Teardrop, Inc., wishes to expand its facilities. The company currently has 6.8 million shares outstanding and no debt. The stock sells for $65 per share, but the book value per share is $20. Net income for Teardrop is currently $11.5 million. The new facility will cost $30 million, and it will increase net income by $675,000. The par value of the stock is $1 per share. a. Assuming a constant price–earnings ratio, what will the effect be of issuing new equity to finance the investment? To answer, calculate the new book value per share, the new total earnings, the new EPS, the new stock price, and the new market-to-book ratio. What is going on here? b. What would the new net income for Teardrop have to be for the stock price to remain unchanged?
> You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech equipment). The scanner costs $5,800,000, and it would be depreciated straight-line to zero over four ye
> 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? 9.125 May 09 100.09375 100.12500 -2.15 ...
> Metallica Bearings, Inc., is a young start-up company. No dividends will be paid on the stock over the next nine years, because the firm needs to plow back its earnings to fuel growth. The company will pay a dividend of $17.50 per share in 10 years and w
> What are the possible reasons why the stock price typically drops on the announcement of a seasoned new equity issue?
> Several publicly traded companies have issued more than one class of stock. Why might a company issue more than one class of stock?
> Technical analysis is a controversial investment practice. Technical analysis covers a wide array of techniques, which are all used in an attempt to predict the direction of a particular stock or the market. Technical analysts look at two major types of
> You are evaluating Project A and Project B. Project A has a short period of future cash flows, while Project B has relatively long future cash flows. Which project will be more sensitive to changes in the required return? Why?
> What are the differences between preferred stock and debt?
> In 2003, Porsche unveiled its new sports utility vehicle (SUV), the Cayenne. With a price tag of over $40,000, the Cayenne goes from zero to 62 mph in 8.5 seconds. Porsche’s decision to enter the SUV market was in response to the runaway success of other
> In April 2014, International Lease Finance Corporation (ILFC) announced a deal to purchase eight Airbus A330-200 and A350-900 passenger aircraft. ILFC then signed a long-term lease contract on the planes with Azul Linhas Aéreas Brasileiras to be used for
> Historically, the U.S. tax code treated dividend payments made to shareholders as ordinary income. Thus, dividends were taxed at the investor’s marginal tax rate, which was as high as 38.6 percent in 2002. Capital gains were taxed at a capital gains tax
> The Woods Co. and the Garcia Co. have both announced IPOs at $40 per share. One of these is undervalued by $11, and the other is overvalued by $3, but you have no way of knowing which is which. You plan on buying 1,000 shares of each issue. If an issue i
> What factors influence a firm’s choice of external versus internal equity financing?
> Technical analysis is a controversial investment practice. Technical analysis covers a wide array of techniques, which are all used in an attempt to predict the direction of a particular stock or the market. Technical analysts look at two major types of
> Consider the following cash flows on two mutually exclusive projects for the Bahamas Recreation Corporation (BRC). Both projects require an annual return of 14 percent. As a financial analyst for BRC, you are asked the following questions: a. If your d
> You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.73 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
> Given the information in Problem 10, what was the average real risk-free rate over this time period? What was the average real risk premium?
> Consider a project with a required return of R percent that costs $I and will last for N years. The project uses straight-line depreciation to zero over the N-year life; there are neither salvage value nor net working capital requirements. a. At the acco
> Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $730,000 is estimated to result in $270,000 in annual pretax cost savings. The press falls in the MACRS five- year class, and it w
> Define the three forms of market efficiency.
> Rob Stevens is the chief executive officer of Isner Construction, Inc., and owns 850,000 shares of stock. The company currently has 5.1 million shares of stock and convertible bonds with a face value of $40 million outstanding. The convertible bonds have
> 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 = 53% per year
> Roll Corporation (RC) currently has 465,000 shares of stock outstanding that sell for $73 per share. Assuming no market imperfections or tax effects exist, what will the share price be after: a. RC has a five-for-three stock split? b. RC has a 15 percent
> The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.9 million in annual p
> The all-equity firm Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here: MHMM is considering an investment that has the same PE ratio as the firm. The cost o
> You own 1,000 shares of stock in Avondale Corporation. You will receive a dividend of $2.60 per share in one year. In two years, Avondale will pay a liquidating dividend of $53 per share. The required return on Avondale stock is 14 percent. What is the c
> For the company in the previous problem, what is the value of being able to issue subsidized debt instead of having to issue debt at the terms it would normally receive? Assume the face amount and maturity of the debt issue are the same.
> In the previous question, suppose the corporate tax rate is 35 percent. What is EBIT in this case? What is the WACC? Explain.
