Basics of Financial Management Final Exam

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Pearson Company bought a machine on January 1, 2014. The machine cost $144,000 and had an expected salvage value of $24,000. The life of the machine was estimated to be 5 years. The depreciable cost of the machine is

$144,000 - $24,000 = $120,000

Joseph Harris is considering an investment that pays 8.8 percent annually. How much must he invest today such that he will have $35,000 in seven years?

$19,394

At the beginning of each year, Bill Ross invests $1,400 semiannually at 8% for nine years. The cash value of the annuity due at the end of the ninth year is

$37,339.18

Congratulations! You just bought a new car for $18,000 and plan to take out a loan for the full amount. The local credit union will lend you the money at 2.75% interest for four years, and you will make monthly payments, beginning next month. How much is each monthly payment?

$396.43

Juan Vinson is planning to buy a house in five years. He is looking to invest $25,000 today in an index mutual fund that will provide him a return of 12 percent annually. How much will he have at the end of five years?

$44,059

Bonds will sell at par when their coupon rate is _________ the discount rate.

- Equal To

Ivanhoe Tire Co. just paid an annual dividend of $1.20 on its common shares. If Ivanhoe is expected to increase its annual dividend by 7.10 percent per year into the foreseeable future and the current price of Ivanhoe's common shares is $11.92, what is the cost of common stock for Ivanhoe?

17.88%

Find the return on a share of preferred stock that pays $3.90 per year given a market price of $30.00 per share.

3.90/30= 13%

Patrick Smith has $6,500 to invest in a small business venture. His partner has promised to pay him back $8,300 in five years. What is the return earned on this investment?

5.0%

A Treasury bond is quoted at a price of 101:14 with a current yield of 7.236 percent. What is the coupon rate?

7.34 percent price =101 and 14/32 of face 1.014375*1000=1,014.375 annual interest=.07236*1014.375=73.40 coupon rate= 73.40/1000=7.34%

Direct financing occurs when

A borrower-spender borrows directly from a lender-saver

What is a primary market? What does IPO stand for?

A primary market is where new securities are sold for the first time. IPO stands for Initial Public Offering.

In calculating the daily balance, cash advances are

Added in

A sinking fund

Aids in meeting a future obligation

Amount financed is equal to

Cash price- down payment

Morton Industries' common stock sells for $54. Dividends are expected to continue to grow at a rate of 8% annually. If Morton returns 13%, what was its most recent dividend?

D0 = $2.50

Junk Bonds

High risk debt with ratings of BBB- or below by Standard & Poor's; High yield — typically pay 3%-5% more than AAA grade long-term bonds.

Which of the following is a stakeholder of a firm?

employees

Using higher interest rates will

increase the future value of any investment.

If the interest rates are historically low for the past few years...

the best strategy is to invest in short term bonds to avoid interest rate risk

As market interest rates rise..

the long term bonds suffer more in value than short term bonds

Future value measures:

what one or more cash flows are worth at the end of a specified period.

An investor predicts that, one year from today, Acme Inc. will pay a common stock dividend of $1.75 and the price per share will be $35. If the investor's required rate of return is 10%, how much should she expect to pay for the stock today?

$33.41

QN=495 (20733)43 Constant growth: You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most you would be willing to pay for this stock?

$61

Tammy Smith purchased a call option with a striking price of $40 at a price of $3.50. At expiration, the stock price has risen to $45.00. What is Tammy's return on investment?

($45 - $40 - $3.5) / $3.50 = $1.50 / $3.50 = 0.429

Dynoxo Textiles has a cash inflow of $1 million, which it needs for a long-term investment, at the end of one year. It plans to deposit the money in a bank CD that pays daily interest at an annual rate of 4.50 percent. What will be the value of the investment at the end of the year? (Round to the nearest dollar.)

$1,046,025 Work: Financial Calculator- N = 1 x 365 N = 365PV = -$1,000,000 I/Y = 4.5 / 365 I/Y = 0.012328767 PMT = $0 CPT for FV $1,046,024.958

Suppose you must estimate the cost of equity for a firm, and you have the following data: rRF = 5.5%; rM - rRF = 6%; b = 0.8; D1 = $1.00; P0 = $25.00; g = 6%; rd = the firm's bond yield = 6.5%. What is this firm's cost of equity using the CAPM approach?

10.3%

An oil exploration firm is currently searching for oil. Their probability of finding oil this year is 38% and if they hit oil we expect the stock to return 36%. If they do not hit oil we expect the stock to return -15%. What is the expected return of the stock?

4.38%

Your brother has asked you for a loan and has promised to pay you $7100 at the end of three years. If you normally invest to earn 8.5 percent per year, how much will you be willing to lend to your brother if you view this purely as a financial transaction (i,e you don't give your brother a special deal)?

5,558.65 is the amount to be invested today

Assume that you own an investment that will pay you $15,000 per year for 12 years, with the first payment today. You need money today to start a new business, and your uncle offers to give you $120,000 for the investment. If you sell it, what rate of return would your uncle earn on the annuity?

8.41%

A 10-year, 4.5 percent, semiannual coupon bond issued by Tyler Rentals has a $1,000 face value. The bond is currently quoted at 98.7. What is the clean price of this bond if the next interest payment will occur 2 months from today?

987.00 clean price=.987*1000 clean price just current quote*fv

Oil Well Supply offers 7.5 percent coupon bonds with semiannual payments and a yield to maturity of 7.68 percent. The bonds mature in 6 years. What is the market price per bond if the face value is $1,000?

991.47 n=6*2 i/y=7.68/2 pv=? pmt=75/2 fv=1000

Schlumberger Ltd issues a 0.13 coupon bond with annual payments that has 6 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently priced at $1029 in the markets?

12%

Boretti has $400,000 in a stock fund. The fund pays a 10% return, compounded annually. If he does not make another deposit into the account, how long will it take for the account to increase to $2million?

16.89 years

Anthony Walker is considering an investment that pays 6.4 percent, compounded annually. How much will he have to invest today so that the investment will be worth 29K in six years?

19,987.03 is the amount to be invested today

Sunland Specialties just purchased inventory-management computer software at a cost of $1,518,950. Cost savings from the investment over the next six years will produce the following cash flow stream: $181,340, $326,240, $332,600, $587,250, $802,320, and $687,740. What is the payback period on this investment?

4.11 years

Coupon interest rate

is the percentage of the par value of the bond that will be paid out annually in the form of interest, e.g.; 7% bond means the investor gets $70 (.07 x 1000) per year

Diversification provides a benefit to investors when the investor

selects two or more securities whose returns are not highly correlated with each other.

The proper time to harvest an asset is when

the percentage NPV increase of harvesting a project at a future point in time is at the last date where the increase is greater than the cost of capital.

What are typically the main components of an executive compensation package?

The three main components of a typical executive compensation package are: base salary, bonus based on accounting performance, and compensation tied to the firm's stock price.

What are the two risk-hedging instruments discussed in the chapter?

The two risk-hedging instruments discussed are futures and options contracts.

The Security Market Line is the graphic representation of the Capital Asset Pricing Model

True

The growth rate over time is exponential.

True

Common stocks

True owners of the firm, has no maturity date, no upper or lower limit on dividends, dividend payments must be declared each period (usually quarterly) by the firm's board of directors.

Which of the following statements is most correct?

When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

Cullumber Corp. has five-year semi-annual bonds outstanding that pay a coupon rate of 8.4 percent, these bonds are priced at $1,065.16. What is the yield to maturity on these bonds? Assume semiannual coupon payments. What is the effective annual yield?

Yield to maturity 6.84% Effective annual yield. 6.96%

Phosfranc Inc., is expecting the following cash flows starting at the end of the year—$133,245, $152,709, $161,554, and $200,760. If their opportunity cost of capital is 9.4 percent, find the future value of these cash flows.

$734,731

Nancy Billows promised to pay her son $600 quarterly for four years. If Nancy can invest her money at 6% in an ordinary annuity, she must invest how much today?

$8,478.72

Lori Willis plans to invest for retirement, which she hopes will be in 20 years. She is planning to invest $25,000 today in U.S. Treasury bonds that will earn interest at 6.25 percent annually. How much will she have at the end of 20 years?

$84,046

If a share of preferred stock pays a quarterly dividend of $2.25, has a $60 par value and investors require a return of 15%, the stock will sell for:

(2.25 × 4)/.15 = $60

Suppose that your required real rate of return is 3.8 percent and the inflation rate is 1.8 percent. You would expect to see a rate of ______ percent on a Treasury bill.

5.67

Present Value

Amount at the beginning of the term

Which ONE of the following statements is true?

As interest rates decline, the prices of bonds rise; and as interest rates rise, the prices of bonds decline.

Asset Ratio*

Asset ratio = Market value of assets / Total market value of debt and equity A = A/V

QN=175 (20428)50 Which of the following statements is true?

Because investors are risk averse, they require a premium to purchase a security that exposes them to default risk.

Which of the following statements is true?

Because investors are risk averse, they require a premium to purchase a security that exposes them to default risk.

The market risk premium is 8.86 percent, and the risk-free rate is 4.40 percent. If the expected return on a bond is 9.36 percent, what is its beta?

Beta of the bond = 0.56

How does the business cycle affect the nominal interest rate and inflation rate?

Both the nominal interest and inflation rates tend to follow the business cycle; that is, they rise with economic expansion and fall during a recession.

How are brokers different from dealers?

Brokers bring buyers and sellers together. They execute a transaction for their client and are compensated with a commission fee. Brokers never own the securities being sold and therefore do not bear any risk of ownership. In contrast, dealers purchase securities and sell them from an inventory that they own. Dealers profit if they are able to sell securities for a price greater than they paid for them. Because they own the securities, dealers face the risk that the prices of the securities in their inventory will fall below what they paid for those securities.

Debt Ratio Formula*

Debt ratio = Market value of debt / Total market value of debt and equity D = D/V

Prepayment of a loan without penalty is a right of all borrowers.

False

The present value of future cash flows:

Increase as the discount rate decreases.

a stock is selling for $20.00(Po). the projected selling price one year from now(P1) is $22.50, and the projected dividend payment one yr from now (D1) is $1.00. What is the expected return on an investment in the stock made today?

Ke=D1/Po+g=1/20+.125= 17.5%

Which of the following is an example of an OTC market?

New York Stock Exchange

Which type of project do financial managers typically use the highest cost of capital when evaluating?

New product projects

_____________ represent dollars stated in terms of constant purchasing power.

Real dollars

What is the key economic principle involved in calculating the present value or future value of multiple cash flows?

Regardless of whether you are calculating the present value or the future value of a cash flow stream, the key idea is to discount or compound the cash flows to the same point in time.

Which of the following need to be excluded from the calculation of the firm's amount of permanent debt?

Revolving lines of credit

Which of the following is NOT a good method of title assurance?

Seller provides a quitclaim deed

The real asset that gives the best approximation of the risk free rate that we need in the CAPM is:

Short term US government debt

Which of the following business organizational form(s) create(s) a tax liability on income at the personal income tax rate?

Sole Proprietorship AND Partnership

What is the Sarbanes-Oxley Act, and what does it focus on? Why does it focus in these areas?

The Sarbanes-Oxley Act is an act of Congress that was passed in 2002. This act was passed in the aftermath of several corporate scandals that occurred at the turn of the century. The act focuses on (1) reducing agency costs in corporations, (2) restoring ethical conduct within the business sector, and (3) improving the integrity of accounting reporting system within firms. Failures in these areas led to the corporate scandals that preceded passage of Sarbanes-Oxley.

Which of the following statements is true of amortization?

The amortization schedule provides principal, interest, and unpaid principal balance for each month.

When will the annual percentage rate (APR) be the same as the effective annual rate (EAR)?

The annual percentage rate (APR) will be the same as the effective annual rate only if the compounding period is annual, not otherwise.

Which of the following is true of the future value of an investment?

The higher the interest rate, the higher the future value of an investment.

Which of the following statements is true?

The interest rate risk premium always adds an upward bias to the slope of the yield curve.

What are the two basic sources of funds for all businesses?

The two basic sources of funds for all businesses are debt and equity.

Which one of the following statements is true?

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond. AND It is the yield that the investor earns if the bond is held to maturity, and all the coupon and principal payments are made as promised. AND A bond's yield to maturity changes daily as interest rates increase or decrease.

As the coupon rate increases, the bond price will increase.

True

If Laura has to choose between a loan that charges quarterly interest and a loan that charges monthly interest, she should always choose the one charging quarterly interest.

True

If taken without accompanying changes in cash flow, changes in a company's accounting earnings do not impact the overall value of the firm.

True

If the current market price of corn is $100 per bushel and the nominal rate of interest is 10 percent, then the real price of corn next period should also be $100.

True

Vanilla bonds have coupon payments that are fixed for the life of the bond, with the principal being repaid at maturity.

True

The value of the bond is equal to the sum of the present value of all future payments

True.

A firm receives a cash flow from an investment that will increase by 10 percent annually for an infinite number of years. This cash flow stream is called:

a growing perpetuity.

Use of warehouse receipt in short-term financing indicated that

a loan has been secured by inventory

A firm's overall cost of capital is

a weighted average of the costs of capital for the collection of individual projects that the firm is working on.

Which of the following should not be included in a project's cash flow calculations?

allocated expenses

which of the following is a stakeholder:

an employee AND a lender AND the IRS

With strong-form market efficiency,

it would not be possible to earn abnormally high returns by trading on private information.

In order to calculate free cash flow by starting with incremental cash flow from operations, we should

subtract the incremental capital expenditures and the incremental additions to working capital.

If the market price of a bond decreases...

the YTM increases and vice a versa.

The larger the risk...

the larger the rate of return

Marketability is the ability of an investor

to sell a security quickly, at a low transaction cost, and at a price close to its fair market value.

What three different models are used to value stocks based on different dividend patterns?

Based on dividend patterns, we can use the following three models to value stock: (1) zero-growth dividend model, (2) constant-growth dividend model, or (3) supernormal dividend growth model.

When discount rate:

Decreases, the PV of any future cash flow increases

When term BEST describes a person that owns a property and is conveying title to the property to another person?

Deed

The current stock price of Sandhill, Inc., is $46.70. If the required rate of return is 30 percent, what is the dividend paid by this firm if the dividend is not expected to grow in the future?

Dividend paid. $14.01

Shares of common stock of the Samson Co. offer an expected total return of 21.0 percent. The dividend is increasing at a constant 5.5 percent per year. The dividend yield must be:

Dividend yield = 0.210 - 0.055 = 15.50 percent.

Most secondary market transactions for corporate bonds take place on the New York Stock Exchange.

False

_____ occur(s) when one party in a business transaction has information that is unavailable to the other parties in the transaction.

Information asymmetry

Frazier Enterprises stock is selling for $45 today. you are expecting a dividend of $4 next yr and a capital gains yield of 10% calculate the price of the stock 1-yr from now

g=(P1-Po)/Po.10=(P1-45)/45P1=$49.50

The primary sources of funds available to a business include all of the following except

government grants

The present value is simply the current value of a future cash flow that has been discounted at the appropriate discount rate.

True

When estimating the cost of debt capital for the firm, we are primarily interested in

the cost of long-term debt.

Liquidation Value

the dollar sum that could be realized if an asset were sold individually

QN=224 (20468)57 Capital rationing implies that

the firm does not have enough resources to fund all of the available projects.

Market Value

the observed value for the asset in the marketplace, could be different from the par value

The three economic factors that affect the shape of the yield curve are:

the real rate of interest, the expected rate of inflation, and interest rate risk.

The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as the:

the stand-alone principle.

If interest rates decrease...

the value of all bonds increase longer term bonds gain more in value than shorter term bonds

Assume that you borrow $700 from a friend and intend to repay the amount in four equal annual installments beginning one year from today. Your friend wishes to be reimbursed for the time value of money at an 8% annual rate.

PV 700/PVA 3.31213 = 211.34

You believe that the Non-Stick Gum Factory will pay a dividend of $5 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 5% a year in perpetuity. If you require a return of 17% on your investment, how much should you be prepared to pay for the stock?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. P0=DIV1 / (r - g) =$5 / (0.17 - 0.05) =$41.67

Which financial institution is usually the most important to businesses?

The primary financial intermediaries are commercial banks, life insurance companies, casualty insurance companies, pension funds, investment funds, and business finance companies. Commercial banks are the largest and most prominent financial intermediaries in the economy and offer the widest range of financial services to businesses.

The default risk premium is based on the probability that a bond issuer will not fulfill all of a bond's contractual provisions.

True

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond.

True

Trade credit is the most popular form of short term financing available for most businesses

True

The US has a ______________ tax system.

progressive

capital budgeting decisions generally have the most effect on:

the asset portion of the balance sheet

For a U.S. corporation with income above $20 million,

the average tax rate is equal to the marginal tax rate.

Common stock holders receive two types of income:

dividends and capital gains/loss (appreciation/depreciation in price),

Kevin Rogers is interested in buying a five-year bond that pays a coupon of 10 percent on a semiannual basis. The current market rate for similar bonds is 8.8 percent. What should be the current price of this bond?

$1,048

You need to have $15,000 in five years to pay off a home equity loan. You can invest in an account that pays 5.75 percent compounded quarterly. How much will you have to invest today to attain your target in five years?

$11,275

The Good Life offers a common stock that pays an annual dividend of $2 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 9 percent return on your equity investments?

$22.22

Graciela Treadwell won a lottery. She will have a choice of receiving $25,000 at the end of each year for the next 30 years, or a lump sum today. If she can earn a return of 10 percent on any investment she makes, what is the least she should be willing to accept today as a lump-sum payment?

$235,700

Barbara Lakey is saving to buy a new car in four years. She will save $5,500 at the end of each of the next four years. If she invests her savings at 7.75 percent annually, how much will she have after four years?

$24,692

Ed Sloan bought a new Explorer for $22,000. He put down $7,000 and paid $290 for 60 months. The total finance charge to Ed is

$2400

GlobalShippers Inc. has forecasted earnings of $1,233,600, $1,345,900, and $1,455,650 for the next three years. What is the future value of these earnings if the firm's opportunity cost is 13 percent?

$4,551,701

Carpino Company purchased equipment and these costs were incurred: Cash price - $70,000 Sales taxes - 3,500 Insurance during transit - 750 Installation and testing - 1,500 Total costs - $75,750 What's amount should be recorded as the cost of the Equipment?

$75,750

Which of the following statements about bonds is true?

- If market interest rates are below a bond's coupon interest rate, then the bond will sell above its par value AND - Long-term bonds have more interest rate risk than do short-term bonds (all else equal) AND - Bond prices move in the opposite direction of market interest rates.

The market risk premium is 9.0 percent, and the risk-free rate is 5.0 percent. If the expected return on a bond is 9.5 percent, what is its beta?

0.50

QN=434 (20680)40 You invested $3,000 in a portfolio with an expected return of 10 percent and $2,000 in a portfolio with an expected return of 16 percent. What is the expected return of the combined portfolio?

12.4%

Beautinator Cosmetics borrowed $152,300 from a bank for three years. If the quoted rate (APR) is 11.75 percent, and the compounding is daily, what is the effective annual rate (EAR)?

12.5%

The beta of RicciCo.'s stock is 3.2, whereas the risk-free rate of return is 9 percent. If the expected return on the market is 18 percent, then what is the expected return on RicciCo.?

37.80%

A three-year bank CD paying 7.12 percent compounded monthly. Calculate effective annual interest rate (EAR)?

7.37%

Mary wants to invest her recent bonus in an 12-year, 8 percent coupon bond that pays semiannual coupon payments. The bonds are selling at $1,043.24 today. If she buys this bond and holds it to maturity, what would be her yield-to-maturity?

7.45%

A three-year bank CD paying 7.32 percent compounded quarterly. Calculate effective annual interest rate (EAR)?

7.52%

A three-year bank CD paying 7.62 percent compounded annually. Calculate effective annual interest rate (EAR)?

7.82%

Today, you want to sell a $1,000 face value zero coupon bond you currently own. The bond matures in 4.5 years. How much will you receive for your bond if the market yield to maturity is currently 5.33 percent?

789.22 n=4.5*2 iy=5.33/2 pv=? pmt=0 fv=1000

The cost of preferred equity: Billy's Goat Coats has a preferred share issue outstanding with a current price of $38.89. The firm last paid a dividend on the issue of $3.50 per share. What is the firm's cost of preferred equity?

9% k∨ps = D∨ps/P∨ps 3.5/38.89 = 0.09

If inflation is anticipated to be 10 percent during the next year while a nominal rate of 20 percent will be earned on U.S. Treasury bills, then what is the accurate real rate of return on these securities?

9.09%

Ratings by standard and poor's:

AAA, AA, A, BBB, BB, B, CCC, CC, C, D

Debentures

Any unsecured long-term debt, no collateral of any kind

Which of the following is primarily responsible for managing all financial aspects of a firm?

Chief Financial Officer (CFO)

Future value focuses on the valuation of cash flows received over time, while present value focuses on the valuation of cash flows received at a point in time.

False

A stock with a Beta of more than one:

Has experienced price changes that are more volatile than the over market.

Which of the following statements best describes the relationship between interest rates and the business cycle?

Interest rates tend rise during economic expansion and decline during recessions.

Why do interest rates follow the business cycle?

Interest rates tend rise during economic expansion and decline during recessions.

What is the main difference between money markets and capital markets?

Money markets are markets in which short-term debt instruments with maturities of less than one year are bought and sold. Capital markets are markets in which equity securities and debt instruments with maturities of more than one year are bought and sold.

from the owner's perspective, which of the following should be the primary focus of managers:

NOT revenue maximization NOT profit maximization NOT COGS minimization

Which of the following statements is NOT true about preferred stock?

Preferred dividends are tax deductible just like the interest on bonds.

An inverted yield curve occurs when:

Short term bonds pay higher yields than longer term bonds.

From the owner's perspective, which of the following should be the goal of a firm?

Stockholders' wealth maximization

A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT

The bond's yield to maturity is greater than its coupon rate.

A bond with a face value of $1,000 will have a current price of $1,000 if the coupon rate is equal to the yield to maturity.

True

A mortgage default can result in failure to pay property taxes.

True

The NYSE is an example of:

an organized exchange.

QN=219 (20469)55 Capital rationing implies that

funding needs exceed funding resources.

Which of the following statements is true?

high-yield (junk) bonds are those rated BB and lower

Working capital management decisions help to determine:

how a firm's day-to-day financial matters should be managed.

When computing the NPV of a capital budgeting project, one should NOT

ignore the salvage value.

You have been offered Synergy Inc.'s preferred stock at a price of $31.50. It pays a dividend of $4.41 per year. Calculate the return on the stock?

k = DP/PP = 4.41/31.50 = 14%

The tax rate that should be used when forecasting cash flows from operations is the _____.

marginal

The firm's ____________ is used to calculate NOPAT because the profits from a project are assumed to be incremental to the firm.

marginal tax rate

The compensation received for assuming the risk in a balanced portfolio of risky assets is the _____.

market risk premium

which of the following business organizational form(s) create(s) a tax liability on income at the personal income tax rate:

sole proprietorship AND partnership

Inverted yield curves are observed when

the economy is in recession.

The cost of capital depends primarily on?

the use of the funds, not the source.

which one of the following statements about zero coupon bonds is not true?

zero coupon bonds make coupon payments but no principal payment at maturity

Portfolio Beta Formula

βp = (Wa × β) + (Wb × β)

QN=389 (20620)37 Present value of an annuity: Transit Insurance Company has made an investment in another company that will guarantee it a cash flow of $37,250 each year for the next five years. If the company uses a discount rate of 15 percent on its investments, what is the present value of this investment?

$124,868

Stuart Weddle's father is 55 years old and wants to set up a cash flow stream that would be forever. He would like to receive $15,000 every year, beginning at the end of this year. If he could invest in account earning 9 percent annually, how much would he have to invest today to receive his perpetual cash flow?

$166,667

Each quarter, Sheridan, Inc., pays a dividend on its perpetual preferred stock. Today the stock is selling at $62.00. If the required rate of return for such stocks is 18.00 percent, what is the quarterly dividend paid by this Sheridan?

$2.79

Dat Nguyen is depositing $20,000 in an account paying an annual interest rate of 8.5 percent compounded monthly. What is the interest on interest after 10 years?

$9,652.94

Current interest rates are 8%. You want to buy a long-term bond with a face value of $1000 that pays a coupon rate of 10%. Which of the following prices is feasible?

$1,111.11

If you want to have $150,000 in 2 years, how much do you need to put in a savings account today that pays 5% compounded annually?

$136,054.42 Work: Financial Calculator- N = 2 FV = $150,000 I/Y = 5 PMT = $0 CPT for PV -$136,054.42 (Calculator says negative since it's money you are giving up)

A loan was made 10 years ago for $140,000 at 10.5% for a 30 year term. Rates are currently 9.25%. What is the market value of the loan?

$139,828

Jacob's friend, Albert, borrows today with a promise to repay $7,418.87 in four years. If Jacob could earn 5.45 percent annually on the any investment he makes today, how much would he be willing to lend Albert today?

$6,000

You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most you would be willing to pay for this stock?

$61

List the three forms of the efficient market hypothesis, and describe what information is assumed to be reflected in security prices under each of these hypotheses.

1) Strong-Form Efficiency - all information is reflected in the security prices. 2) Semistrong-Form Efficiency - all public information is reflected in the security prices. 3) Weak-Form Efficiency - all information contained in past prices is reflected in security prices.

Blue Jazz, Inc., has 7.4 percent coupon bonds on the market that have 12 years left to maturity. The bonds make annual payments. If the YTM on these bonds is 5.8 percent, the current price of the bond $______. Round it two decimial places, and do not include the $ sign, e.g., 935.67.

1,135.62

Getty Markets has bonds outstanding that pay a 5 percent semiannual coupon, have a 5.28 percent yield to maturity, and a face value of $1,000. The current rate of inflation is 4.1 percent. What is the real rate of return on these bonds?

1.13% r=(1.0747/1.04)-1=3.34% big key here is -1 again

a stock just paid an annual dividend of $2.00, which is expected to remain constant indefinitely. The market return is 14%. The estimated selling price of the stock is:

2/.14= $14.29

If we take a portfolio of average stocks and diversify away all the risk we can, we would expect to still have a volatility (Standard Deviation) of:

20%

Assume you plan to buy a new car in 5 years and you think it will cost $20,000 at that time. What amount must you invest today in order to accumulate $20,000 in 5 years, if you can earn 8% interest compounded annually?

20,000*.68058 (from table 2 with i=.08, n=5) = $13,611.60

Hesterberg is a weightlifter whose maximum lift is 220 pounds. He believes he can increase his maximum by 5% per month for the next four months. If Hesterberg achieves his goal, his maximum lift will increase to approximately:

267 pounds.

Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate the average tax rate for Lansing, Inc., this year. Lansing's pretax income was $275,000.

33.0%

Kathy's Blooms purchased a delivery van with a $50,000 list price. The company was given a $5,000 cash discount by the dealer, and paid $2,500 sales tax. Annual insurance on the van is $1,250. As a result of the purchase, by how much will Kathy's Blooms increase its van account?

50,000 - 5,000 + 2,500 = 47,500

Your brother has asked you to help him to choose an investment. He has $6,000 to invest today for a period of two years. You identify a bank CD that pays an interest rate of 4.25 percent with the interest being paid quarterly. What will be the value of the investment in two years?

6,529

The average risk-premium for the market from 1926 to 2009 was

6.01%

Ten years ago, you put $150,000 into an interest earning account. Today it is worth $275,000. What is the effective annual interest earned on the account?

6.25%

A borrower takes out a 3 year mortgage loan for $100,000 with an interest rate of 6% plus 4 points. What is the effective annual interest rate on the loan if the loan is carried for al 30 years?

6.4%

Consider a 19-year bond with 6 percent annual coupon payments. The market rate (YTM) is 6.7 percent for this bond. The current yield of the bond is _______ percent.

6.48

Collingwood Homes has a bond issue outstanding that pays an 8.5 percent coupon and matures in 16.5 years. The bonds have a par value of $1,000 and a market price of $944.30. Interest is paid semiannually. What is the yield to maturity.

9.16% n=16.5*2 i/y=? pmt=85/2 fv=1000

What is the difference between a perpetuity and an annuity?

A cash flow stream that consists of the same amount being received or paid on a periodic basis for a limited time period is called an annuity. If the same payments are made periodically forever, the contract is called a perpetuity.

The future value of an investment of $5,000 earning an annual interest of 10 percent equals $6,000 at the end of one year.

False

The growth rate over time is linear.

False

The impact of a project on another project's cash flows should be ignored.

False

The lower the discount rate, the lower the present value of a future cash flow.

False

The lowest interest rate charged by a bank for a short-term loan is called the discount rate

False

Oriole Corp. management is expecting a project to generate after-tax income of $68,970 in each of the next three years. The average book value of the project's equipment over that period will be $215,880. If the firm's investment decision on any project is based on an ARR of 37.5 percent. What is the project's accounting rate of return? Should the firm accept this project?

