Question: You want to create a portfolio equally

> Which has greater interest rate risk, a 30-year Treasury bond or a 30-year BB corporate bond?

> Tesla Corporation needs to raise funds to finance a plant expansion, and it has decided to issue 25-year zero coupon bonds to raise the money. The required return on the bonds will be 5.4 percent. a. What will these bonds sell for at issuance? b. Using t

> In Problem 26, suppose you’re confident about your own projections, but you’re a little unsure about Detroit’s actual machine screw requirements. What is the sensitivity of the project OCF to changes in the quantity supplied? What about the sensitivity o

> FFDP Corp. has yearly sales of $42 million and costs of $13 million. The company’s balance sheet shows debt of $64 million and cash of $21 million. There are 1,750,000 shares outstanding and the industry EV/EBITDA multiple is 6.8. What is the company’s e

> Ramsay Corp. currently has an EPS of $3.10, and the bench-mark PE for the company is 21. Earnings are expected to grow at 6 percent per year. a. What is your estimate of the current stock price? b. What is the target stock price in one year? c. Assuming

> Assume that markets are efficient. During a trading day American Golf, Inc., announces that it has lost a contract for a large golfing project that, prior to the news, it was widely believed to have secured. If the market is efficient, how should the sto

> In the previous problem, what is the probability that the return is less than 2100 percent? (Think.) What are the implications for the distribution of returns?

> Consider two streams of cash flows, A and B. Stream A’s first cash flow is $11,600 and is received three years from today. Future cash flows in Stream A grow by 4 percent in perpetuity. Stream B’s first cash flow is 2$13,000, is received two years from t

> Pricing Model Ken is interested in buying a European call option written on Southeastern Airlines, Inc., a non-dividend-paying common stock, with a strike price of $65 and one year until expiration. Currently, the company’s stock sells for $62 per share.

> Cost of Capital In a world of corporate taxes only, show that the R WACC can be written as R WACC = R0 x [1 - tC (B/V )].

> We are evaluating a project that costs $588,000, has an eight-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 70,000 units per year. Price per unit is $36, variab

> Based on the following information, calculate the expected return and standard deviation for each of the following stocks. What are the covariance and correlation between the returns of the two stocks? Probability of State of Economy State of Return

> An investment project provides cash inflows of $790 per year for eight years. What is the project payback period if the initial cost is $3,200? What if the initial cost is $4,800? What if it is $7,300?

> You’ve just found a 10 percent coupon bond on the market that sells for par value. What is the maturity on this bond?

> Consider a project to supply Detroit with 25,000 tons of machine screws annually for automobile production. You will need an initial $2,700,000 investment in threading equipment to get the project started; the project will last for five years. The accoun

> Office Automation, Inc., must choose between two copiers, the XX40 or the RH45. The XX40 costs $1,499 and will last for three years. The copier will require a real aftertax cost of $120 per year after all relevant expenses. The RH45 costs $2,399 and will

> Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $630,000. Without new projects, both firms will continue to generate earnings of $630,000 in perpetuity. Assume that all earnings are paid as dividends and that

> The efficient market hypothesis implies that all mutual funds should obtain the same expected risk-adjusted returns. Therefore, we can simply pick mutual funds at random. Is this statement true or false? Explain.

> Butler International Limited is evaluating a project in Erewhon. The project will create the following cash flows: All cash flows will occur in Erewhon and are expressed in dollars. In an attempt to improve its economy, the Erewhonian government has de

> A company has a single zero coupon bond outstanding that matures in 10 years with a face value of $10 million. The current value of the company’s assets is $9.05 million, and the standard deviation of the return on the firm’s assets is 39 percent per yea

> Williamson, Inc., has a debt–equity ratio of 2.3. The firm’s weighted average cost of capital is 10 percent, and its pretax cost of debt is 6 percent. The tax rate is 35 percent. a. What is the company’s cost of equity capital? b. What is the company’s u

> Why is underpricing not a great concern with bond offerings?

