To solve the bid price problem presented in the text, we set the project NPV equal to zero and found the required price using the definition of OCF. Thus the bid price represents a financial breakeven level for the project. This type of analysis can be extended to many other types of problems.
a. In Problem 20, assume that the price per carton is $26 and find the project NPV. What does your answer tell you about your bid price? What do you know about the number of cartons you can sell and still break even? How about your level of costs?
b. Solve Problem 20 again with the price still at $26, but find the quantity of cartons per year that you can supply and still break even. Hint: It’s less than 125,000
c. Repeat (b) with a price of $26 and a quantity of 125,000 cartons per year, and find the highest level of fixed costs you could afford and still break even. Hint: It’s more than $485,000.
Problem 20:
Martin Enterprises needs someone to supply it with 125,000 cartons of machine screws per year to support its manufacturing needs over the next five years, and you’ve decided to bid on the contract. It will cost you $910,000 to install the equipment necessary to start production; you’ll depreciate this cost straight-line to zero over the project’s life. You estimate that, in five years, this equipment can be salvaged for $85,000. Your fixed production costs will be $485,000 per year, and your variable production costs should be $17.35 per carton. You also need an initial investment in net working capital of $90,000. If your tax rate is 21 percent and you require a return of 12 percent on your investment, what bid price should you submit?
> Nemesis, Inc., has 165,000 shares of stock outstanding. Each share is worth $77, so the company’s market value of equity is $12,705,000. Suppose the firm issues 30,000 new shares at the following prices: $77, $73, and $65. What effect will each of these
> The Raven Co. has just gone public. Under a firm commitment agreement, Raven received $21.39 for each of the 20 million shares sold. The initial offering price was $23 per share, and the stock rose to $28.41 per share in the first few minutes of trading.
> In Problem 5, if the SEC filing fee and associated administrative expenses of the offering are $1.2 million, how many shares need to be sold?Problem 5:The Whistling Straits Corporation needs to raise $60 million to finance its expansion into new markets.
> Given the following information for Bowie Pizza Co., calculate the depreciation expense: Sales = $64,000; Costs = $30,700; Addition to retained earnings = $5,700; Dividends paid = $1,980; Interest expense = $4,400; Tax rate = 22 percent
> The Maybe Pay Life Insurance Co. is trying to sell you an investment policy that will pay you and your heirs $35,000 per year forever. If the required return on this investment is 4.7 percent, how much will you pay for the policy?
> The Whistling Straits Corporation needs to raise $60 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If the offer price is $21 per share and the company’
> The Woods Co. and the Spieth Co. have both announced IPOs at $40 per share. One of these is undervalued by $9, and the other is overvalued by $4, but you have no way of knowing which is which. You plan to buy 1,000 shares of each issue. If an issue is un
> Red Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share pric
> Ying Import has several bond issues outstanding, each making semiannual interest payments. The bonds are listed in the following table. If the corporate tax rate is 22 percent, what is the aftertax cost of the company’s debt?,,,
> Being Human, Inc., recently issued new securities to finance a new TV show. The project cost $35 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas
> Sommer, Inc., is considering a project that will result in initial aftertax cash savings of $2.3 million at the end of the first year, and these savings will grow at a rate of 2 percent per year indefinitely. The firm has a target debt-equity ratio of .6
> You want to borrow $115,000 from your local bank to buy a new sailboat. You can afford to make monthly payments of $2,250, but no more. Assuming monthly compounding, what is the highest rate you can afford on a 60-month APR loan?
> The Clifford Corporation has announced a rights offer to raise $35 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a nonrefundable reviewing fee of $5,000 per page. The stock c
> Cully Company needs to raise $80 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 70 percent common stock,
> Suppose your company needs $24 million to build a new assembly line. Your target debt-equity ratio is .75. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3 percent. Your boss has decided to fund the project by bor
> You want to be a millionaire when you retire in 40 years. How much do you have to save each month if you can earn an annual return of 9.7 percent? How much do you have to save each month if you wait 10 years before you begin your deposits? 20 years?