Accounting rate of return = 31.9% Should the firm accept this project? = The firm should reject the project.

Lee Wills loaned Audrey Chin $16,000 to open Snip Its Hair Salon. After 6 years, Audrey will repay Lee with 8% interest compounded quarterly. How much will Lee receive at the end of 6 years?

Amount received $25734.40

Tony Ring wants to attend Northeast College. He will need $60,000 4 years from today. Assume Tony's bank pays 12% interest compounded semiannually. What must Tony deposit today so he will have $60,000 in 4 years?

Amount to be deposited $37,644

The term "percentage rent" refers to rent paid as a percent of space leased.

False

The value of a dollar invested at a positive interest rate grows over time but at an increasingly slower rate further into the future.

False

Why would the owners of a business choose to form a corporation even though they will face double taxation?

Because the benefits, such as limited liability and access to large amounts of capital at relatively low cost in the public markets, outweigh the cost of double taxation (as well as the higher costs associated with forming a corporation).

Upward-sloping yield curves often occur before the beginning of recession.

False

Which of the following alternatives involve calculating the future value of multiple cash flows?

Calculating income after retirement

CHAPTER 1 AND 2

CHAPETER 1 AND 2

CHAPTER 1 AND 2 HOMEWORK

CHAPTER 1 REVIEW PROBLEMS

CHAPTER 10 HOMEWORK

CHAPTER 13 HOMEWORK

Norman, Inc. is considering two mutually exclusive projects. Project A is a six-year project with a NPV of $3,000 and Project B is a four-year project with an NPV of $2,278. Project A has an equivalent annual cash flow of $730 and Project B has an equivalent annual cash flow of $750. Which project should the firm select?

Choose Project B because it has the higher equivalent annual cash flow.

What are some services that commercial banks provide to businesses?

Commercial banks are the largest financial intermediaries in the economy and offer the widest range of financial services to businesses. Nearly every business has a significant relationship with a commercial bank - usually a checking or transaction account and some type of credit or loan arrangement. In addition, banks do a significant amount of equipment lease financing.

7 years ago Carla Vista Corporation issued 20-year bonds that had a $1,000 face value, paid interest annually, and had a coupon rate of 6 percent. If the market rate of interest is 5.5 percent today, what is the current market price of an Carla Vista Corporation bond? Are these bonds selling at a premium or discount?

Current market price $1045.58 Premium

Sheridan Energy Company has issued perpetual preferred stock with a stated (par) value of $100 and a dividend of 5.5 percent. If the required rate of return is 11.00 percent, what is the stock's current market price?

Current market price. $50

the last dividend paid by Abbot Labs was $1.00. Abbot's growth rate is expected to be a constant 8% for three yrs, after which the growth rate is expected to be 10%. Investors require a return of 16% on stocks like Abbot. What should the price of Abbot's stock be?

D1= 1.08: D2= 1.1664; D3= 1.2597; D4=1.3857P3=(1.3857)/(.16-.10)=23.0947Calculator steps for PV:CF1=1.08; CF2= 1.1664; CF3=1.2597+23.0947=24.3544PV=$17.40

The key difference between investment grade bonds and junk bonds are:

Default risk.

_________ refers to the cash flow that a project is expected to generate after all operating expenses and taxes have been paid.

Incremental cash flow from operations

A portfolio with a level of systematic risk is the same as that of the market has a beta that is

Equal to one

Continuous compound formula

FV=PVe^(r)(t)

Which of the following statements about preferred stock is FALSE?

Failure to pay dividends on preferred stocks will result in a default.

A bond with a longer time to maturity will have less sensitivity to changes in interest rates

False

A mortgage is the same thing as a note.

False

A non-recourse loan is one in which the borrower is personally liable for payment of all amounts due under the terms of the note.

False

A progressive tax system means that a taxpayer will pay a higher tax rate for a given dollar of earnings for every successive year.

False

one advantage of the gross income multiplier technique is that it is most suitable for properties in which operating expenses vary widely across the properties being surveyed.

False

Which of the following statements is true of convertible bonds?

Firms that issue convertible bonds can do so at a lower interest rate

Which of the following theorems explains the relationship between interest rates and bond prices?

For a given change in interest rates, the prices of long-term bonds will change more drastically than the prices of short-term bonds.

As the market interest rate goes up, what happens to the price of existing bonds?

Goes down.

Which of the following is true of risk and expected returns?

Higher the risk, higher the expected returns on an investment.

Which of the following is the best example of a sunk cost?

Historical research and development costs.

Alpha issued a 6% preferred stock 15 years ago (par value $100). What is it selling for today if the relevant rate of return is now 9%?

PP = 6/.09 = $66.67

Equation for present value

PV = FV/(1+i)^n

Increases in working capital are considered cash flows associated with investments.

True

The time-value-of-money concept assumes that

People accept less money to reduce the time they must wait.

a share of stock is currently selling for $20.80. If the dividend just paid is $2.00 and investors are seeking a 14% return, what is the anticipated rate of constant growth?

Po=Do(1+g)/(k-g) 20.80=2(1+g)/(.14-g) g= 4%

a share of stock is currently selling for $31.80. if the anticipated constant growth rate for dividends is 6% and investors are seeking a 16% return, what is the dividend just paid?

Po=Do(1+g)/(k-g) 31.80=Do(1+g)/(.16-g) Do=$3

Newly issued securities are sold to investors in which one of the following markets?

Primary

What is the difference between primary and secondary markets?

Primary markets are markets where new securities are sold for the first time. Secondary markets are where the owners of outstanding securities can sell them to other investors. They provide the means for investors to sell their securities and get cash.

Each quarter, Crane, Inc., pays a dividend on its perpetual preferred stock. Today the stock is selling at $63.00. If the required rate of return for such stocks is 16.00 percent, what is the quarterly dividend paid by this Crane?

Quarterly dividend paid. $2.52

Which of the following does the audit committee have unconditional authority to do?

Question any person employed by the firm.

Distinguish between quoted interest rate, interest rate per period, and effective annual interest rate.

Quoted interest rate, such as APR, is the interest rate that has been annualized by multiplying the rate per period by the number of compounding periods. Interest rate per period is the quoted rate per period. It can be stated in the form of an APR—in that case, just divide it by the number of compounding periods to obtain the interest rate per period. Finally, EAR is the annual rate of interest that accounts for the effects of compounding.

A stock sells for $50. The next dividend will be $5 per share. If the rate of return earned on reinvested funds is a constant 15% and the company reinvests a constant 20% of earnings in the firm, what must be the discount rate?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. g=Return on equity × Plowback ratio =0.15 × 0.20 =0.03, or 3% r=DIV1 / P0 + g =$5 / $50 + 0.03 =0.13, or 13 %

What critical economic role does the financial system play in the economy?

The financial system is in place to gather money from people and businesses and then channel these funds to those who need it. An efficient financial system is essential for a healthy economy. The major players in the U.S. financial system are big institutions such as the New York Stock Exchange, Citigroup, or State Farm Insurance.

Premium

The market value of a bond will be above the par or face value when the investor's required rate is lower than the coupon interest rate. The bond will sell at a premium or above face value. When the bond sells at a premium the coupon rate is larger than the current yield and larger than the YTM.

Which of the following statements is true with respect to the present value of a future amount?

The relation between present value and time is exponential.

Give two examples of perpetuities.

The text gives the example of British government bonds called consols that have no maturity and have been traded in the markets since the end of the Napoleonic wars. Another example could be a preferred stock of a company that has no maturity and will pay a constant dividend forever.

What is the Rule of 72?

This is a rule of thumb to determine how fast an investment can double. It is a rule that allows you to closely approximate the time that it would take to double your money. It works well with interest rates between 5 and 20 percent, but varies more with higher rates. The Rule of 72 says that the time to double your money (TDM) approximately equals 72/i, where i is the rate of return expressed as a percentage. For example, if a bank paid 10% interest it would take 7.2 (72/10 = 7.2) years to double your money.

Total Interest

Total Interest=Future Value- Present Value TI=FV-PV

If the bond currently sells at a premium, what is the relationship between YTM, current yield and the coupon rate?

YTM < Current Yield < Coupon Rate

If a firm has had an agency conflict which is reflected in a poor performing stock for a long period of time, then the firm may become a target of

a corporate raider

A construction firm is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the firm owns adjacent to the airport. The firm's decision will be to

accept both projects because they are independent projects.

The ___________ is intended to reconcile changes in the balance sheet cash accounts.

accounting statement of cash flows

The amounts owed to a firm by its customers are called

accounts receivable

the audit committee reports directly to the

board of directors

Which of the following is a basic source of funds for a firm?

debt AND equity

Money obtained through various types of loans is called

debt capital

Long-term debt typically describes

debt with a maturity greater than one year.

Using lower interest rates will

decrease the future value of any investment.

Using higher discount rates will

decrease the present value of any future cash flow.

The common stock of Ruby Janes pays a constant annual dividend. Thus, the market price of Ruby Janes stock will:

decrease when the market rate of return increases.

Depreciation expense _____.

decreases taxable income and decreases taxes

Income after deducting loss of rents due to vacancy and nonpayment of rents, as well as any concessions, is referred to as:

effective gross income

the profitability of a firm can be negatively affected by:

either too much inventory or too little inventory

You are considering the purchase of Sanders Corp., a constant growth stock. the stock paid a recent dividend of $3.00. The next dividend is expected to be $3.18. if the stock is returning 15%,calculate its dividend yield

g= (3.18-3.00)/3.00= .06= 6% The 6% is the capital gains yield k=dividend yield +capital gains yield 15%=dividend yield+ 6% dividend yield= 9%

Bonds sell at a discount when the market rate of interest is

greater than the bond's coupon rate

Which of the following descriptions most accurately reflects the risk position of an ARM lender in comparison to that of a FRM lender?

interest rate risk - lower; default risk -higher

Bond issuance costs include

investment banking fees. AND legal fees. AND accountant fees.

The current price of Zebar is $32.00 and its last dividend was $.60. What is its return if dividends are expected to grow indefinitely at 8 percent?

kE = [.60(1.08)/32] + .08 = 10.03%

Selling at discount

means trading at less than the face value, if sells at a discount, the ror to the bondholder is above the coupon rate of the bond.

Selling at premium

means trading at more than the face value. If the bonds sells at a premium, the investors' or holders' ror is below the coupon rate of the bond.

Financial markets in which equity and debt instruments with maturities less than one year are traded are called:

money markets

If the expected return on an asset is less than its required return given on the Security Market Line, the stock is said to be.

overpriced

which of the following type of owner is protected by limited liability:

owner of a corporation

a stakeholder is

someone who has a claim on the cash flows of the firm

QN=228 (20467)56 The cost of capital is

the minimum return that a capital budgeting project must earn for it to be accepted.

Jeff Corporation purchased a limited-life intangible asset for $150,000 on May 1, 2010. It has a useful life of 10 years. What total amount of amortization expense should have been recorded on the intangible asset by December 31, 2012?

($150,000 ÷ 10) × (2 + 8/12) = $40,000. (2 + 8/12)= 2 years and 8 months.

A 16-year, 4.5 percent coupon bond pays interest annually. The bond has a face value of $1,000. What is the percentage change in the price of this bond if the market yield to maturity rises to 5.7 percent from the current rate of 5.5 percent?

2.14% decrease % change formula=new-old/old find pv for both then use % change formula

If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation is anticipated to be 8 percent, then what should nominal rate of return be?

23.12%

QN=535 (20772)48 If the real return on U.S. Treasury bills is 14 percent while the rate of expected inflation is anticipated to be 8 percent, then what should nominal rate of return be?

23.12%

Pace Enterprises' common stock sells for $29, and its dividends are expected to grow at a rate of 9 percent annually. If investors in Pace require a return of 14%, what is the expected dividend next year?

29=D0(1.09)/(.14-.09)D0=1.33D1=1.33(1.09) = $1.45

Barbara Jones want to accumulate $10k by the end of 12 years. If the annual interest rate is 9.20 percent and interest compounds semiannually, how much will she have to invest today to achieve her goal?

3,398.13 present value of investment

Swan Lake Marina is expected to pay an annual dividend of $1.58 next year. The stock is selling for $18.53 a share and has a total return of 12 percent. What is the dividend growth rate?

3.47 percent (g = 0.12 - ($1.58/$18.53) = 3.47 percent)

Ted Williams made deposits of $500 at the end of each year for eight years. The rate is 8% compounded annually. The value of Ted's annuity at the end of eight years is

$5318.31 Yearly deposit at the end of each year = $500 NO of years = 8 ROI = 8% compounded annually Maturity amount = 5318.31 $, out of which principal 4000 and interest 1318.31

A bond with a coupon rate that is less than the yield to maturity will be priced at a discount.

True

All other things being equal, a given change in the interest rates will have a greater impact on the price of a low-coupon bond than a higher-coupon bond with the same maturity.

True

Borrowers with fixed rate mortgages generally benefit if actual inflation is higher than expected inflation.

True

Conceptually, free cash flows are what is left over for distribution to creditors and stockholders after the firm has made the necessary investments in working capital and long-term assets.

True

Convertible bonds can be converted into shares of common stock at some predetermined ratio at the discretion of the bondhold

True

Corporate bonds have a thin market relative to market for corporate stocks.

True

If the salvage value, at the time of an asset disposition, is less than the book value of the asset, then the firm will effectively receive a positive cash flow from taxes on the sale.

True

If you start with incremental net operating profits after tax (NOPAT) and add depreciation and amortization to it, then you will obtain incremental cash flow from operations.

True

It is possible for a firm to have one depreciation schedule for tax purposes and another for financial reporting purposes.

True

Tony Ring wants to attend Northeast College. If he deposits $37,644 today, how much will he have 4 years from now at 12% interest compounded semiannually?

Amount $59,997

Sam Long anticipates he will need approximately $225,000 in 15 years to cover his 3-year-old daughter's college bills for a 4-year degree. How much would he have to invest today at an interest rate of 8 percent compounded semiannually?

Amount $69,367.50

Future Value

Amount at the end of the time period

Crane Corp. management is evaluating two mutually exclusive projects. The cost of capital is 15 percent. Costs and cash flows for each project are given in the following table. Year. Project 1 Project 2 0. -$1,311,723. -$1,306,190 1 230,000. 374,000 2 342,000 374,000 3 470,000. 374,000 4. 519,000. 374,000 5 750,000. 374,000 Calculate NPV and IRR of two projects. Which project should be accepted?

NPV of project 1 is $125,533 NPV of project 2 is -$52,484 IRR of project 1 is 18.29% IRR of project 2 is 13.29% Crane Corp. should accept Project 1

Railway Cabooses just paid its annual dividend of $2.50 per share. The company has been reducing the dividends by 11.7 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 13 percent?

P0 = [$2.50 × [1 + (- 0.117)]] / [0.13 - (- 0.117)] = $8.94

Static Inc. has had a hard time recently. In order to help the firm survive a downturn in the market for its products, management has announced that it doesn't plan to pay dividends for the next three years. A modest dividend of $2.00 is projected for the fourth year after which dividends are expected to grow at 5% indefinitely. Similar stocks return 10%. How much should Static's stock sell for today?

P3=2.00/(.10-.05)=40 P0=40(.7513) = $30.05

Currently a bond is sold at a price of $1,302.68 or the yield to maturity of 6.78%. If the default risk of this bond increases, then you would expect:

The bond price to decrease and the YTM to increase

Suppose three investments have equal lives and multiple cash flows. A high discount rate tends to favor: a. The investment with large cash flows early. b. The investment with large cash flows late. c. The investment with even cash flows. d. None of the investments since they have equal lives.

The investment with large cash flows early. The correct answer is a. The investment with large cash flows early will be worth more compared to the one with the large cash flows late. The cash flows that come in later will have a heavier penalty when using a higher discount rate. Thus the investment with large cash flows early will be favored

Which of the following statements is true?

The largest investors in corporate bonds are institutional investors such as life insurance companies and pension funds. AND The market for corporate bonds is thin compared to the market for corporate stocks. AND Prices in the corporate bond market tend to be more volatile than prices of securities sold in markets with greater trading volumes.

What does it mean to "underwrite" a new security issue? What compensation does an investment banker get from underwriting a security issue?

To underwrite a new security issue means that the investment banker buys the entire issue from the firm at a guaranteed price and then resells the security to individual investors or other institutions at a higher price. The difference between the banker's purchase price and the total resale price is called the underwriting spread, and it is the banker's compensation. In addition to underwriting new securities, investment banks also provide other services, such as preparing the prospectus, preparing legal documents to be filed with the SEC, and providing general financial advice to the issuer.

If you can invest $200,000 at a 10.5% annual rate, compounded monthly, how long will it take to have $500,000?

105 months

You own a uranium mine, and the price of uranium is expected to increase at a rate of 3 percent per year. The cost of capital for your firm is 15 percent, and you are evaluating whether or not to begin harvesting the element. The correct choice is to begin harvesting immediately under all circumstances.

False

Zero coupon bonds sell well above their par value because they offer no coupons.

False

who among the following is the "principal" in the agency relationship of a corporation: a company engineer, the CEO of a firm, a stockholder, the board of directors

A stockholder

The unadjusted NPV of two projects with different useful lives can be compared to evaluate which project is the better of the two.

False

what is an example of frivolous agency costs

excessive perks

What is not a characteristic of a shareholder?

expects to receive interest

Which of the following statements about the time value of money concept is true?

It means a dollar received today is worth more than a dollar received tomorrow.

How and why do large business firms use money markets?

Large businesses use money markets to adjust their liquidity positions. If a firm has idle cash sitting around, it can invest it in negotiable CDs, Treasury bills, or other money market instruments. On the other hand, if a company has a temporary cash shortage, it can borrow in the money markets by selling commercial paper at lower interest rates than it could borrow through a commercial bank.

Reynolds Metals common stock is selling for $25 a share and has a dividend yield of 3.1 percent. What is the dividend amount?

$0.78 (Dividend = 0.031 × $25 = $0.78)

Sharon Smith will receive $1 million in 50 years. The discount rate is 14%. As an alternative, she can receive $1,000 today. Which should she choose?

$1,000,000 x 0.001 = $1,000 they are indifferent

Which of the following investments will have the highest future value?

$1,300 invested at an quarterly interest rate of 2.25% for 5 years

A borrower takes out a 30 year mortgage loan for $250,000 with an interest rate of 5%. What would the monthly payment be?

$1,342

Amanda Chin purchased a home for $296,000; she put 20% down with a mortgage rate of 6% for 30 years. What is Amanda's monthly payment?

$1,420.80

Delfino's expects to pay an annual dividend of $1.50 per share next year. What is the anticipated dividend for year 5 if the firm increases its dividend by 2 percent annually?

$1.50 x (1.02)^5

The difference between the monthly payments on a $120,000 home at 6 ½% and at 8% for 25 years is

$115.20

What is the present value, and when is it used?

Present value is the amount a future sum is worth today, given a certain rate of return. The present value concept should be used when calculating how much money you need today in order to reach your financial goal sometime in the future.

Pete's Real Estate is currently valued at $65,000. Pete feels the value of his business will increase at a rate of 10% per year, compounded semiannually for the next 5 years. At a local fundraiser, a competitor offered Pete $70,000 for the business. If he sells, Pete plans to invest the money at 6% compounded quarterly. What price should Pete ask?

Price $78,614.79

Sunland Corp is issuing a 10-year bond with a coupon rate of 10 percent. The interest rate for similar bonds is currently 9 percent. Assuming annual payments, what is the value of the bond?

Value of bond. $1064.18

Wildhorse Corp. is expected to grow rapidly at a rate of 35 percent for the next seven years. The company's first dividend, to be paid three years from now, will be $5. After seven years, the company (and the dividends it pays) will grow at a rate of 6.3 percent. What is the value of Wildhorse stock with a required rate of return of 14 percent?

Value of stock. $115.35

You are interested in buying the preferred stock of a bank that pays a dividend of $2.45 every quarter. If you discount such cash flows at 8 percent, what is the value of this stock?

Value of the stock. $122.5

You are interested in buying the preferred stock of a bank that pays a dividend of $2.35 every quarter. If you discount such cash flows at 10 percent, what is the value of this stock?

Value of the stock. $94

Which of the following firms is most likely to receive venture capital

Virtual reality Internet company

ABC Corporation has the following information: Total market value of a company's stock: $650 million Total market value of the company's debt: $150 million Cost of Equity: 10% Cost of Debt: 8% Corporate tax rate is 35 percent What is the WACC of ABC Corporation?

WACC = (E/V) × RE + (D/V) × RD × (1 − TC) WACC = (650/800) × .10 + (150/800) × .08 × (1 − .35) WACC = (.8125) × .10 + (.1875) × .08 × (1 − .35) WACC = .08125 + .00975 WACC = .091 = 9.1%

After-tax WACC*

WACC = [(E/V)RE] + [(D/V) RD * (1 - TC)] E/V - weight of equity RE - cost of equity D/V - weight of debt RD - cost of debt D = market price of single bond * bonds outstanding E = (# shares outstanding * price/share) V = D + E

Cullumber Corp. management plans to issue seven-year zero coupon bonds. It has learned that these bonds will sell today at a price of $444.86. What is the yield to maturity on these bonds?

Yield to maturity 12.27%

Sandra Robinson is looking to invest in a three-year bond that makes semi-annual coupon payments at a rate of 5.375 percent. If these bonds have a market price of $987.61, what yield to maturity can she expect to earn?

Yield to maturity 5.83%

Blossom Corp. has five-year semi-annual bonds outstanding that pay a coupon rate of 8.4 percent, these bonds are priced at $1,076.66. What is the yield to maturity on these bonds? Assume semiannual coupon payments. What is the effective annual yield?

Yield to maturity. 6.58% Effective annual yield. 6.69%

Which of the following investments will have the highest future value at the end of three years? Assume that the effective annual rate for all investments is the same.

You earn $1,000 at the beginning of every year for the next three years (a total of three payments).

which form of business organization generates the majority of business revenues and profits in the United States?

corporation

The book value of a plant asset is the difference between the

cost of the asset and the accumulated depreciation to date.

Brown Mack, Inc., currently has two large manufacturing divisions that share a single plant. Brown Mack owns the plant but has calculated that $6 million of overhead expenses should be allocated to the two equal-sized divisions. If Brown Mack starts a third manufacturing division, of equal size to the other two divisions, then what overhead cost should the new division take into account on its capital budgeting cash flow analysis?

A borrower takes out a 30 year mortgage loan for $250,000 with an interest rate of 5% and monthly payments. What portion of the first month's payment would be applied to interest?

$1,042

University Corp. issued five-year bonds that pay a coupon of 6.5 percent semiannually. The current market rate for similar bonds is 5.5 percent. How much will you be willing to pay for the bond today?

$1,043

Dynoxo Textiles has a cash inflow of $1 million, which it needs for a long-term investment, at the end of one year. It plans to deposit the money in a bank CD that pays daily interest at 4.50 percent. What will be the value of the investment at the end of the year?

$1,046,025

Crane, Inc., has issued a three-year bond that pays a coupon rate of 6.6 percent. Coupon payments are made semiannually. Given the market rate of interest of 4.6 percent, what is the market value of the bond?

$1,055.45

Selma just purchased a bond. It has a semiannual coupon of 9.0%, a par value of $1,000, and a maturity date exactly twenty years in the future. If the bond's yield to maturity is 6.82%, then what price did Selma pay for the bond?

$1,236.06

Your birthday is next week and instead of other presents, your parents promised to give you $1,100 in cash. Since you have a part-time job and, thus, don't need the cash immediately, you decide to invest the money in a bank CD that pays 7.00 percent, compounded quarterly, for the next two years. How much money can you expect to earn in this period of time?

$1,263.77

Allegion plc issues a 0.19 semi-annual coupon bond with 8 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.08?

$1,641

An amortization schedule shows

Portion of payment broken down to interest and principal

Annuity payments at the end of the period

Ordinary annuity

Total Compound Interest is the:

Sum of simple interest and the interest on interest

Celesta Frank wants to go on a cruise in three years. She could earn 8.2 percent compounded monthly in an account if she were to deposit the money today. She needs to have $10,000 in three years. How much will she have to deposit today?

$7,826

Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate the total taxes paid for Lansing, Inc., this year. Lansing's pretax income was $275,000.

$90,500

Marginal and average tax rates: Use the tax rate taken from Exhibit 11.6 to calculate the total taxes paid for Lansing, Inc., this year. Lansing's pretax income was $275,000. SEE IMAGE

$90,500

The assumption that a knowledgeable buyer would not pay more for property than what other buyers have recently paid for comparable properties, provides the rationale for the sales comparison approach.

True

U.S. Treasury securities are the best proxy measure for the risk-free rate.

True

When analyzing a project, if the expected future cash flows are denominated in nominal dollars, then the discount rate should represent a nominal rate as well.

True

Suppose a firm's expected dividends for the next three years are as follows: D1 = $1.10, D2 = $1.20, D3 = $1.30. After three years, the firm's dividends are expected to grow at 5 percent per year. What should the current price of the firm's stock (P0) be today if investors require a rate of return of 12 percent on the stock?

$16.74

Joseph Ray just received an inheritance of $35,775 from his great aunt. He plans to invest the funds for retirement. If Joseph can earn 4.75% per year with quarterly compounding for 32 years, how much will he have accumulated?

$162,113 FV=PV(1+i/m)^mn=35,775(1+0.0475/4)^(4*32)=162,113.25

Daniel Jackson is considering an investment that pays 5.50 percent, compounded annually. How much will he have to invest today so that the investment will be worth $26,500 in six years?

$19,219.01

Provo, Inc., had revenues of $10 million, cash operating expenses of $5 million, and depreciation and amortization of $1 million during 2008. The firm purchased $500,000 of equipment during the year while increasing its inventory by $300,000 (with no corresponding increase in current liabilities). The marginal tax rate for Provo is 40 percent. Free cash flow: What is Provo's free cash flow for 2008?

$2,600,000

Management of Cullumber Mints, a confectioner, is considering purchasing a new jelly bean-making machine at a cost of $312,500. They project that the cash flows from this investment will be $134,000 for the next seven years. If the appropriate discount rate is 14 percent, what is the NPV for the project?

$262,133

Lloyd Harrisis planning to invest $3,500 every year for the next six years in an investment paying 13 percent annually. What will be the amount he will have at the end of the six years?

$29,129

Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and depreciation and amortization of $1.5 million during 2008. The firm purchased $700,000 of equipment during the year while increasing its inventory by $500,000 (with no corresponding increase in current liabilities). The marginal tax rate for Champagne is 30 percent. Free cash flow: What is Champagne's cash flow from operations for 2008?

$3,250,000

$3,400,000

Bovic Inc. is a growing company with sales of $1.25 million this year. The company expects to grow at an annual rate of 25 percent for the next three years, followed by 20 percent per year for the next two years. What will be Bovic's sales at the end of five years?

$3,515,625

Shaun Barringer has started on his first job. He plans to start saving for retirement. He will invest $5,000 at the end of each year for the next 45 years in a fund that will earn a return of 10 percent. How much will Shaun have at the end of 45 years?

$3,594,524

John Sullivan bought a new Brunswick boat for $17,000. He made a $2,500 down payment on it. The bank's loan was for 60 months. Finance charges totaled $4,900. His monthly payment is

$323.33 He owes 17000-2500=14500 after the down payment. Add 4900 for finance charges and he owes 19400 still. Divide 19400 by 60 to get a payment of $323.33 per month.

The required rate of return is 20.70 percent. Sheridan Corp. has just paid a dividend of $3.12 and is expected to increase its dividend at a constant rate of 8.80 percent. What is the expected price of the stock three years from now?

$36.74

Joe Sullivan invests $9,000 at the end of each year for 20 years. The rate of interest Joe earns is 8% annually. The final value of Joe's investment at the end of the 20th year on this ordinary annuity is

$411,857.68 amount = 9000(1.08^20 - 1)/.08 = 9000(45.7619643) = $411,857.68

Expected cash flows: FireRock Wheel Corp is evaluating a project in which there is a 40 percent probability of revenues totaling $3 million and a 60 percent probability of revenues totaling $1 million per year. Its cash expenses will be $1.0 million while depreciation expense will be $200,000; then what is the expected free cash flow from taking the project if the marginal tax rate for the firm is 30 percent?

$620,000

Ryngaert Inc. recently issued bonds that mature in 15 years. They have a par value of $1,000 and an annual coupon of 5.7%. If the current market interest rate is 9.7%, at what price should the bonds sell?

$690.48

John Johnson is planning to invest $29,000 today in a mutual fund that will provide a return of 11 percent each year. What will be the value of the investment in 10 years?

$82,343.21

Braniff Ground Services stock has an expected return of 9 percent and a variance of 0.25 percent. What is the coefficient of variation for Braniff?

0.5556

If inflation is anticipated to be 6 percent during the next year, while the real rate of interest for a one-year loan is 5 percent, then what should the nominal rate of interest be for a risk-free one-year loan?

