Modigliani and Miller assumed that firms do not grow. How does positive growth change their conclusions about the value of the levered firm and its cost of capital?
> What types of risks are interest-rate and exchange rate swaps designed to mitigate? Why might one company prefer fixed-rate payments while another company prefers floating-rate payments, or payments in one currency versus another?
> a. If a firm buys under terms of 3/15, net 45, but actually pays on the 20th day and still takes the discount, what is the nominal cost of its nonfree trade credit? b. Does it receive more or less credit than it would if it paid within 15 days?
> Snider Industries sells on terms of 2/10, net 45. Total sales for the year are $1,500,000. Thirty percent of customers pay on the 10th day and take discounts; the other 70% pay, on average, 50 days after their purchases. a. What is the days sales outstan
> What is the nominal and effective cost of trade credit under the credit terms of 3/15, net 30?
> Williams & Sons last year reported sales of $10 million and an inventory turnover ratio of 2. The company is now adopting a new inventory system. If the new system is able to reduce the firm’s inventory level and increase the firm’s inventory turnover ra
> The Raattama Corporation had sales of $3.5 million last year, and it earned a 5% return (after taxes) on sales. Recently, the company has fallen behind in its accounts payable. Although its terms of purchase are net 30 days, its accounts payable represen
> Why do companies use so many different types of instruments to raise capital? Why not just use debt and common stock?
> Define each of the following terms: a. Preferred stock b. Cumulative dividends; arrearages c. Warrant; detachable warrant d. Stepped-up price e. Convertible security f. Conversion ratio; conversion price; conversion value g. Sweetener
> Suppose a company simultaneously issues $50 million of convertible bonds with a coupon rate of 10% and $50 million of straight bonds with a coupon rate of 14%. Both bonds have the same maturity. Does the convertible issue’s lower coupon rate suggest that
> Evaluate the following statement: “Issuing convertible securities is a means by which a firm can sell common stock for more than the existing market price.”
> How does a firm’s dividend policy affect each of the following? a. The value of its long-term warrants b. The likelihood that its convertible bonds will be converted c. The likelihood that its warrants will be exercised
> What does it mean to “manage” risk? Should its stockholders want a firm to “manage” all of the risks it faces?
> If a firm expects to have additional financial requirements in the future, would you recommend that it use convertibles or bonds with warrants? What factors would influence your decision?
> What effect does the trend in stock prices (subsequent to issue) have on a firm’s ability to raise funds through: (a) convertibles and (b) warrants?
> Is preferred stock more like bonds or common stock? Explain.
> The Howland Carpet Company has grown rapidly during the past 5 years. Recently, its commercial bank urged the company to consider increasing its permanent financing. Its bank loan under a line of credit has risen to $250,000, carrying an 8% interest rate
> Fifteen years ago, Roop Industries sold $400 million of convertible bonds. The bonds had a 40-year maturity, a 5.75% coupon rate, and paid interest annually. They were sold at their $1,000 par value. The conversion price was set at $62.75, and the common
> The Tsetsekos Company was planning to finance an expansion. The principal executives of the company all agreed that an industrial company such as theirs should finance growth by means of common stock rather than by debt. However, they felt that the curre
> Maese Industries Inc. has warrants outstanding that permit the holders to purchase 1 share of stock per warrant at a price of $25. a. Calculate the exercise value of the firm’s warrants if the common sells at each of the following prices: (1) $20, (2) $2
> Neubert Enterprises recently issued $1,000 par value 15-year bonds with a 5% coupon paid annually and warrants attached. These bonds are currently trading for $1,000. Neubert also has outstanding $1,000 par value 15-year straight debt with a 7% coupon pa
> Niendorf Incorporated needs to raise $25 million to construct production facilities for a new type of USB memory device. The firm’s straight nonconvertible debentures currently yield 9%. Its stock sells for $23 per share, has an expected constant growth
> Stohs Semiconductor Corporation plans to issue $50 million of 20-year bonds in 6 months. The interest rate would be 9% if the bonds were issued today. How can Stohs set up a hedge against an increase in interest rates over the next 6 months? Assume that
> Big Sky Mining Company must install $1.5 million of new machinery in its Nevada mine. It can obtain a bank loan for 100% of the purchase price, or it can lease the machinery. Assume that the following facts apply. 1. The machinery falls into the MACRS 3
> Two companies, Energen and Hastings Corporation, began operations with identical balance sheets. A year later, both required additional fixed assets at a cost of $50,000. Energen obtained a 5-year, $50,000 loan at an 8% interest rate from its bank. Hasti
> Consider the data in Problem 19-1. Assume that Reynolds’ tax rate is 40% and that the equipment’s depreciation would be $100 per year. If the company leased the asset on a 2-year lease, the payment would be $110 at the beginning of each year. If Reynolds
> Reynolds Construction needs a piece of equipment that costs $200. Reynolds can either lease the equipment or borrow $200 from a local bank and buy the equipment. If the equipment is leased, the lease would not have to be capitalized. Reynoldsâ€
> Sadik Industries must install $1 million of new machinery in its Texas plant. It can obtain a bank loan for 100% of the required amount. Alternatively, a Texas investment banking firm that represents a group of investors believes it can arrange for a lea
> What are some reasons why companies decide to go public? If going public is a good idea, why don’t all companies do so?