> An all-equity firm is considering the following projects:The T-bill rate is 4 percent, and the expected return on the market is 11 percent.a. Which projects have a higher expected return than the firm’s 11 percent cost of capital?b. Whi
> Titan Mining Corporation has 7.5 million shares of common stock outstanding, 250,000 shares of 4.2 percent preferred stock outstanding, and 140,000 bonds with a semiannual coupon of 5.1 percent outstanding, par value $1,000 each. The common stock current
> Knight Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of $35. At the close of business, the day before the ex-rights day, the compa
> Prahm Corp. wants to raise $4.7 million via a rights offering. The company currently has 530,000 shares of common stock outstanding that sell for $55 per share. Its underwriter has set a subscription price of $30 per share and will charge the company a s
> Show that the value of a right just prior to expiration can be written as:Value of a right=PRO PX = (PRO Ps) / (N + 1)where PRO, PS, and PX stand for the rights-on price, the subscription price, and the ex-rights price, respectively, and N is the number
> Bell Hill Mfg. is considering a rights offer. The company has determined that the ex-rights price would be $63. The current price is $68 per share, and there are 26 million shares outstanding. The rights offer would raise a total of $70 million. What is
> In Problem 10, what would the ROE on the investment have to be if we wanted the price after the offering to be $75 per share? (Assume the PE ratio remains constant.) What is the NPV of this investment? Does any dilution take place?Problem 10:The Metallic
> Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,560,000; the new one will cost $1,872,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $
> The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:Stock price …………………………………………………………………………………………… $ 75Number of shares ……………………………………………………………………………… 64,
> Leah, Inc., is proposing a rights offering. Presently there are 375,000 shares outstanding at $67 each. There will be 50,000 new shares offered at $58 each.a. What is the new market value of the company?b. How many rights are associated with one of the n
> You have an investment that will pay you 0.67 percent per month. How much will you have per dollar invested in one year? In two years?
> Targaryen Corporation has a target capital structure of 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 10 percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 6 percent. The rel
> For the firm in Problem 7, suppose the book value of the debt issue is $95 million. In addition, the company has a second debt issue on the market, a zero coupon bond with eight years left to maturity; the book value of this issue is $40 million, and the
> Jiminy’s Cricket Farm issued a 30-year, 6 percent semiannual bond three years ago. The bond currently sells for 93 percent of its face value. The company’s tax rate is 22 percent.a. What is the pretax cost of debt?b. What is the after tax cost of debt?c.
> Viserion, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 23 years to maturity that is quoted at 103 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually. What
> Holdup Bank has an issue of preferred stock with a stated dividend of $4.25 that just sold for $93 per share. What is the bank’s cost of preferred stock?
> Suppose Stark, Ltd., just issued a dividend of $2.51 per share on its common stock. The company paid dividends of $2.01, $2.17, $2.25, and $2.36 per share in the last four years. If the stock currently sells for $43, what is your best estimate of the com
> Stock in Daenerys Industries has a beta of 1.05. The market risk premium is 7 percent, and T-bills are currently yielding 3.4 percent. The company’s most recent dividend was $2.35 per share, and dividends are expected to grow at an annual rate of 4.1 per
> The Rhaegel Corporation’s common stock has a beta of 1.07. If the risk-free rate is 3.5 percent and the expected return on the market is 10 percent, what is the company’s cost of equity capital?
> Your company has been approached to bid on a contract to sell 4,800 voice recognition (VR) computer keyboards per year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment
> What would the lease payment have to be for both lessor and lessee to be indifferent about the lease?
> You are planning to save for retirement over the next 30 years. To do this, you will invest $750 per month in a stock account and $250 per month in a bond account. The return of the stock account is expected to be 10 percent, and the bond account will pa
> Given the following information for Watson Power Co., find the WACC. Assume the company’s tax rate is 21 percent.Debt: …………………….. 15,000 bonds with a 5.8 percent coupon outstanding, $1,000 par value, 25 years to maturity, selling for 108 percent of par;
> Starset, Inc., has a target debt-equity ratio of .85. Its WACC is 9.1 percent, and the tax rate is 23 percent.a. If the company’s cost of equity is 14 percent, what is its pretax cost of debt?b. If instead you know that the after tax cost of debt is 6.5
> In Problem 12, suppose the most recent dividend was $3.25 and the dividend growth rate is 5 percent. Assume that the overall cost of debt is the weighted average of that implied by the two outstanding debt issues. Both bonds make semiannual payments. The
> Dinklage Corp. has 7 million shares of common stock outstanding. The current share price is $68, and the book value per share is $8. The company also has two bond issues outstanding. The first bond issue has a face value of $70 million, a coupon rate of
> Fama’s Llamas has a weighted average cost of capital of 7.9 percent. The company’s cost of equity is 11 percent, and its pretax cost of debt is 5.8 percent. The tax rate is 25 percent. What is the company’s target debt-equity ratio?
> Lannister Manufacturing has a target debt-equity ratio of .55. Its cost of equity is 11 percent, and its cost of debt is 6 percent. If the tax rate is 21 percent, what is the company’s WACC?