11%.

You need to have $15,000 in five years to pay off a home equity loan. You can invest in an account that pays 5.75percent compound quarterly. How much will you have to invest today to attain your target in five years?

11,275

You know that the return of Cullumber Cyclicals common shares is 1.5 times as sensitive to macroeconomic information as the return of the market. If the risk-free rate of return is 2.50 percent and market risk premium is 5.71 percent, what is Cullumber Cyclicals' cost of common equity capital?

11.07%

QN=519 (20761)46 Discounted payback: Roswell Energy Company is installing new equipment at a cost of $10 million. Expected cash flows from this project over the next five years will be $1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's discount rate for such projects is 14 percent. What is the project's discounted payback period?

4.2 years

Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The machinery will result in additional annual cash flows of $375,000 over the next five years. The firm's cost of capital is 10 percent. What is the discounted payback period for this project? If its acceptance period is three years, will this project be accepted?

4.3 years; no

The expected return on Karol Co. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of Karol Co is 2.3, then what is the risk premium on the market portfolio?

5.0%

The yield to maturity on a bond is currently 8.46 percent. The real rate of return is 3.22 percent. What is the rate of inflation?

5.08% h=(1+0.0846/1+0.0322)-1=5.08% -1 is huge

Robert just purchased a bond for a price of $951.35. It has a par value of $1,000 and it will mature in exactly five years. If this bond has a semiannual coupon of 4%, then what is its yield to maturity?

5.12%

Shoreline Foods pays a constant annual dividend of $1.60 a share and currently sells for $28.50 a share. What is the rate of return?

5.61 percent (R=$1.60/$28.50 = 5.61 percent)

Thermo Fisher Scientific issues a 0.12 annual coupon bond with 29 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.21?

573

Greenbrier Industrial Products' bonds have a 7.60 percent coupon and pay interest annually. The face value is $1,000 and the current market price is $1,062.50 per bond. The bonds mature in 16 years. What is the yield to maturity?

6.94% n=16 iy=? pv=-1062.50 pmt=76 fv=1000

Find the value of a share of preferred stock that pays $6.00 per year given a return of 16%.

6/.16 = $37.50

If a share of preferred stock pays a quarterly dividend of $1.50, has a $40 par value, and is currently selling for $50.00, it is earning an annual return of:

6/50=12%

The cost of debt: Dynamo Corporation has semiannual bonds outstanding with 12 years to maturity and are currently priced at $1,080.29. If the bonds have a coupon rate of 8 percent, then what is the equivalent annual return (EAR) to the investor for purchasing the bonds at the described price?

7.12% N= 12*2=24 PV = -1080.29 PMT = 1000*.08 = 80/2 = 40 FV = 1000 CPT -> I/Y = 3.5 EAR - 1+.035= 1.035 --> (1.035)^2 = 1.0712-1 = .0712*100 = 7.12

Jenny LePlaz is looking to invest in a five-year bond that pays annual coupons of 6.25 percent and currently sells at $912.34. What is the current market yield on such bonds?

8.5%

The common stock of Kyocera currently sells for $88.50 and its last (D0) dividend was $1.10. Determine the implied constant growth rate for Kyocera assuming it returns 14%.

88.50=1.10(1+g)/(.14-g) g = 12.6%

Grand Adventure Properties offers a 9.5 percent coupon bond with annual payments. The yield to maturity is 11.2 percent and the maturity date is 11 years from today. What is the market price of this bond if the face value is $1,000?

895.43 n=11 iy=11.2 pv=? pmt=95 fv=1000

Blue Jazz, Inc., has 10 percent coupon bonds on the market that have 20 years left to maturity. The bonds make annual payments. If the YTM on these bonds is 11.3 percent, the current price of the bond $______.

898.48

You invest $270 in a mutual fund today that pays 8.10 percent interest annually. How long will it take to double your money? (Round to the nearest year)

9 years Work: Financial Calculator- FV = $270 x 2 FV = $540 I/Y = 8.1 PMT = $0 PV = -$270 CPT for N 8.899447742 years

You form a portfolio by buying $84914 of American Airlines stock, and $50819 of Southwest stock. If American Airlines stock has an expected return of 9.1% and Southwest stock has an expected return of 9.2%, what is the expected return of your portfolio?

9.14%

Explain how bond yields are calculated.

A bond's yield is calculated by finding the interest rate that equates the bond's price to the present value of its interest payments and principal amount. The calculation of a bond's yield, or its yield to maturity, takes into account the bond's time to maturity, the coupon rate, and face value.

Which one of the following statements is true?

A discount bond has a coupon rate that is less than the bond's yield to maturity.

Why is a dollar today worth more than a dollar one year from now?

A dollar is worth more today than one year from now, due to its potential earning capacity. If you have the money in your hand today, you have the opportunity to invest it and earn interest or you can purchase goods and services for your immediate consumption. Given that people have a positive preference for consumption, time value of money holds true.

How can a lack of business ethics negatively affect the performance of an economy? Give an example.

A lack of business ethics can lead to corruption, which, in turn, creates inefficiencies in an economy, inhibits the growth of capital markets, and slows the rate of overall economic growth. For example, the Russian economy has had a relatively difficult time attracting foreign investment since the fall of the Soviet Union due, in part, to weak ethics and corruption in the business community and local and national governments. Lower foreign investment has led to slower overall economic growth than the country might otherwise have enjoyed.

Why can skipping payment of a preferred dividend be a bad signal?

A preferred dividend is treated like an interest payment on debt by financial markets and investors. Although the firm will not be in default, any delay or failure to pay the dividends by the firm will be treated seriously by the financial markets and make them think that the firm is in financial difficulty.

Stock Market Index: What is a stock market index?

A stock market index is used to measure the performance of the stock market. These indexes reflect the value of the stocks in a particular market, such as the NYSE or the NASDAQ, or across markets, and increase and decrease as the values of the stocks go up and down. Examples of stock market indexes include the Dow Jones Industrial Average, the New York Stock Exchange Index, the Standard & Poor's 500 Index, and the NASDAQ Composite Index.

Which of the following classes of securities is likely to have the lowest corporate borrowing cost?

AAA rated bonds.

Expeditors Intl of WA Inc issues a 0.17 coupon bond with annual payments that has 22 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently priced at $1280 in the markets?

ANSWER: ENTER: (N=22, I/Y=?, PV=-1280, PMT=170, FV=1000) and find I/Y=0.1308

Which of the following statements is CORRECT?

All else equal, bonds with high credit ratings have yields to maturity that are lower than bonds with low credit ratings.

Which of the following situations will result in an increase in the future value of an investment?

An increase in the length of the holding period.

Regatta, Inc., has six-year bonds outstanding that pay an 8.25 percent coupon rate. Investors buying the bond today can expect to earn a yield to maturity of 6.875 percent. How much will you be willing to pay for Regatta's bond today? Assume annual coupon payments.

Answer: ENTER: N= 6 I/YR= 6.875 PV=? PMT= (.0825x1,000) = 82.50 FV= 1,000 and find PV=$1,066

Third Relationship

As the interest rate changes, longer term bonds are more affected than short term bonds, therefore, a bondholder owning a long-term bond is exposed to greater interest rate risk than when owning a short-term bond.

Financial markets in which equity and debt instruments with maturities greater than one year are traded are called:

Capital markets.

Ted McKay has just bought the common stock of Pharoah Corp. Management of Pharoah expects the company expects to grow at the following rates for the next three years: 30 percent, 25 percent, and 15 percent. Last year the company paid a dividend of $2.60. Assume a required rate of return of 11 percent. Compute the expected dividend for the first year Compute the expected dividend for the second year. Compute the expected dividend for the third year. Compute the present value of these dividends if the required rate of return is 11 percent.

D1 $3.38 D2. $4.23 D3 $4.86 Present value. $10.03

Williamson metal inc paid a dividend last year of $3 and is expecting dividends to grow at an 18% rate in years 1 and 2 followed by constant growth of 6% per year thereafter. similar stocks return 12% calculate the value of the stock today

D1 = 3(1.18) = 3.54 D2 = 3.54(1.18) = 4.18 P2 = (4.18(1.06))/.06= 73.85 4.18 + 73.85=78.03 Calculator Steps: CFo=0, C01=3.54, C02=78.03; NPV: I = 12 NPV = $65.37

Why don't small businesses make greater use of the direct credit markets since these markets enable firms to finance their activities at a very low cost?

Direct credit markets are geared toward big, established companies since they are wholesale in nature and the minimum transaction size is far beyond the needs of a small business. Small businesses are better off borrowing money from financial intermediaries, such as commercial banks.

Equation for future value

FV = PV * (1+i)^n i=interest rate, n=compounding periods

Accounting earnings are a reliable measure of the costs and benefits of a project.

False

Allocated costs such as corporate overhead should be included in cash flow calculations.

False

What are two basic services that investment banks provide in the economy?

Investment banks specialize in helping companies sell new debt or equity as well as provide other services such as broker and dealer services.

Identify seven mechanisms that can help better align the goals of managers with those of stockholders.

Mechanisms that can help align the goals of managers with those of stockholders are as follows: (1) the board of directors, (2) management compensation, (3) the managerial labor market, (4) competition among managers, (5) large stockholders, (6) the takeover market, and (7) the legal and regulatory environment.Boards of directors that are independent from managers can help limit the extent to which managers are able to act solely in their own interest. Firms design compensation plans that are tied to firm performance in order to provide managers with incentives to make decisions consistent with the goal of stockholder value maximization. A third mechanism that helps align the goals of managers is the managerial labor market. It is difficult for poorly performing managers to find a good job elsewhere, and it is difficult for a poorly performing firm to hire good managers, which a firm's current managers typically want to do. Competition among managers within a firm is a fourth mechanism that helps align the goals of managers with those of stockholders. This is because managers who act in the interest of stockholders are more likely to advance within the firm. Because large stockholders have a lot to gain from aligning the goals of managers with their own, they are likely to expend resources to encourage managers to maximize stock value. Sixth, the threat of a takeover, which leads to firing of poor managers, can provide current managers with incentives to perform well. Finally, laws and regulations limit the ability of managers to make decisions that harm stockholders.

The finance charge is equal to the total of all monthly payments

Minus amount financed

What is the term-to-maturity (life) of a bond that sells for $953.52, has a YTM of 12%, and has a coupon rate of 11%? Paid semi-annually

NOT - 4 years NOR - 8 years NOR - 10 years NOR - 14 years

If you are dealing with percentage returns, then which of the following is generally true?

NOT The variance of the return distribution is generally smaller than the standard deviation. NOT The variance of the return distribution is generally larger than the standard deviation. NOT The variance of the return distribution is measured in the same units as expected return.

What is net working capital?

Net working capital is the difference between a firm's total current assets and its total current liabilities.

Which of the following statements is NOT true about common stock?

Owners of common stock are guaranteed dividend payments by the firm.

An Allied Northern preferred stock pays a $3.84 annual dividend. What is the value of the stock at a 9.5 percent return?

P0 = $3.84 / .095 = $40.42

Kate could not attend the last shareholders' meeting and thus she granted the authority to vote on her behalf to the managers of the firm. Which one of the following terms is used to describe the method by which Kate's shares were voted?

Proxy

QUIZLET CHAPTER 10 HOMEWORK QUIZLET

QUIZLET CHAPTER 10 QUIZLET

What is the cost of equity for the TMB Corporation based on the following information? Risk premium = 5% Risk free rate = 4% TMB beta: 1.50

RTMB = Rf + ßTMB × (RM - Rf) = 4% + 1.50 × 5% = 11.50%

Lynn Ally, owner of a local Subway shop, loaned $40,000 to Pete Hall to help him open a Subway franchise. Pete plans to repay Lynn at the end of 8 years with 6% interest compounded semiannually.How much will Lynn receive at the end of 8 years?

Receive $64188

What is the difference between saver-lenders and borrower-spenders, and who are the major representatives of each group?

Saver-lenders are those who have more money than they need right now. The principal saver-lenders in the economy are households. Borrower-spenders are those who need the money saver-lenders are offering. The main borrower-spenders in the economy are businesses followed by the federal government, although households are important mortgage borrowers.

Which of the following investment classes had the greatest variability in returns for recent historical data?

Small U.S. Stocks

If you hold a single asset, the best measure of risk is the:

Standard deviation (volatility)

Stock Market Index: What is the Dow Jones Industrial Average?

The Dow is the most widely published stock index and reflects the value of the stocks of 30 large companies. The value of the shares of these companies represents about 20 percent of the market value of all U.S. stocks.

Explain why you would expect the discount factor to become smaller when based on the longer the time to payment.

The discount factor will become smaller the longer the time to payment due to time value of money. The longer you have to wait to obtain the money, the less value it will have to you. Mathematically, the discount factor is calculated as 1/(1 + i)^n. The longer the time to payment, the larger n gets, which will make the discount factor smaller.

Which of the follow statements about the time value of money is true?

The further in the future you receive a dollar, the less it is worth today

Explain the phrase "a dollar today is worth more than a dollar tomorrow."

The implication is that if one was to receive a dollar today instead of in the future, the dollar could be invested and will be worth more than a dollar tomorrow because of the interest earned during that one day. This makes it more valuable than receiving a dollar tomorrow.

What are the major responsibilities of the CFO?

The major responsibilities of a CFO are recommendation and financial analysis of financial decisions. Although all top managers in a firm participate in these decisions, the final report and analysis is ultimately the responsibility of the CFO.

Which of the following factors is NOT part of the definition of market value?

The property has been on the open market for less than a year.

Which of the following statements is most true about zero coupon bonds?

They typically sell at a deep discount below par when they are first issued.

We think most investors are risk averse, by this we mean:

They will take risk, but expect to be compensated for taking it with positive expected returns

Which of the following statements best describes time lines?

Time lines are an important tool for analyzing problems that involve cash flows over time.

Which of the following statements is true of amortization?

With an amortized loan, a larger proportion of each month's payment goes toward interest in the early periods.

Cullumber, Inc., has four-year bonds outstanding that pay a coupon rate of 6.00 percent and make coupon payments semiannually. If these bonds are currently selling at $915.89. What is the yield to maturity that an investor can expect to earn on these bonds? What is the effective annual yield?

Yield to maturity. 8.53% Effective annual yield. 8.7%

The CFO of a certain company always wears his green suit on a day that the firm is about to release positive information about his company. You believe that you can profit from this information by buying the firm's shares at the beginning of every day that the CFO shows up wearing this green suit. Describe which form of market efficiency is consistent with your belief.

You believe that the CFO's decision to wear a green suit indicates that positive information will be announced and that the company's stock price will increase following that announcement. If you are correct, knowing what the CFO is wearing before any announcement is valuable private information which should enable you to earn abnormally high returns. Therefore, your belief is consistent with the semistrong-form of market efficiency - according to which it is possible to earn abnormally high returns by trading on private information.

What are zero coupon bonds, and how are they priced?

Zero coupon bonds are debt instruments that do not pay coupon interest but promise a single payment (interest earned plus principal) paid at maturity. The price of a zero coupon bond can be calculated using the same equation as used for coupon bonds, but setting the coupon payments to zero. The resulting formula is as follows: SEE IMAGE Because zero coupon bonds offer the entire payment at maturity, for a given change in interest rates, their price fluctuates more than coupon bonds with a similar maturity.

Which one of the following statements about zero coupon bonds is NOT true?

Zero coupon bonds make coupon payments but no principal payment at maturity.

The price of a share of stock today is $25.00. if the return on the share is estimated at 18 % and the stock generally pays a dividend of $1 per yr, what is its projected selling price in one yr?

[(P1-25)+1]/25=.18 p1=$28.50

Direct financing occurs when:

a borrower-spender borrows directly from a lender-savers.

When compared to the straight-line depreciation method, MACRS has

a greater proportion of its depreciation early in the life of the asset.

The appropriate risk-free rate to use when calculating the cost of equity for a firm is

a long-term Treasury rate.

he appropriate risk-free rate to use when calculating the cost of equity for a firm is

a long-term Treasury rate.

A preferred stock would be an ideal example of:

a perpetuity.

You are the financial planner for Johnson Controls. Assume last year's profits were $700,000. The board of directors decided to forgo dividends to stockholders and retire high-interest outstanding bonds that were issued 5 years ago at a face value of $1,250,000. You have been asked to invest the profits in a bank. The board must know how much money you will need from the profits earned to retire the bonds in 10 years. Bank A pays 6% compounded quarterly, and Bank B pays 612% compounded annually.

a-1: Bank B a-2: Profit $665875 b. Future Value $64056.04

Two projects are considered to be mutually exclusive if

both selecting one would automatically eliminate accepting the other and the projects perform the same function.

Income taxes have the effect of

decreasing the cost of debt.

Dexter inc. has a bond issue outstanding. The issue's indenture provision prohibits the firm from redeeming the bonds during the first 3 years. The provision is referred to as the ____ provision.

deferred call

Cash flows over a project's life should include _____.

depreciation and amortization expenses

The NPV of a project is estimated by

discounting the expected cash flows of a project in the future.

The process of converting future cash flows to what its present value is called:

discounting.

The steps in effective financial planning are

establishing organizational goals, budgeting for financial needs, and identifying sources of financing.

If markets are not reasonably efficient, then

estimates of expected returns that were based on security prices will not be reliable.

A bond will sell at a premium when its coupon interest rate:

exceeds the market interest rate on similar bonds.

The cash flows used in capital budgeting calculations are based on.

forecasts of future cash revenues, expenses, and investment outlays.

The cash flows used in capital budgeting calculations are based on:

forecasts of future cash revenues, expenses, and investment outlays.

The percent of investment that the project costs can be referred to as all of the following, except:

free cash flow

Owners of preferred stock:

have limited voting rights. usually receive fixed dividend payments. AND are given priority treatment over common stock with respect to dividends payments AND the claims against the firm's assets in the event of bankruptcy or liquidation.

If shareholders are granted preemptive right they will:

have priority in the purchase of any newly issued shares

Which of the following statements is true?

he further in the future you receive a dollar, the less it is worth today

Callable bonds

if the prevailing interest rate declines, the firm may want to pay off the bonds or call early and reissue at a more favorable interest rate.

Using lower discount rates will

increase the present value of any future cash flow.

The present value of future cash flows:

increases as the discount rate decreases.

The term ___________ refers to the fact that these cash flows reflect the amount by which the firm's total after-tax free cash flows will change if the project is adopted.

incremental

The systematic risk of an investment is measured by _____

its beta

which of the following is considered a hybrid organizational form: partnership, limited liability partnership, corporation, sole proprietorship

limited liability partnership

One reason for the existence of agency problems between managers and stockholders is that:

management is separate from ownership.

current liabilities are liabilities that:

must be paid within a year

You are considering purchasing a share of Cass Inc. stock today for $75.00. You forecast no dividend payment this yr but 2 yrs from today , you expect a $10 dividend. you plan to sell the stock immediately after receiving the dividend. if you want to return of 15% on the investment, how much must your forecast of the stock price be two yrs from today?

n=2; I/Y=15; PV=75.00; PMT=0; FV=99.19 99.19-10.00=$89.19

The dividend yield is defined as:

next year's expected cash dividend divided by the current market price per share.

The cost of an intangible asset with an indefinite life should

not be amortized.

Preferred stock is sometimes treated like a debt security because:

preferred dividend payments are similar to bond interest payments and are fixed in nature regardless of the firm's earnings.

What is usually executed at the same time as a mortgage and creates the obligation to repay the loan in accordance with its terms?

promissory note

Equivalent annually compounded rate (EACR) Effective interest rate

the annually compounded rate which produces the same results as a given interest rate and compounding

Capital budgeting decisions generally have the most effect on:

the asset portion of the balance sheet.

If the interest rates are historically high for the past few years...

the best strategy is to invest in long term bonds to avoid interest rate risk

A corporate bond's coupon rate is the annual coupon payment divided by:

the bond's face value

The recommended model to estimate the cost of common equity for a firm is

the capital asset pricing model(CAPM).

When analyzing a firm's cost of debt, we are typically interested in

the cost of the debt on the date that the analysis is being completed.

With the change in interest rates...

the coupon rate and the par value don't change, the only thing that changes is the market price of bonds.

which of the following statement is incorrect?

the face or par value for most corporate bonds is equal to $100, and it is the principal amount owed to bondholders at the end of first year

In order for a firm to estimate its cost of debt capital by observing the price of its debt instruments,

the firm must depend on markets being reasonably efficient.

Nominal rate

the original interest rate

Marketability is the ability of an investor

to sell at a profit under all circumstances.

Short-term financing not backed by collateral is called

unsecured financing

In calculating the current price of a bond paying semiannual coupons, one needs to

use double the number of years for the number of payments made. use the semiannual coupon. use the semiannual rate as the discount rate.

In calculating the current price of a bond paying semiannual coupons, one needs to

use double the number of years for the number of payments. AND use half the annual coupon. AND use half the annual rate as the discount rate.

If a firm has bonds outstanding and the firm would like to calculate the current cost of debt for the bonds, then the firm would

use the current yield to maturity of the bonds to estimate the cost.

Book Value

value of an asset as shown on a firm's balance sheet

The bonds that has no coupon payments but promise a single payment at maturity is:

zero coupon bonds.

What are some of the drawbacks to setting profit maximization as the main goal of a company?

· It is difficult to determine what is meant by "profit". · It does not address the size and timing of cash flows—it does not account for the time value of money. · It ignores the uncertainty or risk of cash flows.

Which of the following types of owners is protected by limited liability?

Owner of a corporation

The stock of Music City Inc. is selling for $37.50. The firm recently paid a dividend of $1.10. What is its implied constant growth rate if the market return is 14 percent?

$37.50 = $1.10(1 + g)/ (.14 - g) g = 10.75%

At the end of 8 years, your friend wants to have $50,000 saved for a down payment on a house. He expects to earn 8%, compounded monthly, on his investments over the next 8 years. How much would your friend have to put in his investment account each month to reach his goal?

$374

Sunland Real Estate Company management is planning to fund a development project by issuing 10-year zero coupon bonds with a face value of $1,000. Assuming semiannual compounding, what will be the price of these bonds if the appropriate discount rate is 9.8 percent?

$384.14

Computing the terminal-year FCF: Babaloo Nightclubs purchased a disco mirror that currently has a book value of $10,000. If Babaloo sells the disco mirror for $500 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 39 percent marginal tax rate?

$4,205

Viviana Carroll needs to have $25,000 in five years. If she can earn 8 percent annually on any investment, what is the amount that she will have to invest every year at the end of each year for the next five years?

$4,261

Krysel Inc. is expecting a new project to begin producing cash flows at the end of this year. They expect cash flows to be as follows: 1 = $663,547; 2 = $698,214; 3 = $795,908; 4 = $798,326; 5 = $755,444 If they can reinvest these cash flows to earn a return of 9.2 percent, what is the future value of this cash flow stream at the end of five years?

$4,429,046

If Norman invested $100,000 for 3 years at 12%, how much interest on interest will he earn?

$4,492.80

QN=371 (20643)38 Annuity due: Your inheritance will pay you $100,000 a year for five years beginning now. You can invest it in a CD that will pay 7.75 percent annually. What is the present value of your inheritance?

$433,064

Ely Co. bought a patent from Baden Corp. on January 1, 2013, for $450,000. An independent consultant retained by Ely estimated that the remaining useful life at January 1, 2013 is 15 years. Its unamortized cost on Baden's accounting records was $225,000; the patent had been amortized for 5 years by Baden. How much should be amortized for the year ended December 31, 2013 by Ely Co.?

$450,000 ÷ 15 = $30,000.

QN=536 (20788)49 Capital rationing. The profitability index for a project is 1.18. If the project will produce cash inflows of $60,000 for the next 12 years, what is the initial outlay for the project if the appropriate discount rate is 5 percent?

$450,670

Hall Co. incurred research and development costs in 2013 as follows: Materials used in research and development projects $ 450,000 Equipment acquired that will have alternate future uses in future research and development projects 3,000,000 Depreciation for 2013 on above equipment 500,000 Personnel costs of persons involved in research and development projects 750,000 Consulting fees paid to outsiders for research and development projects 300,000 Indirect costs reasonably allocable to research and development projects 225,000 $5,225,000 The amount of research and development costs charged to Hall's 2013 income statement should be

$5,225,000 - $3,000,000 = $2,225,000.

expenses for a 1000 square foot office space are $6.00 per square foot. The lease specifies an expense stop of $5.40. What is the total expense paid by the landlord?

$5,400

The Waffle House pays a constant annual dividend of $1.25 per share. How much are you willing to pay for one share if you require a 25 percent rate of return?

$5.00 (P = $1.25/0.25 = $5.00)

Carla Vista Corp. is a fast-growing company whose management expects it to grow at a rate of 28 percent over the next two years and then to slow to a growth rate of 13 percent for the following three years. If the last dividend paid by the company was $2.15. What is the dividend for the 5th year?

$5.083

Given a mortgage of $48,000 for 15 years with a rate of 11%, what are the total finance charges?

$50,236.80 ($48,000/$1000 = 48; 48 x $11.37 = $545.76; $545.76 x 180 = $98,236.80;$98,236.80 - $48,000 = $50,236.80)

Zephyr Electricals is a company with no growth potential. Its last dividend payment was $4.50, and it expects no change in future dividends. What is the current price of the company's stock given a discount rate of 9 percent?

$50.00

Mr. Nailor invests $5,000 in a money market account at his local bank. He receives annual interest of 8% for 7 years. How much return will his investment earn during this time period?

$5000 * 1.71382 = 8,570 - 5000 = 3570

The U.S. Treasury has issued 10-year zero coupon bonds with a face value of $1,000. Assume that the bond compounds interest semiannually. What will be the current market price of these bonds if the yield to maturity for similar investments in the market is 6.75 percent?

$515

ABC Corporation's common stock sells for $52.45 per share. The most actively traded option on ABC's common stock is a call option with a striking price of $50, that is currently priced at $3.12. What is the intrinsic value of the call option?

$52.45 - $50.00 = $2.45

Operating Cash Flow: Premier Steel, Inc. is considering the purchase of a new machine for $100,000 that has a useful life of 3 years. The firm's cost of capital is 11.0% and the tax rate is 40%. This machine will be sold for its salvage value of $20,000 at the end of 3-years. The machine will require an investment of $2,500 in spare parts inventory upon installation. The machine will cost $8,000 to ship and $4,000 to install and modify it. Sales are as follows: year 1 = $90,000; year 2 = $97,500; year 3 = $105,000. Operating expenses are year 1 = $25,000; year 2 = $27,000; year 3 = $29,000. The investment in working capital will be liquidated at termination of the project at the end of year 3. MACRS Rates 33% 45% 15% 7% Using MACRS, what is the operating cash flow in year 1?

$53,784

The 7 percent, semi-annual coupon bonds offered by House Renovators are callable in 2 years at $1,054. What is the amount of the call premium on a $1,000 par value bond?

$54 call premium= 1054-1000=54

You plan to buy a new car. The price is $30,000 and you will make a down payment of $4,000.Your annual interest rate is 10% and you intend to pay for the car over five years. What will be your monthly payment?

$552.42

Michael Jones borrowed some money from his friend and promised to repay him $1,210, $1,330, $1,520, $1,620, and $1,620 over the next five years. If the friend normally discounts investment cash flows at 6.5 percent annually, how much did Michael borrow?

$6,008.76

QN=532 (20780)47 Projects with different lives: Your firm is deciding whether to purchase a durable delivery vehicle or a short-term vehicle. The durable vehicle costs $25,000 and should last five years. The short-term vehicle costs $10,000 and should last two years. If the cost of capital for the firm is 15 percent, then what is the equivalent annual cost for the best choice for the firm?

$6,151, short-term vehicle

Shelton Enterprises is expecting tremendous growth from its newest boutique store. Next year the store is expected to bring in net cash flows of $675,000. The company expects its earnings to grow annually at a rate of 13 percent for the next 15 years. What is the present value of this growing annuity if the firm uses a discount rate of 18 percent on its investments?

$6,448,519

Leroy Diaz plans to invest some money today so that he will receive $8,500 in six years. If the investment he is considering will pay 4.25 percent compounded daily, how much will he have to invest today?

$6,587

Leroy Diaz plans to invest some money today so that he will receive $7,500 in three years. If the investment he is considering will pay 3.65 percent compounded daily, how much will he have to invest today?

$6,722

Twilight Corporation acquired End-of-the-World Products on January 1, 2012 for $8,000,000, and recorded goodwill of $1,500,000 as a result of that purchase. At December 31, 2012, the End-of-the-World Products Division had a fair value of $6,800,000. The net identifiable assets of the Division (excluding goodwill) had a fair value of $5,800,000 at that time. What amount of loss on impairment of goodwill should Twilight record in 2012?

$6,800,000 - $5,800,000 = $1,000,000 $1,500,000 - $1,000,000 = $500,000.

