Question: Tool Manufacturing has an expected EBIT of $

> 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

> Microhard has issued a bond with the following characteristics: Par: $1,000 Time to maturity: 20 years Coupon rate: 7 percent Semiannual payments Calculate the price of this bond if the YTM is: a. 7 percent b. 9 percent c. 5 percent

> An investment project costs $17,500 and has annual cash flows of $4,300 for six years. What is the discounted payback period if the discount rate is 0 percent? What if the discount rate is 10 percent? If it is 17 percent?

> Consider two mutually exclusive new product launch projects that Nagano Golf is considering. Assume the discount rate for both products is 15 percent. Project A: Nagano NP-30. Professional clubs that will take an initial investment of $660,000 at Time 0.

> In the previous problem, suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold. Naturally, expansion would be desirable only if the project were a success. This implies that if the proj

> Bridgton Golf Academy is evaluating new golf practice equipment. The “Dimple-Max” equipment costs $64,000, has a three-year life, and costs $7,500 per year to operate. The relevant discount rate is 12 percent. Assume that the straight-line depreciation m

> National Business Machine Co. (NBM) has $4.5 million of extra cash after taxes have been paid. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets. The resulting investment income will be paid out as a

> The Dart Company is financed entirely with equity. The company is considering a loan of $2.6 million. The loan will be repaid in equal installments over the next two years, and it has an interest rate of 8 percent. The company’s tax rate is 35 percent. A

> Floyd Industries stock has a beta of 1.15. The company just paid a dividend of $.85, 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 3.9 percent. The most re

> In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?

> You find a certain stock that had returns of 12 percent, 215 percent, 13 percent, and 27 percent for four of the last five years. If the average return of the stock over this period was 10.5 percent, what was the stock’s return for the missing year? What

> The Faulk Corp. has a 6 percent coupon bond outstanding. The Gonas Company has a 14 percent bond outstanding. Both bonds have 12 years to maturity, make semiannual payments, and have a YTM of 10 percent. If interest rates suddenly rise by 2 percent, what

> Fifth National Bank just issued some new preferred stock. The issue will pay an annual dividend of $5 in perpetuity, beginning five years from now. If the market requires a return of 4.7 percent on this investment, how much does a share of preferred stoc

> Suppose the president of the company in the previous problem stated that the company should increase the amount of debt in its capital structure because of the tax-advantaged status of its interest payments. His argument is that this action would increas

> In the previous problem, suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within 610 percent. Calculate the best-case and worst-case NPV figures.

> In spite of the theoretical argument that dividend policy should be irrelevant, the fact remains that many investors like high dividends. If this preference exists, a firm can boost its share price by increasing its dividend payout ratio. Explain the fal

> Newtech Corp. is going to adopt a new chip-testing device that can greatly improve its production efficiency. Do you think the lead engineer can profit from purchasing the firm’s stock before the news release on the device? After reading the announcement

> One thing put–call parity tells us is that given any three of a stock, a call, a put, and a T-bill, the fourth can be synthesized or replicated using the other three. For example, how can we replicate a share of stock using a call, a put, and a T-bill?

> A call option matures in six months. The underlying stock price is $75, and the stock’s return has a standard deviation of 30 percent per year. The risk-free rate is 4 percent per year, compounded continuously. If the exercise price is $0, what is the pr

> Consider the following cash flows of two mutually exclusive projects for Tokyo Rubber Company. Assume the discount rate for both projects is 8 percent. a. Based on the payback period, which project should be taken? b. Based on the NPV, which project sh

> In the previous problem, suppose you think it is likely that expected sales will be revised upward to 9,500 units if the first year is a success and revised downward to 3,800 units if the first year is not a success. a. If success and failure are equally

> Phillips Industries runs a small manufacturing operation. For this fiscal year, it expects real net cash flows of $235,000. The company is an ongoing operation, but it expects competitive pressures to erode its real net cash flows at 3 percent per year i

> High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model is available only on a lease basis. The lease payments wi

> Mitsi 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 $30. At the close of business the day before the ex-rights day, the company

> Franklin Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 315,000 shares of stock outstanding. Under Plan II, there would be 225,000 shares of stock

> As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not n

> The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid

> Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .40, but the industry target debt–equity ratio is .35. The industry average beta is 1.2. The market risk

> Cavo Corporation expects an EBIT of $26,850 every year forever. The company currently has no debt, and its cost of equity is 14 percent. The tax rate is 35 percent. a. What is the current value of the company? b. Suppose the company can borrow at 8 perce

> Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $19 million, and the company paid $1,150,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the d

> Stock Y has a beta of 1.20 and an expected return of 12.7 percent. Stock Z has a beta of .90 and an expected return of 11.1 percent. If the risk-free rate is 4.5 percent and the market risk premium is 7.1 percent, are these stocks correctly priced?