> Williams Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 6.5 percent, payable annually. The one-year interest rate is 6.5 percent. Next year, there is a 35 percent probability that interest rates will increase to 8
> Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt: 10,000 5.6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 97 percent of par; the bonds make
> Universal Laser, Inc., just paid a dividend of $2.90 on its stock. The growth rate in dividends is expected to be a constant 6 percent per year, indefinitely. Investors require a 15 percent return on the stock for the first three years, a 13 percent retu
> Which of the following should be treated as an incremental cash flow when computing the NPV of an investment? a. A reduction in the sales of a company’s other products caused by the investment. b. An expenditure on plant and equipment that has not yet be
> What is the impact of lengthening the time to expiration on an option’s value? Explain.
> If Wild Widgets, Inc., were an all-equity company, it would have a beta of .95. 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
> The shareholders of Bryant Power Corp. need to elect three new directors to the board. There are 16,500,000 shares of common stock outstanding, and the current share price is $13.75. If the company uses cumulative voting procedures, how much will it cost
> What are the comparative advantages of a competitive offer and a negotiated offer, respectively?
> Why is it that municipal bonds are not taxed at the federal level, but are taxable across state lines? Why is it that U.S. Treasury bonds are not taxable at the state level? (You may need to dust off the history books for this one.)
> Projects A and B have the following cash flows: a. If the cash flows from the projects are identical, which of the two projects would have a higher IRR? Why? b. If C1B 5 2C1A, C2B 5 2C2A, and C3B 5 2C3A, then is IRRA5 IRR B? Year Project A Project
> Evaluate the following statement: Managers should not focus on the current stock value because doing so will lead to an overemphasis on short-term profits at the expense of long-term profits.
> In 2003, Porsche unveiled its new sports utility vehicle (SUV), the Cayenne. With a price tag of over $40,000, the Cayenne goes from zero to 62 mph in 8.5 seconds. Porsche’s decision to enter the SUV market was in response to the runaway success of other
> The following material represents the cover page and summary of the prospectus for the initial public offering of the Pest Investigation Control Corporation (PICC), which is going public tomorrow with a firm commitment initial public offering managed by
> What is the basic goal of financial management with regard to capital structure?
> What is wrong with measuring the performance of a U.S. growth stock manager against a benchmark composed of British stocks?
> Looking back at the crossover bonds we discussed in the chapter, why do you think split ratings such as these occur?
> If a project with conventional cash flows has a payback period less than the project’s life, can you definitively state the algebraic sign of the NPV? Why or why not? If you know that the discounted payback period is less than the project’s life, what ca
> A project has perpetual cash flows of C per period, a cost of I, and a required return of R. What is the relationship between the project’s payback and its IRR? What implications does your answer have for long-lived projects with relatively constant cash
> Suppose you are offered $9,400 today but must make the following payments: a. What is the IRR of this offer? b. If the appropriate discount rate is 10 percent, should you accept this offer? c. If the appropriate discount rate is 20 percent, should you
> What are the prices of a call option and a put option with the following characteristics? Stock price = $57 Exercise price = $60 %3D Risk-free rate = 6% per year, compounded continuously Maturity = 4 months Standard deviation = 54% per year
> The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business. Management has decided that it must use the system to stay competitive; it will provide $2.9 million in annual p
> The Mann Company belongs to a risk class for which the appropriate discount rate is 10 percent. Mann currently has 240,000 outstanding shares selling at $105 each. The firm is contemplating the declaration of a $4 dividend at the end of the fiscal year t
> Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $93 million. The equipment will be fully depreciated using the straight-line met
> Overnight Publishing Company (OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm’s debt is held by one institution that is willing to sell it back to OPC fo
> Kose, Inc., has a target debt–equity ratio of .45. Its WACC is 9.8 percent, and the tax rate is 35 percent. a. If Kose’s cost of equity is 13 percent, what is its pretax cost of debt? b. If instead you know that the aftertax cost of debt is 5.9 percent,
> Assume that the returns on individual securities are generated by the following two-factor model: Here: Rα is the return on Security i at Time t. F1t and F2t are market factors with zero expectation and zero covariance. In addition, assume
> You own a stock portfolio invested 15 percent in Stock Q, 35 percent in Stock R, 30 percent in Stock S, and 20 percent in Stock T. The betas for these four stocks are .75, 1.90, 1.38, and 1.16, respectively. What is the portfolio beta?
> What happens to the price of a convertible bond if interest rates increase?
> Why does the value of a share of stock depend on dividends?
> In Problem 9, suppose the average inflation rate over this period was 4.2 percent, and the average T-bill rate over the period was 5.1 percent. a. What was the average real return on the company’s stock? b. What was the average nominal risk premium on th
> If Treasury bills are currently paying 3.9 percent and the inflation rate is 2.1 percent, what is the approximate real rate of interest? The exact real rate?