Jill plans to save $25,000 a year for 40 years, with the first payment beginning next year. There will be 40 payments and each payment will be invested in an IRA account with an estimated return of 8%. How much should Jill have at the end of year 41? Note, there are 40 payments, but 41 compounding periods.

$6,994,526

QN=496 (20725)44 PV of dividends: Kleine Toymakers is introducing a new line of robotic toys, which it expects to grow their earnings at a much faster rate than normal over the next three years. After paying a dividend of $2.00 last year, it does not expect to pay a dividend for the next three years. After that Kleine plans to pay a dividend of $4.00 in year 4 and then increase the dividend at a rate of 10 percent in years 5 and 6. What is the present value of the dividends to be paid out over the next six years if the required rate of rat of return is 15 percent?

$6.57

Richard McLean wants to invest $3,000 in an account paying 5.25 percent compounded quarterly. What is the interest on interest after four years?

$65.98

Shawn Bowker invested $10,000 in a money market account that will pay 5.75 percent compounded daily. How much will the interest on interest be after two years?

$68.63

Stag Corp. will pay dividends of $4.75, $5.25, $5.75, and $7 for the next four years. Thereafter, the company expects 7 percent growth in dividends. If the required rate of return is 15 percent, what is the current market price of the stock?

$69.41

Camille Noah is investing $5,000 in an account paying 6.75 percent annually for three years. What is the interest on interest if interest is compounded?

$69.88 Deposit today = PV = $5,000 Interest rate = i = 6.75% No. of years = n = 3 Simple interest: Simple interest per year = $5,000 × (0.0675) = $337.50 Simple interest for 3 years = $337.50 × 3 = $1,012.50 Future value with compound interest: FV3 = $5,000 (1 + 0.0675)3 = $6,082.38 Simple interest = $1,012.50 Interest on interest = $6,082.38 - $5,000 - $1,012.50 = $69.88

Mia Lane bought a high-definition television for $7,500. Based on her income, she could afford to pay back only $600 per month. There is 1 ½% monthly interest charge on the unpaid balance. The U.S. Rule is used in the calculation. At the end of month 1, the balance outstanding is

$7,012.50 Principal Borrowed $ 7,500.00 Monthly Interest Rate 1.50% Amount paid per month$600.00 Principal due post 1 month =7500*(1+1.5%) $ 7,612.50 Unpaid Principal Balance (UPB)$ 7,012.50

Stowell earns 20% interest compounded annually on his savings. He will deposit $1,500 today, $1,650 one year from today, and $1,820 two years from today. What will be the account balance three years from today?

$7,152

A 1,500 square foot office space is leased at $12.00 square foot. The space is vacant one month out of the year. Office expenses are $6.50 per square foot and an expense stop is set at $6.00 per square foot. What is the annual net operating income?

$7,500

Celesta Frank wants to go on a cruise in three years. She could earn 8.2 percent compounded monthly in an account if she deposits the money today. She needs to have $10,000 in three years. How much will she have to deposit today?

$7,826 Work: Financial Calculator- N = 3 x 12 N = 36 FV = $10,000 I/Y = 8.2 / 12 I/Y = 0.68333 PMT = $0 CPT for PV -$7,826 (Calculator says negative since it's money you are giving up)

A 7 percent preferred stock pays a total of _____ a year in dividends per share. Assume dividends are paid quarterly.

$7.00

Ambassador Corp. sells household cleaners producing a revenue stream that has remained unchanged in the last few years. The firm does not expect any change in its earnings or dividends for the next several years. The stock is currently selling at $46.88. If the required rate of return is 16 percent, what is the dividend paid by this company?

$7.50

Bryant Investments is putting out a new product. The product will pay out $32,000 in the first year, and after that the payouts will grow by an annual rate of 2.75 percent forever. If you can invest the cash flows at 7.25 percent, how much will you be willing to pay for this perpetuity?

$711,111

Mary Smith is interested in buying a five-year zero coupon bond with a face value of $1,000. She understands that the market interest rate for similar investments is 7.0 percent. Assume annual coupon payments. What is the current value of this bond?

$712.99

Danks Corporation purchased a patent for $900,000 on September 1, 2010. It had a useful life of 10 years. On January 1, 2012, Danks spent $220,000 to successfully defend the patent in a lawsuit. Danks feels that as of that date, the remaining useful life is 5 years. What amount should be reported for patent amortization expense for 2012?

$900,000 - [($900,000 ÷ 10) × 1 1/3] = $780,000. ($780,000 + $220,000) ÷ 5 = $200,000.

If Johnson put $800,000 in a savings account today, how much will it grow to in 3 years if the bank pays 4% annual interest compounded continuously?

$901,997.48 Work: FV Compounded Continuously = PV x e^ (Interest Rate x N) FV = $800,000 x e^(4% x 3) FV = $901,997.48

Brian Lee just received a cash gift from his grandfather. He plans to invest in a five-year bond issued by Carla Vista Corp. that pays an annual coupon rate of 6.0 percent. If the current market rate is 7.00 percent, what is the maximum amount Brian should be willing to pay for this bond?

$959.00

On January 1, 2009, Russell Company purchased a copyright for $2,000,000, having an estimated useful life of 16 years. In January 2013, Russell paid $300,000 for legal fees in a successful defense of the copyright. Copyright amortization expense for the year ended December 31, 2013, should be

($2,000,000 - [($2,000,000 ÷ 16) × 4] = $1,500,000 ($1,500,000 + $300,000) ÷ 12 = $150,000.

Vickers Company uses the units-of-activity method in computing depreciation. A new plant asset is purchased for $36,000 that will produce an estimated 100,000 units over its useful life. Estimated salvage value at the end of its useful life is $3,000. What is the depreciation cost per unit?

($36,000 - $3,000) ÷ 100,000 = $0.33

Books Brothers stock was priced at $15 per share two years ago. The stock sold for $13 last year and now it sells for $18. What was the total return for owning Books Brothers stock during the most recent year?

(18-13)/13 = 0.3846 Total rate of return = 38.46% OR 38%

Sharbaugh Inc.'s most recent dividend was $2.0 per share. the dividend is expected to grow at a rate of 4% per year for the foreseeable future. if the market return is 13% on investments with comparable risk, what should the stock sell for today?

(2.00*1.04)/(.13-.04)=$23.11

Francis purchased a stock one year ago for $20, and it is now worth $24. The stock paid a dividend of $3 during the year. What was the stock's rate of return from capital appreciation during the year?

(24-20)/20 = .20 = 20%

Julio purchased a stock one year ago for $27. The stock is now worth $32, and the total return to Julio for owning the stock was 37 percent. What is the dollar amount of dividends that he received for owning the stock during the year?

(32-27-X)/27 = 0.37, X = 5

A share of Jones Inc. preferred stock pays a dividend of $1.25 each quarter. You are willing to pay $37.50 for this stock. Your annual return on the investment is:

(4 × 1.25/37.50 = .133 = 13.3%)

George Wilson purchased Bright Light Industries common stock for $47.50 on January 31, 2010. The firm paid dividends of $1.10 during the last 12 months. George sold the stock today (January 30, 2011) for $54.00. What is George's holding period return?

(54-47.50+1.10)/47.50 = .1600 = 16%

Ahmet purchased a stock for $45 one year ago. The stock is now worth $65. During the year, the stock paid a dividend of $2.50. What is the total return to Ahmet from owning the stock?

(65-45+2.50)/45 = 0.5 = 50%

Rains Company purchased equipment on January 1 at a list price of $75,000, with credit terms 2/10, n/30. Payment was made within the discount period. Rains paid $3,750 sales tax on the equipment, and paid installation charges of $1,320. Prior to installation, Rains paid $3,000 to pour a concrete slab on which to place the equipment. What is the total cost of the new equipment?

(75,000 x 98%) + 3,750 + 1,320 + 3,000 = 81,570

Equipment was purchased for $90,000. Freight charges amounted to $4,200 and there was a cost of $12,000 for building a foundation and installing the equipment. It is estimated that the equipment will have a $18,000 salvage value at the end of its 5-year useful life. Depreciation expense each year using the straight-line method will be.

(Cost - Salvage value) / Useful life = Depreciation expense (90,000 + 4,200 + 12,000)/5 = $17640

Which of the following S&P ratings applies to the most risky investment grade bonds?

- BBB

A company sells a plant asset that originally cost $225,000 for $75,000 on December 31, 2014. The accumulated depreciation account had a balance of $90,000 after the current year's depreciation of $22,500 had been recorded. The company should recognize a

$75,000 - ($225,000 - $90,000) = ($60,000) $60,000 loss on disposal.

Jack Palomo has deposited $2,500 today in an account paying 6 percent interest annually. What would be the simple interest earned on this investment in five years? If the account paid compound interest, what would be the interest on interest in five years?

$750; $95.56 Deposit today = PV = $2,500 Interest rate = i = 6% No. of years = n = 5 Simple interest: Simple interest per year = $2,500 × (0.06) = $150.00 Simple interest for 5 years = $150 × 5 = $750.00 Future value with compound interest: FV5 = $2,500 (1 + 0.06)5 = $3,345.56 Simple interest = $750 Interest on interest = $3,345.56 − $2,500 − $750 = $95.56

Lori Willis plans to invest for retirement, which she hopes will be in 25 years. She is planning to invest $23,000 today in U.S. Treasury bonds that will earn interest at 5.0 percent annually. How much will she have at the end of 25 years?

$77,886

Assume that you are considering the purchase of a stock which will pay dividends of $4.50 during the next year. Further assume that you will be able to sell the stock for $85.00 one year from today and that your required rate of return is 15 percent. How much would you be willing to pay for the stock today?

$77.83

Which of the following investments will have the highest FV?

$1000 invested at an annual interest rate of 10% for 10 years

You have won the lottery and will receive 20 annual payments of $10,000 starting today. If you can invest these payments at 8.5%, what is the present value of your winnings?

$102,667

a borrower takes our a 30 year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a "teaser" rate of 4%. after that, the rate can reset with a 2% annual rate cap. On the reset date, the composite rate is 5%. What would the Year 3 monthly payment be?

$1067

A bond with a $1,000 face value and an 8 percent annual coupon pays interest semiannually. The bond will mature in 15 years. The yield to maturity is 11 percent. The price of the bond should be:

$781.99

QN=286 (20540)31 Centennial Brewery produced revenues of $1,145,227 in 2008. It has expenses (excluding depreciation) of $812,640, depreciation of $131,335, and interest expense of $81,112. It pays an average tax rate of 34 percent. What is the firm's net income after taxes?

$79,292

Jill Diamond bought a home for $190,000 with a down payment of $65,000. The rate of interest was 7% for 35 years. Her monthly mortgage payment is

$798.75 (190k-65k=125 125x6.39=798.75) 6.39 is the 7%rate for 35yrs.

Your aunt is planning to invest in a bank CD that will pay 5.5 percent interest semiannually. If she has $7,000 to invest, how much will she have at the end of four years?

$8,696.66

Lizzy Clar bought a home for $160,000, putting down $30,000. The rate of interest is 7% for 25 years. The total yearly mortgage payment is

$11,029.20 (160k-30k=130k $130 × $7.07 = $919.10 $919.10 × 12 months = $11,029.20)

Ryan Campbell has invested in a fund that will provide him a cash flow of $11,700 for the next 20 years. If his opportunity cost is 8.5 percent, what is the present value of this cash flow stream?

$110,721

A borrower has secured a 30 year, $150,000 loan at 7% with monthly payments. Fifteen years later an investor wants to purchase the loan from the lender. If market interest rates are 5%, what would the investor be willing to pay for the loan?

$118,748

Juan and Rachel Burpo plan to buy a time-share in six years of $16,860. In order to have adequate funds to do so, the Burpo want to make a deposit to their money market fund today. Assume that they will be able to earn an investment rate of 5.75%, compounded annually. How much will Juan and Rachel need to deposit today to achieve their goal?

$12,055 Work: Financial Calculator- N = 6 I/Y = 5.75 PMT = $0 FV = $16,860 CPT for PV PV = -$12,055.22 (Negative because you're giving up money)

Cellular Talk is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 25 percent a year for the next three years and then decreasing the growth rate to 6 percent per year. The company just paid its annual dividend in the amount of $0.80 per share. What is the current value of one share of this stock if the required rate of return is 17 percent?

$12.14

How much are you willing to pay for one share of Delphia stock if the company just paid a $1.34 annual dividend, the dividends increase by 2.8 percent annually, and you require a 14 percent rate of return?

$12.30

Ransport Company has made an investment in another company that will guarantee it a cash flow of $37,250 each year for the next five years. If the company uses a discount rate of 15 percent on its investments, what is the present value of this investment?

$124,868

Jones Co. borrowed money that is to be repaid in 12 years. So that the loan will be paid back at end of the 12th year, the company invests $8,000 at end of each year at 5% compounded annually. The amount of the original loan was

$127,336.80

James Perkins wants to have a million dollars at retirement, which is 15 years away. He already has $200,000 in an IRA earning 8 percent annually. How much does he need to save each year, beginning at the end of this year to reach his target? Assume he could earn 8 percent on any investment he makes.

$13,464

James Perkins wants to have a million dollars at retirement, which is 15 years away. He already has $200,000 in an IRA earning 8 percent annually. How much does he need to save each year, beginning at the end of this year, to reach his target? Assume he could earn 8 percent annually on any investment he makes.

$13,464

You are purchasing a used car and will make 5 annual payments of $3,500 starting one year from today. If your funds could be invested at 9%, what is the present value of the car?

$13,614

$13.11

Healthy Foods just paid its annual dividend of $1.45 a share. The firm recently announced that all future dividends will be increased by 2.8 percent annually. What is one share of this stock worth to you if you require a 14 percent rate of return?

$13.31 (P0 = ($1.45 × 1.028)/(0.14 - 0.028) = $13.31)

Richard McLean wants to invest $4,100 in an account paying 5 percent compounded quarterly. What is the interest on interest after five years?

$131.35

Stu Reese has a $150,000 7 ½% mortgage. His monthly payment is $1,010.10. His first payment will reduce the principal to an outstanding balance of

$149,927.40 ($150,000 x .075 x (1/12) = $937.50 $1010.10 - $937.50 = $72.60 $150,000.00 - $72.60 = $149,927.40)

Robert White will receive cash flows of $4,450, $4,775, and $5,125from his investment. If he can earn 7 percent on any investment that he makes, what is the future value of his investment cash flows at the end of three years?

$15,329

You need to have $22,000 in five years to payoff a home equity loan. You can invest in an account that pays 6.85 percent compounded quarterly. How much will you have to invest today to attain your target in five years?

$15,665

Solar Energy, Inc. will pay an annual dividend of $1.85 next year. The company just announced that future dividends will be increasing by 2 percent annually. How much are you willing to pay for one share of this stock if you require a 14 percent return?

$15.42 (Po = $1.85/(0.14 - 0.02) = $15.42)

Joseph Harris is considering an investment that pays 6.5 percent annually. How much does he need to invest today so that he will have $25,000 in seven years?

$16,088

Your friend has a trust fund that will pay him $100,000 at the end of 10 years. Your friend, however, wants his money today. He promises to sign his trust fund over to you if you give him some money today. You require a 20% interest rate on money you lend to friends. How much would you be willing to lend under these rates?

$16,151

Joyce Thomas wants to buy a house in six years. She hopes to have $25,000 at that time. If the bank CD she wants to invest in will pay 7.5 percent annually, how much will she have to invest today?

$16,199

Steve Fisher is saving for a new car. He needs to have $ 21,000 for the car in three years. How much will he have to invest today in an account paying 8 percent annually to achieve his target?

$16,670

A borrower has a 30-year mortgage loan for $200,000 with an interest rate of 6% and monthly payments. If she wants to pay off the loan after 8 years, what would be the outstanding balance on the loan?

$175,545

Ivanhoe Corp. paid a dividend of $2.50 yesterday. The company's dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors in stocks of companies like Ivanhoe require a rate of return of 19 percent, what should be the market price of Ivanhoe stock?

$18.75

Ivanhoe, Inc., paid a dividend of $3.97 last year. The company's management does not expect to increase its dividend in the foreseeable future. If the required rate of return is 20.0 percent, what is the current value of the stock?

$19.85

Correct answer icon Your answer is correct. Champagne, Inc., had revenues of $12 million, cash operating expenses of $8 million, and depreciation and amortization of $1.5 million during 2008. The firm purchased $700,000 of equipment during the year while increasing its inventory by $500,000 (with no corresponding increase in current liabilities). The marginal tax rate for Champagne is 30 percent. Free cash flow: What is Champagne's free cash flow for 2008?

$2,050,000

Dynoxo Textiles has a cash inflow of $2 million, which it needs for a long-term investment, at the end of one year. It plans to deposit the money in a bank CD that pays daily interest at 7.50 percent. What will be the value of the investment at the end of the year?

$2,155,752

When to replace an asset: Burt's Pizzas is considering whether to purchase an oven. Burt's calculates that its current oven generates $4,000 of cash flow per year. A new oven would cost $15,000 and would provide cash flow of $6,000 per year for six years. What is the equivalent annual cash flow for the new oven (round to the nearest dollar), and should Burt's purchase the new oven? Assume the cost of capital for Burt's is 12 percent.

$2,352, do not purchase the oven

$2,400,000

Tim Dodson has borrowed $8,600 to pay for his new car. The annual interest rate on the loan is 9.4 percent, and the loan needs to be repaid in four payments. What will be his annual payment if he begins his payment beginning now?

$2,448

Johnson Corporation has just paid a dividend of $4.45. The company has forecasted a dividend growth rate of 8 percent for the next several years. If the appropriate discount rate is 14 percent, what is the current price of this stock?

$80

Dat Nguyen is depositing $17,500 in an account paying an annual interest rate of 8.25 percent compounded monthly. What is the interest on interest after six years?

$2,497.63 Deposit today = PV = $17,500 Interest rate = i = 8.25% No. of years = n = 6 Frequency of compounding = m = 2 Simple interest: Simple interest per year = $17,500 (0.0825) = $1,443.75 Simple interest for 6 years = $1,443.75 × 6 = $8,662.50 Future value with compound interest: = $17,500 × (1.006875)^72 = $28,660.13 Simple interest = $8,662.50 Interest on interest = $28,660.13 − $17,500 − $8,662.50 = $2,497.63

Newship Inc. has borrowed from its bank at a rate of 8 percent and will repay the loan with interest over the next five years. Its scheduled payments, starting at the end of the year are as follows—$450,000, $560,000, $750,000, $875,000, and $1,000,000. What is the present value of these payments?

$2,815,885

Your birthday is next week and instead of other presents, your parents promised to give you $2,400 in cash. Since you have a part-time job and, thus, don't need the cash immediately, you decide to invest the money in a bank CD that pays 8.60 percent, compounded quarterly, for the next two years. How much money can you expect to earn in this period of time?

$2,845.24 Work: Financial Calculator- N = 2 x 4 N = 8 PV = -$2,400 I/Y = 8.6 / 4 I/Y = 2.15 PMT = $0 CPT for FV $2,845.24

Each quarter, Transam, Inc., pays a dividend on its perpetual preferred stock. Today, the stock is selling at $83.45. If the required rate of return for such stocks is 10.5 percent, what is the quarterly dividend paid by the firm?

$2.19

The common stock of The Garden of Eden is selling for $42 a share. The company pays a constant annual dividend and has a total return of 5.8 percent. What is the amount of the dividend?

$2.44

Braxton's Cleaning Company stock is selling for $32.60 a share based on a 14 percent rate of return. What is the amount of the next annual dividend if the dividends are increasing by 5 percent annually?

$2.93

Paul Springer plans to save for a down payment for a house in 10 years. He will be able to invest $12,000 today in a money market account that will pay him an interest of 5.50 percent on a monthly basis. How much will he have at the end of 10 years?

$20,773

The Stagnant Growth Corporation has paid a constant dividend of $2.50 per year for the past 3 years and is expected to continue paying the same dividend per share for the foreseeable future. If the required rate of return on its common stock is 12%, the most an investor should pay per share is _____.

$20.83

Kathleen just received a bonus from EG. She is excited because her dad started his career with EG. If her bonus of $300,000 is equivalent to the bonus paid to her dad 10 years ago, how much was her dad's bonus? Assume that the average annual inflation rate was 3.8%.

$206,608

Joe Jay purchased a new colonial home for $260,000, putting down 20%. He decided to use Loyal Bank for his mortgage. They were offering a 6 1/2% for a 25-year mortgage. The principal after the first payment had a balance outstanding of

$207,720.59 ($260,000 x .8 = $208,000; $208,000 x .065 x 1/12 = $1,126.67 $208 x $6.76 = $1406.08 - $1,126.67 = $279.41 $208,000 - $279.41 = $207,720.59.)

Ann Chang is investing $2,500 today and will do so at the beginning of each of the next six years for a total of seven payments. If her investment can earn 12 percent annually, how much will she have at the end of seven years?

$25,223

Laura Hall wants to accumulate $8,500 by the end of 12 years. If the annual interest rate is 8.50 percent and interest compounds semiannually, how much will she have to invest today to achieve her goal?

$3,130.35

Bill Moore took out an $80,000 mortgage on a ski chalet. The bank charged 4 points at closing. The points in dollars cost Bill:

$3,200 Mortgage on ski chalet = $80000 Charge by Bank at closing ( in Points) = 4 The points in dollars cost Bill is $ 80000 * 0.04 = $3,200

Shaun Barringer has started on his first job. He plans to start saving for retirement. He will invest $5,000 at the end of each year for the next 45 years in a fund that will earn an annual return of 10 percent. How much will Shaun have at the end of 45 years?

$3,594,524

Computing the terminal-year FCF: Miles Cyprus Corp. purchased a truck that currently has a book value of $1,000. If the firm sells the truck for $5,000 today, then what is the amount of cash that it will net after taxes if the firm is subject to a 30 percent marginal tax rate?

$3,800

A perpetuity bond pays a coupon of $136 per year and has a required rate of return of 3.5%. What is the market value of the bond?

$3,885.71 136 / 0.035 = 3,885.71

$3.523

$3.98

A bond has a coupon rate of 6 percent and the bond makes semiannual coupon payments. The dollar amount of coupon interest received every six months is

$30.

Blossom Corp. will pay dividends of $5.00, $6.25, $4.75, and $3.00 in the next four years. Thereafter, management expects the dividend growth rate to be constant at 5 percent. If the required rate of return is 15.50 percent, what is the current value of the stock?

$30.64

Joseph Ray just received an inheritance of $48,900 from his great aunt. He plans to invest the funds for retirement. If Joseph can earn 5.25% per year with quarterly compounding for 35 years, how much will he have accumulated?

$303,482

Metasteel Limited Co. has a stable track record with sales that are not expected to grow in the next several years. Its last annual dividend was $5.75. If the required rate of return on similar investments is 18 percent, what is the current stock price?

$31.94

Your friend just won the lottery. He has a choice of receiving $50,000 a year for the next 20 years or a lump sum today. The lottery uses a 15% discount rate. What would be the lump sum amount your friend would receive?

$312,967

Consider the table. Assume that the subject property has effective gross income of $53,000 and a NOI of $27,500. What value would a cap rate approach yield (rounded to the nearest $100)?

$322,600

Consider the table. Assume that the subject property has effective gross income of $53,000 and a NOI of $27,500. What value would a GIM approach yield (rounded to the nearest $100)?

$328,600

A lottery winner was given a perpetual payment of $25,362. She could invest the cash flows at 7.5 percent annually. What is the present value of this perpetuity?

$338,160

A company sells a plant asset that originally cost $240,000 for $80,000 on December 31, 2014. The accumulated depreciation account had a balance of $120,000 after the current year's depreciation of $20,000 had been recorded. The company should recognize a

$80,000 - ($240,000 - $120,000) = ($40,000) $40,000 loss on disposal.

A company has the following assets: 1. Buildings and Equipment, - less accumulated depreciation of $5,000,000 - $35,000,000 2. Copyrights - 2,400,000 3. Patents - 10,000,000 4. Land - 12,000,000 The total amount reported under Property, Plant, and Equipment would be

$35,000,000 + $12,000 = $47,000,000

Brandon Ramirez wants to set up a scholarship at his alma mater. He is willing to invest $320,000 in an account earning 11 percent annually. What will be the annual scholarship that can be given from this investment?

$35,200

During 2013, Leon Co. incurred the following costs: Testing in search for process alternatives $ 350,000 Costs of marketing research for new product 250,000 Modification of the formulation of a process 560,000 Research and development services performed by Beck Corp. for Leon 425,000 In Leon's 2013 income statement, research and development expense should be

$350,000 + $560,000 + $425,000 = $1,335,000.

Clorox Co issues a 0.02 annual coupon bond with 7 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.2?

$351

Zimmer's common stock sells for $37 and its dividend is expected to grow at a rate of 8 percent annually. What is the expected dividend (D1) if Zimmer is returning 16%?

$37 = D1 / (.16 - .08) D1 = $2.96

$800,000

The Columbia Consumer Products Co. has issued perpetual preferred stock with a $100 par value. The firm pays a quarterly dividend of $2.60 on this stock. What is the current price of this preferred stock given a required rate of return of 12.5 percent?

$83.20

Discover Financial Services issues a 0.09 semi-annual coupon bond with 15 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.11?

$855

Jack Palomo has deposited $3,500 today in an account paying 5 percent interest annually. What would be the simple interest earned on this investment in five years? If the account paid compound interest, what would be the interest on interest in five years?

$875; $91.99

Rosalia White will invest $3,000 in an IRA for the next 30 years starting at the end of this year. The investment will earn 13 percent annually. How much will she have at the end of 30 years?

$879,598

A beauty product company is developing a new fragrance named Happy Forever. There is a probability of 0.52 that consumers will love Happy Forever, and in this case, annual sales will be 1.02 million bottles; a probability of 0.37 that consumers will find the smell acceptable and annual sales will be 228,000 bottles; and a probability of 0.11 that consumers will find the smell unpleasant and annual sales will be only 50,000 bottles. The selling price is $36, and the variable cost is $11 per bottle. Fixed production costs will be $1.08 million per year, and depreciation will be $1.15 million. Assume that the marginal tax rate is 40 percent. What are the expected annual incremental after-tax free cash flows from the new fragrance?

$9,115,900

Celesta Frank wants to go on a cruise in three years. She could earn 8.25 percent compounded monthly in an account if she were to deposit the money today. She needs to have $12,000 in three years. How much will she have to deposit today?

$9,377

Which one of the following statements is NOT true?

As interest rates increase, bond prices increase.

Which one of the following processes do we use when calculating the price of an asset?

Discounting

Mr. Smith has allowed Mrs. Jones to run a sewer line through Mr. Smith's backyard so that Mrs. Jones has access to the city sewer system. This is an example of a(n):

Easement

Which of the following should not be included in a schedule of cash flows from operations when evaluating a capital project?

sunk costs

Equity Ratio*

Equity Ratio = Market value of equity / Total market value of assets Equity Ratio Formula = Shareholder's Equity / Total Asset E = E/V

If ror is greater than coupon rate...

the market value of a bond will be less than the par value

Gerold's Travel Service just paid $1.79 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 3.2 percent. If you require a 10.5 percent rate of return, how much are you willing to pay to purchase one share of this stock?

$25.31

Bovic Inc. is a growing company with sales of $1.25 million this year. The company expects to grow at an annual rate of 25 percent for the next three years, followed by 20 percent per year for the next two years.What will be Bovic's sales at the end of five years?

$3,515,625 Work: FV = PV x (1 + [I/Y])^(N1) X (1 + [I/Y])^(N2) FV = $1.25m x (1 + 0.25)^(3) x (1 + 0.20)^(2) FV = $3,515,625

Maria Miller wants to accumulate $9,500 by the end of 12 years. If the annual interest rate is 8.40 percent and interest compounds semiannually. How much will she have to invest today to achieve her goal?

$3,539.14 Work: Financial Calculator- N = 12 x 2 N = 24 FV = $9,500 I/Y = 8.4 / 2 I/Y = 4.2 PMT = $0 CPT for PV -$3,539.14 (Calculator says negative since it's money you are giving up)

Damien McCoy has loaned money to his brother at an interest rate of 5.85 percent. He expects to receive $987, $1,012, $1,062, and $1,162 at the end of the next four years as complete repayment of the loan with interest. How much did he loan out to his brother?

$3,657

A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. If the firm takes that project, then it will reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

$3.4 million

Dexter Mills issued 20-year bonds a year ago at a coupon rate of 10.2 percent. The bonds make semiannual payments. The yield-to-maturity on these bonds is 9.2 percent. What is the current bond price?

1098.00 n=19*2 iy=9.2/2 pv=? pmt=102 fv=1000

A firm is considering taking a project that will produce $12 million of revenue per year. Cash expenses will be $5 million, and depreciation expenses will be $1 million per year. The project would also reduce the cash revenues of an existing project by $2 million. What is the free cash flow on the project, per year, if the firm is in the 40 percent marginal tax rate?