> Refer back to Table 10.2(given below). What range of returns would you expect to see 68 percent of the time for large-company stocks? What about 95 percent of the time? Table 10.2 Total Annual Returns, U.S. Securities Markets, 1926-2014

> Laurel, Inc., and Hardy Corp. both have 6.5 percent coupon bonds outstanding, with semiannual interest payments, and both are priced at par value. The Laurel, Inc., bond has 3 years to maturity, whereas the Hardy Corp. bond has 20 years to maturity. If i

> Mau Corporation stock currently sells for $64.87 per share. The market requires a return of 10.5 percent on the firm’s stock. If the company maintains a constant 5 percent growth rate in dividends, what was the most recent dividend per share paid on the

> If the market places the same value on $1 of dividends as on $1 of capital gains, then firms with different payout ratios will appeal to different clienteles of investors. One clientele is as good as another; therefore, a firm cannot increase its value b

> Flatte Restaurant is considering the purchase of a $7,500 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 1,300 soufflés per year, with each costing $

> All else being the same, which has more interest rate risk, a long-term bond or a short-term bond? What about a low coupon bond compared to a high coupon bond? What about a long-term, high coupon bond compared to a short-term, low coupon bond?

> Your aunt is in a high tax bracket and would like to minimize the tax burden of her investment portfolio. She is willing to buy and sell to maximize her aftertax returns, and she has asked for your advice. What would you suggest she do?

> Jared Lazarus has just been named the new chief executive officer of BluBell Fitness Centers, Inc. In addition to an annual salary of $475,000, his three-year contract states that his compensation will include 20,000 at-the-money European call options on

> The treasurer of Amaro Canned Fruits, Inc., has projected the cash flows of Projects A, B, and C as follows: Suppose the relevant discount rate is 12 percent per year. a. Compute the profitability index for each of the three projects. b. Compute the NP

> Miller Corporation has a premium bond making semiannual payments. The bond pays a coupon of 8.5 percent, has a YTM of 7 percent, and has 13 years to maturity. The Modigliani Company has a discount bond making semiannual payments. This bond pays a coupon

> We are examining a new project. We expect to sell 7,000 units per year at $38 net cash flow apiece for the next 10 years. In other words, the annual operating cash flow is projected to be $38 3 7,000 5 $266,000. The relevant discount rate is 16 percent,

> Etonic, Inc., is considering an investment of $395,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be $255,000 and $82,000, respectively. Both re

> In the previous problem, assume the risk-free rate is only 5 percent. What is the risk-neutral value of the option now? What happens to the risk-neutral probabilities of a stock price increase and a stock price decrease?

> Return to the case of the diagnostic scanner discussed in Problems 1 through 6. Suppose the entire $5,800,000 purchase price of the scanner is borrowed. The rate on the loan is 8 percent, and the loan will be repaid in equal installments. Create a lease-

> Wuttke Corp. wants to raise $5,375,000 via a rights offering. The company currently has 950,000 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 Wuttke a 6 perce

> Beasley, Inc. is going to elect nine board members next month. Betty Brown owns 12.4 percent of the total shares outstanding. How confident can she be of having one of her candidate friends elected under the cumulative voting rule? Will her friend be ele

> The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 4.7 percent. Suppose the capital gains tax rate is

> Bruin Industries just issued $265,000 of perpetual 8 percent debt and used the proceeds to repurchase stock. The company expects to generate $123,000 of earnings before interest and taxes in perpetuity. The company distributes all its earnings as dividen

> Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $83. a. Are the call options in the money? What is the intrinsic value of an RWJ Corp. call option? b. Are the put options in the money?