> Based on the following information, calculate the expected return and standard deviation of each of the following stocks. Assume each state of the economy is equally likely to happen. What are the covariance and correlation between the returns of the two

> Assuming that the returns from holding small-company stocks are normally distributed, what is the approximate probability that your money will double in value in a single year? Triple in value?

> Repeat parts (a) and (b) in Problem 1 assuming the company has a tax rate of 35 percent. Problem 1: Music City, Inc., has no debt outstanding and a total market value of $295,000. Earnings before interest and taxes, EBIT, are projected to be $23,000 if

> What are the direct and indirect costs of bankruptcy? Briefly explain each.

> Suppose the following bond quote for IOU Corporation appears in the financial page of today’s newspaper. Assume the bond has a face value of $1,000, semiannual coupon payments, and the current date is April 15, 2015. What is the yield t

> Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value is $2.8 million. Its current book value is $1.6 million. If not sold, the old machine will require maintenance costs of $855,000 at the end of the year for t

> Imagine that a particular macroeconomic variable that influences your firm’s net earnings is positively serially correlated. Assume market efficiency. Would you expect price changes in your stock to be serially correlated? Why or why not?

> The Utah Mining Corporation is set to open a gold mine near Provo, Utah. According to the treasurer, Monty Goldstein, “This is a golden opportunity.” The mine will cost $2,700,000 to open and will have an economic life of 11 years. It will generate a cas

> 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 million in anticipation of using it as a toxic

> On Tuesday, December 8, Hometown Power Co.’s board of directors declares a dividend of 75 cents per share payable on Wednesday, January 17, to shareholders of record as of Wednesday, January 3. When is the ex-dividend date? If a shareholder buys stock be

> Suppose Sunburn Sunscreen and Frostbite Thermalwear in the previous problems have decided to merge. Because the two companies have seasonal sales, the combined firm’s return on assets will have a standard deviation of 29 percent per year. a. What is the

> Green Manufacturing, Inc., plans to announce that it will issue $1.8 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with a coupon rate of 6 percent. Green is currently an all-equity company worth $5.

> This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm tha

> 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 12.9 percent. If Stock X has an expected return of 11.2 percent and a beta of 1.30 and Stock Y has an expected re

> An election is being held to fill three seats on the board of directors of a firm in which you hold stock. The company has 17,400 shares outstanding. If the election is conducted under cumulative voting and you own 300 shares, how many more shares must y

> Suppose the returns on long-term government bonds are normally distributed. Based on the historical record, what is the approximate probability that your return on these bonds will be less than 23.7 percent in a given year? What range of returns would yo

> Erna Corp. has 9 percent coupon bonds making annual payments with a YTM of 7.81 percent. The current yield on these bonds is 8.42 percent. How many years do these bonds have left until they mature?

> Applied Nanotech is thinking about introducing a new surface cleaning machine. The marketing department has come up with the estimate that Applied Nanotech can sell 15 units per year at $275,000 net cash flow per unit for the next five years. The enginee

> Four years ago, Bling Diamond, Inc., paid a dividend of $1.51 per share. The company paid a dividend of $1.87 per share yesterday. Dividends will grow over the next five years at the same rate they grew over the last four years. Thereafter, dividends wil

> Suppose the market is semistrong form efficient. Can you expect to earn excess returns if you make trades based on: a. Your broker’s information about record earnings for a stock? b. Rumors about a merger of a firm? c. Yesterday’s announcement of a succe

> You are determining whether your company should undertake a new project and have calculated the NPV of the project using the WACC method when the CFO, a former accountant, notices that you did not use the interest payments in calculating the cash flows o

> The Yurdone Corporation wants to set up a private cemetery business. According to the CFO, Barry M. Deep, business is “looking up.” As a result, the cemetery project will provide a net cash inflow of $315,000 for the firm during the first year, and the c

