Question: Mr. Sam Golff desires to invest a

> Explain the effect of the risk-return trade-off on the market value of common stock.

> The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11¾ percent seven years ago. Interest rates have fallen to 10¾ percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any furthe

> The Bowman Corporation has a $18 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally is

> A $1,000 par value bond was issued 20 years ago at a 9 percent coupon rate. It currently has five years remaining to maturity. Interest rates on similar debt obligations are now 10 percent. a. Compute the current price of the bond using an assumption of

> A $1,000 par value bond was issued 25 years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity. Interest rates on similar obligations are now 8 percent. a. What is the current price of the bond? (Look up the answer in Table

> Seventeen years ago, the Archer Corporation borrowed $6,500,000. Since then, cumulative inflation has been 65 percent (a compound rate of approximately 3 percent per year). a. When the firm repays the original $6,500,000 loan this year, what will be the

> Assume a zero-coupon bond that sells for $403 and will mature in 10 years at $1,250. What is the effective yield to maturity? (Compute PVIF and go to Appendix B for the 10-year figure to find the answer, or compute FVIF and go to Appendix A for the 10-ye

> A 17-year, $1,000 par value zero-coupon rate bond is to be issued to yield 7 percent. a. What should be the initial price of the bond? (Take the present value of $1,000 for 17 years at 7 percent, using Appendix B.) b. If immediately upon issue, interest

> A previously issued A2, 15-year industrial bond provides a return three-fourths higher than the prime interest rate of 11 percent. Previously issued A2 public utility bonds provide a yield of three-fourths of a percentage point higher than previously iss

> The Pioneer Petroleum Corporation has a bond outstanding with an $85 annual interest payment, a market price of $800, and a maturity date in five years. Find the following: a. The coupon rate. b. The current rate. c. The yield to maturity.

> Walton and Company is the managing investment banker for a major new underwriting. The price of the stock to the investment banker is $23 per share. Other syndicate members may buy the stock for $24.25. The price to the selected dealers group is $24.80,

> Assume a firm has several hundred possible investments and that it wants to analyze the risk-return trade-off for portfolios of 20 projects. How should it proceed with the evaluation?

> Assume Sybase Software is thinking about three different size offerings for issuance of additional shares. What is the percentage underwriting spread for each size offer?

> Jordan Broadcasting Company is going public at $50 net per share to the company. There also are founding stockholders that are selling part of their shares at the same price. Prior to the offering, the firm had $26 million in earnings divided over 11 mil

> American Health Systems has 6,400,000 shares of stock outstanding and will report earnings of $10 million in the current year. The company is considering the issuance of 1,700,000 additional shares, which can only be issued at $18 per share. a. Assume th

> American Health Systems currently has 6,400,000 shares of stock outstanding and will report earnings of $10 million in the current year. The company is considering the issuance of 1,700,000 additional shares that will net $30 per share to the corporation

> The management of Mitchell Labs decided to go private in 2002 by buying all 2.80 million of its outstanding shares at $24.80 per share. By 2006, management had restructured the company by selling off the petroleum research division for $10.75 million, th

> I. B. Michaels has a chance to participate in a new public offering by Hi-Tech Micro Computers. His broker informs him that demand for the 700,000 shares to be issued is very strong. His broker’s firm is assigned 25,000 shares in the distribution and wil

> Tyson Iron Works is about to go public. It currently has after tax earnings of $4,400,000, and 4,200,000 shares are owned by the present stockholders. The new public issue will represent 500,000 new shares. The new shares will be priced to the public at

> The Hamilton Corporation Company has 4 million shares of stock outstanding and will report earnings of $6,910,000 in the current year. The company is considering the issuance of 1 million additional shares that can only be issued at $30 per share. a. Ass

> The Presley Corporation is about to go public. It currently has aftertax earnings of $7,200,000, and 2,100,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 800,000 new shares. The new shares will

> Midland Corporation has a net income of $19 million and 4 million shares outstanding. Its common stock is currently selling for $48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of $21,120,000. Th

> If risk is to be analyzed in a qualitative way, place the following investment decisions in order from the lowest risk to the highest risk: a. New equipment b. New market c. Repair of old machinery d. New product in a foreign market e. New product in a r

> The Landers Corporation needs to raise $1.60 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 10 percent. Twenty thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rat

> The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D1) at the end of the current year will be $1.64. The growth rate (g) is 8 percent and the discount rat

> Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers, and Chance is attempting to price the issue. The car rental industry generally trades at a 20 percent discount below the P/E ratio on the Standard & Poorâ