> The Drogon Co. just issued a dividend of $2.80 per share on its common stock. The company is expected to maintain a constant 4.5 percent growth rate in its dividends indefinitely. If the stock sells for $58 a share, what is the company’s cost of equity?
> Consider the following information:
> A portfolio is invested 25 percent in Stock G, 55 percent in Stock J, and 20 percent in Stock K. The expected returns on these stocks are 11 percent, 9 percent, and 15 percent, respectively. What is the portfolio’s expected return? How do you interpret y
> Based on the following information, calculate the expected return:
> Suppose the firm in Problem 16 is considering two mutually exclusive investments. Project A has an NPV of $1,900, and Project B has an NPV of $2,800. As the result of taking Project A, the standard deviation of the return on the firm’s assets will increa
> Based on the following information, calculate the expected return:,,,
> Based on the following information, calculate the expected return:,,,
> You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 12.1 percent and Stock Y with an expected return of 9.8 percent. If your goal is to create a portfolio with an expected return of 10.85 percent, how much
> Use the results of Problem 26 to find the degree of operating leverage for the company in Problem 27 at the base-case output level of 30,000 tons. How does this number compare to the sensitivity figure you found in Problem 28? Verify that either approach
> You own a portfolio that is invested 35 percent in Stock X, 20 percent in Stock Y, and 45 percent in Stock Z. The expected returns on these three stocks are 9 percent, 15 percent, and 12 percent, respectively. What is the expected return on the portfolio
> Use the results of Problem 25 to find the accounting, cash, and financial break-even quantities for the company in Problem 27.Data from Problem 27:Consider a project to supply Detroit with 30,000 tons of machine screws annually for automobile production.
> Suppose you observe the following situation:a. Calculate the expected return on each stock.b. Assuming the capital asset pricing model holds and Stock A’s beta is greater than Stock B’s beta by .35, what is the expecte
> Suppose you observe the following situation:
> Consider the following information about Stocks I and II:The market risk premium is 7 percent, and the risk-free rate is 3.5 percent. Which stock has the most systematic risk? Which one has the most unsystematic risk? Which stock is “ri
> You receive a credit card application from Shady Banks Savings and Loan offering an introductory rate of 1.25 percent per year, compounded monthly for the first six months, increasing thereafter to 17.8 percent compounded monthly. Assuming you transfer t
> 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 12.7 percent. If Stock X has an expected return of 11.4 percent and a beta of 1.25, and Stock Y has an expected r
> A proposed cost-saving device has an installed cost of $735,000. 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 $55,000, the tax rate
> 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:,,,
> Consider the following information about three stocks:b. If the expected T-bill rate is 3.80 percent, what is the expected risk premium on the portfolio?c. If the expected inflation rate is 3.30 percent, what are the approximate and exact expected real r
> In Problem 20, McGilla Golf would like to know the sensitivity of NPV to changes in the price of the new clubs and the quantity of new clubs sold. What is the sensitivity of the NPV to each of these variables?Data from Problem 20:McGilla Golf has decided
> Assume that the historical return on large-company stocks is a predictor of the future returns. What return would you estimate for large-company stocks over the next year? The next 10 years? 20 years? 40 years?
> A stock has a beta of 1.12 and an expected return of 10.8 percent. A risk-free asset currently earns 2.7 percent.
> You own a portfolio that has $3,480 invested in Stock A and $7,430 invested in Stock B. If the expected returns on these stocks are 8 percent and 11 percent, respectively, what is the expected return on the portfolio?
> In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?Previous problem:Stock Y has a beta of 1.2 and an expected return of 11.1 percent. Stock Z has a beta of .80 and an expected return of 7.85 percen
> Stock Y has a beta of 1.2 and an expected return of 11.1 percent. Stock Z has a beta of .80 and an expected return of 7.85 percent. If the risk-free rate is 2.4 percent and the market risk premium is 7.2 percent, are these stocks correctly priced?
> Fuente, Inc., has identified an investment project with the following cash flows. If the discount rate is 8 percent, what is the future value of these cash flows in Year 4? What is the future value at a discount rate of 11 percent? At 24 percent?Year ………
> Asset W has an expected return of 11.8 percent and a beta of 1.10. If the risk-free rate is 3.3 percent, complete the following table for portfolios of Asset W and a risk-free asset. Illustrate the relationship between portfolio expected return and portf
> A stock has an expected return of 11.85 percent, its beta is 1.24, and the expected return on the market is 10.2 percent. What must the risk-free rate be?