> With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps

> Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $25,000 that matures in one year. The current market value of the firm’s assets is $27,200. The standard deviation of the return on the firm’s assets is 53 percent per ye

> Locomotive Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 35 percent to 50 percent. The firm currently has $3.1 million worth of debt outstandin

> Trower Corp. has a debt–equity ratio of .85. The company is considering a new plant that will cost $145 million to build. When the company issues new equity, it incurs a flotation cost of 8 percent. The flotation cost on new debt is 3.5 percent. What is

> Advance, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 13 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 7 percent. What is the compan

> You bought one of Bergen Manufacturing Co.’s 6.4 percent coupon bonds one year ago for $1,032.50. These bonds make annual payments and mature six years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 5.5 per

> You purchase a bond with a coupon rate of 5.9 percent and a clean price of $984. If the next semiannual coupon payment is due in four months, what is the invoice price?

> Allied Products, Inc., is considering a new product launch. The firm expects to have an annual operating cash flow of $13.5 million for the next 10 years. Allied Products uses a discount rate of 13 percent for new product launches. The initial investment

> What is the quirk in the tax code that makes a levered firm more valuable than an otherwise identical unlevered firm?

> Juggernaut Satellite Corporation earned $23 million for the fiscal year ending yesterday. The firm also paid out 30 percent of its earnings as dividends yesterday. The firm will continue to pay out 30 percent of its earnings as annual, end-of-year divide

> Briley, Inc., is expected to pay equal dividends at the end of each of the next two years. Thereafter, the dividend will grow at a constant annual rate of 4 percent, forever. The current stock price is $53. What is next year’s dividend payment if the req

> A famous economist just announced in The Wall Street Journal his findings that the recession is over and the economy is again entering an expansion. Assume market efficiency. Can you profit from investing in the stock market after you read this announcem

> This problem is useful for testing the ability of financial calculators and computer software. Consider the following cash flows. How many different IRRs are there? (Hint: Search between 20 percent and 70 percent.) When should we take this project?

> 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

> The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The market value of Knight Company’s 6 percent bonds is $1.4 million. Financial information for the two firms appears here. All

> Suppose a three-factor model is appropriate to describe the returns of a stock. Information about those three factors is presented in the following chart: a. What is the systematic risk of the stock return? b. Suppose unexpected bad news about the firm

> Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .55. It’s considering building a new $50 million manufacturing facility. This new plant is expected to generate aftertax

> Consider the following information about three stocks: a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected return? The variance? The standard deviation? b. If the expected T-bill rate is 3.80

> Refer to Table 10.1 in the text and look at the period from 1973 through 1980. a. Calculate the average return for Treasury bills and the average annual inflation rate (consumer price index) for this period. b. Calculate the standard deviation of Treasur

> True or false: The most important characteristic in determining the expected return of a well-diversified portfolio is the variances of the individual assets in the portfolio. Explain.

> You purchase a bond with an invoice price of $950. The bond has a coupon rate of 5.2 percent, and there are 2 months to the next semiannual coupon date. What is the clean price of the bond?

> Hickock Mining is evaluating when to open a gold mine. The mine has 44,000 ounces of gold left that can be mined, and mining operations will produce 5,500 ounces per year. The required return on the gold mine is 12 percent, and it will cost $29 million t

> Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $750,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Op

> Pasqually Mineral Water, Inc., will pay a quarterly dividend per share of $.90 at the end of each of the next 12 quarters. Thereafter, the dividend will grow at a quarterly rate of 1 percent, forever. The appropriate rate of return on the stock is 10 per

> Your broker commented that well-managed firms are better investments than poorly managed firms. As evidence your broker cited a recent study examining 100 small manufacturing firms that eight years earlier had been listed in an industry magazine as the b

> An investment under consideration has a payback of six years and a cost of $573,000. If the required return is 12 percent, what is the worst-case NPV? The best-case NPV? Explain. Assume the cash flows are conventional.