> How do companies decide whether or not to refund their outstanding bonds? If the NPV as calculated in a bond refunding analysis is positive, does that mean that the company should call and refund the bond? What is the effect of calling a bond on its bond
> What’s the difference between an IPO and an SEO? Would you view purchasing a stock in an SEO to be more or less risky than purchasing a stock in an IPO? Would you expect the same first day returns for an SEO purchase as for an IPO purchase? Why?
> On the day an IPO comes out, the market price can rise above the offering price or fall below that price. Is it more common for the market price to close above or below the offering price on the day of an IPO? If a company’s market price rises above the
> Jan Volk, financial manager of Green Sea Transport (GST), has been asked by her boss to review GST’s outstanding debt issues for possible bond refunding. Five years ago, GST issued $40,000,000 of 11%, 25-year debt. The issue, with semiannual coupons, is
> Is bankruptcy a fairly common occurrence among large companies, or is it restricted primarily to small firms?
> Bynum and Crumpton Inc. (B&C), a small jewelry manufacturer, has been successful and has enjoyed a positive growth trend. Now B&C is planning to go public with an issue of common stock, and it faces the problem of setting an appropriate price for
> Benjamin Garcia’s start-up business is succeeding, but he needs $200,000 in additional funding to fund continued growth. Benjamin and an angel investor agree the business is worth $800,000 and the angel has agreed to invest the $200,000 that is needed. B
> Security Brokers Inc. specializes in underwriting new issues by small firms. On a recent offering of Beedles Inc., the terms were as follows: Price to public: ……………………………. $5 per share Number of shares: ………………………. 3 million Proceeds to Beedles: ……………………
> Mullet Technologies is considering whether or not to refund a $75 million, 12% coupon, 30-year bond issue that was sold 5 years ago. It is amortizing $5 million of flotation costs on the 12% bonds over the issue’s 30-year life. Mullet’s investment banks
> What is a synthetic lease? How are such leases structured, and what is their primary purpose? Is it likely that the use of synthetic leases will increase or decrease?
> Differentiate between an operating lease, a capital lease (also known as a financial lease), and a sale and leaseback arrangement. How might investors be misled by firms that use lease financing extensively, and what rules have accounts put in place in a
> Is leasing a zero sum game in the sense that any gain to the lessee is a cost to the lessor? If not, how might both parties gain from a lease transaction? In your answer, explain how the lessee and the lessor analyze the situation, why they might use dif
> Define the term NAL as it is used in lease analysis, and then explain how the NAL is calculated.
> Assuming that FASB Statement 13 is working as it is supposed to work, should traditional leasing arrangements enable a firm to use more financial leverage than it otherwise could? How do synthetic leases alter the situation? How do FASB Statement 13 and
> How do IRS regulations affect leasing decisions?
> In your answers to the following set of questions, assume that Ross Corporation has $200 million of assets at book value, $150 million of liabilities owed to 500 different creditors, and $50 million of common equity book value. Also, assume that Ross has
> Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives current market prices and other information from several online data services and then either displays the information o
> The stockholders’ claim in a levered firm can be viewed as a call option; stockholders have the option to purchase the firm’s assets by paying off its debt. What incentives does this provide to stockholders and managers in choosing investment projects?
> How is the value of a financial option affected by: (a) the current price of the underlying asset, (b) the exercise (or strike) price, (c) the risk-free rate, (d) the time until expiration (or maturity), and (e) the variance of returns on the asset?
> Define each of the following terms: a. MM Proposition I without taxes and with corporate taxes b. MM Proposition II without taxes and with corporate taxes c. Miller model d. Adjusted present value (APV) model e. Value of debt tax shield f. Equity as an o
> Your firm’s CEO has just learned about options and how your firm’s equity can be viewed as an option. Why might he want to increase the riskiness of the firm, and why might the bondholders be unhappy about this?
> A utility company is allowed to charge prices high enough to cover all costs, including its cost of capital. Public service commissions are supposed to take actions that stimulate companies to operate as efficiently as possible in order to keep costs, an
> Explain, in your own words, how MM uses the arbitrage process to prove the validity of Proposition I. Also, list the major MM assumptions and explain why each of these assumptions is necessary in the arbitrage proof.