> Winston Sporting Goods is considering a public offering of common stock. Its investment banker has informed the company that the retail price will be $16.85 per share for 550,000 shares. The company will receive $15.40 per share and will incur $180,000 i

> Trump Card Co. will issue stock at a retail (public) price of $32. The company will receive $29.20 per share. a. What is the spread on the issue in percentage terms? b. If the firm demands receiving a new price only $2.20 below the public price suggested

> Becker Brothers is the managing underwriter for a 1.45-million-share issue by Jay’s Hamburger Heaven. Becker Brothers is “handling” 10 percent of the issue. Its price is $27 per share, and the price to the public is $28.95. Becker also provides the marke

> Kevin’s Bacon Company Inc. has earnings of $9 million with 2,100,000 shares outstanding before a public distribution. Seven hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 300,000 are shares currently

> The Wrigley Corporation needs to raise $44 million. The investment banking firm of Tinkers, Evers, & Chance will handle the transaction. a. If stock is utilized, 2,300,000 shares will be sold to the public at $20.50 per share. The corporation will recei

> Louisiana Timber Company currently has 5 million shares of stock outstanding and will report earnings of $9 million in the current year. The company is considering the issuance of 1 million additional shares that will net $40 per share to the corporation

> Digital Technology wishes to determine its coefficient of variation as a company over time. The firm projects the following data (in millions of dollars): a. Compute the coefficient of variation (V) for each time period. b. Does the risk (V) appear to

> Explain how the concept of risk can be incorporated into the capital budgeting process.

> Five investment alternatives have the following returns and standard deviations of returns: Using the coefficient of variation, rank the five alternatives from lowest risk to highest risk. Returns: Standard Deviation Alternative Expected Value A $

> Five investment alternatives have the following returns and standard deviations of returns: Using the coefficient of variation, rank the five alternatives from lowest risk to highest risk. Returns: Standard Alternative Expected Value Deviation A $

> Possible outcomes for three investment alternatives and their probabilities of occurrence are given next. Rank the three alternatives in terms of risk from lowest to highest (compute the coefficient of variation). Alternative 1 Alternative 2 Altern

> Al Bundy is evaluating a new advertising program that could increase shoe sales. Possible outcomes and probabilities of the outcomes are shown next. Compute the coefficient of variation. Additional Sales Possible Outcome in Units Probability Ineffec

> Shack Homebuilders Limited is evaluating a new promotional campaign that could increase home sales. Possible outcomes and probabilities of the outcomes are shown next. Compute the coefficient of variation. Additional Sales in Units Possible Outcome

> Sampson Corp. is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given. a. What is the expected value of unit sales for the new product? b. What is the standard deviation of

> Sheila Goodman recently received her MBA from the Harvard Business School. She has joined the family business, Goodman Software Products Inc., as vice president of finance. She believes in adjusting projects for risk. Her father is somewhat skeptical but

> Ms. Sharp is looking at a number of different types of investments for her portfolio. She identifies eight possible investments. a. Graph the data in a manner similar to Figure 13-11. Use the axes that follow for your data: b. Draw a curved line repr

> Hooper Chemical Company, a major chemical firm that uses such raw materials as carbon and petroleum as part of its production process, is examining a plastics firm to add to its operations. Before the acquisition, the normal expected outcomes for the fir

> Treynor Pie Company is a food company specializing in high-calorie snack foods. It is seeking to diversify its food business and lower its risks. It is examining three companies—a gourmet restaurant chain, a baby food company, and a nut

> When is the coefficient of variation a better measure of risk than the standard deviation?

> The Oklahoma Pipeline Company projects the following pattern of inflows from an investment. The inflows are spread over time to reflect delayed benefits. Each year is independent of the others. The expected value for all three years is $70. a. Compute

> When returns from a project can be assumed to be normally distributed, such as those (represented by a symmetrical, bell-shaped curve), the areas under the curve can be determined from statistical tables based on standard deviations. For example, 68.26 p

> Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next: a. What is the expected value of unit sales for the new product? b. What is the standard

> Allison’s Dresswear Manufacturers is preparing a strategy for the fall season. One alternative is to expand its traditional ensemble of wool sweaters. A second option would be to enter the cashmere sweater market with a new line of high

> Highland Mining and Minerals Co. is considering the purchase of two gold mines. Only one investment will be made. The Australian gold mine will cost $1,649,000 and will produce $353,000 per year in years 5 through 15 and $503,000 per year in years 16 thr

> Debby’s Dance Studios is considering the purchase of new sound equipment that will enhance the popularity of its aerobics dancing. The equipment will cost $27,900. Debby is not sure how many members the new equipment will attract, but s

> Fill in the following table from Appendix B. Does a high discount rate have a greater or lesser effect on long-term inflows compared to recent ones? Discount Rate Year 5% 20% 1. 10. 20.

