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Question: When you take out an ordinary student


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 guarantees made by the U.S. government. Such guarantees don’t show up in calculations of government spending or in official deficit figures. Why not? Should they show up?



> Kevin Nomura is a Japanese student who is planning a one year stay in the United States. He expects to arrive in the United States in eight months. He is worried about depreciation of the yen relative to the dollar over the next eight months and wishes t

> 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

> National Electric Company (NEC) is considering a $45 million project in its power systems division. Tom Edison, the company’s chief financial officer, has evaluated the project and determined that the project’s unlevered cash flows will be $3.1 million p

> 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.

> 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 $36,000. This is the base capitalized cost. Other costs that may be added to

> Seger, 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.

> Suppose the firm in the previous problem is considering two mutually exclusive investments. Project A has an NPV of $1,200, and Project B has an NPV of $1,600. As a result of taking Project A, the standard deviation of the return on the firm’s assets wil

> Cleveland Compressor and Pnew York Pneumatic are competing manufacturing firms. Their financial statements are printed here. a. How are the current assets of each firm financed? b. Which firm has the larger investment in current assets? Why? c. Which fir

> This morning you agreed to buy a one-year Treasury bond in six months. The bond has a face value of $1,000. Use the spot interest rates listed here to answer the following questions: Time EAR 6 months……............................3.61% 12 months…

> William Santiago is interested in entering the import/export business. During a recent visit with his financial advisers, he said, “If we play the game right, this is the safest business in the world. By hedging all of our transactions in the foreign exc

> Monster Magnet Manufacturing is considering leasing some equipment. The annual lease payment would be $375,000 per year for six years. The appropriate interest rate is 8 percent and the company is in the 38 percent tax bracket. How would signing the leas

> 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 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

> An asset costs $620,000 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

> The Thakor Corporation’s purchases from suppliers in a quarter are equal to 75 percent of the next quarter’s forecast sales. The payables period is 60 days. Wages, taxes, and other expenses are 20 percent of sales, and

> Stackhouse Industries has a new project available that requires an initial investment of $4.5 million. The project will provide unlevered cash flows of $675,000 per year for the next 20 years. The company will finance the project with a debt-to-value rat

> Rework Problem 13 assuming the following: a. Wildcat maintains a minimum cash balance of $20 million. b. Wildcat maintains a minimum cash balance of $10 million. Based on your answers in (a) and (b), do you think the firm can boost its profit by changing

> You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1,000, and the 1-year and 11-year spot interest rates are 5 percent and 7 percent, respectively. a. What is the forward p

> You have been hired to value a new 20-year callable, convertible bond. The bond has a 5.8 percent coupon rate, payable annually. The conversion price is $150, and the stock currently sells for $32.20. The stock price is expected to grow at 12 percent per

> Sunburn Sunscreen has a zero coupon bond issue outstanding with a $25,000 face value that matures in one year. The current market value of the firm’s assets is $26,300. The standard deviation of the return on the firm’s assets is 38 percent per year, and

> It is said that the equityholders of a levered firm can be thought of as holding a call option on the firm’s assets. Explain what is meant by this statement.

> 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. Previous problem

> Wolfson Corporation has decided to purchase a new machine that costs $3.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax rate is 35 percent. The Sur Bank has offered Wolfson a f

> Neon Corporation’s stock returns have a covariance with the market portfolio of .0415. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk premium is 7.5 percent. The company has bonds outstanding wit

> Wildcat, Inc., has estimated sales (in millions) for the next four quarters as follows: Sales for the first quarter of the year after this one are projected at $120 million. Accounts receivable at the beginning of the year were $34 million. Wildcat has

> The forward price (F) of a contract on an asset with neither carrying costs nor convenience yield is the current spot price of the asset (S0) multiplied by 1, plus the appropriate interest rate between the initiation of the contract and the delivery date

> Blue Steel Community Bank has the following market value balance sheet: a. What is the duration of the assets? b. What is the duration of the liabilities? c. Is the bank immune to interest rate risk? Market Value Duration Asset or Liability (in $ mi

> For the following scenarios, describe a hedging strategy using futures contracts that might be considered. a. A public utility is concerned about rising costs. b. A candy manufacturer is concerned about rising costs. c. A corn farmer fears that this year

> The capital structure of Ricketti Enterprises, Inc., consists of 20 million shares of common stock and 1.5 million warrants. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $19. The current stock pric

> An insurance policy is considered analogous to an option. From the policyholder’s point of view, what type of option is an insurance policy? Why?