> Sunburn Sunscreen has a zero coupon bond issue outstanding with a $20,000 face value that matures in one year. The current market value of the firm’s assets is $21,700. The standard deviation of the return on the firm’s assets is 38 percent per year, and

> You own a portfolio that has $2,700 invested in Stock A and $3,800 invested in Stock B. If the expected returns on these stocks are 9.5 percent and 14 percent, respectively, what is the expected return on the portfolio?

> Acetate, Inc., has equity with a market value of $29.5 million and debt with a market value of $8 million. Treasury bills that mature in one year yield 5 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the com

> Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding

> Critically evaluate the following statement: Playing the stock market is like gambling. Such speculative investing has no social value, other than the pleasure people get from this form of gambling.

> Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.

> A stock has had the following year-end prices and dividends: What are the arithmetic and geometric returns for the stock? Year Price Dividend $73.18 2 77.98 $ 1.15 3 69.13 1.25 4 84.65 1.36 91.37 1.47 6 103.66 1.60

> RAK Co. wants to issue new 20-year bonds for some much-needed expansion projects. The company currently has 6.4 percent coupon bonds on the market that sell for $1,063, make semiannual payments, and mature in 20 years. What coupon rate should the company

> Young screenwriter Carl Draper has just finished his first script. It has action, drama, and humor, and he thinks it will be a blockbuster. He takes the script to every motion picture studio in town and tries to sell it but to no avail. Finally, ACME stu

> A firm is considering an investment in a new machine with a price of $15.6 million to replace its existing machine. The current machine has a book value of $5.4 million and a market value of $4.1 million. The new machine is expected to have a four-year l

> The Durkin Investing Agency has been the best stock picker in the country for the past two years. Before this rise to fame occurred, the Durkin newsletter had 200 subscribers. Those subscribers beat the market consistently, earning substantially higher r

> Empirical research has found that there have been significant increases in stock price on the day an initial dividend (i.e., the first time a firm pays a cash dividend) is announced. What does this finding imply about the information content of initial d

> A stock is currently priced at $35. A call option with an expiration of one year has an exercise price of $50. The risk-free rate is 7 percent per year, compounded continuously, and the standard deviation of the stock’s return is infinitely large. What i

> In Problem 1, what was the dividend yield? The capital gains yield?

> You are evaluating a project that costs $75,000 today. The project has an inflow of $155,000 in one year and an outflow of $65,000 in two years. What are the IRRs for the project? What discount rate results in the maximum NPV for this project? How can yo

> Treasury bid and ask quotes are sometimes given in terms of yields, so there would be a bid yield and an ask yield. Which do you think would be larger? Explain.

> Dream, Inc., has debt outstanding with a face value of $5 million. The value of the firm if it were entirely financed by equity would be $18.65 million. The company also has 360,000 shares of stock outstanding that sell at a price of $41 per share. The c

> RightPrice Investors, Inc., is considering the purchase of a $415,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $50,000 in

> After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 8 percent or paying the cash out to investors who would invest in the

> Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 18,000 shares of stock outstanding, currently worth $35 per share. Beta Corporation uses leverage in its capital

> Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material supply. The current cash flow from assets for Arras is $6.8 million.

> A stock has had returns of 24 percent, 12 percent, 38 percent, 22 percent, 21 percent, and 216 percent over the last six years. What are the arithmetic and geometric returns for the stock?

> Hacker Software has 6.2 percent coupon bonds on the market with 9 years to maturity. The bonds make semiannual payments and currently sell for 104 percent of par. What is the current yield on the bonds? The YTM? The effective annual yield?

> Your buddy comes to you with a sure-fire way to make some quick money and help pay off your student loans. His idea is to sell T-shirts with the words “I get” on them. “You get it?” He says, “You see all those bumper stickers and T-shirts that say ‘got m

> You have found the following stock quote for RJW Enterprises, Inc., in the financial pages of today’s newspaper. What is the annual dividend? What was the closing price for this stock that appeared in yesterday’s paper

> 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