> Dixie Dynamite Company is evaluating two methods of blowing up old buildings for commercial purposes over the next five years. Method one (implosion) is relatively low in risk for this business and will carry a 12 percent discount rate. Method two (explo

> Waste Industries is evaluating a $70,000 project with the following cash flows: The coefficient of variation for the project is .847. Based on the following table of risk-adjusted discount rates, should the project be undertaken? Select the appropriate

> Discuss the concept of risk and how it might be measured.

> Kyle’s Shoe Stores Inc. is considering opening an additional suburban outlet. An after tax expected cash flow of $130 per week is anticipated from two stores that are being evaluated. Both stores have positive net present values. Which

> Mountain Ski Corp. was set up to take large risks and is willing to take the greatest risk possible. Lakeway Train Co. is more typical of the average corporation and is risk-averse. a. Which of the following four projects should Mountain Ski Corp. choose

> Tim Trepid is highly risk-averse, while Mike Macho actually enjoys taking a risk. a. Which one of the four investments should Tim choose? Compute coefficients of variation to help you in your choice. b. Which one of the four investments should Mike cho

> The Short-Line Railroad is considering a $140,000 investment in either of two companies. The cash flows are as follows: a. Using the payback method, what will the decision be? b. Explain why the answer in part a can be misleading. Year Electric Co.

> Assume a $90,000 investment and the following cash flows for two alternatives. a. Calculate the payback for investment A and B. b. If the inflow in the fifth year for Investment A was $25,000,000 instead of $25,000, would your answer change under the p

> Assume a $40,000 investment and the following cash flows for two alternatives. Which of the alternatives would you select under the payback method? Year Investment X Investment Y 1 $6,000 $15,000 2 8,000 20,000 3 9,000 10,000 17,000 20,000

> Assume a $250,000 investment and the following cash flows for two products: Which alternatives would you select under the payback method? Year Product X Product Y 1 $90,000 $50,000 2 90,000 80,000 60,000 60,000 4 20,000 70,000

> Al Quick, the president of a New York Stock Exchange —listed firm, is very short-term oriented and interested in the immediate consequences of his decisions. Assume a project that will provide an increase of $2 million in cash flow because of favorable t

> Assume a firm has earnings before depreciation and taxes of $440,000 and depreciation of $140,000. a. If it is in a 35 percent tax bracket, compute its cash flow. b. If it is in a 20 percent tax bracket, compute its cash flow.

> Hercules Exercise Equipment Co. purchased a computerized measuring device two years ago for $58,000. The equipment falls into the five-year category for MACRS depreciation and can currently be sold for $24,800. A new piece of equipment will cost $148,000

> How does an asset’s ADR (asset depreciation range) relate to its MACRS category?

> Data Point Engineering is considering the purchase of a new piece of equipment for $240,000. It has an eight-year midpoint of its asset depreciation range (ADR). It will require an additional initial investment of $140,000 in non depreciable working capi

> An asset was purchased three years ago for $120,000. It falls into the five-year category for MACRS depreciation. The firm is in a 25 percent tax bracket. Compute the following: a. Tax loss on the sale and the related tax benefit if the asset is sold now

> The Spartan Technology Company has a proposed contract with the Digital Systems Company of Michigan. The initial investment in land and equipment will be $120,000. Of this amount, $70,000 is subject to five-year MACRS depreciation. The balance is in non

> Assume a firm has earnings before depreciation and taxes of $200,000 and no depreciation. It is in a 25 percent tax bracket. a. Compute its cash flow. b. Assume it has $200,000 in depreciation. Re compute its cash flow. c. How large a cash flow benefit d

> Universal Electronics is considering the purchase of manufacturing equipment with a 10-year midpoint in its asset depreciation range (ADR). Carefully refer to Table 12-11 to determine in what depreciation category the asset falls. (Hint: It is not 10 yea

> Oregon Forest Products will acquire new equipment that falls under the five-year MACRS category. The cost is $300,000. If the equipment is purchased, the following earnings before depreciation and taxes will be generated for the next six years. The fir

> The Summit Petroleum Corporation will purchase an asset that qualifies for three-year MACRS depreciation. The cost is $160,000 and the asset will provide the following stream of earnings before depreciation and taxes for the next four years: The firm i