$3.4 million

The general ledger of Vance Corporation as of December 31, 2012, includes the following accounts: Copyrights $ 30,000 Deposits with advertising agency (will be used to promote goodwill) 27,000 Discount on bonds payable 70,000 Excess of cost over fair value of identifiable net assets of Acquired subsidiary 440,000 Trademarks 90,000 In the preparation of Vance's balance sheet as of December 31, 2012, what should be reported as total intangible assets?

$30,000 + $440,000 + $90,000 = $560,000.

Krysel Inc. is expecting a new project to begin producing cash flows at the end of this year. They expect cash flows to be as follows: 1 - $663,547 2 - $698,214 3 - $795,908 4 - $798,326 5 - $755,444 If they can reinvest these cash flows to earn a return of 9.2 percent, what is the future value of this cash flow stream at the end of five years?

$4,429,046

If inflation is anticipated to be 6% during the next year, while the real rate of interest for a one-year loan is 5%, then what should the nominal rate of interest be for a risk-free one-year loan?

11% Nominal rate of interest = Anticipated interest + real rate of interest

Equipment with a cost of $225,000 has an estimated salvage value of $15,000 and an estimated life of 4 years or 10,000 hours. It is to be depreciated by the straight-line method. What is the amount of depreciation for the first full year, during which the equipment was used 2,700 hours?

($225,000 - $15,000) ÷ 4 = $52,500

Your brother has asked you for a loan and has promised to pay you $5,500 at the end of three years. If you normally invest to earn 7.00 percent per year, how much will you be willing to lend to your brother if you view this purely as a financial transaction (i.e., you don't give your brother a special deal)?

$4,489.64

Tamera Watson is saving for her daughter's college education. She wants to have $50,000 available when her daughter graduates from high school in four years. If the investment she is considering will pay 8.25 percent compounded monthly, how much will she have to invest today to reach her target?

$35,987 Return expected from investment = i = 8.25% Duration of investment = n = 4 years Frequency of compounding = m = 12 Target investment proceeds in 4 years = FV4 = $50,000 Present value of amount = PV FV=PV(1+i/m)^mn=PV(1+0.0825/12)^(12*4)=50000

Mitchell Corporation bought equipment on January 1, 2014 .The equipment cost $180,000 and had an expected salvage value of $30,000. The life of the equipment was estimated to be 6 years. The depreciation expense using the straight-line method of depreciation is

($180,000 - $30,000) ÷ 6 = $25,000

The Glass Ceiling paid an annual dividend of $2.20 per share last year. Management just announced that future dividends will increase by 2.8 percent annually. What is the amount of the expected dividend in year 5?

$2.53 (D5 = $2.20 × (1.028)5 = $2.53)

$2.752

You are interested in investing $15,000, a gift from your grandparents, for the next four years in a mutual fund that will earn an annual return of 8 percent. What will your investment be worth at the end of four years?

$20,407 Work: Future Value = Present Value x (1+Interest Rate) ^ (Number of years/payment frequency per year) FV = (-15,000 x [1+8%]^[4/1])PV is negative because you are giving up money. FV = $20,407

Calculate the value of preferred stock:

= Annual dividend / required rate of return

Frazier Inc. paid a dividend of $4 last year (D0). The firm is expecting dividends to grow at 21% in years 1-2 and 10% in Year 3. After that growth will be constant at 8% per year. Similar investments return 14%. Calculate the value of the stock today.

D1 = 4(1.21) = 4.84 D2 = 4.84(1.21) = 5.86 D3 = 5.86(1.10) = 6.45 P3 = (6.45(1.08))/(.14-.08) = 116.10 6.45 + 116.10 = 122.55 Calculator Steps: CFo=0, C01=4.84, C02=5.86, C03=122.55; NPV: I = 14 NPV = $91.47

If ABC corporation paid a dividend of $6 per share last year. The stock currently sells for $80 per share. You estimate that the dividend will grow steadily at a rate of 6% per year into the indefinite future. What is the cost of equity?

D1 = D0 × (1 + g) = $6 × 1.06 = $6.36 RE = D1/P0 + g = $6.36/80 + .06 = 13.95%

Cantaloupe Growers Corp. is expanding into a new geographic area. Management expects the new market to fuel growth of 22% for three years. After that normal growth of 6% will resume. Cantaloupe's most recent annual dividend was $1.25. Other fruit companies have been returning about 12% lately. How much should a share of Cantaloupe be worth?

D1=1.25(1.22)=1.53 D2=1.86 D3=2.27 D4=2.27(1.06)=2.41 P3=2.41/(.12-.06) = 40.17 P0=1.53(.8929)+1.86(.7972)+2.27(.7118)+40.17(.7118)= $33.06

Long Life Insurance Inc just paid a dividend of $1.50, and projects supernormal growth at of 12% for the next three years. After that growth is expected to slow down to a normal 4% and go on at that rate for the foreseeable future. Similar stocks are earning a return of 10%. How much would you pay for a share of Long Live today?

D1=1.50(1.12)=1.68 D2=1.88 D3=2.11 D4=2.11(1.04)=2.19 P3=2.19/(.10-.04) = 36.50 P0=1.68(.9091)+1.88(.8264)+2.11(.7513)+36.50(.7513)= $32.08

Delta Company has some very exciting prospects in the near future. As a result it is expected to grow at a rate of 20% for the next year. After that it will grow at 7% indefinitely. The interest rate is currently 14% and Delta paid a dividend of $2.60 recently. What should Delta sell for today?

D1=2.60(1.20)=3.12 D2=3.12(1.07)=3.34 P1=3.34/(.14-.07) = 47.71 P0=3.12(.8772)+47.71(.8772) = $44.59

Sudberry Systems Corp. is launching a new product that analysts expect will propel its growth to 18% for about a year. After that everyone expects the firm to return to a more normal 5% growth rate indefinitely. Sudberry recently paid an annual dividend of $3.50. Similar stocks are currently returning 9%. What is the most an investor should be willing to pay for a share of Sudberry?

D1=3.50(1.18)=4.13; D2=4.13(1.05)=4.34 P1=4.34/(.09-.05) = 108.50 P0=4.13(.9174)+108.50(.9174) = $103.33

Rapid City Motors Co. expects to grow at 20% for two years. After that it expects 8% growth indefinitely. The firm recently declared a $4.00 annual dividend. Similar stocks return about 12%. How much should a share of Rapid City be worth today?

D1=4.00(1.20)=4.80 D2=5.76 D3=5.76(1.08)=6.22 P3=6.22/(.12-.08) = 155.50 P0=4.80(.8929)+5.76(.7972)+155.50(.7972) = $132.84

Genestek Inc. just paid a $5.00 dividend. Due to a new product about to be released, analysts expect the company to grow at a supernormal rate of 15% for three years. After that it is expected to grow at a normal rate of 4% indefinitely. Stocks similar to Genestek are currently earning shareholders a return of 12%. The estimated selling price of the stock is:

D1=5.00(1.15)=5.75 D2=6.61 D3=7.60 D4=7.60(1.04)=7.90 P3=7.90/(.12-.04) = 98.75 P0=5.75(.8929)+6.61(.7972)+7.60(.7118)+98.75(.7118)= $86.10

The price of a stock at year 4 can be expressed as:

D4/(R-g)

Types of Bonds

Debentures Mortgage Bonds Zero and Very Low Coupon Bonds Junk Bonds (High-Yield Bonds) Convertible bonds

What are default risk premiums, and what do they measure?

Default risk premiums are the amount of return that investors must be paid to purchase a security that possesses default risk compared to a similar risk-free investment. Default risk premiums, at any point in time, represent compensation for the expected financial injury for owning a bond plus some additional premium for bearing risk.

Describe the three most prominent bond rating systems.

Default risk premiums tend to increase during periods of economic decline and to narrow during periods of economic expansion. This phenomenon is due to changes in investors' willingness to own bonds with different credit ratings over the business cycle, the so-called flight to quality argument. Specifically, during periods of expansion when few defaults take place, investors are willing to invest in bonds with low credit quality (these bonds typically pay higher interest rates) to gain higher yields. In contrast, during tough economic times when many businesses fail, investors are concerned with safety. Accordingly, they adjust their portfolios to include more high-quality credits and sell off bonds with low credit ratings. The three most prominent credit rating agencies are Moody's Investors Service (Moody's), Standard & Poor's (S&P) and Fitch. Exhibit 8.4 describes the corporate bond rating systems used by the three rating agencies.

First cash flow is expected to occur more than one period after the date of the agreement

Deferred annuity

Why is stock valuation more difficult than bond valuation?

Despite the availability of mathematical models to value stocks, it is more difficult to apply valuation techniques to stocks than to bonds. First, unlike bonds, firms are not in default if dividends are not declared. This makes it difficult to determine the size and timing of the cash flows. Second, common stock, unlike bonds, does not have a fixed maturity, and hence, it is difficult to determine a terminal value unlike bonds, which have a maturity value. Next, it is easier to calculate the present value of a bond because the required rate of return is observable. In the case of stocks, it is rather difficult to estimate a required rate of return for many stocks and classify them into different risk groups.

Long-term financing should be used to do which of the following?

Develop new products

If an investor buys enough different assets it is generally possible to eliminate all:

Diversifiable risk

Why is there a limit to the benefits of diversification?

Diversification cannot eliminate market risk

What is the name given to the model that computes the present value of a stock by dividing next year's annual dividend amount by the difference between the discount rate and the rate of change in the annual dividend amount?

Dividend growth model

is (are) the earnings of a corporation that are distributed to the stockholders

Dividends

What is double taxation?

Double taxation occurs when earnings are taxed twice. The owners of a C-corporation are subject to double taxation—first at the corporate level when the firm's earnings are taxed and then again at a personal level when they receive dividends.

The expected return on KarolCo. stock is 16.5 percent. If the risk-free rate is 5 percent and the beta of KarolCo is 2.3, then what is the risk premium on the market?

E(RKarole) = 0.165 = Rrf + βKarole(E(RM) - Rrf) = 0.05 + 2.3(Risk Premium) Risk Premium 0.05 + 2.3 (Risk premium) = 0.165. Therefore Risk Premium = 0.05 = 5%

The expected return on Mike's Seafood stock is 17.9 percent. If the expected return on the market is 13 percent and the beta for Kiwi is 1.7, then what is the risk-free rate?

E(RMike) = 0.179 = Rrf + βMike(E(RM) - Rrf) =Rrf + 1.7(0.13 - Rrf ) = Rrf = 0.006 = 6%

Explain why total financial assets in the economy must equal total financial liabilities.

Every financial asset must be financed with some type of a claim or liability. Since all of an economy's financial assets are just a collection of the individual financial assets, then they should also sum to the collective claims on those assets in the economy.

Assume the expected return on the market is 8 percent and the risk-free rate is 4 percent. What is the expected return for a stock with a beta equal to 1.50? What is the market risk premium?

Expected return = 0.10 Market risk premium = 0.04

In February 2014 the risk-free rate was 4.09 percent, the market risk premium was 7 percent, and the beta for Twitter stock was 1.18. What is the expected return that was consistent with the systematic risk associated with the returns on Twitter stock?

Expected return = 12.35%

Damien knows that the beta of his portfolio is equal to 1, but he does not know the risk-free rate of return or the market risk premium. He also knows that the expected return on the market is 8 percent. What is the expected return on Damien's portfolio?

Expected return = 8%

Expected cash flow approach

Expected value of cash flows * Present value factor (found through i and n) = Present Value

Which of the following describes the function of an expense stop in a lease?

Expenses above the stop are paid by the tenant.

What are some of the major external and internal factors that affect a firm's stock price? What is the difference between the two general types of factors?

External factors that affect the firm's stock price are: (1) economic shocks, such as natural disasters or wars, (2) the state of the economy, such as the level of interest rates, and (3) the business environment, such as taxes or regulations. On one hand, external factors are variables over which the management has no control. On the other hand, internal factors that affect the stock price can be controlled by management to some degree, because they are firm specific, such as financial management decisions, product quality and cost, and the line of business, the management has selected to enter. Finally, perhaps the most important internal variable that determines the stock price is the expected cash flow stream: its magnitude, timing, and riskiness.

Blue Sky Company's 12/31/12 balance sheet reports assets of $7,500,000 and liabilities of $3,000,000. All of Blue Sky's assets' book values approximate their fair value, except for land, which has a fair value that is $450,000 greater than its book value. On 12/31/12, Horace Wimp Corporation paid $7,650,000 to acquire Blue Sky. What amount of goodwill should Horace Wimp record as a result of this purchase?

FV of assets= ($7,500,000 + $450,000) = $7,950,000 FV of liabilities= $3,000,000 FV of the Net assets= $4,950,000 Goodwill= Price paid - FV of the Net assets = $7,650,000 - $4,950,000 = $2,700,000.

To save for her newborn son's college education, Lea Wilson will invest $1,000 at the beginning of each year for the next 18 years. The interest rate is 12 percent. What is the future value?

FVA = A xFVIFA (App. C: 12%, 18 + 1 = 19 periods)= $1,000 x (63.440 - 1) = $62,440

Analysts are constantly looking for positively correlated stocks so as to enhance their portfolio's diversification.

False

As interest rates fall, the prices of bonds decline.

False

BioGeological Pharmaceuticals invested $100 million on a heart drug that does not prevent heart disease. BioGeological has since found that the drug does prevent diabetes. When considering whether to market the drug as a diabetic panacea, the firm should consider the $100 million spent while investigating the heart-related effects.

False

Bonds with a call provision pay lower yields than comparable noncallable bonds.

False

Compound interest consists only of interest-on-interest.

False

Debt capital is borrowed money that does not have to be repaid

False

Deciding whether or not to spend $5 million to purchase a new piece of equipment is an example of a working capital decision faced by a financial manager.

False

Higher coupon bonds have greater interest rate risk.

False

If Bank A pays interest on a monthly basis and Bank B pays the same interest on a quarterly basis, then investing $1,000 in Bank B will lead to a higher future value than investing the same amount in Bank A.

False

If a firm expects to increase its investment in inventory due to a prospective project, then this is an example of an incremental capital expenditure.

False

If interest rates increase then bond prices will also increase

False

Short-term financing is used to finance a merger or expansion

False

Since our perspective when evaluating a project is that of all of the investors in the firm, creditors as well as stockholders, then we should evaluate the pretax cash flows produced by a project.

False

Since our perspective when evaluating a project is that of all the shareholders only, then we should evaluate the after-tax cash flows produced by a project.

False

The expected cash flows for a project are fixed amounts that have zero variability in the projected values.

False

The future value of $1 grows in a linear fashion over time given a positive rate of interest.

False

The purchase of a factory building for a prospective project is an example of an incremental addition to working capital.

False

The research and development costs to date of a project should be considered when analyzing the cash flows of a prospective project

False

The yield to maturity of a bond never changes.

False

When using the gross income multiplier technique in conjunction withe the income approach to valuation, potential gross income is preferred to effective gross income.

False

The coupon rate on the firm's outstanding debt can be used as a substitute for the cost of debt.

False The coupon rate on the firm's outstanding debt is NOT a substitute. That rate just tells us roughly what the firm's cost of debt was back when the bonds were issued, not what the cost of debt is today.

If the interest rate per year and the number of years involved remain the same, the total amount of interest earned on an investment will remain the same irrespective of the frequency of compounding

False. The total amount of interest earned on an investment depends on the frequency of compounding, as well as interest rate per year and the number of years involved.

A ______ estate represents the most complete form of ownership of real estate; the owner is free to divide it up into lesser estates and sell, lease, or borrow against them as he or she wishes.

Fee Simple

Economic Value

Finance theory suggests that the current value of any bond is based upon the PV of the principal and the PV of bond's interest payment; also called fair value

You are in desperate need of cash and turn to your uncle, who has offered to lend you some money. You decide to borrow $1,560 and agree to pay back $1,790 in two years. a. What annual interest rate is your uncle charging you? (Round to 2 decimals) b. Alternatively, you could borrow from your bank that is charging 6.50 percent interest annually. Should you borrow from your uncle or the bank?

Financial Calculator- a) I/Y Uncle charging you N = 2 PV = -$1,560 PMT = $0 FV = $1,790 CPT for I/Y 7.12% b) Who should you borrow from? Compare bank rate to uncle's rate 6.5% < 7.12% Borrow from the bank

Lisa plans to invest some money so that she has $3,500 at the end of three years. Determine how much should she invest today given the following choices: (Do not round intermediate calculations and round your final answer to the nearest penny.) a. 4.2 percent compounded daily. b. 4.9 percent compounded monthly. c. 5.2 percent compounded quarterly. d. 5.4 percent compounded annually.

Financial Calculator: a. Daily N = 3 x 365 N = 1,095 FV = $3,500 I/Y = 4.2 / 365 I/Y = 0.011506849 PMT = $0 CPT for PV -$3,085.67 (Calculator says negative since it's money you are giving up) b. Monthly N = 3 x 12 N = 36 FV = $3,500 I/Y = 4.9 / 12 I/Y = 0.408333 PMT = $0 CPT for PV -$3,022.43 (Calculator says negative since it's money you are giving up) c. Quarterly N = 3 x 4 N = 12 FV = $3,500 I/Y = 5.2 / 4 I/Y = 1.3 PMT = $0 CPT for PV -$2,997.47 (Calculator says negative since it's money you are giving up) d. Annually N = 3 FV = $3,500 I/Y = 5.4 PMT = $0 CPT for PV -$2,989.14 (Calculator says negative since it's money you are giving up)

You have $12,000 in cash. You can deposit it today in a mutual fund earning 9.2 percent semiannually, or you can wait, enjoy some of it, and invest $11,000 in your brother's business in two years. Your brother is promising you a return of at least 11.6 percent on your investment. Whichever alternative you choose, you will need to cash in at the end of 10 years. Assume your brother is trustworthy and both investments carry the same risk. (Round all answers 2 decimal places). a. What would be the future value of the mutual fund investment? b. What would be the future value of investing in your brother's business? c. Which one would yield the largest amount in 10 years?Your brother's business or The mutual fund?

Financial Calculator: a. FV of Investing in Mutual Fund N = 10 x 2 N = 20 I/Y = 9.2 / 2 I/Y = 4.6 PV = -$12,000 PMT = $0 CPT for FV$29,499.52 b. FV of Investing in Brother N = 10 - 2 N = 8 I/Y = 11.6 PV = -$11,000 PMT = $0 CPT for FV $26,467.09 c. Compare FV from mutual fund and brother $29,499.52 > $26,467.09 The mutual fund.

How do financial institutions act as intermediaries to provide services to small businesses?

Financial intermediaries allow smaller companies to access the financial markets. They do this by converting securities with one set of characteristics into securities with another set of characteristics that meets the needs of smaller companies. By repackaging securities, they are able to meet the needs of different clients.

What is financial intermediation, and why is it important?

Financial intermediation is the process of converting financial securities with one set of characteristics into securities with another set of characteristics. For example, commercial banks use consumer CD deposits to make loans to small businesses.

What three major decisions are of most concern to financial managers?

Financial managers are most concerned with the capital budgeting decisions, the financing decisions, and the working capital management decisions.

What is the appropriate decision criterion for financial managers to use when selecting a capital project?

Financial managers should select a capital project only if the value of the project's expected future cash flows exceeds the cost of the project. In other words, managers should only make investments that will increase firm value, and thus increase the stockholders' wealth.

Finding the future value of an ordinary annuity?

You are planning to take a spring break trip to Cancun your senior year. The trip is exactly two years away, but you want to be prepared and have enough money when the time comes. Explain how you would determine the amount of money you will have to save in order to pay for the trip.

First, determine how much money you will need for the trip. Second, check how much you already have and how it translates into future value cash—how much it will be worth in two years. Next, determine how much you will have to deposit today, given the bank's offered interest rate, to ensure that you will have saved up the difference when the time for your senior spring break comes.

Identify the steps involved in computing the future value when you have multiple cash flows.

First, prepare a time line to identify the size and timing of the cash flows. Second, calculate the present value of each individual cash flow using an appropriate discount rate. Finally, add up the present values of the individual cash flows to obtain the present value of a cash flow stream. This approach is especially useful in the real world where the cash flows for each period are not the same.

Give an example of a conflict of interest in a business setting, other than the one involving the real estate agent discussed in the chapter text.

For example, imagine a situation in which you are a financial officer at a growing software company and your firm has decided to hire outside consultants to formulate a global expansion strategy. Coincidentally, your wife works for one of the major consulting firms that your company is considering hiring. In this scenario, you have a conflict of interest, because instinctively, you might be inclined to give the business to your wife's firm, because it will benefit your family's financial situation if she lands the contract, regardless of whether or not it makes the best sense for your firm.

Which on of the following statements is correct?

From a legal perspective, preferred stock is a form of corporate equity

List the two ways in which a transfer of funds takes place in an economy. What is the main difference between these two?

Funds can flow directly through financial markets or indirectly through intermediation markets where funds flow through financial institutions first.

Compound Interest Formula

Future Value=(Present Value)(1+interest rate)^(number of time periods) FV=PV(1+i)^n

Explain the difference between future value and present value.

Future value measures what one or more cash flows will be worth at the end of a specified period, while present value measures what one or more future cash flows are worth today (at time = 0).

Which type of deed offers the grantee the MOST protection?

General warranty deed

Which of the following is/are advantages of the corporate form of organization? a. Reduced start-up costs b. Greater access to capital markets c. Unlimited liability d. Single taxation

Greater access to capital markets b. (Shares in a corporation can be sold to raise capital from investors who are not involved in the business. This greatly increases the amount of capital that can be raised to fund the business.)

Compound growth is exponential over time. Explain.

Growth rates, as well as interest rates, are not linear, but rather exponential over time. In other words, the growth rate of the invested funds is accelerated by the compounding of interest. Over time, the principal amount gets larger as interest is added due to the compounding effect.

What are growth stocks, and why do they typically pay little or no dividends?

Growth stocks are defined as equity in any company whose earnings are growing faster than the average firm and the higher growth rate is expected to continue for some time. Instead of paying dividends, these firms reinvest the earnings back into the firm to pursue other high-return investment opportunities.

Stillwater Drinks is trying to determine when to harvest the water from the fountain of youth that it currently owns. If it harvests the water in year 1, the NPV of the project would increase over an immediate harvest by 18 percent. A year 2 harvest would create an NPV increase of 12 percent over that of year 1 and year 3 would create an NPV increase of 8 percent over that of year 2. If the cost of capital is 17 percent for Stillwater, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

Harvest in year 1.

Windy Burgers is trying to determine when to harvest a herd of cows that it currently owns. If it harvests the herd in year 1, the NPV of the project would increase over an immediate harvest by 25 percent. A year 2 harvest would create an NPV increase of 15 percent over that of year 1 and year 3 would create an NPV increase of 7 percent over that of year 2. If the cost of capital is 12 percent for Windy, then which harvest year would maximize the NPV for the firm? Assume that all NPVs are calculated from the perspective of today.

Harvest in year 2.

If a company's weighted average cost of capital is less than the required return on equity, then the firm:

Has debt in its capital structure

Holding all else constant, what will happen to the present value of a future amount if you increase the discount rate? What if you increase the number of years?

Holding all else constant, both increasing the discount rate and increasing the number of years, will decrease the present value.

Sunland, Inc., a resort management company, is refurbishing one of its hotels at a cost of $6,231,527. Management expects that this will lead to additional cash flows of $1,435,000 for the next six years. What is the IRR of this project? If the appropriate cost of capital is 12 percent, should Sunland go ahead with this project? What is the IRR? Should the firm accept the project?

IRR = 10.10% Should the firm accept the project? = The firm should reject the project.

Choose the answer below that does NOT describe the circumstances where IRR conflicts with NPV in the decision to accept a project.

IRR assumes that all cash flows received during the life of a project are reinvested at the IRR while the NPV method assumes that they are reinvested at the cost of capital rate.

Management of Joseph Moore, a confectioner, is considering purchasing a new jelly bean-making machine at a cost of $225,566. They project that the cash flows from this investment will be $103,640 for the next seven years. If the appropriate discount rate is 14 percent, what is the IRR that Joseph Moore management can expect on this project?

IRR is 42%

Which of the following statements is CORRECT

If a bond's yield to maturity exceeds its coupon rate, the bond will sell at a discount below par.

Which one of the following statements is NOT true?

If market prices reflect all relevant information about securities at a particular point in time, the market is operationally efficient.

Second Relationship

If the bondholder's required rate of return (current interest rate) equals the coupon interest rate, the bond will sell at par, or maturity value. AND If the current interest rate exceeds the bond's coupon rate, the bond will sell below par value or at a "discount." AND If the current interest rate is less than the bond's coupon rate, the bond will sell above par value or at a "premium."

What does a competitive financial system imply about interest rates?

If the financial system is competitive, one will receive the highest possible rate for money invested with a bank and the lowest possible interest rate when borrowing money. Also, only firms with good credit ratings and projects with high rates of return will be financed.

What can happen if a firm is poorly managed and its stock price falls substantially below its maximum potential price?

If the stock price falls below its maximum potential price, it attracts corporate raiders, who look for fundamentally sound but poorly managed companies they can buy, turn around, and sell for a handsome profit.

Which of the following statements is true about secondary markets?

In secondary markets, outstanding shares of stock are bought and sold among investors.

QN=192 (20433)53 Which one of the following statements is NOT true about secondary markets?

In terms of total volume of activity and total capitalization of the firms listed, the NASDAQ is the largest in the world and the NYSE is the second largest.

Claim on assets

In the case of insolvency, claims of debt, including bonds are honored before those of preferred or common stock.

Why are common stockholders considered to be more at risk than the holders of other types of securities?

In the hierarchy of lenders of funds to a firm, common stockholders have the most to lose. In the event of a firm becoming bankrupt, the law requires that creditors of different types, including bondholders, be paid off first. Next, preferred stockholders are paid off. Finally, common stockholders receive their investment if any funds are still available. Thus, common stockholders receive their money back last and are placed at most risk. This feature of common equity is referred to as residual claim.

Why might a firm prefer to have a security issue underwritten by an investment banking firm?

In the most common type of underwriting arrangement, called firm-commitment underwriting, the investment banker assumes the risk of buying the new securities from the issuing company and reselling them to investors. The investment banker guarantees to buy the entire security issue from the company at a fixed price.

If a firm has the option of leasing some factory space to another firm or utilizing it for another product line, then if the firm chose the product line how should it handle the lost lease payments on the factory space?

Include it as an opportunity cost.

What is compounding interest?

Includes interest not only on the initial investment, but also the accumulated interest in previous periods

When discount rate

Increases, the PV of a future cash flow decreases

The present value of an ordinary annuity

Indicates how much money needs to be invested today

Equation for simple interest

Interest = P(Face amount) x i(interest rate) x n(years)

Explain why interest rates follow the business cycle.

Interest rates tend to follow the business cycle to rise during economic expansion and decline during recession. On the one hand, during an expansion, there is upward pressure on interest rates as businesses begin to grow and borrow more money. On the other hand, during a recession, the demand for goods and services is lower, businesses borrow less, and as a result the economy slows down and the interest rates decline. Typically, the Fed also loosens credit to stimulate the economy, which puts further downward pressure on the interest rates.

Jackie Rich would like to buy a $26,995 Toyota hybrid car in 4 years. Jackie wants to put the money aside now. Jackie's bank offers 8% interest compounded semiannually. How much must Jackie invest today?

Investment $19,725.25

Lance Jackson deposited $5,000 at Basil Bank at 9% interest compounded daily. What is Lance's investment at the end of 4 years?

Investment $7166.50

What is an IPO, and what role does an investment banker play in the process?

Investment bankers specialize in helping firms to sell their new debt or equity issues in financial markets. In an initial public offering (IPO), the investment banker prepares the new issue for sale and then underwrites the deal. Other functions of the investment banker in an IPO process include preparing the prospectus, registering the documentation with the SEC, and providing general financial advice to the issuer.

Investor A holds a 10-year bond paying 8 percent a year, while investor B also has a 10-year bond that pays a 6 percent coupon. Which investor has the higher interest rate risk? Explain.

Investor B will have the higher interest rate risk since lower coupon bonds have a higher interest rate risk than higher coupon bonds of the same maturity.

How does information about a firm's prospects get reflected in its share price?

Investors act upon the expectations of a firm's prospects through trading of the securities. The buying and selling then causes the price of the security to reflect their assessment of its value.

Facebook does not pay dividends. How can it have a positive stock price?

Investors expect that Facebook will eventually start paying dividends and the value of its shares reflects the present value of these expected dividends. The fact that a company is not currently paying dividends does not mean that its stock is worthless. It is not uncommon for high growth firms not to pay dividends, since they often have to reinvest all of their earnings to maintain their high growth rate. However, if they are successful, as their growth rate slows over time they will begin to pay dividends.

Which of the following statements is NOT true?

Investors must pay a premium to purchase a security that exposes them to default risk.

Which one of the following statements is NOT true?

Investors must pay a premium to purchase a security that exposes them to default risk.

