Question: You bought a stock three months ago

> 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

> Tool Manufacturing has an expected EBIT of $67,000 in perpetuity and a tax rate of 35 percent. The firm has $130,000 in outstanding debt at an interest rate of 8 percent, and its unlevered cost of capital is 15 percent. What is the value of the company a

> 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

> 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

> Rhiannon Corporation has bonds on the market with 11.5 years to maturity, a YTM of 7.3 percent, and a current price of $1,080. The bonds make semiannual payments. What must the coupon rate be on these bonds?

> Suppose the company in Problem 1 has a market-to-book ratio of 1.0. a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued. Also calculate the percentage changes in ROE for economic expansion and recessio

> Every IPO is unique, but what are the basic empirical regularities in IPOs?

> The desire for current income is not a valid explanation of preference for high current dividend policy because investors can always create homemade dividends by selling a portion of their stocks. Is this statement true or false? Why?

> Sinking funds have both positive and negative characteristics for bondholders. Why?

> Aerotech, an aerospace technology research firm, announced this morning that it has hired the world’s most knowledgeable and prolific space researchers. Before today, Aerotech’s stock had been selling for $100. Assume that no other information is receive

> It is sometimes stated that “the internal rate of return approach assumes reinvestment of the intermediate cash flows at the internal rate of return.” Is this claim correct? To answer, suppose you calculate the IRR of a project in the usual way. Next, su

> A controversy erupted regarding bond-rating agencies when some agencies began to provide unsolicited bond ratings. Why do you think this is controversial?

> Explain why shelf registration has been used by many firms instead of syndication.

> The bird-in-the-hand argument, which states that a dividend today is safer than the uncertain prospect of a capital gain tomorrow, is often used to justify high dividend payout ratios. Explain the fallacy behind this argument.

> Wii Brothers, a game manufacturer, has a new idea for an adventure game. It can market the game either as a traditional board game or as an interactive DVD, but not both. Consider the following cash flows of the two mutually exclusive projects for the co

> The next dividend payment by ECY, Inc., will be $2.90 per share. The dividends are anticipated to maintain a growth rate of 5.5 percent, forever. If the stock currently sells for $53.10 per share, what is the required return?

> L.J.’s Toys, Inc., just purchased a $375,000 machine to produce toy cars. The machine will be fully depreciated by the straight-line method over its five-year economic life. Each toy sells for $21. The variable cost per toy is $8, and the firm incurs fix

> You bought a share of 3.5 percent preferred stock for $92.07 last year. The market price for your stock is now $96.12. What was your total return for last year?

> Locate the Treasury bond in Figure 8.4(given below) maturing in February 2037. What is its coupon rate? What is its bid price? What was the previous day’s asked price? Assume a par value of $10,000. Treasury Notes & Bonds Asked Mat

> McGilla Golf has decided to sell a new line of golf clubs. The clubs will sell for $850 per set and have a variable cost of $430 per set. The company has spent $150,000 for a marketing study that determined the company will sell 60,000 sets per year for

> Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,100,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are $204,000 per year. Machine B costs $6,100,00

> 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

> In the previous problem, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the price of the transaction today?

> Wolfson Corporation has decided to purchase a new machine that costs $2.8 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

> Valley Corp.’s stock is currently selling at $37 per share. There are 1 million shares outstanding. The firm is planning to raise $2.5 million to finance a new project. What are the ex-rights stock price, the value of a right, and the appropriate subscri

> The net income of Novis Corporation is $85,000. The company has 25,000 outstanding shares and a 100 percent payout policy. The expected value of the firm one year from now is $1,725,000. The appropriate discount rate for the company is 12 percent, and th

> Dorman Industries has a new project available that requires an initial investment of $4.3 million. The project will provide unlevered cash flows of $710,000 per year for the next 20 years. The company will finance the project with a debt-to-value ratio o

> In the previous problem, suppose the project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project. What is the project’s Year 0 net cash flow? Year 1? Year 2?

> Explain the following limits on the prices of warrants: a. If the stock price is below the exercise price of the warrant, the lower bound on the price of a warrant is zero. b. If the stock price is above the exercise price of the warrant, the lower bound

> Suppose your company needs $35 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 6 percent, but the flotation cost for debt is only 2 percent. Your boss has decided to fund the project by bor

> Lohn Corporation is expected to pay the following dividends over the next four years: $13, $8, $6.50, and $2.40. Afterwards, the company pledges to maintain a constant 4.5 percent growth rate in dividends forever. If the required return on the stock is 1

> It is said that the equity holders 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.

> If interest rates fall, will the price of noncallable bonds move up higher than that of callable bonds? Why or why not?

> A hundred years ago or so, companies did not compile annual reports. Even if you owned stock in a particular company, you were unlikely to be allowed to see the balance sheet and income statement for the company. Assuming the market is semistrong form ef

> It is sometimes stated that “the net present value approach assumes reinvestment of the intermediate cash flows at the required return.” Is this claim correct? To answer, suppose you calculate the NPV of a project in the usual way. Next, suppose you do t

> Take a look back at Figure 8.4(given below). Notice the wide range of coupon rates. Why are they so different? Treasury Notes & Bonds Asked Maturity 1/31/2015 2/15/2016 3/15/2017 3/31/2018 5/15/2019 8/15/2020 6/30/2021 11/15/2022 5/15/2023 11/15/202

> Cutler Petroleum, Inc., is trying to evaluate a generation project with the following cash flows: a. If the company requires a 10 percent return on its investments, should it accept this project? Why? b. Compute the IRR for this project. How many IRRs

> Shadow Corp. has no debt but can borrow at 6.5 percent. The firm’s WACC is currently 9.8 percent, and the tax rate is 35 percent. a. What is the company’s cost of equity? b. If the company converts to 25 percent debt, what will its cost of equity be? c.

> Hannon Home Products, Inc., recently issued $2 million worth of 3 percent convertible debentures. Each convertible bond has a face value of $1,000. Each convertible bond can be converted into 23.50 shares of common stock any time before maturity. The sto

> An all-equity firm is considering the following projects: The T-bill rate is 3.5 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?

> Complete the following sentence for each of these investors: a. A buyer of call options. b. A buyer of put options. c. A seller (writer) of call options. d. A seller (writer) of put options. “The (buyer/seller) of a (put/call) option (pays/receives) mone