5 percent loan to finance the project from a local bank. All principal will be repaid in one balloon payment at the end of the fourth year. The bank will charge the firm $45,000 in flotation fees, which will be amortized over the four-year life of the loan. If the company financed the project entirely with equity, the firm’s cost of capital would be 13 percent. The corporate tax rate is 30 percent. Using the adjusted present value method, determine whether the company should undertake the project.
> Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 8 percent loan with gross proceeds of $5,850,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 2.5 percent of gross proceeds and will be a
> Consider the following financial statement information for the Bulldog Icers Corporation: Calculate the operating and cash cycles. How do you interpret your answer? Item Beginning Ending Inventory $17,385 $19,108 Accounts receivable 13,182 13,973 Ac
> What are the costs of shortages? Describe them.
> What is the duration of a bond with three years to maturity and a coupon of 7 percent paid annually if the bond sells at par?
> If a textile manufacturer wanted to hedge against adverse movements in cotton prices, it could buy cotton futures contracts or buy call options on cotton futures contracts. What would be the pros and cons of the two approaches?
> An analyst has recently informed you that at the issuance of a company’s convertible bonds, one of the two following sets of relationships existed: Assume the bonds are available for immediate conversion. Which of the two scenarios do
> An analyst has recently informed you that at the issuance of a company’s convertible bonds, one of the two following sets of relationships existed: Assume the bonds are available for immediate conversion. Which of the two scenarios do y
> Star Mining buys a gold mine, but the cost of extraction is currently too high to make the mine profitable. In option terminology, what type of option(s) does the company have on this mine?
> Rework Problem 1 assuming that the scanner will be depreciated as three-year property under MACRS Problem 1 Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should you lease or buy? Required data: You work for a nuclear
> Refer to Table 25.2 given below to answer this question. Suppose today is November 22, 2011, and your firm produces breakfast cereal and needs 140,000 bushels of corn in March 2012 for an upcoming promotion. You would like to lock in your costs today bec
> What are the prices of a call option and a put option with the following characteristics? Stock price = $93 Exercise price = $90 Risk-free rate = 4% per year, compounded continuously Maturity = 5 months Standard deviation = 62% per year
> Discuss the IRS criteria for determining whether a lease is tax deductible. In each case give a rationale for the criterion.
> What are the two types of risk that are measured by a levered beta?
> The Litzenberger Company has projected the following quarterly sales amounts for the coming year: a. Accounts receivable at the beginning of the year are $310. Litzenberger has a 45-day collection period. Calculate cash collections in each of the four q
> Is it possible for a firm’s cash cycle to be longer than its operating cycle? Explain why or why not.
> You are short 25 gasoline futures contracts, established at an initial settle price of $2.46 per gallon, where each contract represents 42,000 gallons. Over the subsequent four trading days, gasoline settles at $2.42, $2.47, $2.50, and $2.56, respectivel
> A company produces an energy-intensive product and uses natural gas as the energy source. The competition primarily uses oil. Explain why this company is exposed to fluctuations in both oil and natural gas prices.
> A warrant gives its owner the right to purchase three shares of common stock at an exercise price of $53 per share. The current market price of the stock is $58. What is the minimum value of the warrant?
> What is dilution, and why does it occur when warrants are exercised?
> Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $93 per barrel, and the l
> Explain why a swap is effectively a series of forward contracts. Suppose a firm enters a swap agreement with a swap dealer. Describe the nature of the default risk faced by both parties.
> In the previous question, over what range of lease payments will the lease be profitable for both parties? Required information You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice wi
> What are the prices of a call option and a put option with the following characteristics? Stock price = $57 Exercise price = $60 Risk-free rate = 6% per year, compounded continuously Maturity = 3 months Standard devi ation = 54% per year
> Discuss the accounting criteria for determining whether a lease must be reported on the balance sheet. In each case give a rationale for the criterion.
> North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.10 if both were all equity financed. The market value information for each company is shown here: The expected return on the ma
> If Wild Widgets, Inc., were an all-equity company, it would have a beta of .85. The company has a target debt–equity ratio of .40. The expected return on the market portfolio is 11 percent, and Treasury bills currently yield 4 percent. The company has on
> Indicate the impact of the following on the cash and operating cycles, respectively. Use the letter I to indicate an increase, the letter D for a decrease, and the letter N for no change. a. The terms of cash discounts offered to customers are made less
> You are long 10 gold futures contracts, established at an initial settle price of $1,580 per ounce, where each contract represents 100 ounces. Over the subsequent four trading days, gold settles at $1,587, $1,582, $1,573, and $1,584, respectively. Comput
> Bubbling Crude Corporation, a large Texas oil producer, would like to hedge against adverse movements in the price of oil because this is the firm’s primary source of revenue. What should the firm do? Provide at least two reasons why it probably will not
> Hannon Home Products, Inc., recently issued $2 million worth of 8 percent convertible debentures. Each convertible bond has a face value of $1,000. Each convertible bond can be converted into 21.50 shares of common stock any time before maturity. The sto
> What happens to the price of a convertible bond if interest rates increase?