Which of the following is true of the rule of 72

It can be used to determine the amount of time it takes to double an investment

Which of the following statements is true about the general dividend valuation model?

It implies that the underlying value of a share of stock is determined by the market's expectations of the future dividends that the firm will generate.

Which one of the following statements is NOT true?

It is the interest rate at which the present value of the actual cash flows generated by the investment equals the bond's price at the time of sale of the bond.

Under what conditions does it make sense to use the constant-growth dividend model to value a stock?

It only makes sense to use the constant-growth dividend model to value the stock of a company that is already paying a dividend and when that dividend can reasonably be expected to grow at a constant rate foreverin other words, the stock of a mature company. As discussed in the chapter, the growth rate of such a company will be less than the sum of the long term rate of inflation and the real growth rate of the economy. It must also be less than the required rate of return on the stock.

Explain how to calculate the future value of a stream of cash flows.

It would helpful to first construct a time line so that we can identify the timing of each cash flow. Then you would calculate the future value of each individual cash flow. Finally, you would add up the future values of all the individual cash flows to determine the future value of the cash flow stream.

Why do some people view preferred stock as a special type of a bond rather than a stock?

Just like debt, preferred stock is often callable and may be convertible into common stock. Also, like debt, it has "credit" ratings that are similar to those issued to bonds. But most important, preferred stock has no voting rights and just like bonds pays fixed dividends. For these reasons, many analysts treat preferred stock as a special kind of debt rather than as an equity.

How do large corporations adjust their liquidity in the money markets?

Large corporations can take advantage of money markets to adjust for their liquidity by selling or buying short-term financial instruments such as commercial paper, CDs, or Treasury bills. Large corporations with cash surplus can invest in short-term securities, while corporations with cash shortfalls can sell securities or borrow funds on a short-term basis. Money market instruments have a maturity anywhere between one day and one year and therefore are very liquid and less risky than long-term debt.

Why can the market price of a stock differ from its true (intrinsic) value?

Let us start by first defining the market price of a stock as the price that equates the demand for a stock with the supply of the stock. The role of the stock market is to bring buyers and sellers together in the most efficient way such that stocks are bought and sold at the market price. In reality, however, barriers of various kinds including the geographic separation of the two parties, strong demand that leads to overvaluation and vice versa, make the market price of a security slightly different than its true (intrinsic) value. The more efficient the market place, the smaller the deviation between the two.

Limited Liability

Liability of the shareholder is limited to the amount of their investment. Limited liability feature aids the firm in raising funds.

Explain what is meant by stockholders' limited liability.

Limited liability for a stockholder means that the stockholder's legal liability extends only to the capital contributed or the amount invested.

Which of the following is a characteristic of common stock?

Limited liability for owners

Convertibility

May allow the investor to exchange the bond for a predetermined number of the firm's shares of common stock. More desirable than other bonds

The total cost of interest is equal to the total of all monthly payments

Minus amount of mortgage

What is the primary role of money markets? Explain how the money markets work.

Money markets provide an option for large corporations to adjust their liquidity positions. Since only seldom are cash receipts and cash expenditures perfectly synchronized, money markets allow companies to temporarily invest idle cash in Treasury bills or negotiable CDs. If a company is short on cash, it can borrow the money from money markets by selling commercial paper at lower interest rates than through commercial banks.

What is the compounding period for most bonds sold in the United States?

Most bonds sold in the United States pay interest semiannually, whereas European bonds typically only pay interest once a year.

What is the form of business organization taken by most large companies and why?

Most large companies prefer to operate as public corporations because large amounts of capital can be raised in public markets at a relatively low cost.

Suppose that a group of accountants wants to start an accounting business. What organizational form would they most likely choose, and why?

Most lawyers, accountants, and doctors form what are known as limited liability partnerships. This formation combines the tax advantages of partnerships with the limited liability of corporations.

Stock Market Index: What does NASDAQ stand for? What is NASDAQ?

NASDAQ stands for National Association of Securities Dealers Automated Quotation system. NASDAQ is one of the largest electronic stock markets in the world, listing over three thousand companies. It is an OTC market and does not have any physical location. Companies listed on NASDAQ had market capitalization of $10.2 trillion as of February 2017.

It is easy for individuals to trade in the corporate bond market because

NOT the corporate bond market is considered to be very transparent. NOR prices in the corporate bond market tend to be more stable. NOR centralized reporting of deals between buyers and sellers take place.

Corporate overhead allocations should only be taken into account on project analysis if

NOT the firm is currently covering all of its overhead allocations. NOR the firm is currently unable to cover all of its overhead allocations. NOR the overhead allocations involve cash expenditures.

Management of Blossom Mints, a confectioner, is considering purchasing a new jelly bean-making machine at a cost of $312,500. They project that the cash flows from this investment will be $86,000 for the next seven years. If the appropriate discount rate is 14 percent, what is the NPV for the project?

NPV $56,294

Sunland Company is considering buying a new farm that it plans to operate for 10 years. The farm will require an initial investment of $12.00 million. This investment will consist of $2.55 million for land and $9.45 million for trucks and other equipment. The land, all trucks, and all other equipment are expected to be sold at the end of 10 years for a price of $5.00 million, which is $2.35 million above book value. The farm is expected to produce revenue of $2.05 million each year, and annual cash flow from operations equals $1.95 million. The marginal tax rate is 35 percent, and the appropriate discount rate is 10 percent. Calculate the NPV of this investment.

NPV = $1,592,512.95 The project should be = accepted

Crane Lumber, Inc., is considering purchasing a new wood saw that costs $70,000. The saw will generate revenues of $100,000 per year for five years. The cost of materials and labor needed to generate these revenues will total $60,000 per year, and other cash expenses will be $10,000 per year. The machine is expected to sell for $3,200 at the end of its five-year life and will be depreciated on a straight-line basis over five years to zero. Crane's tax rate is 34 percent, and its opportunity cost of capital is 11.50 percent. What is the project's NPV? Should the company purchase the saw?

NPV = $20,867 The company ????? the machine = should buy

Sheridan Industries management is planning to replace some existing machinery in its plant. The cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses an 18 percent discount rate for projects like this. Should management go ahead with the project? What is the NPV? SEE IMAGE

NPV = $82,380 Should management go ahead with the project? = The firm should accept the project.

Blossom Corp. management is investigating two computer systems. The Alpha 8300 costs $3,006,625 and will generate cost savings of $1,548,725 in each of the next five years. The Beta 2100 system costs $4,627,500 and will produce cost savings of $1,177,750 in the first three years and then $2 million for the next two years. The company's discount rate for similar projects is 14 percent. What is the NPV of each system? Which one should be chosen based on the NPV?

NPV of Alpha system $2,310,273 NPV of Beta system $329,700 Chose Alpha 8300

Cullumber Industries is expanding its product line and its production capacity. The costs and expected cash flows of the two independent projects are given in the following table. The firm uses a discount rate of 15.62 percent for such projects. Year Product Line Expansion Production Capacity Expansion 0 -$2,867,100 -$6,652,400 1 623,100 3,077,800 2 1,024,000 3,077,800 3 1,024,000 3,077,800 4 1,024,000 2,527,900 5 1,024,000 2,527,900 a. What are the NPVs of the two projects? b. Should both projects be accepted? or either? or neither? Explain your reasoning.

NPV of product line expansion is $168,975 NPV of production capacity expansion is $2,941,341 Cullumber should accept both projects.

Sunland Mills management is evaluating two alternative heating systems. Costs and projected energy savings are given in the following table. The firm uses 11.50 percent to discount such project cash flows. Year System 100 System 200 0. -$2,334,100. -$1,847,200 1 279,710 869,100 2 398,330 474,200 3 616,340. 650,500 4 912,600 428,200 What is the NPV of the systems? Which system should be chosen?

NPV of system 100 is -$727,764 NPV of system 200 is $60,002 Sunland should choose System 200

Given the following cash flows for a capital project, calculate the NPV and IRR. The required rate of return is 8 percent. Year012345Cash Flows$-42411$12250$14850$23800$8700$6150 NPV=5784. IRR=18.3% NPV=11137. IRR=18.3% NPV=5784. IRR=9.2% NPV=11137. IRR=9.2%

NPV=11137. IRR=18.3%

A DMM is a(n):

NYSE member who functions as a dealer for a limited number of securities.

Jennifer Davis needs to decide whether to accept a bonus of $1,730 today or wait two years and receive $1,990 then. She can invest at 6 percent. What should she do? a) Yes b) No ... she should not accept the bonus today.

No Work: Financial Calculator- N = 2 PV = $1,730 I/Y = 6 PMT = $0 CPT for FV $1,943.83 < $1,990

Because the conversion feature in a convertible bond is valuable to bondholders, convertible bond issues have lower coupon payments than otherwise similar bonds that are not convertible. Does this mean that a company can lower its cost of borrowing by selling convertible debt? Explain.

No. The interest (coupon) payments can be reduced by the company but the company cannot reduce the overall cost of borrowing by selling convertible debt. The reduction in the value of the interest payments is offset by the value of the conversion feature. If the company's stock price goes above the price implied by the conversion ratio, the existing stockholders must share some of their gains with the bondholders. Investors are going to look for a required rate of return that compensates them for the risk that they are bearing. The only difference with a convertible bond is that some of that compensation comes in the form of the ability to benefit from appreciation in the company's stock price.

Which of the following accounts is EXCLUDED when calculating net operating working capital?

Notes payable to banks

What are some ways to resolve a conflict of interest?

One way to resolve a conflict of interest is by complete disclosure. As long as both parties are aware of the fact that, for example, both parties in a contract negotiation are represented by the same firm, disclosure is sufficient. Another way to avoid a conflict of interest is for the company to remove itself from serving the interest of one of the parties. This is, for example, the case with accounting firms not being allowed to serve as consultants to companies for whom they perform audits.

How do an ordinary annuity, an annuity due, and a perpetuity differ?

Ordinary annuity assumes that the cash flows occur at the end of a period. Most types of loans are ordinary annuities. On the other hand, annuity due is an annuity whose payment is to be made immediately (or at the beginning of a period) instead of at the end of the period. For example, in many leases the first payment is due immediately, and each successive payment must be made at the beginning of the month. Perpetuity is a special case of annuity, and it refers to a constant stream of identical cash flows with no end.

Which of the following statements is true about common stock?

Owners of common stock have the lowest-priority claim on the firm's assets in the event of bankruptcy.

Leslie's Unique Clothing Stores offers a common stock that pays an annual dividend of $3.30 a share. The company has promised to maintain a constant dividend. How much are you willing to pay for one share of this stock if you want to earn a 12.80 percent return on your equity investments?

P = $3.30 / 0.1280 = $25.78

Fast Wheels, Inc. expects to pay an annual dividend of $0.72 next year. Dividends have been growing at a compound annual rate of 6 percent and are expected to continue growing at that rate. What is the value of a share of Fast Wheels if similar stocks return 14 percent?

P0 = $.72 / (.14 - .06) = $9.00

What is the value of a share of Henley Inc. to an investor who requires a 12 percent rate of return if Henley's last dividend was $1.20? Assume earnings and dividends are expected to grow indefinitely at a rate of 7% per year.

P0 = $1.20(1.07)/(.12-.07) = $25.68

Zero-Sum Enterprise pays an annual dividend of $1.40 per share and neither earnings nor dividends are expected to grow in the future. What is the value of Zero-Sum's stock to an investor who requires a 14 percent rate of return?

P0 = $1.40/.14 = $10

The Red Bud Co. pays a constant dividend of $3.10 a share. The company announced today that it will continue to do this for another 2 years after which time they will discontinue paying dividends permanently. What is one share of this stock worth today if the required rate of return is 8.7 percent?

P0 = $3.10 / 1.087 + $3.10 / 1.0872 = $5.48

Assume that the dividend on Central Power Company's $3.25 preferred stock issue is paid annually at the end of the year. Determine the price of this issue if its return is 12%.

P0 = $3.25 / .12 = $27.08

Weisbro and Sons common stock sells for $41 a share and pays an annual dividend that increases by 5.6 percent annually. The market rate of return on this stock is 9.60 percent. What is the amount of the last dividend paid by Weisbro and Sons?

P0 = $41 = [D0 × (1 + 0.056)] / (0.0960 - 0.056); D0 = $1.55

Charlie Company is expected to grow at an annual rate of 6% indefinitely. The return on similar stocks is currently 11%. Charlie's board of directors declared a dividend of $1.85 yesterday. What should a share of Charlie Company sell for?

P0 = D0(1+g)/(k-g) = 1.85(1.06)/(.11-.06) = $39.22

Toys-r-Cool Inc.'s constant growth stock's last dividend was $1.50. It is selling for $30.20 in a market in which similar stocks return 12%. Calculate the stock's anticipated growth rate.Toys-r-Cool Inc.'s constant growth stock's last dividend was $1.50. It is selling for $30.20 in a market in which similar stocks return 12%. Calculate the stock's anticipated growth rate.

P0 = D0(1+g)/k-g30.20 = (1.50(1+g))/(.12-g)g = 6.7%

Michael's, Inc. just paid $2.15 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 4.70 percent. If you require a rate of return of 8.9 percent, how much are you willing to pay today to purchase one share of Michael's stock?

P0 = [$2.15 × (1 + 0.047)] / (0.089 - 0.047) = $53.60

NU YU announced today that it will begin paying annual dividends. The first dividend will be paid next year in the amount of $0.29 a share. The following dividends will be $0.34, $0.49, and $0.79 a share annually for the following three years, respectively. After that, dividends are projected to increase by 2.4 percent per year. How much are you willing to pay today to buy one share of this stock if your desired rate of return is 11 percent?

P4 = ($0.79 × 1.024) / (0.11 - 0.024) = $9.40651 P0 = $0.29 / 1.11 + $0.34 / 1.112 + $0.49 / 1.113 + $0.79/ 1.114 + $9.40651 / 1.114 = $7.61

The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 19 percent a year for the next 4 years and then decreasing the growth rate to 4 percent per year. The company just paid its annual dividend in the amount of $1.90 per share. What is the current value of one share of this stock if the required rate of return is 7.40 percent?

P4 = ($1.90 × 1.194 × 1.04) / (0.074 - 0.04) = $116.54560 P0 = ($1.90 × 1.19) / 1.074 + ($1.90 × 1.192) / 1.0742 + ($1.90 × 1.193) / 1.0743 + ($1.90 × 1.194) / 1.0744 + $116.54560 / 1.0744 = $97.48

You are analyzing two proposed capital investments with the following cash flows: SEE IMAGE The cost of capital for both projects is 10 percent. Calculate the profitability index (PI) for each project. What is the PI for project X? What is the PI for project Y? Which project, or projects, should be accepted if you have unlimited funds to invest? Which project should be accepted if they are mutually exclusive?

PI for project X = 1.1621 PI for project Y = 1.1522 If you have unlimited funds, you should invest in = both projects If they are mutually exclusive, you should invest in which project? = project X

you are considering investing in B&B Inc's stock and your broker has told you that you can purchase it for $72. you require a return 12% for this type of investment. the last dividend (Do) that B&B paid was $4 and a 6% constant growth rate is anticipated. should you purchase B&B inc.?

Po=Do(1+g)/(k-g) Po=4(1.06)/(.06)= $7-.67 $72-$70.67=$1.33 the stock is overpriced

a stock just paid a $2.00 dividend that is anticipated to grow at 6% indefinitely. Similar stocks are returning about 13%. the estimated selling price of this stock is:

Po=Do(1+g)/(k-g)= 2(1.06)/(.13-.06) =$30.29

QN=206 (20445)52 Which ONE of the following statements is NOT true about preferred stock?

Preferred dividends are deductable from taxable income just like the interest on bonds.

Is preferred stock a debt or an equity security?

Preferred stock represents an ownership interest in a corporation and is legally a form of equity. However, it does have characteristics that are similar to those of debt, such as no voting rights, fixed payments (dividends), and credit ratings similar to those issued to bonds.

The International Monetary Fund is trying to raise $500 billion in 5 years for new funds to lend to developing countries. At 6% interest compounded quarterly, how much must it invest today to reach $500 billion in 5 years?

Present Value $371.25 billion

Paul Havlik promised his grandson Jamie that he would give him $6,000 8 years from today for graduating from high school. Assume money is worth 6% interest compounded semiannually. What is the present value of this $6,000?

Present value $3739.20

Present value with multiple cash flows: Biogenesis Inc. management expects the following cash flow stream over the next five years. They discount all cash flows using a 23 percent discount rate. What is the present value of this cash flow stream?

Present value of an ordinary annuity: An investment opportunity requires a payment of $750 for 12 years, starting a year from today. If your required rate of return is 8 percent, what is the value of the investment to you today?

Crane Real Estate Company management is planning to fund a development project by issuing 10-year zero coupon bonds with a face value of $1,000. Assuming semiannual compounding, what will be the price of these bonds if the appropriate discount rate is 13.4 percent?

Price of the bond $273.35

Explain why professional partnerships such as physicians' groups organize as limited liability partnerships.

Professional partnerships such as physicians' groups desire to organize as limited liability partnerships (LLPs) to take advantage of the tax arrangements of partnerships combined with the advantages of the limited liability of a corporation. By operating as an LLP, the partnership is able to avoid a potential financial disaster resulting from the misconduct of one partner.

Why is profit maximization an unsatisfactory goal for managing a firm?

Profit maximization is not a satisfactory goal when managing a firm because it is rather difficult to define profits since accountants can apply and interpret the same accounting principles differently. Also, profit maximization does not define the size, the uncertainty, and the timing of cash flows; it ignores the time value of money concept.

You are chairperson of the investment committee at your firm. Five projects have been submitted to your committee for approval this month. The investment required and the project profitability index for each of these projects are presented in the following table: SEE IMAGE If you have $470,000 available for investments, which of these projects would you approve? Assume that you do not have to worry about having enough resources for future investments when making this decision.

Project A AND Project B AND Project C

Which of the following organizational forms is subject to the Securities and Exchange Commission (SEC) regulations?

Public corporation

What are the major differences between public and private markets?

Public markets are organized financial markets (also referred to as Exchanges) where the public buys and sells securities through their stock brokers. The SEC regulates public securities markets in the United States. In contrast, private markets involve direct transactions between two parties. These transactions lack SEC regulation.

QUIZLET CHAPTER 1 AND 2 HOMEWORK QUIZLET

QUIZLET CHAPTER 11 QUIZLET

QUIZLET CHAPTER 13 QUIZLET

QUIZLET CHAPTER 5 HOMEWORK QUIZLET

QUIZLET CHAPTER 6 HOMEWORK QUIZLET

QUIZLET CHAPTER 8 HOMEWORK QUIZLET

QUIZLET CHAPTER 9 HOMEWORK QUIZLET

QUIZLET EXTRA CREDIT HOMEWORK QUIZLET

For the Dividend Growth Model, the equation can be written as follows: P0 = =D1/(RE - g). How can this equation be rearranged?

RE = D1/P0 + g

Carla Vista, Inc., is expected to grow at a constant rate of 5.00 percent. If the company's next dividend, which will be paid in a year, is $1.59 and its current stock price is $22.35, what is the required rate of return on this stock?

Rate of return. 12.11%

The International Publishing Group is raising $10 million by issuing 15-year bonds with a coupon rate of 7.6 percent. Coupon payments will be made annually. Investors buying the bonds today will earn a yield to maturity of 7.6 percent. The Face Value of each bond is $1,000. At what price will the bonds sell in the marketplace?

Sale value $1000

Sandhill, Inc., has a bond issue maturing in seven years that is paying a coupon rate of 7.5 percent (semiannual payments). Management wants to retire a portion of the issue by buying the securities in the open market. If it can refinance at 6.0 percent, how much will Sandhill

Sandhill will pay $10.84.72

What is the market called that allows shareholders to resell their shares to other investors?

Secondary

You just purchased a share of IBM stock on the New York Stock Exchange. What kind of transaction was this? a. Primary market transaction. b. Secondary market transaction. c. Futures market transaction. d. Private placement.

Secondary market transaction. b. (The secondary market is the one in which owners of outstanding securities sell their securities to other investors.)

Cortez Art Gallery is adding to its existing buildings at a cost of $2 million. The gallery expects to bring in additional cash flows of $520,000, $700,000, and $1,000,000 over the next three years. Given a required rate of return of 10 percent, what is the NPV of this project?

-$197,446

QN=304 (20556)34 Efficiency ratio: Deutsche Bearings has total sales of $9,745,923, inventories of $2,237,435, cash and equivalents of $755,071, and days' sales outstanding of 49 days. If the firm's management wanted its DSO to be 35 days, by how much will the accounts receivable have to change?

-$373,816.23

WACC with Preferred Stock

-A third component is added -Equity is split into common and preferred sections -If market value is hard to determine for preferred stock, use book value WACC = [(E/V RE) + (P/V RP) + (D/V RD (1-TC)] *P/V - weight of preferred stock *RP - return on preferred stock

Danford Trucking purchased a tractor trailer for $126,000. Danford uses the units-of-activity method for depreciating its trucks and expects to drive the truck 1,000,000 miles over its 12-year useful life. Salvage value is estimated to be $18,000. If the truck is driven 80,000 miles in its first year, how much depreciation expense should Danford record?

1. ($126,000 - $18,000) ÷ 1,000,000 = 0.108 2. 0.108 × 80,000 = $8,640

Pearson Company bought a machine on January 1, 2014. The machine cost $144,000 and had an expected salvage value of $24,000. The life of the machine was estimated to be 5 years. The book value of the machine at the beginning of the third year would be

1. ($144,000 - $24,000) ÷ 5 = $24,000 2. $24,000 × 2 = $48,000 3. $144,000 - 48,000 = $96,000

A machine with a cost of $480,000 has an estimated salvage value of $30,000 and an estimated useful life of 5 years or 15,000 hours. It is to be depreciated using the units-of-activity method of depreciation. What is the amount of depreciation for the second full year, during which the machine was used 5,000 hours?

1. ($480,000 - $30,000) ÷ 15,000 = $30 2. $30 × 5,000 = $150,000

Ron's Quik Shop bought equipment for $70,000 on January 1, 2013. Ron estimated the useful life to be 5 years with no salvage value, and the straight-line method of depreciation will be used. On January 1, 2014, Ron decides that the business will use the equipment for a total of 6 years. What is the revised depreciation expense for 2014?

1. ($70,000 - 0) ÷ 5 = $14,000 2. ($70,000 - $14,000) ÷ (6 - 1) = $11,200

On January 1, a machine with a useful life of five years and a residual value of $40,000 was purchased for $120,000. What is the depreciation expense for year 2 under the double-declining-balance method of depreciation?

1. 120,000/5 = 24,000 2. 24,000/120,000 = 0.2 3. 0.2 x 2 = 0.4 4. Year 1: $120,000 × .40 = $48,000 5. Year 2: ($120,000 - $48,000) × .40 = $28,800

Brevard Corporation purchased a taxicab on January 1, 2013 for $25,500 to use for its shuttle business. The cab is expected to have a five-year useful life and no salvage value. During 2014, it retouched the cab's paint at a cost of $1,200, replaced the transmission for $3,000 (which extended its life by an additional 2 years), and tuned-up the motor for $150. If Brevard Corporation uses straight-line depreciation, what annual depreciation will Brevard report for 2014?

1. 25,500/5 = 5,100 2. [($25,500 - $5,100) + $3 000] ÷ (5 - 1 + 2) = $3,900

Foyle Company purchased a new van for floral deliveries on January 1, 2014. The van cost $48,000 with an estimated life of 5 years and $12,000 salvage value at the end of its useful life. The double-declining-balance method of depreciation will be used. What is the depreciation expense for 2014?

1. 48,000/5 = 0.2 2. 0.2 x 2 = 0.4 2. $48,000 × .40 = $19,200

Conley Company purchased equipment for $60,000 on January 1, 2012, and will use the double-declining-balance method of depreciation. It is estimated that the equipment will have a 5-year life and a $3,000 salvage value at the end of its useful life. The amount of depreciation expense recognized in the year 2014 will be

1. 60,000/5 = 12,000 2. 12,000/60,000 = 0.2 3. 0.2 x 2 = 0.4 4. 2012: $60,000× .40 = $24,000 5. 2013: ($60,000 - $24,000) × .40 = $14,400 6. 2014: ($60,000 - $38,400) × .40 = $8,640

Identify three fundamental types of decisions that financial managers make and identify which part of the balance sheet each of these decisions affects.

1. Capital Budgeting Decisions - identifying the productive assets the firm should buy. These decisions affect long-term assets on the balance sheet. 2. Financing Decisions - determining how the firm should finance or pay for assets. These decisions affect long-term debt and stockholders' equity on the balance sheet. 3. Working Capital Management Decisions - determining how day-to-day financial matters should be managed. These decisions affect current assets and current liabilities on the balance sheet.

Order of operations

1. Parentheses 2. Exponents 3. Multiplication/division 4. Addition/subtraction

Equipment costing $70,000 with a salvage value of $14,000 and an estimated life of 8 years has been depreciated using the straight-line method for 2 years. Assuming a revised estimated total life of 6 years and no change in the salvage value, the depreciation expense for Year 3 would be

1. [($70,000 - $14,000) ÷ 8] × 2 = $14.000 2. [($70,000 - $14,000) - $14,000] ÷ (6 - 2) = $10,500 1. (Equipment cost - salvage value)/ years estimated life) = x 2. [(Equipment cost - salvage value) - x]/ (Total life - straight line method) = y

Three kinds of stocks...

1. no growth AND 2. constant growth AND 3. differential growth stock (in this class we would not be working on differential growth stock).

3 Basic Decisions a Financial Manager faces:

1. which productive assets the firm should buy (capital budgeting decisions) 2. how the firm should finance the productive assets purchased (financing decisions) 3. how the firm should manage its day‐to‐day financial activities (working capital decisions). The financial manager should make these decisions in a way that maximizes the current value of the firm's stock.

A corporate bond was quoted yesterday at 102.16 while today's quote is 102.19. What is the change in the value of a bond that has a face value of $5,000?

1.50 mkt price= (1.0219-1.0216)*5000

You form a portfolio by buying $30970 of Microsoft stock, and $76241 of Apple stock. Microsoft stock has a beta of 1.46 and Apple stock has a beta of 1.58. What is your portfolio Beta?

1.55

Albend Holmes wants to deposit $4,500 in a bank account that pays 8.25 percent annually. How many years will it take for his investment to grow to $10,000?

10 years

Five years ago, Shirley Harper bought a 10-year bond that pays 8 percent semiannually for $981.10. Today, she sold it for $1,067.22. What is the realized yield on her investment?

10%

Compute the present value of $10,000 received at the beginning of each of the next four years with interest at 6% compounded annually.

10,000 * 3.67301(found through PVAD table)=36,730

The cost of equity: UltraFlex Diving Boards, Inc., is just paid a dividend of $1.50. If the firm's growth in dividends is expected to remain at a flat 4 percent forever, then what is the cost of equity capital for Ultra Flex Diving Boards if the price of its common shares is currently $26.00?

10.00%

Your mother is trying to choose one of the following bank CDs to deposit $12,500. Which will have the highest future value if she plans to invest for 15 years?

10.05% compounded monthly

Jackson Inc. is considering two mutually exclusive, equally risky projects S and L. Their cash flows are shown below. What is the crossover rate? WACC: 7.50% Year. 0 1 2 3 4 CFS. -$1,100. $550. $600. $100. $100 CFL. -$2,700. $650. $725. $800. $1,400

10.16%

Linda Williams wants to invest in four-year bonds that are currently priced at $875.32. These bonds have a coupon rate of 6.4 percent and make semiannual coupon payments. What is the current market yield on this bond?

10.28%

Brian Lee bought 10-year, 11.4 percent coupon bonds issued by the U.S. Treasury three years ago at $900.52. If he sells these bonds, for which he paid the face value of $1,000, at the current price of $832.45, what is his realized yield on the bonds? Assume similar coupon-paying bonds make annual coupon payments.

10.38%

Patrick Smith has $5,000 to invest in a small business venture. His partner has promised to pay him back $8,200 in five years. What is the return earned on this investment?

10.4% Amount being invested = PV = $5,000 Amount to be paid back after 5 years = FV = $8,200 Interest rate on investment = i = ? Duration of investment = n = 5 years Present value of investment = PV

The outstanding bonds of Winter Time Products provide a real rate of return of 5.6 percent. The current rate of inflation is 4.68 percent. What is the actual nominal rate of return on these bonds?

10.54% (1+0.056)*(1+0.0468)-1=10.54% once again the -1 is huge

If a $1,000 face value bond is sold at $956.32 and has a coupon rate of 10%, which of the following rate is the most feasible yield to maturity of this bond?

10.83%

Mr. Blochirt is creating a college investment fund for his daughter. He will put in $1,000 per year for the next 15 years and expects to earn a 6% annual rate of return. How much money will his daughter have when she starts college?