> Greene Sisters has a DSO of 20 days. The company’s average daily sales are $20,000. What is the level of its accounts receivable? Assume there are 365 days in a year.
> The Jimenez Corporation’s forecasted 2016 financial statements follow, along with some industry average ratios. Calculate Jimenez’s 2016 forecasted ratios, compare them with the industry average data, and comment brief
> How can a company use a bankruptcy to abrogate labor contracts? Has this occurred in certain industries in recent years?
> Data for Lozano Chip Company and its industry averages follow. a. Calculate the indicated ratios for Lozano. b. Construct the extended DuPont equation for both Lozano and the industry. c. Outline Lozano’s strengths and weaknesses as
> The Kretovich Company had a quick ratio of 1.4, a current ratio of 3.0, a days sales outstanding of 36.5 days (based on a 365-day year), total current assets of $810,000, and cash and marketable securities of $120,000. What were Kretovich’s annual sales?
> Complete the balance sheet and sales information in the table that follows for J. White Industries using the following financial data: Total assets turnover: 1.5 Gross profit margin on sales: (Sales 2 Cost of goods sold)/Sales 5 25% Total liabilities-
> The Morris Corporation has $600,000 of debt outstanding, and it pays an interest rate of 8% annually. Morris’ annual sales are $3 million, its average tax rate is 40%, and its net profit margin on sales is 3%. If the company does not maintain a TIE ratio
> You are considering an investment in either individual stocks or a portfolio of stocks. The two stocks you are researching, Stock A and Stock B, have the following historical returns: a. Calculate the average rate of return for each stock during the 5-ye
> Stock R has a beta of 1.5, Stock S has a beta of 0.75, the expected rate of return on an average stock is 13%, and the risk-free rate is 7%. By how much does the required return on the riskier stock exceed that on the less risky stock?
> You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta of 1.1. You are considering selling $100,000 worth of one stock with a beta of 0.9 and using the proceeds to purchase another sto
> Suppose you manage a $4 million fund that consists of four stocks with the following investments: If the market’s required rate of return is 14% and the risk-free rate is 6%, what is the fund’s required rate of return?
> Your retirement fund consists of a $5,000 investment in each of 15 different common stocks. The portfolio’s beta is 1.20. Suppose you sell one of the stocks with a beta of 0.8 for $5,000 and use the proceeds to buy another stock whose beta is 1.6. Calcul
> As an equity analyst you are concerned with what will happen to the required return to Universal Toddler Industries’ stock as market conditions change. Suppose rRF 5 5%, rM 5 12%, and bUTI 5 1.4. a. Under current conditions, what is rUTI, the required r
> Carter Enterprises can issue floating-rate debt at LIBOR + 2% or fixed-rate debt at 10%. Brence Manufacturing can issue floating-rate debt at LIBOR + 3.1% or fixed-rate debt at 11%. Suppose Carter issues floating-rate debt and Brence issues fixed-rate de
> Suppose rRF 5 5%, rM 5 10%, and rA 5 12%. a. Calculate Stock A’s beta. b. If Stock A’s beta were 2.0, then what would be A’s new required rate of return?
> The market and Stock J have the following probability distributions: a. Calculate the expected rates of return for the market and Stock J. b. Calculate the standard deviations for the market and Stock J Probability IM r, 0.3 15% 20% 0.4 9 5 0.3 18 1
> A stock’s return has the following distribution: Calculate the stock’s expected return and standard deviation. Rate of Return if Probability of This Demand Occurring Demand for the This Demand Company's Products
> An analyst has modeled the stock of a company using the Fama-French threefactor model. The risk-free rate is 5%, the market return is 10%, the return on the SMB portfolio (rSMB) is 3.2%, and the return on the HML portfolio (rHML) is 4.8%. If ai 5 0, bi 5
> Suppose that the risk-free rate is 5% and that the market risk premium is 7%. What is the required return on (1) the market, (2) a stock with a beta of 1.0, and (3) a stock with a beta of 1.7?
> AA Industries’ stock has a beta of 0.8. The risk-free rate is 4% and the expected return on the market is 12%. What is the required rate of return on AA’s stock?
> Your investment club has only two stocks in its portfolio. $20,000 is invested in a stock with a beta of 0.7, and $35,000 is invested in a stock with a beta of 1.3. What is the portfolio’s beta?