> Niko has purchased a brand new machine to produce its High Flight line of shoes. The machine has an economic life of five years. The depreciation schedule for the machine is straight-line with no salvage value. The machine costs $575,000. The sales price
> You are evaluating two different silicon wafer milling machines. The Techron I costs $245,000, has a three-year life, and has pretax operating costs of $39,000 per year. The Techron II costs $315,000, has a five-year life, and has pretax operating costs
> Vital Silence Corp. has just issued a 30-year callable, convertible bond with an annual coupon rate of 6 percent. The bond has a conversion price of $93. The company’s stock is selling for $28 per share. The owner of the bond will be forced to convert if
> You are in discussions to purchase an option on an office building with a strike price of $63 million. The building is currently valued at $60 million. The option will allow you to purchase the building either six months from today or one year from today
> The Spring Flower Co. has earnings of $2.35 per share. The benchmark PE for the company is 18. What stock price would you consider appropriate? What if the benchmark PE were 21?
> A warrant with six months until expiration entitles its owner to buy 10 shares of the issuing firm’s common stock for an exercise price of $31 per share. If the current market price of the stock is $15 per share, will the warrant be worthless?
> How would the analysis of real options change if a company has competitors?
> 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
> When you take out an ordinary student loan, it is usually the case that whoever holds that loan is given a guarantee by the U.S. government, meaning that the government will make up any payments you skip. This is just one example of the many loan guarant
> A convertible bond with a par value of $1,000 has a conversion ratio of 19.2. What is the conversion price?
> In April 2014, International Lease Finance Corporation (ILFC) announced a deal to purchase eight Airbus A330-200 and A350-900 passenger aircraft. ILFC then signed a long-term lease contract on the planes with Azul Linhas Aéreas Brasileiras to be used for
> The Phew Charitable Trust pays no taxes on its capital gains or on its dividend income or interest income. Would it be irrational for it to have low-dividend, high-growth stocks in its portfolio? Would it be irrational for it to have municipal bonds in i
> What is the difference between internal financing and external financing?
> For each of the following scenarios, discuss whether profit opportunities exist from trading in the stock of the firm under the conditions that (1) the market is not weak form efficient, (2) the market is weak form but not semistrong form efficient, (3)
> What factors determine the beta of a stock? Define and describe each.
> 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.
> The historical asset class returns presented in the chapter are not adjusted for inflation. What would happen to the estimated risk premium if we did account for inflation? The returns are also not adjusted for taxes. What would happen to the returns if
> 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.
> You are discussing a project analysis with a coworker. The project involves real options, such as expanding the project if successful, or abandoning the project if it fails. Your coworker makes the following statement: “This analysis is ridiculous. We lo
> Consider the following two mutually exclusive projects available to Global Investments, Inc.: The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake Project A. At a luncheon for shareholders, the manager of
> In the context of capital budgeting, what is an opportunity cost?
> Is it unfair or unethical for corporations to create classes of stock with unequal voting rights?
> What is the difference between the term structure of interest rates and the yield curve?
> Insurance, whether purchased by a corporation or an individual, is in essence an option. What type of option is an insurance policy?
> Suppose the interest rate on T-bills suddenly and unexpectedly rises. All other things being the same, what is the impact on call option values? On put option values?
> Explain why the aftertax borrowing rate is the appropriate discount rate to use in lease evaluation.
> In 1980, a certain assistant professor of finance bought 12 initial public offerings of common stock. He held each of these for approximately one month and then sold them. The investment rule he followed was to submit a purchase order for every firm comm
> Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such cases the firm is using bankruptcy laws “as a sword rather than a shield.” Is this an ethical tactic?
> What steps can stockholders take to reduce the costs of debt?
> What is homemade leverage?
> A project has an initial cost of I, has a required return of R, and pays C annually for N years. a. Find C in terms of I and N such that the project has a payback period just equal to its life. b. Find C in terms of I, N, and R such that this is a profit
> The Newton Company has 50,000 shares of stock that each sell for $40. Suppose the company issues 9,000 shares of new stock at the following prices: $40, $20, and $10. What is the effect of each of the alternative offering prices on the existing price per
> What is the primary difference between a warrant and a traded call option?
> In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 45 cent per share cash dividend on the new (postsplit) shares represents an increase of 10 percent over last year’s dividend on the presplit stock. Wha
> Bolero, Inc., has compiled the following information on its financing costs: The company is in the 35 percent tax bracket and has a target debt–equity ratio of 60 percent. The target short-term debt/long-term debt ratio is 20 percent.
> When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is: where: VL = The value of a levered firm. VU = The
> ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $640,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $320,000 and the interest rate on its debt is 8 perc
> In the previous problem, suppose the company’s stock has a beta of 1.15. The risk-free rate is 3.7 percent, and the market risk premium is 7 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues.
> Assume that the following market model adequately describes the return-generating behavior of risky assets: Here: Rit = The return on the ith asset at Time t. RMt = The return on a portfolio containing all risky assets in some proportion at Time t. RMt a
> T-bills currently yield 3.9 percent. Stock in Nina Manufacturing is currently selling for $63 per share. There is no possibility that the stock will be worth less than $61 per share in one year. a. What is the value of a call option with a $60 exercise p
> Consider the following information: a. Your portfolio is invested 30 percent each in A and C, and 40 percent in B. What is the expected return of the portfolio? b. What is the variance of this portfolio? The standard deviation? Rate of Return if St