1000 * 23.2760 = 23,275

Ivanhoe Inc.'s common shares currently sell for $35 each. The firm's management believes that its shares should really sell for $50 each. The firm just paid an annual dividend of $2 per share and management expects those dividends to increase by 5 percent per year forever (and this is common knowledge to the market). What is the current cost of common equity for the firm?

11.00%

Suppose the real rate is 9.5 percent and the inflation rate is 1.8 percent. What rate would you expect to see on a Treasury bill?

11.47% 1+R=(1+0.095)*(1+0.018)

Maloney's, Inc. has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. The firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt. What is the after-tax weighted average cost of capital for Maloney's, if it is subject to a 40 percent marginal tax rate?

11.64%

Using the WACC in practice: Maloney's, Inc., has found that its cost of common equity capital is 17 percent and its cost of debt capital is 6 percent. If the firm is financed with $3,000,000 of common shares (market value) and $2,000,000 of debt, then what is the after-tax weighted average cost of capital for Maloney's if it is subject to a 40 percent marginal tax rate?

11.64%

What is the YTM of a $1,000 par value bond with a 10% coupon rate, semi-annual coupon payments, and 9 years to maturity if the bond sells for $900?

11.84% FV = 1,000 PMT = 1000 x 0.1/2 N = 9*2 PV = -900 I = ?

Casa Del Sol Property Development Company is refurbishing a 200-unit condominium complex at a cost of $1,875,000. It expects that this will lead to expected annual cash flows of $415,350 for the next seven years. What internal rate of return can the firm earn from this project?

12%

Kaiser Industries has bonds on the market making annual payments, with 14 years to maturity, and selling for $1,382.01. At this price, the bonds yield 7.5 percent. What is the coupon rate?

12.00 n=14 iy=7.5 pv=-1382.01 pmt=? fv=1000 pmt=120 then divide by 1000(fv) to get coupon rate

Ivanhoe Co. has a capital structure, based on current market values, that consists of 25 percent debt, 15 percent preferred stock, and 60 percent common stock. If the returns required by investors are 8 percent, 12 percent, and 15 percent for the debt, preferred stock, and common stock, respectively, what is Ivanhoe's after-tax WACC? Assume that the firm's marginal tax rate is 40 percent.

12.00%

Shawna Carter wants to invest her recent bonus in a four-year bond that pays a coupon of 11 percent semiannually. The bonds are selling at $962.13 today. If she buys this bond and holds it to maturity, what would be her yield?

12.2%

Global Communications has a 7 percent, semiannual coupon bond outstanding with a current market price of $1,023.46. The bond has a par value of $1,000 and a yield to maturity of 6.72 percent. How many years is it until this bond matures?

12.53years n=? iy=6.72/2 pv=-1023.46 pmt=70/2 fv=1000 n=25.052 divide by 2 to get # of years!!!

You are analyzing the cost of debt for a firm. You know that the firm's 14-year maturity, 7.8 percent coupon bonds are selling at a price of $683.00. The bonds pay interest semiannually. If these bonds are the only debt outstanding for the firm, what is the current YTM of the bonds?

12.70

Using the WACC in practice: Swirlpool, Inc., has found that its cost of common equity capital is 18 percent, and its cost of debt capital is 8 percent. If the firm is financed with 60 percent common shares and 40 percent debt, then what is the after-tax weighted average cost of capital for Swirlpool if it is subject to a 40 percent marginal tax rate?

12.72%

Mike Carlson will receive $12,000 a year from the end of the third year to the end of the 12thyear (10 payments). The discount rate is 10%. The present value today of this deferred annuity is:

12000*6.14457=73734 73734*.82645 = 60,909.

FITCO is considering the purchase of new equipment. The equipment costs $326000, and an additional $106000 is needed to install it. The equipment will be depreciated straight-line to zero over a 5-year life. The equipment will generate additional annual revenues of $274000, and it will have annual cash operating expenses of $81000. The equipment will be sold for $84000 after 5 years. An inventory investment of $72000 is required during the life of the investment. FITCO is in the 40 percent tax bracket, and its cost of capital is 11 percent. What is the project NPV?

124354

Suppose an investor earned a semiannual yield of 6.4 percent on a bond paying coupons twice a year. What is the effective annual yield (EAY) on this investment?

13.21%

You are analyzing the after-tax cost of debt for a firm. You know that the firm's 12-year maturity, 15.50 percent semiannual coupon bonds are selling at a price of $1,117.25. These bonds are the only debt outstanding for the firm. What is the current YTM of the bonds?

13.50%

QN=306 (20559)33 Coverage ratios: Fahr Company had depreciation expenses of $630,715, interest expenses of $112,078, and an EBIT of $1,542,833 for the year ended June 30, 2006. What are the times interest earned and cash coverage ratios for this company?

13.8 times; 19.4 times

The zero coupon bonds of D&L Movers have a market price of $319.24, a face value of $1,000, and a yield to maturity of 8.45 percent. How many years is it until these bonds mature?

13.80 years n=? iy=8.45/2 pv=-319.24 pmt=0 fv=1000 divide by 2 to get years

Your aunt is planning to invest in a bank CD that will pay 7.0 percent interest semiannually. If she has 11,000 to invest, how much will she have at the end of four years?

14,484.90 is the value of investment after 4 years

A Treasury bond is quoted as 99:18 asked and 99:09 bid. What is the bid-ask spread in dollars on a $5,000 face value bond?

14.06 bid-ask spread=99:18-99:09=9/32 of 1% of 5000=14.06

Thomas Taylor has $2,500 to invest. His brother approached him with an investment opportunity that could double his money in 5 years. What interest rate would the investment have to yield in order for Thomas's brother to deliver on his promise? (Round 2 decimal places)

14.87 Work: Financial Calculator- N = 5 PV = -$2,500 PMT = $0 FV = $2,500 x 2 FV = $5,000 CPT for I/Y 14.8698355

Most of the risk-reduction benefits from diversification can be achieved in a portfolio consisting of

15 to 20 assets.

Public Service Enterprise Grp issues a 0.13 coupon bond with semi-annual payments that has 20 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently selling at $896 in the markets?

15%

The cost of equity: Gangland Water Guns, Inc., is expected to pay a dividend of $2.10 one year from today. If the firm's growth in dividends is expected to remain at a flat 3 percent forever, then what is the cost of equity capital for Gangland if the price of its common shares is currently $17.50?

15.00% k∨cs = (D₁/P₀) + g (2.10/17.50)+.03 = .15

In February 2017 the risk-free rate was 4.43 percent, the market risk premium was 8 percent, and the beta for Twitter stock was 1.40. What is the expected return that was consistent with the systematic risk associated with the returns on Twitter stock?

15.63%

Lowell Communications, Inc., has been installing a fiber-optic network at a cost of $18 million. The firm expects annual cash flows of $3.7 million over the next 10 years. What is this project's internal rate of return?

16%

Joseph Harris is considering an investment that pays 6.5 percent annually. How much must he invest today such that he will have $25,000 in seven years?

16,088

Blossom Luxury Liners has preferred shares outstanding that pay an annual dividend equal to $28 per year. If the current price of Blossom preferred shares is $175.00, what is the after-tax cost of preferred stock for Blossom?

16.00%

The cost of equity: TeleNyckel, Inc., has a beta of 1.4 and is trying to calculate its cost of equity capital. If the risk-free rate of return is 9 percent and the market risk premium is 5 percent, then what is the firm's after-tax cost of equity capital if the firm's marginal tax rate is 30 percent?

16.00% k↓cs = R↓rf + (β∨cs x Market Risk Premium) .09 + (1.4 x .05) = 0.16

At what rate must $4,000 be compounded annually for it to increase to $40,000 in 15 years?

16.59% Work: Financial Calculator- N = 15 PV = -$4,000 PMT = $0 FV = $40,000 CPT for I/Y 16.59%

16.89 years

Robert is going to purchase two stocks to form the initial holdings in his portfolio. Iron stock has an expected return of 17 percent, while Copper stock has an expected return of 20 percent. What would the expected return of David's portfolio invests 70 percent of his funds in Iron stock?

17.9%

QN=366 (20615)35 Rate of growth: Link Net, Inc. just generated earnings per share of $3.75 for the fiscal year ending September 30, 2010. The firm is expected to achieve earnings per share of $8.76 in 5-years. At what rate will Link Net, Inc.'s earnings per share be growing over this 5-year period? (Round off to the nearest 1/10 percent)

18.5%

You are purchasing a 20-year, zero-coupon bond. The yield to maturity is 8.68 percent and the face value is $1,000. What is the current market price?

182.80 n=20*2 iy=8.68/2 pv=? pmt=0 fv=1000

Michael Harper has $3,000 to invest for three years. He wants to receive $5,000 at the end of the three years. What invest rate would his investment have to earn to achieve his goal?

19%

Robert is going to purchase two stocks to form the initial holdings in his portfolio. Iron stock has an expected return of 17 percent, while Copper stock has an expected return of 20 percent. If Robert plans to invest 30 percent of his funds in Iron and the remainder in Copper, what will be the expected return from his portfolio?

19.1%

The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what is the expected return on Elsenore?

19.20

The beta of Elsenore, Inc., stock is 1.6, whereas the risk-free rate of return is 8 percent. If the expected return on the market is 15 percent, then what should investors expect as a return on Elsenore?

19.20%

Soo Lee Imports issued 17-year bonds 2 years ago at a coupon rate of 10.3 percent. The bonds make semiannual payments. These bonds currently sell for 102 percent of par value. What is the yield-to-maturity?

2 years ago =15 but its semi annual so *2 n=30

Berg Inc. has just paid a dividend of $2.00 and is now selling for $48 per share. Similar stocks generally earn a 12.5% return. assuming that Berg Inc. is a constant growth stock,what is its expected rate of growth?

2(1+g)/(.125-g)=48 g=.08=8.0%

Your birthday is next week and instead of other presents your parents promised to give you $2,000 in cash. Since you have a part-time job and, thus don't need the cash immediately, you decide to invest the money in a bank CD that pays 5.00 percent, compounded quarterly, for the next two years. How much money can you expect to earn in this period of time?

2,208.97 is the value of an investment after 2 years.

The expected return on Kiwi Computers stock is 16.6 percent. If the risk-free rate is 4 percent and the expected return on the market is 10 percent, then what is Kiwi's beta?

2.10

Redesigned Computers has 6.5 percent coupon bonds outstanding with a current market price of $832. The yield to maturity is 16.28 percent and the face value is $1,000. Interest is paid semiannually. How many years is it until these bonds mature?

2.10years n=? iy=16.28/2 pv=-832 pmt=52.5/2 fv=1000 n=4.19 period divide by 2 to get number of years!!!

The Easton manufacturing Company is looking to replace its conveyor belt system. A new system will cost $345,000, and will result in cost savings of $220,000 in the first year, followed by savings of $100,000 per year over the following 3 years. The payback period for this project is closest to:

2.25 years.

Elmer Sporting Goods is getting ready to produce a new line of golf clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project?

2.43 years

QN=421 (20671)39 If a random variable is drawn from a normal distribution, what is the probability that the random variable is larger than 1.96 standard deviations larger than the mean?

2.50%

Assume a dividend today of $2.50 w/ anticipated growth over the next 3 yrs of 10%. The estimated dividend at the 3rd year is

2.50(1.1)^3=$3.33

Assume a dividend today of$2.50 w/ anticipated growth over the next 3 yrs of 10%. The estimated dividend at the 3rd year is

2.50(1.1)^3=$3.33

You have been asked to analyze a potential project. The project's cost is $180,000. Cash inflows are projected to be: year 1 = $55,000, year 2 = $65,000; year 3 = $75,000; year 4 = $85,500; year 5 = $95,000. What is the investment project's payback?

2.8 years

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the internal rate of return on this project?

20%

Ambrin Corp. expects to receive $2,000 per year for 10 years and $3,500 per year for the next 10 years. What is the present value of this 20 year cash flow? Use an 11% discount rate.

2000*5.88923 = 117783500*5.88923 = 20,612.30520,612.305*.35218 = 7259.247259.24 + 11778 = 19037.24

Crane Wok Co. is expected to pay a dividend of $1.30 one year from today on its common shares. That dividend is expected to increase by 5.00 percent every year thereafter. If the price of Crane common stock is $8.13, what is the cost of its common equity capital?

21.00%

Joe Nautilus has $210,000 and wants to retire. What return must his money earn so he may receive annual benefits of $30,000 for the next 10 years.

210,000/30000 = 7%

Samuel Johnson invested in gold U.S. coins ten years ago, paying $216.53 for one-ounce gold "double eagle" coins. He could sell these coins for $734 today. What was his annual rate of return for this investment?

216.53/734 = .295 n 10 i = 13% (look for .295 on the PV table)

Quick Sale Real Estate Company is planning to invest in a new development. The cost of the project will be $23 million and is expected to generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three years. The company's cost of capital is 20 percent. What is the internal rate of return on this project?

22%

You purchased an investment which will pay you $8,000, in real dollars, a year for the next three years. Each payment will be received at the end of the period with the first payment occurring one year from today. The nominal discount rate is 7.5 percent and the inflation rate is 2.9 percent. What is the present value of these payments?

22,004 find real rate 1+0.075/1+0.029)-1=0.0447 n=3 iy=.0447 pv=? pmt=8000 fv=0

An investment of $130384 is expected to generate an after-tax cash flow of $77000 in one year and another $103500 in two years. The cost of capital is 10 percent. What is the internal rate of return?

23.39 percent

Management of Carla Vista Home Furnishings is considering acquiring a new machine that can create customized window treatments. The equipment will cost $199,550 and will generate cash flows of $104,750 over each of the next six years. If the cost of capital is 13 percent, what is the MIRR on this project?

27.9%

A Treasury bond is quoted at a price of 106:23 with a 3.50 percent coupon. The bond pays interest semiannually. What is the current yield on one of these bonds?

3.28% current price= 106 and 23/32 =1.0671875*1000=1067.1875 current yield= (.035*1000)/1067.1875=3.28%

Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. What is the payback period for this project? If its acceptance period is three years, will this project be accepted?

3.33 years; no

A bond that pays interest annually yielded 7.47 percent last year. The inflation rate for the same period was 4 percent. What was the actual real rate of return on this bond for last year?

3.34% (1.0747/1.04)-1=3.34% big key here is the -1

Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return?

3.38%

Three years ago, Joe bought a 5-year, 10% coupon paid semiannually bond for $1000. Currently, with interest rates having risen sharply, the bond is selling for $800 and you decide to sell it off. If you had re-invested the semi-annual coupons as you received them, what would your realized yield be over the 3-year holding period?

3.63%.

Your mother is trying to choose one of the following bank CDs to deposit $10,000. Which will have the highest future value if she plans to invest for three years?

3.75% compounded annually A. Interest rate on CD = i = 3.50% Frequency of compounding = m = 365 Value of investment after 3 years = FV3 FV3 = PV × (1 + i/m)m×n = $10,000 × (1 + 0.035/365)365×3 = $10,000 × (1.00009589)1,095 = $11,107.05 B. Interest rate on CD = i = 3.25% Frequency of compounding = m = 12 Value of investment after 3 years = FV3 FV3 = PV × (1 + i/m)m×n = $10,000 × (1 + 0.0325/12)12×3 = $10,000 × (1.0027908333)36 = $11,022.66 C. Interest rate on CD = i = 3.40% Frequency of compounding = m = 4 Value of investment after 3 years = FV3 FV3 = PV × (1 + i/m)m×n = $10,000 × (1 + 0.034/4)4×3 = $10,000 × (1.0085)12 = $11,069.06 D. Interest rate on CD = i = 3.75% Frequency of compounding = m = 1 Value of investment after 3 years = FV3 FV3 = PV × (1 + i/m)m×n = $10,000 × (1 + 0.0375) = $10,000 × (1.0375)3 = $11,167.71

Dr. J. wants to buy a Dell computer which will cost $3,000 three years from today. He would like to set aside an equal amount at the end of each year in order to accumulate the amount needed. He can earn 8% annual return. How much should he set aside?

3000/3.2464=924 dollars

You form a portfolio by buying $75727 of Microsoft stock, and $32439 of Apple stock. Microsoft stock has a standard deviation of 32% and Apple stock has a standard deviation of 44%, and they have a correlation of 0.61. What is the standard deviation of your portfolio?

32.2%

Northern Warehouses wants to raise $11.4 million to expand its business. To accomplish this, it plans to sell 40-year, $1,000 face value, zero-coupon bonds. The bonds will be priced to yield 8.75 percent. What is the minimum number of bonds it must sell to raise the $11.4 million it needs?

350,448

An oil exploration firm is currently searching for oil. Their probability of finding oil this year is 58% and if they hit oil we expect the stock to return 72%. If they do not hit oil we expect the stock to return -6%. What is the standard deviation of the return of the stock?

38.5%

QN=365 (20612)36Time to attain goal: Cheryl Merriweather wants to invest in a bank CD that will pay her 7.8 percent annually. If she is investing $11,500 today, when will she reach her goal of $15,000?

4 years

Nickole wants to invest in a bank CD that will pay her 7.8 percent annually. If she invests $11,500 today,when will she reach her goal of $15,000?

4 years Work: Financial Calculator- I/Y = 7.8PV = -$11,500 PMT = $0 FV = $15,000 CPT for N 3.5376

On June 30, 2013, Cey, Inc. exchanged 4,000 shares of Seely Corp. $30 par value common stock for a patent owned by Gore Co. The Seely stock was acquired in 2013 at a cost of $110,000. At the exchange date, Seely common stock had a fair value of $46 per share, and the patent had a net carrying value of $220,000 on Gore's books. Cey should record the patent at

4,000 × $46 = $184,000.

QN=511 (20760)45Payback: Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. What is the payback period for this project? If their acceptance period is five years, will this project be accepted?

4.17 years; yes

Arnold Company purchases a new delivery truck for $40,000. The sales taxes are $2,500. The logo of the company is painted on the side of the truck for $1,200. The truck's annual license is $120. The truck undergoes safety testing for $220. What does Arnold record as the cost of the new truck?

40,000 + 2,500 + 1,200 + 220 = 43,920

The semiannual, 8-year bonds of Alto Music are selling at par and have an effective annual yield of 8.6285 percent. What is the amount of each interest payment if the face value of the bonds is $1,000?

42.25 ICONV to NOM to find nom=.0845 .0845*1000/2=42.25

Your uncle is looking to double his investment of $10,000. He claims he can get earn 14 percent on his investment. How long will it take to double his investment? Use the Rule of 72 and round to the nearest year.

5 Years

5 years

Gap Inc issues a 0.04 coupon bond with annual payments that has 11 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently priced at $950 in the markets?

Your tuition for the coming year is due today. You borrow $8,000 from your uncle and agree to repay in the three years an amount of $9,250. What is the interest rate on this loan?

5% Amount to be borrowed = PV = $8,000 Amount to be paid back after 3 years = FV3 = $9,250 Interest rate on investment = i = ? Duration of investment = n = 3 years Present value of investment = PV

A Treasury bond is quoted at a price of 105:10. What is the market price of this bond if the face value is $5,000?

5,265.63 price=105:10=105 and 10/32 percent of face = 1.053125 * 5000

A corporate bond is quoted at a price of 103.16 and carries a 5.20 percent coupon. The bond pays interest semiannually. What is the current yield on one of these bonds?

5.04% current yield=(.0521000)/1.03161000)=5.04%

Blackwell bonds have a face value of $1,000 and are currently quoted at 98.4. The bonds have a 5 percent coupon rate. What is the current yield on these bonds?

5.08% current yield =.051000/.09841000=5.08%

John Wong purchased a five-year bond today at $1,034.66. The bond pays 6.5 percent semiannually. What will be his yield to maturity?

5.7%

53,784

The outstanding bonds of The River Front Ferry carry a 6.5 percent coupon. The bonds have a face value of $1,000 and are currently quoted at 102.9. What is the current yield on these bonds?

6.32% current yield= .0651000/1.0291000=6.32%

Bryceton, Inc. has bonds on the market with 13 years to maturity, a yield-to-maturity of 9.2 percent, and a current price of $802.30. The bonds make semiannual payments. What is the coupon rate?

6.56% n=13*2 iy=9.2/2 pv=-802.30 pmt=? fv=1000 1)find pmt 2) multiply by 2 for annual 3)divide by 1000(fv) to find coupon %

Durango Water Works has an outstanding issue of preferred stock that has a par (maturity value) of $75.00. The stock, which pays a quarterly dividend of $1.10, will be retired by the firm in 20 years. If the preferred stock is currently selling for $68.00, what is the preferred stock's yield-to-maturity?

6.72%

QN=449 (20722)42 Effective annual yield: Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment?

6.81%

Stanley Hart invested in a municipal bond that promised an annual yield of 6.7 percent. The bond pays coupons twice a year. What is the effective annual yield (EAY) on this investment?

6.81%

Amsted, Inc. is considering a project that will increase revenues by $2.5 million, cash operating expenses by $700,000, and depreciation and amortization by $300,000 during 2011. For this project, the firm will purchase $800,000 of equipment during the year while decreasing its inventory by $200,000 (with no corresponding decrease in current liabilities). The marginal tax rate for Amsted is 35 percent. What is this project's incremental after-tax free cash flow for 2011?

675,000

Scripps Networks Interactive issues a 0.06 coupon bond with semi-annual payments that has 28 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently selling at $910 in the markets?

You have won a contest and will receive $2,500 a year in real terms for the next 3 years. Each payment will be received at the end of the period with the first payment occurring one year from today. The relevant nominal discount rate is 6.3 percent and the inflation rate is 4.5 percent. What are your winnings worth today?

7,057 first find the real rate of return 1+0.063/1+0.045)-1=.031 then use this rate dividing by the cash flows 1.031037827 *3=IY n=3 iy=3.1031037827 pv=? pmt=2500 fv=0

The cost of debt: Beckham Corporation has semiannual bonds outstanding with 13 years to maturity and are currently priced at $746.16. If the bonds have a coupon rate of 8.5 percent, then what is the after-tax cost of debt for Beckham if its marginal tax rate is 35%? Assume that your calculation is made as on Wall Street.

8.125% First find YTM: N= 13*2 =26 PV = -746.16 PMT = 1000*.085 = 85/2 = 42.50 FV = 1000 CPT --> I/Y = 6.25*2 = 12.50 Now adjust for Taxes: 12.5/100 = 0.125 x (1-0.35) = 8.125%

Adams Enterprises' bonds currently sell for $1,030. They have a 15-year maturity, an annual coupon of $85, and a par value of $1,000. What is their yield to maturity?

8.15%

QN=465 (20712)41 Yield to maturity: Nathan Akpan is planning to invest in a seven-year bond that pays annual coupons at a rate of 7 percent. It is currently selling at $927.23. What is the current market yield on such bonds?

8.4%

The RST Corp. is considering the purchase of some new equipment which will cost $120,000, last for 5 years, and generate after-tax cost savings of $45,000, $37,000, $25,000, $20,000, and $20,000 respectively per year. The firm's cost of capital is 10%. What is the IRR of this project?

8.58%.

The bonds issued by Stainless Tubs bear an 8 percent coupon, payable semiannually. The bonds mature in 11 years and have a $1,000 face value. Currently, the bonds sell for $952. What is the yield to maturity?

8.69% n= 11*2 iy=? /2 pv=-952 pmt=80/2 fv=1000

8.89%

8.91%

John Johnson is planning to invest $29k today in a mutual fund that will provide a return of 11 percent each year. What will be the value of the investment in 10 years?

82,343.21 is the value of the investment after 10 years

The cost of debt: Bellamee, Inc., has semiannual bonds outstanding with five years to maturity and are priced at $920.87. If the bonds have a coupon rate of 7 percent, then what is the YTM for the bonds?

9.0% N = 5*2=10 PV= -920.87 PMT = 1000*.07 = 70/2 = 35 FV = 1000 CPT -> I/Y = 4.5 4.5+4.5 = 9.0

The cost of equity: The Dedus Shoes, Inc., has common shares with a price of $28.76 per share. The firm paid a dividend of $1.00 yesterday, and dividends are expected to grow at 10 percent for two years and then at 5 percent thereafter. What is the implied cost of common equity capital for Dedus

9.00% 28.76 = (1.1^2)/(1+r) + (1.1^3)/(1+r)^2 + (1.1^3 * 1.05)/(r-0.05)*(1+r)^3 r= 0.09

9.20%

Twitter (TWTR) has a beta of 1.3. If the expected return on the market is 7.4%, and the risk free rate is 0.7%, what is the expected return on Twitter stock according to the CAPM?

9.41%

Sylvan Trees has a 7 percent coupon bond on the market with ten years left to maturity. The bond makes annual payments and currently sells for $842.10. What is the yield-to-maturity?

9.53% n=10 iy=? pv=-842.10 pmt=70 fv=1000

Shares of common stock of the Windy Farms offer an expected total return of 13.8 percent. The dividend is increasing at a constant 4.2 percent per year. What is the dividend yield?

9.60 percent

Roadside Markets has a 6.75 percent coupon bond outstanding that matures in 10.5 years. The bond pays interest semiannually. What is the market price per bond if the face value is $1,000 and the yield to maturity is 7.2 percent?

967.24 n=10.5*2 i/y=7.2/2 pv=? pmt=67.5/2 fv=1000

Megan Mei is charged 2 points on a $120,000 loan at the time of closing. The original price of the home before the down payment was $140,000. The points in dollars cost Megan

=120000*2/100 =2400

% change formula

=change in price/old price =new-old/old(this formula)!!!

coupon=

=dividend(pmt)/fv(facevalue)

Which of the following forms of business organization is subject to double taxation?

A C-corporation.

Effective annual interest rate: Which of the following investments has the highest effective annual interest rate (EAR)? a. A bank CD that pays 8.25 percent compounded quarterly. b. A bank CD that pays 8.25 percent compounded monthly. c. A bank CD that pays 8.45 percent compounded annually. d. A bank CD that pays 8.25 percent compounded semiannually. e. A bank CD that pays 8 percent compounded daily (on a 365-day per year basis).

A bank CD that pays 8.25 percent compounded monthly. SEE IMAGE

We know that a vanilla bond with a coupon rate below the market rate of interest will sell for a discount and that a vanilla bond with a coupon rate above the market rate of interest will sell for a premium. What kind of bond or loan will sell at its par value regardless of what happens to the market rate of interest?

A bond (or a loan) that pays a variable coupon (interest) rate that moves up and down with the market rate of interest will sell at its par value regardless of what happens in the market. While corporate bonds in the U.S. do not have variable coupon payments, bank loans often have variable rates which adjust frequently enough so that the value of the loans remains relatively constant as interest rates move up and down over time.

Mortgage Bond

A bond secured by a lien on real property

A Junk bond refers to:

A bond that is speculative

Which of the following bonds has the most interest rate risk (the risk that price falls if interest rates rise)?

A bond with a long time to maturity and a low coupon rate.

What economic conditions would prompt investors to take advantage of a bond's convertibility feature?

A bond's convertibility feature becomes attractive when the company's stock price rises above the bond's price. This usually happens in times of economic expansion when the stock market is booming and interest rates are increasing, hence lowering the bond's price.

How do dealers differ from brokers?

A dealer differs from a broker in that a dealer takes ownership of assets and is exposed to inventory risk, while a broker only facilitates a transaction on behalf of a client. Unlike brokers, dealers are subject to capital risk, because they must finance their inventories of securities.

First Relationship

A decrease in interest rates (required rates of return) will cause the value of a bond (regardless of maturity and coupon interest rate) to increase; on the other hand, an interest rate increase will (regardless of maturity and coupon interest rate) cause a decrease in value.

Dividend yield: What is a dividend yield? What does it tell us?

A dividend yield is the ratio of the annual dividend payout and the current market price of a stock. It tells us what percentage return we would earn from dividends alone if we purchased the stock at its current price. Alternatively, it tells us what percentage of the firm's stock value is being distributed to stockholders each year.

Which of the following statements is true of time value of money?

A dollar received today is worth more than a dollar to be received in the future because funds received today can be invested to earn a return.

What are some of the ways in which a financial institution or intermediary can raise money?

A financial intermediary can raise money through the sale of financial products that individuals or businesses will purchase, such as checking and savings accounts, life insurance policies, pension or retirement funds.

What is the appropriate decision rule for a firm considering undertaking a capital project? Give a real-life example.

A firm should undertake a capital project only if the value of its future cash flows exceeds the cost of the project. For example, a financial manager would not invest $10,000,000 in a new production line if the net present value of future cash flows from that line are expected to be only $9,000,000. That would be like throwing $1,000,000 away.

QN=279 (20546)32 Which of the following is the best example of how a market-value balance sheet item differs from the firm's book-value balance sheet item?

A firm sold common stock twenty-years ago for $20.00 share. The firm's common stock is currently selling for $96.50 per share.

What does it mean when a company has a very high P/E ratio? Give examples of industries in which you believe high P/E ratios are justified.