> You have observed the following returns over time: Copyright Assume that the risk-free rate is 6% and the market risk premium is 5%. a. What are the betas of Stocks X and Y? b. What are the required rates of return on Stocks X and Y? c. What is the re
> Assume that you recently graduated and landed a job as a financial planner with Cicero Services, an investment advisory company. Your first client recently inherited some assets and has asked you to evaluate them. The client owns a bond portfolio with $1
> Define and discuss how to calculate a bond’s coupon rate, current yield, expected capital gains yield for the current year, yield to maturity (YTM), and yield to call (YTC). What might be some representative numbers for a strong company like GE today? Ar
> What is the implied interest rate on a Treasury bond ($100,000) futures contract that settled at 100’16? If interest rates increased by 1%, what would be the contract’s new value?
> Financial assets such as mortgages, credit card receivables, and auto loan receivables are often bundled up, placed in a bank trust department, and then used as collateral for publicly traded bonds. Bond prices typically rise when interest rates decline,
> What is a bond rating, and how do ratings affect bonds’ prices and yields? Who rates bonds, and what are some of the factors the rating agencies consider? Is it possible for a given company to have several different bonds outstanding that have different
> Would a bond be more or less desirable if you learned that it has a sinking fund that requires the company to redeem, say, 10% of the original issue each year beginning in 2019, either through open market purchases or by calling the redeemed bonds at par
> Define the terms interest rate risk and reinvestment rate risk. How are these risks affected by maturities, call provisions, and coupon rates? Why might different types of investors view these risks differently? How would they affect the yield curve? Ill
> What is the difference between a diversifiable risk and a nondiversifiable risk? Should stock portfolio managers try to eliminate both types of risk?
> Has the validity of the CAPM been confirmed through empirical tests?
> What is the difference between a historical beta, an adjusted beta, and a fundamental beta? Does it matter which beta is used, and if so, which is best?
> What is the Security Market Line (SML)? What information is developed in the Capital Market Line analysis and then carried over and used to help specify the SML? For practical applications as opposed to theoretical considerations, which is more relevant,
> What is an efficient portfolio? What is the Capital Market Line (CML), how is it related to efficient portfolios, and how does it interface with an investor’s indifference curve to determine the investor’s optimal portfolio? Is it possible that two ratio
> Define the terms covariance and correlation coefficient. How are they related to one another, and how do they affect the required rate of return on a stock? Would correlation affect its required rate of return if a stock were held (say, by the company’s
> A Treasury bond futures contract has a settlement price of 89’08. What is the implied annual yield?
> What is the difference between a spot rate and a forward rate? How can forward rates be used for hedging purposes? Why would hedging occur?
> If a publicly traded company has a large number of undiversified investors, along with some who are well diversified, can the undiversified investors earn a rate of return high enough to compensate them for the risk they bear? Does this affect the compan
> You are given the following set of data: a. Use a spreadsheet (or a calculator with a linear regression function) to determine Stock X’s beta coefficient. b. Determine the arithmetic average rates of return for Stock X and the NYSE over
> The beta coefficient of an asset can be expressed as a function of the asset’s correlation with the market as follows: a. Substitute this expression for beta into the Security Market Line (SML), Equation 3-9. This results in an alterna
> Stock A has an expected return of 12% and a standard deviation of 40%. Stock B has an expected return of 18% and a standard deviation of 60%. The correlation coefficient between Stocks A and B is 0.2. What are the expected return and standard deviation o
> An analyst has modeled the stock of Crisp Trucking using a two-factor APT model. The risk-free rate is 6%, the expected return on the first factor (r1) is 12%, and the expected return on the second factor (r2) is 8%. If bi15 0.7 and bi2 5 0.9, what is Cr
> The standard deviation of stock returns for Stock A is 40%. The standard deviation of the market return is 20%. If the correlation between Stock A and the market is 0.70, then what is Stock A’s beta?
> You are given the following set of data: a. Construct a scatter diagram showing the relationship between returns on Stock Y and the market. Use a spreadsheet or a calculator with a linear regression function to estimate beta. b. Give a verbal interpreta
> Define the following terms, using graphs or equations to illustrate your answers wherever feasible: a. Portfolio; feasible set; efficient portfolio; efficient frontier b. Indifference curve; optimal portfolio c. Capital Asset Pricing Model (CAPM); Capita
> a. Suppose Asset A has an expected return of 10% and a standard deviation of 20%. Asset B has an expected return of 16% and a standard deviation of 40%. If the correlation between A and B is 0.35, what are the expected return and standard deviation for a
> Differentiate between (a) stand-alone risk and (b) risk in a portfolio context. How are they measured and are both concepts relevant for investors? What is securitization? How is securitization supposed to help banks and S&Ls manage risks and increas
> The Zinn Company plans to issue $10,000,000 of 20-year bonds in June to help finance a new research and development laboratory. The bonds will pay interest semiannually. It is now November, and the current cost of debt to the high-risk biotech company is
> What are the advantages of the corporate for mover a sole proprietorship or a partnership? What are the disadvantages of this form?