> An asset costs $550,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The corporate tax rate is 34 percent, and the appropriate interest rate is 10 percent. a. What set of lease payments will m

> MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt–equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm’s levered equity is 16 percent. MVP is planning to expand its prod

> Here are the most recent balance sheets for Country Kettles, Inc. Excluding accumulated depreciation, determine whether each item is a source or a use of cash, and the amount: COUNTRY KETTLES, INC. Balance Sheet 2011 2012 Assets Cash $ 48,180 $ 45,81

> Ted and Alice Hansel have a son who will begin college 10 years from today. School expenses of $30,000 will need to be paid at the beginning of each of the four years that their son plans to attend college. What is the duration of this liability to the c

> What is the difference between transactions and economic exposure? Which can be hedged more easily? Why?

> A stock is currently priced at $73. The stock will either increase or decrease by 15 percent over the next year. There is a call option on the stock with a strike price of $70 and one year until expiration. If the risk-free rate is 8 percent, what is the

> Rob Stevens is the chief executive officer of Isner Construction, Inc., and owns 950,000 shares of stock. The company currently has 6 million shares of stock and convertible bonds with a face value of $40 million outstanding. The convertible bonds have a

> What is the impact of lengthening the time to expiration on an option’s value? Explain.

> Many lessors require a security deposit in the form of a cash payment or other pledged collateral. Suppose Lambert requires Wildcat to pay a $500,000 security deposit at the inception of the lease. If the lease payment is still $1,650,000, is it advantag

> There is a European put option on a stock that expires in two months. The stock price is $73, and the standard deviation of the stock returns is 70 percent. The option has a strike price of $80, and the risk-free interest rate is a 5 percent annual perce

> Why would ALC be willing to buy planes from Boeing and Airbus and then lease the planes to China Eastern Airlines? How is this different from just lending money to China Eastern Airlines to buy the planes?

> 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 $80 million. The equipment will be fully depreciated using the straight-line met

> Here are some important figures from the budget of Cornell, Inc., for the second quarter of 2013: The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its sales will be collected in the month of the sale, and th

> ABC Company and XYZ Company need to raise funds to pay for capital improvements at their manufacturing plants. ABC Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at 11 percent fixed rate

> Bernanke Corp. has just issued a 30-year callable, convertible bond with a coupon rate of 6 percent annual coupon payments. 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

> 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?

> 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

> You are given the following information concerning options on a particular stock: Stock price = $83 Exercise price = $80 Risk-free rate = 6% per year, compounded continuously Maturity = 6 months Standard deviation = 53% per year a. What is the

> How would the analysis of real options change if a company has competitors?

> Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years to provide it with at least eight years of tax loss carry forwards. Thus, Quartz’s effective tax rate is zero. Quartz plans to lease equipment from N

> Suppose it is estimated that the equipment will have an after tax residual value of $700,000 at the end of the lease. What is the maximum lease payment acceptable to Wildcat now? Required information The Wildcat Oil Company is trying to decide whether to

> Why wouldn’t China Eastern Airlines purchase the planes if they were obviously needed for the company’s operations?

> Shattered Glass, Inc., is an all-equity firm. The cost of the company’s equity is currently 11 percent, and the risk-free rate is 3.5 percent. The company is currently considering a project that will cost $11.4 million and last six years. The project wil

> 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.

> Lewellen Products has projected the following sales for the coming year: Sales in the year following this one are projected to be 15 percent greater in each quarter. a. Calculate payments to suppliers assuming that Lewellen places orders during each qua

> In an ideal economy, net working capital is always zero. Why might net working capital be positive in a real economy?

> What is the duration of a bond with four years to maturity and a coupon of 8 percent paid annually if the bond sells at par?

> Explain why a put option on a bond is conceptually the same as a call option on interest rates.

> Sportime Fitness Center, Inc., issued convertible bonds with a conversion price of $51. The bonds are available for immediate conversion. The current price of the company’s common stock is $44 per share. The current market price of the convertible bonds

> Why do firms issue convertible bonds and bonds with warrants?

> Wet for the Summer, Inc., manufactures filters for swimming pools. The company is deciding whether to implement a new technology in its pool filters. One year from now the company will know whether the new technology is accepted in the market. If the dem

> You are discussing real options with a colleague. During the discussion, the colleague states, “Real option analysis makes no sense because it says that a real option on a risky venture is worth more than a real option on a safe venture.’’ How should you

> Super Sonics Entertainment is considering buying a machine that costs $540,000. The machine will be depreciated over five years by the straight-line method and will be worthless at that time. The company can lease the machine with year-end payments of $1

> What are the deltas of a call option and a put option with the following characteristics? What does the delta of the option tell you? Stock price = $67 Exercise price = $70 Risk-free rate = 5% per year, compounded continuously Maturity = 9 month

> The following is the sales budget for Shleifer, Inc., for the first quarter of 2013: Credit sales are collected as follows: 65 percent in the month of the sale. 20 percent in the month after the sale. 15 percent in the second month after the sale. The a

> What is meant by the term off–balance sheet financing? When do leases provide such financing, and what are the accounting and economic consequences of such activity?

> Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 8 percent loan with gross proceeds of $5,850,000. The interest payments on the loan will be made annually. Flotation costs are estimated to be 2.5 percent of gross proceeds and will be a

> Consider the following financial statement information for the Bulldog Icers Corporation: Calculate the operating and cash cycles. How do you interpret your answer? Item Beginning Ending Inventory $17,385 $19,108 Accounts receivable 13,182 13,973 Ac

> What are the costs of shortages? Describe them.

> What is the duration of a bond with three years to maturity and a coupon of 7 percent paid annually if the bond sells at par?

> If a textile manufacturer wanted to hedge against adverse movements in cotton prices, it could buy cotton futures contracts or buy call options on cotton futures contracts. What would be the pros and cons of the two approaches?

> An analyst has recently informed you that at the issuance of a company’s convertible bonds, one of the two following sets of relationships existed: Assume the bonds are available for immediate conversion. Which of the two scenarios do

> An analyst has recently informed you that at the issuance of a company’s convertible bonds, one of the two following sets of relationships existed: Assume the bonds are available for immediate conversion. Which of the two scenarios do y

> Star Mining buys a gold mine, but the cost of extraction is currently too high to make the mine profitable. In option terminology, what type of option(s) does the company have on this mine?

> Rework Problem 1 assuming that the scanner will be depreciated as three-year property under MACRS Problem 1 Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should you lease or buy? Required data: You work for a nuclear

> Refer to Table 25.2 given below to answer this question. Suppose today is November 22, 2011, and your firm produces breakfast cereal and needs 140,000 bushels of corn in March 2012 for an upcoming promotion. You would like to lock in your costs today bec

> 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 = 62% per year

> Discuss the IRS criteria for determining whether a lease is tax deductible. In each case give a rationale for the criterion.

> What are the two types of risk that are measured by a levered beta?

> The Litzenberger Company has projected the following quarterly sales amounts for the coming year: a. Accounts receivable at the beginning of the year are $310. Litzenberger has a 45-day collection period. Calculate cash collections in each of the four q

> Is it possible for a firm’s cash cycle to be longer than its operating cycle? Explain why or why not.

> You are short 25 gasoline futures contracts, established at an initial settle price of $2.46 per gallon, where each contract represents 42,000 gallons. Over the subsequent four trading days, gasoline settles at $2.42, $2.47, $2.50, and $2.56, respectivel

> A company produces an energy-intensive product and uses natural gas as the energy source. The competition primarily uses oil. Explain why this company is exposed to fluctuations in both oil and natural gas prices.

> A warrant gives its owner the right to purchase three shares of common stock at an exercise price of $53 per share. The current market price of the stock is $58. What is the minimum value of the warrant?

> What is dilution, and why does it occur when warrants are exercised?

> Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $93 per barrel, and the l

> Explain why a swap is effectively a series of forward contracts. Suppose a firm enters a swap agreement with a swap dealer. Describe the nature of the default risk faced by both parties.

> In the previous question, over what range of lease payments will the lease be profitable for both parties? Required information You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice wi

> What are the prices of a call option and a put option with the following characteristics? Stock price = $57 Exercise price = $60 Risk-free rate = 6% per year, compounded continuously Maturity = 3 months Standard devi ation = 54% per year

> Discuss the accounting criteria for determining whether a lease must be reported on the balance sheet. In each case give a rationale for the criterion.

> North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.10 if both were all equity financed. The market value information for each company is shown here: The expected return on the ma

> If Wild Widgets, Inc., were an all-equity company, it would have a beta of .85. 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

> Indicate the impact of the following on the cash and operating cycles, respectively. Use the letter I to indicate an increase, the letter D for a decrease, and the letter N for no change. a. The terms of cash discounts offered to customers are made less

> You are long 10 gold futures contracts, established at an initial settle price of $1,580 per ounce, where each contract represents 100 ounces. Over the subsequent four trading days, gold settles at $1,587, $1,582, $1,573, and $1,584, respectively. Comput

> Bubbling Crude Corporation, a large Texas oil producer, would like to hedge against adverse movements in the price of oil because this is the firm’s primary source of revenue. What should the firm do? Provide at least two reasons why it probably will not

> Hannon Home Products, Inc., recently issued $2 million worth of 8 percent convertible debentures. Each convertible bond has a face value of $1,000. Each convertible bond can be converted into 21.50 shares of common stock any time before maturity. The sto

> What happens to the price of a convertible bond if interest rates increase?

> General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $55. a. Suppose the stock is currently trading for $51 per share. What is

> The Webber Company is an international conglomerate with a real estate division that owns the right to erect an office building on a parcel of land in downtown Sacramento over the next year. This building would cost $25 million to construct. Due to low d

> 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

2.99

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