> List the three assumptions that lie behind the Modigliani–Miller theory in a world without taxes. Are these assumptions reasonable in the real world? Explain.

> The Saunders Investment Bank has the following financing outstanding. What is the WACC for the company? Debt: 50,000 bonds with a coupon rate of 5.7 percent and a current price quote of 106.5; the bonds have 20 years to maturity. 200,000 zero coupon bond

> Asset W has an expected return of 11.9 percent and a beta of 1.2. If the risk-free rate is 4 percent, complete the following table for portfolios of Asset W and a risk-free asset. Illustrate the relationship between portfolio expected return and portfoli

> Refer back to Table 10.2. What range of returns would you expect to see 68 percent of the time for long-term corporate bonds? What about 95 percent of the time?

> Antiques R Us is a mature manufacturing firm. The company just paid a dividend of $13, but management expects to reduce the payout by 4 percent per year, indefinitely. If you require a return of 10 percent on this stock, what will you pay for a share tod

> A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation.

> For the firm in the previous problem, suppose the book value of the debt issue is $35 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 12 years left to maturity; the book value of this issue is $80 million

> Today, the following announcement was made: “Early today the Justice Department reached a decision in the Universal Product Care (UPC) case. UPC has been found guilty of discriminatory practices in hiring. For the next five years, UPC must pay $2 million

> a. What is the relationship between the price of a bond and its YTM? b. Explain why some bonds sell at a premium over par value while other bonds sell at a discount. What do you know about the relationship between the coupon rate and the YTM for premium

> Consider the following cash flows of two mutually exclusive projects for AZ-Motorcars. Assume the discount rate for both projects is 10 percent. a. Based on the payback period, which project should be accepted? b. Based on the NPV, which project should

> Refer to Table 10.1. What was the average real return for Treasury bills from 1926 through 1932?

> You buy a zero coupon bond at the beginning of the year that has a face value of $1,000, a YTM of 6.3 percent, and 25 years to maturity. If you hold the bond for the entire year, how much in interest income will you have to declare on your tax return? As

> The Clifford Corporation has announced a rights offer to raise $26 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

> 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?

> Sparkling Water, Inc., expects to sell 2.7 million bottles of drinking water each year in perpetuity. This year each bottle will sell for $1.35 in real terms and will cost $.85 in real terms. Sales income and costs occur at year-end. Revenues will rise a

> Omega Airline’s capital structure consists of 2.7 million shares of common stock and zero coupon bonds with a face value of $18 million that mature in six months. The firm just announced that it will issue warrants with an exercise price of $95 and six m

> A stock is currently priced at $84. The stock will either increase or decrease by 17 percent over the next year. There is a call option on the stock with a strike price of $80 and one year until expiration. If the risk-free rate is 8 percent, what is the

> Suppose stock returns can be explained by the following three-factor model: Assume there is no firm-specific risk. The information for each stock is presented here: The risk premiums for the factors are 4.9 percent, 3.8 percent, and 5.3 percent, respe

> Automobiles are often leased, and there are several terms unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car is $32,000. This is the base capitalized cost. Other costs that may be added to

> Show that the value of a right can be written as: 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 of rights needed to buy one

> The Sharpe Co. just paid a dividend of $1.60 per share of stock. Its target payout ratio is 40 percent. The company expects to have earnings per share of $5.10 one year from now. a. If the adjustment rate is .3 as defined in the Lintner model, what is th

> Mojito Mint Company has a debt–equity ratio of .35. The required return on the company’s unlevered equity is 12.8 percent, and the pretax cost of the firm’s debt is 6.5 percent. Sales revenue for the company is expected to remain stable indefinitely at l

> Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $23 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpe

> Och, Inc., is considering a project that will result in initial aftertax cash savings of $2.9 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The company has a target debt–equity ratio of .6

> The owners’ equity accounts for Hexagon International are shown here: a. If the company’s stock currently sells for $39 per share and a 10 percent stock dividend is declared, how many new shares will be distributed?