> Assume $65,000 is going to be invested in each of the following assets. Using Tables 12-11 and 12-12, indicate the dollar amount of the first year’s depreciation. a. Office furniture. b. Automobile. c. Electric and gas utility property. d. Sewage treatme

> Telstar Communications is going to purchase an asset for $380,000 that will produce $180,000 per year for the next four years in earnings before depreciation and taxes. The asset will be depreciated using the three-year MACRS depreciation schedule. (This

> Davis Chili Company is considering an investment of $35,000, which produces the following inflows: You are going to use the net present value profile to approximate the value for the internal rate of return. Please follow these steps: a. Determine the

> What is the net present value profile? What three points should be determined to graph the profile?

> Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The inv

> The Suboptimal Glass Company uses a process of capital rationing in its decision making. The firm’s cost of capital is 10 percent. It will only invest $77,000 this year. It has determined the internal rate of return for each of the foll

> The Caffeine Coffee Company uses the modified internal rate of return. The firm has a cost of capital of 11 percent. The project being analyzed is as follows ($26,000 investment): a. What is the modified internal rate of return? An approximation from A

> Turner Video will invest $58,500 in a project. The firm’s cost of capital is 12 percent. The investment will provide the following inflows: The internal rate of return is 11 percent. a. If the reinvestment assumption of the net presen

> Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $40,000, and that it has a 24 percent tax bracket. a. Compute its cash flow using the following format: b. Compute the cash flow for the company if depreciati

> You are asked to evaluate the following two projects for the Norton Corporation. Using the net present value method combined with the profitability index approach described in footnote 2 of this chapter, which project would you select? Use a discount rat

> The Pan American Bottling Co. is considering the purchase of a new machine that would increase the speed of bottling and save money. The net cost of this machine is $60,000. The annual cash flows have the following projections: a. If the cost of capita

> The Hudson Corporation makes an investment of $24,000 that provides the following cash flow: Year Cash Flow  1 $ 13,000  2 13,000  3 4,000   a. What is the net present value at an 8 percent discount rate? b. What is the internal rate of r

> Skyline Corp. will invest $130,000 in a project that will not begin to produce returns until after the 3rd year. From the end of the 3rd year until the end of the 12th year (10 periods), the annual cash flow will be $34,000. If the cost of capital is 12

> The Horizon Company will invest $60,000 in a temporary project that will generate the following cash inflows for the next three years. The firm will also be required to spend $10,000 to close down the project at the end of the three years. If the cost

> How does the modified internal rate of return include concepts from both the traditional internal rate of return and the net present value methods?

> What is the difference between technical insolvency and bankruptcy?

> Aerospace Dynamics will invest $110,000 in a project that will produce the following cash flows. The cost of capital is 11 percent. Should the project be undertaken? (Note that the fourth year’s cash flow is negative.) Year Cash Fl

> Home Security Systems is analyzing the purchase of manufacturing equipment that will cost $50,000. The annual cash inflows for the next three years will be a. Determine the internal rate of return. b. With a cost of capital of 18 percent, should the ma

> You buy a new piece of equipment for $16,230, and you receive a cash inflow of $2,500 per year for 12 years. What is the internal rate of return?

> X-treme Vitamin Company is considering two investments, both of which cost $10,000. The cash flows are as follows: a. Which of the two projects should be chosen based on the payback method? b. Which of the two projects should be chosen based on the net

> Assume a corporation has earnings before depreciation and taxes of $90,000, depreciation of $40,000, and a 25 percent tax bracket. Compute its cash flow using the following format: Earnings before depreciation and taxes Depreciation Earnings before

> Airborne Airlines Inc. has a $1,000 par value bond outstanding with 25 years to maturity. The bond carries an annual interest payment of $88 and is currently selling for $950. Airborne is in a 25 percent tax bracket. The firm wishes to know what the afte

> Royal Jewelers Inc. has an after tax cost of debt of 7 percent. With a tax rate of 25 percent, what can you assume the yield on the debt is?

> Calculate the after tax cost of debt under each of the following conditions: Yield Corporate Tax Rate a. 8.0% 26% b. 9.0 35 8.0 C.

> Calculate the after tax cost of debt under each of the following conditions: Yield Corporate Tax Rate а. 8.0% 18% b. 12.0 34 C. 10.6 15

> Eaton Electronic Company’s treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). Assume: a. Comput

> Why does capital budgeting rely on analysis of cash flows rather than on net income?