> General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $55. a. Suppose the stock is currently trading for $51 per share. What is
> The Webber Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $25 million to construct. Due to low d
> Utility companies often face a decision to build new plants that burn coal, oil, or both. If the prices of both coal and gas are highly volatile, how valuable is the decision to build a plant that can burn either coal or oil? What happens to the value of
> The price of Tara, Inc., stock will be either $50 or $70 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. a. Suppose the current price of Tara stock is $62. What is the value of the call o
> Assume that your company does not contemplate paying taxes for the next several years. What are the cash flows from leasing in this case? You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common p
> Comment on the following remarks: a. Leasing reduces risk and can reduce a firm’s cost of capital. b. Leasing provides 100 percent financing. c. If the tax advantages of leasing were eliminated, leasing would disappear.
> 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
> Indicate the effect that the following will have on the operating cycle. Use the letter I to indicate an increase, the letter D for a decrease, and the letter N for no change. a. Receivables average goes up. b. Credit repayment times for customers are in
> For the year just ended, you have gathered the following information about the Holly Corporation: a. A $200 dividend was paid. b. Accounts payable increased by $500. c. Fixed asset purchases were $900. d. Inventories increased by $625. e. Long-term debt
> Suppose a financial manager buys call options on 50,000 barrels of oil with an exercise price of $95 per barrel. She simultaneously sells a put option on 50,000 barrels of oil with the same exercise price of $95 per barrel. Consider her gains and losses
> What is the difference between a forward contract and a futures contract? Why do you think that futures contracts are much more common? Are there any circumstances under which you might prefer to use forwards instead of futures? Explain.
> When should a firm force conversion of convertibles? Why?
> Eckely, Inc., recently issued bonds with a conversion ratio of 17.5. If the stock price at the time of the bond issue was $48.53, what was the conversion premium?
> Gasworks, Inc., has been approached to sell up to 5 million gallons of gasoline in three months at a price of $3.65 per gallon. Gasoline is currently selling on the wholesale market at $3.30 per gallon and has a standard deviation of 58 percent. If the r
> What is the difference between an American option and a European option?
> The price of Ervin Corp. stock will be either $74 or $96 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5 percent. a. Suppose the current price of Ervin stock is $80. What is the value of the call
> What would the lease payment have to be for both the lessor and the lessee to be indifferent about the lease? You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high
> What are some of the potential problems with looking at IRRs when evaluating a leasing decision?
> McConnell Corp. has a book value of equity of $13,205. Long-term debt is $8,200. Net working capital, other than cash, is $2,205. Fixed assets are $18,380. How much cash does the company have? If current liabilities are $1,630, what are current assets?
> Refer to Table 25.2 in the text to answer this question. Suppose you sell five March 2012 silver futures contracts on November 22, 2011, at the last price of the day. What will your profit or loss be if silver prices turn out to be $31.39 per ounce at ex
> If a firm is buying call options on pork belly futures as a hedging strategy, what must be true about the firm’s exposure to pork belly prices?
> In the previous problem, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today? Data from previous problem
> Explain the following limits on the prices of warrants: a. If the stock price is below the exercise price of the warrant, the lower bound on the price of a warrant is zero. b. If the stock price is above the exercise price of the warrant, the lower bound
> Jared Lazarus has just been named the new chief executive officer of BluBell Fitness Centers, Inc. In addition to an annual salary of $410,000, his three-year contract states that his compensation will include 15,000 at-the-money European call options on
> Complete the following sentence for each of these investors: a. A buyer of call options. b. A buyer of put options. c. A seller (writer) of call options. d. A seller (writer) of put options. “The (buyer/seller) of a (put/call) option (pays/receives) mone
> Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new cars are expected to generate $175,000 per year in ear
> Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $114. a. Suppose you buy 10 contracts of the February 110 call option. How much will you pay, ignoring commissions? b. In part (a), supp
> Indicate the impact of the following corporate actions on cash, using the letter I for an increase, D for a decrease, or N when no change occurs. a. A dividend is paid with funds received from a sale of debt. b. Real estate is purchased and paid for with
> Refer to Table 25.2 in the text to answer this question. Suppose you purchase a March 2012 cocoa futures contract on November 22, 2011, at the last price of the day. What will your profit or loss be if cocoa prices turn out to be $2,431 per metric ton at
> If a firm is selling futures contracts on lumber as a hedging strategy, what must be true about the firm’s exposure to lumber prices?
> Gary Levin is the chief executive officer of Mountainbrook Trading Company. The board of directors has just granted Mr. Levin 30,000 at-the-money European call options on the company’s stock, which is currently trading at $50 per share. The stock pays no
> What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?