> Aria Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:Year ………………………………………………………………………………………….. Unit Sales1 …………………………………………………………………………………………………….. 73,0002 …………………………………………………………………………………………………….. 86,0
> A stock has an expected return of 10.45 percent, its beta is .93, and the risk-free rate is 3.6 percent. What must the expected return on the market be?
> A stock has an expected return of 10.2 percent, the risk-free rate is 3.9 percent, and the market risk premium is 7.2 percent. What must the beta of this stock be?
> A stock has a beta of 1.15, the expected return on the market is 10.3 percent, and the risk-free rate is 3.1 percent. What must the expected return on this stock be?
> You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.17 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
> You own a stock portfolio invested 20 percent in Stock Q, 30 percent in Stock R, 35 percent in Stock S, and 15 percent in Stock T. The betas for these four stocks are .79, 1.23, 1.13, and 1.36, respectively.What is the portfolio beta?
> Consider the following information:b. What is the variance of this portfolio? The standard deviation?
> What are the portfolio weights for a portfolio that has 115 shares of Stock A that sell for $43 per share and 180 shares of Stock B that sell for $19 per share?
> First Simple Bank pays 6.4 percent simple interest on its investment accounts. If First Complex Bank pays interest on its accounts compounded annually, what rate should the bank set if it wants to match First Simple Bank over an investment horizon of 10
> You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 8 percent, −15 percent, 19 percent, 31 percent, and 21 percent.a. What was the arithmetic average return on the company’s stock over this five-year period?b.
> Refer to Table 12.1 in the text and look at the period from 1970 through 1975. Data from Table 12.1:a. Calculate the arithmetic average returns for large-company stocks and T-bills over this period.b. Calculate the standard deviation of the returns for l
> Using the following returns, calculate the arithmetic average returns, the variances, and the standard deviations for X and Y.
> In the previous problem, suppose the fixed asset actually qualifies for 100 percent bonus depreciation in the first year. What is the new NPV?Previous problem:You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers
> In the previous problem, suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV figures.Previous problem:We are evaluating a project that costs
> What was the average annual return on large-company stocks from 1926 through 2016: a. In nominal terms?b. In real terms?
> Suppose you bought a bond with an annual coupon of 7 percent one year ago for $1,010. The bond sells for $985 today.a. Assuming a $1,000 face value, what was your total dollar return on this investment over the past year?b. What was your total nominal ra
> Rework Problems 1 and 2 assuming the ending share price is $58.Data from Problem 2:In Problem 1, what was the dividend yield? The capital gains yield?Data from Problem 1:Suppose a stock had an initial price of $65 per share, paid a dividend of $1.45 per
> In Problem 27, suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirement. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity of
> If the appropriate discount rate for the following cash flows is 7.17 percent per year, what is the present value of the cash flows?Year …………………………………………………………………………… Cash Flow1 …………………………………………………………………………………….. $2,4802 ………………………………………………………………………………………
> This problem concerns the effect of taxes on the various break-even measures. a. Show that, when we consider taxes, the general relationship between operating cash flow, OCF, and sales volume, Q, can be written as:b. Use the expression in part (a) to fin
> 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 on
> Hybrid cars are touted as a “green” alternative; however, the financial aspects of hybrid ownership are not as clear. Consider the 2016 Toyota Camry Hybrid LE, which had a list price of $5,500 (including tax consequences) more than the comparable Volkswa
> 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 $1.9 million in anticipation of using it as a toxi
> Over a 40-year period, an asset had an arithmetic return of 11.2 percent and a geometric return of 9.4 percent. Using Blume’s formula, what is your best estimate of the future annual returns over 5 years? 10 years? 20 years?
> In Problem 1, what was the dividend yield? The capital gains yield?Data from Problem 1:Suppose a stock had an initial price of $65 per share, paid a dividend of $1.45 per share during the year, and had an ending share price of $71. Compute the percentage
> You are considering a new product launch. The project will cost $1,950,000, have a four-year life, and have no salvage value; depreciation is straight-line to zero. Sales are projected at 210 units per year; price per unit will be $17,500, variable cost
> In the previous problem, what is the degree of operating leverage at the given level of output? What is the degree of operating leverage at the accounting break-even level of output?Data from Problem 17:Consider a four-year project with the following inf
> Suppose the returns on long-term corporate bonds are normally distributed. Based on the historical record, what is the approximate probability that your return on these bonds will be less than −2.1 percent in a given year? What range of returns would you