> A stock has a beta of 1.13 and an expected return of 12.1 percent. A risk-free asset currently earns 3.6 percent. a. What is the expected return on a portfolio that is equally invested in the two assets? b. If a portfolio of the two assets has a beta of

> Synovec Corp. is experiencing rapid growth. Dividends are expected to grow at 30 percent per year during the next three years, 18 percent over the following year, and then 8 percent per year indefinitely. The required return on this stock is 11 percent,

> You find a put and a call with the same exercise price and maturity. What do you know about the relative prices of the put and call? Prove your answer and provide an intuitive explanation.

> You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 13 percent and Stock Y with an expected return of 8.5 percent. If your goal is to create a portfolio with an expected return of 11.9 percent, how much mo

> Cap Henderson owns Neotech stock because its price has been steadily rising over the past few years and he expects this performance to continue. Cap is trying to convince Sarah Jones to purchase some Neotech stock, but she is reluctant because Neotech ha

> When the 56-year-old founder of Gulf & Western, Inc., died of a heart attack, the stock price immediately jumped from $18.00 a share to $20.25, a 12.5 percent increase. This is evidence of market inefficiency because an efficient stock market would have

> The 100-year bonds we discussed in the chapter have something in common with junk bonds. Critics charge that, in both cases, the issuers are really selling equity in disguise. What are the issues here? Why would a company want to sell “equity in disguise

> Hanmi Group, a consumer electronics conglomerate, is reviewing its annual budget in wireless technology. It is considering investments in three different technologies to develop wireless communication devices. Consider the following cash flows of the thr

> In Problem 14, what is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision? Problem 14: Bruce & Co. expects its EBIT to be $145,000 every year forever. The company can borrow a

> Southern Alliance Company needs to raise $55 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 65 percent c

> You bought a stock three months ago for $62.18 per share. The stock paid no dividends. The current share price is $65.37. What is the APR of your investment? The EAR?

> Gemini, Inc., an all-equity firm, is considering an investment of $1.4 million 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 $502,000

> Locate the Treasury bond in Figure 8.4(given below) maturing in November 2039. Is this a premium or a discount bond? What is its current yield? What is its yield to maturity? What is the bid-ask spread in dollars? Assume a par value of $1,000. Treas

> In the previous problem, you feel that the values are accurate to within only 610 percent. What are the best-case and worst-case NPVs? (Hint: The price and variable costs for the two existing sets of clubs are known with certainty; only the sales gained

> Suppose you bought a bond with a 5.8 percent coupon rate one year ago for $1,030. The bond sells for $1,059 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

> Consider the following cash flows on two mutually exclusive projects: The cash flows of Project A are expressed in real terms, whereas those of Project B are expressed in nominal terms. The appropriate nominal discount rate is 13 percent and the inflat

> Superior Clamps, Inc., has a capital structure consisting of 7 million shares of common stock and 900,000 warrants. Each warrant gives its owner the right to purchase one share of newly issued common stock for an exercise price of $25. The warrants are E

> You are given the following information concerning options on a particular stock: a. What is the intrinsic value of the call option? Of the put option? b. What is the time value of the call option? Of the put option? c. Does the call or the put have th

> An asset costs $590,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 7 percent and the lessee can borrow at 9 percent. The corporate tax rate is 34 percent for both co

> Hoobastink Mfg. is considering a rights offer. The company has determined that the ex-rights price will be $61. The current price is $68 per share, and there are 10 million shares outstanding. The rights offer would raise a total of $67 million. What is

> Gibson Co. has a current period cash flow of $1.3 million and pays no dividends. The present value of the company’s future cash flows is $18 million. The company is entirely financed with equity and has 550,000 shares outstanding. Assume the dividend tax

> Newkirk, Inc., is an unlevered firm with expected annual earnings before taxes of $21 million in perpetuity. The current required return on the firm’s equity is 16 percent, and the firm distributes all of its earnings as dividends at the end of each year

> Phillips Co. is growing quickly. Dividends are expected to grow at a rate of 25 percent for the next three years, with the growth rate falling off to a constant 5 percent thereafter. If the required return is 12 percent and the company just paid a divide

> Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company’s profits are driven by the amount of work Tom does. If he works 40 hours each week, the company’s EBIT will be $475,000 per year; if he work

> You are the CEO of Titan Industries and have just been awarded a large number of employee stock options. The company has two mutually exclusive projects available. The first project has a large NPV and will reduce the total risk of the company. The secon