> In the previous problem, assume that the exercise style on the option is American rather than European. What is the price of the option now? Previous problem The stock price is $73, and the standard deviation of the stock returns is 70 percent. The optio
> Why might a firm choose to engage in a sale and leaseback transaction? Give two reasons.
> Suppose a three-factor model is appropriate to describe the returns of a stock. Information about those three factors is presented in the following chart: a. What is the systematic risk of the stock return? b. Suppose unexpected bad news about the firm
> A stock has had returns of 27 percent, 12 percent, 32 percent, 212 percent, 19 percent, and 231 percent over the last six years. What are the arithmetic and geometric returns for the stock?
> In contrast to the CAPM, the APT does not indicate which factors are expected to determine the risk premium of an asset. How can we determine which factors should be included? For example, one risk factor suggested is the company size. Why might this be
> The Durkin Investing Agency has been the best stock picker in the country for the past two years. Before this rise to fame occurred, the Durkin newsletter had 200 subscribers. Those subscribers beat the market consistently, earning substantially higher r
> Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material supply. The current cash flow from assets for Arras is $7.5 million.
> Suppose a stock had an initial price of $75 per share, paid a dividend of $1.20 per share during the year, and had an ending share price of $86. What was the dividend yield? The capital gains yield?
> Suppose a stock had an initial price of $75 per share, paid a dividend of $1.20 per share during the year, and had an ending share price of $86. Compute the percentage total return.
> The following diagram shows the cumulative abnormal returns (CAR) for 386 oil exploration companies announcing oil discoveries between 1950 and 1980. Month 0 in the diagram is the announcement month. Assume that no other information is received and the s
> 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
> Is the following statement true or false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to hold this asset in equilibrium. Explain.
> 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?
> 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
> 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
> 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?
> Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas
> You have $100,000 to invest in a portfolio containing Stock X, Stock Y, and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an expected return of 11.22 percent and that has only 96 percent of the risk of
> You bought one of Bergen Manufacturing Co.’s 7 percent coupon bonds one year ago for $1,080.50. These bonds make annual payments and mature six years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 5.5 perce
> 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
> Define the three forms of market efficiency.
> The following three stocks are available in the market: Assume the market model is valid. a. Write the market model equation for each stock. b. What is the return on a portfolio with weights of 30 percent Stock A, 45 percent Stock B, and 25 percent Sto
> Trower Corp. has a debt–equity ratio of .85. The company is considering a new plant that will cost $145 million to build. When the company issues new equity, it incurs a flotation cost of 8 percent. The flotation cost on new debt is 3.5 percent. What is
> You want to create a portfolio equally as risky as the market, and you have $1,000,000 to invest. Given this information, fill in the rest of the following table: Asset Investment Beta Stock A $180,000 85 Stock B $290,000 1.40 Stock C 1.45 Risk-free
> You’ve observed the following returns on Mary Ann Data Corporation’s stock over the past five years: 27 percent, 13 percent, 18 percent, 214 percent, and 9 percent. Suppose the average inflation rate over this period was 4.2 percent, and the average T-bi
> Refer to T able 10.1 in the text and look at the period from 1973 through 1980. a. Calculate the average return for Treasury bills and the average annual inflation rate (consumer price index) for this period. b. Calculate the standard deviation of Treasu
> Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .55. It’s considering building a new $50 million manufacturing facility. This new plant is expected to generate aftertax
> Consider the following information about three stocks: a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected return? The variance? The standard deviation? b. If the expected T-bill rate is 3.80
> A stock has had the following year-end prices and dividends: What are the arithmetic and geometric returns for the stock? Year Price Dividend $61.18 2 64.83 $.72 3 72.18 .78 4 63.12 .86 69.27 .95 76.93 1.08 56
> Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding
> Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.
> Advance, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 8 percent annually. What is A
> You own a portfolio that has $2,100 invested in Stock A and $3,200 invested in Stock B. If the expected returns on these stocks are 11 percent and 14 percent, respectively, what is the expected return on the portfolio?
> You find a certain stock that had returns of 12 percent, 221 percent, 9 percent, and 32 percent for four of the last five years. If the average return of the stock over this period was 11 percent, what was the stock’s return for the missing year? What is
> Based on the following information, calculate the expected return and standard deviation: State of Probability of State of Economy Rate of Return Economy if State Occurs Depression 10 -.105 Recession 25 .059 Normal 45 130 Вoom .20 211
> TransTrust Corp. has changed how it accounts for inventory. Taxes are unaffected, although the resulting earnings report released this quarter is 20 percent higher than what it would have been under the old accounting system. There is no other surprise i
> Floyd Industries stock has a beta of 1.3. The company just paid a dividend of $.95, and the dividends are expected to grow at 4.5 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 4.3 percent. The most rec