A high P/E ratio implies that investors believe that the firm has good prospects for earnings growth in the future. In fact, they believe that the firm will have higher growth potential than firms with lower P/E ratios. Companies in industries that are fast growing like biotech or any hi-tech industry have high P/E ratios. In the past, firms like Cisco and Intel had very high P/E ratios. As these firms matured and settled to annual growth rates of 15 percent or less, their P/E ratios have declined.

Which of the following types of owners cannot be engaged in managing the business?

A limited partner

What is a partnership, and what is the biggest disadvantage of this form of business organization? How can this disadvantage be avoided?

A partnership consists of two or more owners legally joined together to manage a business. The major disadvantage to partnerships is that all partners have unlimited liability for the organization's debts and legal obligations no matter what stake they have in the business. One way to avoid this is to form a limited partnership in which only general partners have unlimited liability and limited partners are only responsible for business obligations up to the amount of capital they have invested in the partnership.

Explain the difference between profitable and unprofitable firms.

A profitable firm is able to generate enough cash flows from productive assets to cover its operating expenses, taxes, and payments to creditors. Unprofitable firms fail to do this, and therefore they may be forced to declare bankruptcy.

What is the difference between a growing annuity and a growing perpetuity?

A stream of cash flows that is growing at a constant rate over time can be called a growing annuity or growing perpetuity. If the cash flows extend over a finite length of time, then we call it a growing annuity and can use Equation6.5 to compute the present value. If the growth will continue for a very long time period and perhaps, forever, we refer to it as the growing perpetuity. We would then use Equation 6.6 to estimate the present value of this cash flow stream.

Effective annual interest rate: You are considering three alternative investments: (1) a three-year bank CD paying 7.5 percent compounded quarterly; (2) a three-year bank CD paying 7.3 percent compounded monthly; and (3) a three-year bank CD paying 7.75 percent compounded annually. Which investment has the highest effective annual interest rate (EAR)?

A three-year bank CD paying 7.75 percent compounded annually. SEE IMAGE

What is a time line, and why is it important in financial analysis?

A time line is a horizontal line that starts at time zero (today) and shows cash flows as they occur over time. It is an important tool used to analyze cash flows over certain time periods, as the timing of each cash flow has a big impact on the final figure, and therefore on the resulting investment decision.

Suppose you have just bought a 16-year, 8% semiannual coupon bond. Your purchasing price of the bond implies that the current YTM is 7%. Assuming you keep this bond till its maturity, the number of coupon payments during the 16 year period is ___A___Correct Response; the dollar amount of each coupon payment is $___B___Correct Response (no decimal places without the $ sign); the dollar amount that you will receive at maturity is $ ___C___

A32 B40 C1000

Which of the following classes of securities is likely to have the lowest corporate borrowing cost? (LO 5) a. AAA rated bonds. b. A rated bonds. c. BB rated bonds. d. C rated bonds. e. All of the above will have the same corporate borrowing cost.

AAA rated bonds. Solution: a. The issuers of AAA rated bonds should have the lowest borrowing cost because their default risk premium is lower than issuers with weaker credit ratings.

Monster Beverage Corp issues a 0.17 annual coupon bond with 24 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.07?

ANSWER: ENTER: (N=24, I/Y=7, PV=?, PMT=170, FV=1000) => PV=$2146.93

Coca-Cola Enterprises issues a 0.07 semi-annual coupon bond with 16 years of maturity. What is the bond's price if the yield to maturity (YTM) is 0.13?

ANSWER: ENTER: (N=32, I/Y=6.5, PV=?, PMT=35, FV=1000) => PV=$599.98

Tyson Foods Inc A issues a 0.03 coupon bond with semi-annual payments that has 24 years of maturity. What is the bond's yield to maturity (YTM) if the bond is currently selling at $848 in the markets?

ANSWER: ENTER: (N=48, I/Y=?, PV=-848, PMT=15, FV=1000) and find I/R (multiplied by 2)=0.04

What is the APR, and why are lending institutions required to disclose this rate?

APR, or the annual percentage rate, is the annualized interest rate using simple interest. It is defined as the simple interest charged per period multiplied by the number of compounding periods per year. Lending institutions are mandated by Federal Truth-in-Lending Act regulations to disclose this rate to essentially make it easier for consumers to be exposed to the same kind of rate by all businesses.

In a reasonably efficient market, if a stock has a beta of 1.4 we expect that it will have (______) exposure to market risk and (_______) expected returns.

Above average, above average

Explain why long-term bonds with zero coupons are riskier than short-term bonds that pay coupon interest.

According to bond theorems number two and three, for a given change in interest rates, longer-term bonds with low coupon rates have greater price changes than shorter-term bonds with higher coupon rates. The likelihood of interest rates changing during the long run is higher than the short term. Thus, long-term zero coupon bonds have greater interest rate risk—greater price swings—than short-term bonds that pay coupon payments.

General Mills just is undertaking an analysis on a new cereal. The firm realizes that if they come out with a new product it would affect sales of existing products? What is the best course of action for General Mills in this analysis?

Account for the reduction of sales from existing cereals in the projection of cash flows on the new product.

What is an agency relationship, and what is an agency conflict? How can agency conflicts be reduced in a corporation?

Agency relationships develop when a principal hires an agent to perform some service or represent the firm. An agency conflict arises when the agent's interests and behaviors are at odds with those of the principal. Agency conflicts can be reduced through the following three mechanisms: management compensation, control of the firm, and the board of directors.

Which of the following statements is CORRECT?

All else equal, long-term bonds have less reinvestment rate risk than short-term bonds.

Which of the following is a similar concept to the compound growth rate of money?

All of these.

Explain why profit maximization is not the best goal for a company. What is a better goal?

Although profit maximization appears to be the logical goal for any company, it has many drawbacks. First, profit can be defined in a number of different ways, and variations in net income for similar firms can vary widely. Second, accounting profits do not exactly equal cash flows. Third, profit maximization does not account for timing and ignores risk associated with cash flows. An appropriate goal for financial managers who do not have these objections is to maximize the value of the firm's current stock price. In order to achieve this goal, management must make financial decisions so that the total value of cash inflows exceeds the total value of cash outflows.

ELO Corporation purchased a patent for $180,000 on September 1, 2010. It had a legal life of 20 years and a useful life of 10 years . On January 1, 2012, ELO spent $44,000 to successfully defend the patent in a lawsuit. ELO feels that as of that date, the remaining useful life is 5 years. What amount should be reported for patent amortization expense for 2012?

Amortization from Sept 1, 2010 to Jan 1, 2012: ($180,000 ÷ 10) × (1 + 4/12) = $24,000. Remaining value before defense: $180,000 - $24,000= $156,000. Cost of successful defense: ($156,000 + $44,000) ÷ 5 = $40,000. Assume the defense is not successful, what will be the entry? The patent is impaired (removed from the book) by recording an impairment loss of $156,000.

After reviewing the CPI inflation calculator at inflationdata.com, Hanna Lind realized the importance of creating an investment plan for her future. She would need $9,691.50 in 2015 to have the same purchasing power her $7,000 (stored in a fireproof safe in her home since 2010) had when she put it there. To protect her savings against further inflation and to help her prepare for a healthy financial future, Hanna deposits her $7,000 in an investment account in 2015 earning 6% interest compounded quarterly. How much will Hanna have in her account in 2025?

Amount $12,698

Jim Ryan, an owner of a Burger King restaurant, assumes that his restaurant will need a new roof in 7 years. He estimates the roof will cost him $9,000 at that time. What amount should Jim invest today at 6% compounded quarterly to be able to pay for the roof?

Amount to be invested $5931.90

What are agency conflicts?

An agency conflict occurs when the goals of the principals are not aligned with the goals of the agents. Management is often more concerned with pursuing its own self-interest, and so the maximization of shareholder value is pushed to the side.

Describe what an information asymmetry is in a business transaction. Explain how the inequity associated with an information asymmetry might be, at least partially, solved through the market for goods or services.

An information asymmetry exists when one party to a business transaction possesses information that is not available to the other parties in the transaction. If the parties with less information understand their relative disadvantage, they are likely to pay lower prices for the goods and services they purchase, or charge higher prices for the goods and services they sell.

Which of the following investors should be willing to pay the highest price for an asset?

An investor with a 50-asset portfolio.

Announcement Effect

Announcement of a positive news would cause the stock price to increase because the required ror is likely to decrease and the growth rate in future dividends to increase

A series of equal periodic payments

Annuity

Annuity payments at the beginning of the period

Annuity Due

On January 1, 2013, Todd Furniture Company hired a new sales manager for the new showroom. The sales manager is expected to work 30 years before retirement on December 31, 2042. Annual retirement benefits will be paid at the end of each year of retirement, a period that is expected to be 25 years. The sales manager will earn $2,500 in annual retirement benefits for the first year worked, 2013. How much must Todd Furniture contribute to the company pension fund in 2013 to provide for $2,500 in annual pension benefits for 25 years that are expected to begin in 30 years? Todd Furniture's pension fund is expected to earn 5% interest.

Annuity amount PVA = PVA2500 PV = PV of amount 2500 14.09394 = 35234.85.23138=$8152.64

Giant Electronics is issuing 20-year bonds that will pay coupons semiannually. The coupon rate on this bond is 7.8 percent. If the market rate for such bonds is 7 percent, what will the bonds sell for today?

Answer: ENTER: N= 20x2=40 I/YR=7/2=3.5 PV=? PMT= (.078x1,000)/2=39 FV= 1,000 and find PV=$1,085

Shana Norris wants to buy five-year zero coupon bonds with a face value of $1,000. Her yield to maturity is 8.5 percent. Assuming annual compounding, what would be the current market price of these bonds?

Answer: ENTER: N=5 I/YR=8.5/2=4.25 PV=? PMT=0 FV= 1,000 and find PV=$665

Alice Trang is planning to buy a six-year bond that pays a coupon of 10 percent semiannually. Given the current price of $878.21, what is the yield to maturity on these bonds?

Answer: ENTER: N=6x2=12 I/YR=? PV=-878.21 PMT=(.10x1,000)/2=50 FV= 1,000 and find I/YR=6.49x2=12.98%

How is a preferred stock with a fixed maturity valued?

Any preferred stock with a defined maturity date is similar to a bond with a fixed maturity date. This similarity allows for the preferred stock to be valued in a similar fashion after making adjustments for differences in the preferred stock relative to a bond. Using Equation 8.2, developed to value bonds, the coupons are replaced by the preferred dividends and the number of payments is adjusted to four a year to accommodate the fact that firms pay the dividends every quarter and not semi-annually. This results in the model represented by Equation 9.7.

Which one of the following characteristics does not pertain to corporations? a. Can enter into contracts b. Can borrow money c. Are the easiest type of business to form d. Can be sued e. Can own stock in other companies

Are the easiest type of business to form The answer that does not pertain to corporations is: c. Are the easiest type of business to form.

What is the relation between business cycles and the general level of interest rates?

As Exhibit 2.5 shows, interest rates tend to follow the business cycle. The level of interest rates tends to rise during periods of economic expansion and decline during periods of economic contraction.

If interest rates are expected to increase, should investors look to long-term bonds or short-term securities? Explain.

As interest rates increase, bond prices decrease with longer-term bonds, experiencing a bigger decline than shorter-term securities. So, investors expecting an increase in interest rates should choose short-term securities over long-term securities and reduce their interest rate risk.

A company acquires a patent for a drug with a remaining legal and useful life of six years on January 1, 2011 for $2,100,000. The company uses straight-line amortization for patents. On January 2, 2013, a new patent is received for a timed-release version of the same drug. The new patent has a legal and useful life of twenty years. The least amount of amortization that could be recorded in 2013 is

BV of the drug on January 2, 2013: $2,100,000 - [($2,100,000 ÷ 6) × 2] = $1,400,000. Useful life becomes 20 years on January 2, 2013: Amortization expense per year: $1,400,000 ÷ 20 = $70,000.

Harrel Company acquired a patent on an oil extraction technique on January 1, 2012 for $7,500,000. It was expected to have a 10 year life and no residual value. Harrel uses straight-line amortization for patents. On December 31, 2013, the expected future cash flows expected from the patent were expected to be $900,000 per year for the next eight years. The present value of these cash flows, discounted at Harrel's market interest rate, is $4,200,000. At what amount should the patent be carried on the December 31, 2013 balance sheet?

BV of the patent on December 31, 2013: (Cost- Total amortization in 2012 and 2013)= $7,500,000 - [($7,500,000 ÷ 10) × 2] = $6,000,000. Recoverability test: The expected future cash flows= $900,000 x 8= $7,200,000 BV= $6,000,000 No need for impairment because the expected future cash flows are higher than BV. Thus, the patent will be carried at $6,000,000.

On January 2, Year 1, FNR Co. purchased a franchise with a finite useful life of 20 years for $100,000. An additional franchise fee of 3% of franchise operation revenues must be paid each year to the franchisor. Revenues from franchise operations amounted to $400,000 during Year 1. The pattern of consumption of benefits of the franchise is not reliably determinable, suggesting that the straight line method is used. The residual value is zero. In its December 31, Year 1, balance sheet, what amount should FNR report as an intangible asset-franchise?

BV= 100,000 (Note that franchise fee will not be capitalized) Useful life=20 Amortization expense= 100,000/20= 5,000 Remaining Amount on December 31, Year 1= 95,000

Lee Holmes deposited $15,000 in a new savings account at 9% interest compounded semiannually. At the beginning of year 4, Lee deposits an additional $40,000 at 9% interest compounded semiannually. At the end of 6 years, what is the balance in Lee's account?

Balance $77,531.78

Why were commercial banks prohibited from engaging in investment banking activities until 1999?

Banks had been barred from investment banking following the Great Depression because it was believed that these activities were too risky for banks. At the time, it was believed that excessive risk taking by banks had resulted in a large number of bank failures, which precipitated the Great Depression. Recent research has exonerated the banking system of this charge.

Why do earnings from compounding drive much of the return earned on a long-term investment?

Because longer the investment period, the greater the proportion of total earnings from interest earned on interest.

In a reasonably efficient market, if a stock has a beta of 0.7 we expect that it will have (______) exposure to market risk and (_______) expected returns.

Below average, below average

If you hold a portfolio of many assets, the best measure of risk is the:

Beta

Which of the following is the best measure of the systematic risk in a portfolio?

Beta

Three $1,000 par value, 10-year bonds have the same amount of risk, hence their yields to maturity are equal. Bond 8 has an 8% annual coupon, Bond 10 has a 10% annual coupon, and Bond 12 has a 12% annual coupon. Bond 10 sells at par. Assuming that interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

Bond 8 sells at a discount (its price is less than par), and its price is expected to increase over the next year.

Explain why bond prices and interest rates are negatively related. What are the roles of the coupon rate and the term to maturity in this relation?

Bond prices and interest rates are negatively related because the market rate varies, while the coupon rate and face value are constant over the life of the bond. Thus, as rates increase, of the present value of the interest and principle payments from existing bonds declines. o For a given change in interest rates, longer-term bonds experience greater price changes (price volatility) than shorter-term bonds. Longer-term bonds have a larger proportion of their cash flows farther in the future, and the change in the present value of those longer-term cash flows will be greater when interest rates change because they are more heavily discounted. In addition, the longer it takes for investors to receive the cash flows, the more uncertainty they have to deal with and hence the more price-volatile the bond will be. o Lower coupon bonds are more price volatile than higher coupon bonds. The same argument used above also explains this relationship. The lower the coupon on a bond, the greater the proportion of cash flows that investors receive at maturity, as opposed to the higher coupon bonds which give the investors cash flow in higher amounts before maturity.

What is interest rate risk?

Bond prices are negatively related to interest rate movements. As interest rates rise, bond prices fall, and vice versa. Interest rate risk simply recognizes the fact that bond prices fluctuate as interest rates change, and, if you sell a bond before maturity, you may sell the bond for a price other than what you paid for it. The greater the fluctuation in bond prices due to changes in interest rates, the greater the interest rate risk.

The Maryland Department of Transportation has issued 25-year bonds that make semiannual coupon payments at a rate of 9.875 percent. The current market rate for similar securities is 11 percent. Refer to your answers in part b. How do the interest rate changes affect premium bonds and discount bonds?

Bonds, in general, decrease in price when interest rates go up. When interest rates decrease, bond prices increase.

Economic units that need to borrow money are said to be: a. Lender-savers b. Borrower-spenders c. Balanced budget keepers. d. None of the above.

Borrower-spenders Such units are said to be (b) Borrower-spenders.

Explain the economic role of brokers and dealers. How does each make a profit?

Brokers and dealers play a similar economic role in that they both bring buyers and sellers of a commodity together in a market. However, brokers only facilitate a transaction by helping the two parties make a transaction and brokers are therefore only compensated for taking on that role. They bear no risk of ownership of securities during the transaction. Dealers on the other hand, take risk in that they will purchase (sell) a commodity from a seller (buyer) without another buyer (seller) necessarily being available. In other words, a dealer will take the risk of purchasing (selling) a commodity and will therefore be compensated for taking that risk.

CHAPTER 11 HOMEWORK

CHAPTER 2 REVIEW PROBLEMS

CHAPTER 5 HOMEWORK

CHAPTER 5 REVIEW PROBLEMS

CHAPTER 6 HOMEWORK

CHAPTER 6 REVIEW PROBLEMS

CHAPTER 7 EXTRA CREDIT

CHAPTER 8 HOMEWORK

CHAPTER 8 REVIEW QUESTIONS

CHAPTER 9 HOMEWORK

CHAPTER 9 REVIEW PROBLEMS

Which of the following factors or activities can be controlled by a firm's managers?

Capital budgeting

Give an example of a capital budgeting decision and a financing decision.

Capital budgeting involves deciding which productive assets the firm invests in, such as buying a new plant or investing in the renovation of an existing facility. Financing decisions determine how a firm will raise capital. Examples of financing decisions include the decision to borrow from a bank or issue debt in the public capital markets.

How do capital market instruments differ from money market instruments?

Capital market instruments are less liquid or marketable, they have longer maturities, usually between 1 and 30 years, and they carry more financial risk.

What are capital markets, and why are they important to corporations?

Capital markets refer to the segment of the marketplace where capital goods are financed with long-term debt or equities. The most important capital market instruments are common stocks and corporate bonds. Capital markets are important to corporations because they allow them to obtain necessary financing.

What is a firm's capital structure, and why is it important?

Capital structure shows how a company is financed; it is the mix of debt and equity on the liability side of the balance sheet. It is important as it affects the risk and the value of the company. In general, companies with higher debt-to-equity proportions are riskier because debt comes with legal obligations to pay periodic payments to creditors and to repay the principal at the end.

Describe the cash flows between a firm and its stakeholders.

Cash flows are generated by a firm's productive assets that were purchased through either issuing debt or raising equity. These assets generate revenues through the sale of goods and services. A portion of this revenue is then used to pay wages and salaries to employees, pay suppliers, pay taxes, and pay interest on the borrowed money. The leftover money, residual cash, is then either reinvested back in the business or is paid out to stockholders in the form of dividends.

Which one of the following types of securities has no priority in a bankruptcy proceeding?

Common stock

Dividend Valuation Method

Common stock value = expected dividend in year 1 / (required rate of return - growth rate)

Which one of the following statements is true?

Competition among investors is an important driver of informational efficiency. AND If market prices reflect all relevant information about securities at a particular point in time, the market is informationally efficient. AND In an informationally efficient market, market prices adjust quickly to new information about a security as it becomes available.

What is compounding, and how does it affect the future value of an investment?

Compounding is the process that refers to converting the initial (principal) amount into a future value. In order to obtain the future value of the principal amount, you calculate what the value of that amount will be at the end of the time period, assuming the initial investment will earn interest and that interest is invested and earns additional interest in future periods.

Which one of the following statements about vanilla bonds is NOT true?

Coupon payments are usually made quarterly.

Kimberly Young wants to invest in four-year bonds that are currently priced at $863.21. These bonds have a coupon rate of 6.0 percent and make semiannual coupon payments. What is the current market yield on this bond?

Current market yield 10.25%

Jennifer Davis wants to invest in four-year bonds that are currently priced at $853.73. These bonds have a coupon rate of 5.7 percent and make semiannual coupon payments. What is the current market yield on this bond?

Current market yield. 10.25%

What does an inverted yield curve usually signal?

Current or future recession.

The First Bank of Flagstaff has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.65 on this stock. What is the current price of this preferred stock given a required rate of return of 10.0 percent?

Current price. $66

Sheridan Corp. will pay dividends of $5.00, $6.25, $4.75, and $3.00 in the next four years. Thereafter, management expects the dividend growth rate to be constant at 7 percent. If the required rate of return is 16.00 percent, what is the current value of the stock?

Current value $33.35

Patricia Johnson is interested in buying a five-year zero coupon bond with a face value of $1,000. She understands that the market interest rate for similar investments is 12.0 percent. Assume annual coupon payments. What is the current value of this bond?

Current value of bond $567.43

Sarah Allen is interested in buying a five-year zero coupon bond with a face value of $1,000. She understands that the market interest rate for similar investments is 9.5 percent. Assume annual coupon payments. What is the current value of this bond?

Current value of bond $635.23

You are currently thinking about investing in a stock valued at $33 per share. The stock recently paid a dividend of $2.30 and its dividend is expected to grow at a rate of 5 percent for the foreseeable future. You normally require a return of 12 percent on stocks of similar risk. Is the stock overpriced, underpriced, or correctly priced?

Current value of stock = $34.50 The stock is ????? at $33 = Underpriced

Sunland Corporation will pay dividends of $2.65, $2.85, and $3.20 in the next three years. After three years, the dividends are expected to grow at a constant rate of 4 percent per year. If the required rate of return is 12.0 percent, what is the current value of the Sunland common stock?

Current value of the common stock. $36.53

Cullumber Inc. has seven-year bonds outstanding that pay a 11 percent coupon rate. Investors buying these bonds today can expect to earn a yield to maturity of 6.650 percent. What is the current value of these bonds? Assume annual coupon payments.

Current value. $1237.32

Oriole Corp. will pay dividends of $5.00, $6.25, $4.75, and $3.00 in the next four years. Thereafter, management expects the dividend growth rate to be constant at 5 percent. If the required rate of return is 17.50 percent, what is the current value of the stock?

Current value. $26.5

Crane, Inc., paid a dividend of $3.61 last year. The company's management does not expect to increase its dividend in the foreseeable future. If the required rate of return is 10.0 percent, what is the current value of the stock?

Current value. $36.10

Whenever a project has a negative impact on an existing project's cash flows, then that effect should

be included as a negative revenue amount on the new project's cash flow analysis.

Whenever a project has a negative impact on an existing project's cash flows, then that effect should:

be included as a negative revenue amount on the new project's cash flow analysis.

The audit committee reports directly to the

board of directors.

Which of the following is correct?

bonds that sell at prices above par are called premium bonds

When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if

both the projects are independent and the cash flow pattern is conventional.

A broker is an agent who:

brings buyers and sellers together

A statement that projects income and/or expenditures over a specified future period is called a

budget

financial markets in which equity and debt instruments with maturities greater than one year are traded are called:

capital markets

Additions to tangible assets, intangible assets, and current assets can be described as

cash flows associated with investments.

Rights

certificates issued to the existing shareholders giving them an option to purchase a stated number of new shares of stock at a specified price during a two- to ten-week period

As a bond nears maturity, its price will move:

closer to par value

Kevin received unsecured financing from a bank for his plumbing business. This means that Kevin did not have to provide the bank with any

collateral

A form of equity which receives no preferential treatment in either the payment of dividends or in bankruptcy distributions is called _____ stock.

common

Riskiest factor from highest to lowest

common stocks, preferred stocks, bonds.

The process of converting an amount given at the present time into a future value is called

compounding.

The process of converting an amount given at the present time into a future value is called:

compounding.

The total holding period return on an investment ____

consists of a capital appreciation component and an income component.

Suppose you have just bought a 10-year, 6% semiannual coupon bond with $1,000 par value. Your purchasing price of the bond implies that the current YTM is 7%. Select all that are true.

Your purchasing price would have been lower than the par value. The cash flows associated with the bond are an ordinary annuity for the 10 year period with a $1,000 lump sum at the maturity. You will receive a $30 coupon payment every six month.

Which of the following statements is true of zero coupon bonds?

Zero coupon bonds have no coupon payments over its life and only offer a single payment at maturity. AND Zero coupon bonds sell well below their face value (at a deep discount) because they offer no coupons. AND The most frequent and regular issuer of zero coupon securities is the U.S. Treasury Department.

Which ONE of the following statements is true?

Which of the following statement is incorrect?

Zero coupon bonds sell well above their par value because they offer no coupons.

Analysts expect a stock to be selling for $22 in one yr. it is also expected to pay a $1 dividend during the yr. if you require a 15% return on this kind of investment, what is the most you can pay for the stock today

[(22-Po)+1]/Po=.15 Po=$20

The price of a share of stock today is $50.00, and the projected selling price in one year is $55.00. the estimated dividend during the yr is $1.00 the expected return on the stock is..

[(55-50)+1]/50 =12%

A firm's target capital structure represents ?

a fixed debt-equity ratio that the company attempts to maintain.

The firm can be viewed as

a portfolio of individual projects, each with their own risks, cost of capital, and returns.

The financial market where a new security is sold for the first time is:

a primary market.

A tax system in which taxpayers pay a progressively larger share of their income in taxes as their income rises is called

a progressive tax system.

The impact of a project on a firm's overall value depends on

a project's cash flow.

If you are deciding whether to take one project or another, where the projects have different useful lives, then you could utilize

a repeated investment analysis to decide which project is better for the firm. AND an equivalent annual annuity analysis to decide which project is better for the firm.

If you just purchased a share of IBM through a New York Stock Exchange-based transaction, you participated in:

a secondary market transaction.

Cranjet Inc. is issuing 10,000 bonds, and its investment banker has guaranteed a price of $985 per bond. If the investment banker sells the entire issue to investors for $10,150,000. a. What is the underwriting spread for this issue? b. What is the percentage underwriting cost? c. How much did Cranjet raise?

a. $300,000 ($10,150,000 - $985 x 10,000) b. 3.05 percent [($1,105-985) /$985] c. $9,850,000 ($985 x 10,000)

Pete Air wants to buy a used Jeep in 5 years. He estimates the Jeep will cost $15,000. Assume Pete invests $10,000 now at 12% interest compounded semiannually. a. Calculate the maturity value of the investment. b. Will Pete have enough money to buy the Jeep at the end of 5 years?

a. Maturity value $17,908.00 b. Yes

Identify whether the following transactions are primary market or secondary market transactions. a. Jim Hendry bought 300 shares of IBM through his brokerage account. b. Peggy Jones bought $5,000 of General Motors bonds from another investor. c. Hathaway Insurance Company bought 500,000 shares of Trigen Corp. when the company issued stock.

a. Secondary market transactions. b. Secondary market transactions. Primary market transactions.

Zippy Corporation just sold $30 million of convertible bonds with a conversion ratio of 40. Each $1,000 bond is convertible into 25 shares of Zippy's stock. a. What is the conversion price of Zippy's stock? b. If the current price of Zippy's stock is $15 and the company's annual stock return is normally distributed with a standard deviation of $5, what is the probability that investors will find it attractive to convert the bond into Zippy stock in the next year?

a. The conversion price is $1,000/40 = $25. b. The stock price would have to increase by approximately two standard deviations (2 $5 = $10) for the price to increase to $25 and for conversion to become attractive to the investors. From Chapter 7we know that 95% of possible outcomes fall within two standard deviations of the mean (average) value in a normal distribution. This means that there is a 5 percent chance that the stock price will move up or down by $10 or more. Since the normal distribution is symmetric, this means that there is only a 2.5 percent chance that Zippy's stock price will increase enough for it to become attractive for the investors to exercise the conversion option in the next year.

Par Value

ame as Face value or principal of the bond, returned to the bondholder at maturity, corporate bonds are issued at denominations of $1,000.

Cost allocation of an intangible asset is referred to as

amortization.

If your investment pays the same amount at the beginning of each year for a period of 10 years, the cash flow stream is called:

an annuity due.

The effective annual rate (EAR) will equal the annual percentage rate (APR) if interest is compounded:

annually.

Subordinated Debentures

are honored only after the claims of secured debt and unsubordinated debentures have been satisfied; are the riskiest of all bonds and carry a higher yield to maturity.

If a bond's coupon rate is equal to the market rate of interest, then the bond will sell:

at a price equal to its face value.

If a bond's coupon rate is equal to the market rate, then the bond will sell

at a price equal to its face value.

if a bond's coupon rate is greater than the market rate of interest, then the bond will sell

at a price greater than its face value

If a bond's coupon rate is greater than the market rate of interest, then the bond will sell:

at a price greater than its face value.

A mortgage agreement provides the lender with ________ interests.

Secured

What are over-the-counter markets (OTCs), and how do they differ from organized exchanges?

Securities that are not listed on an organized exchange are sold OTC. An OTC market differs from an organized exchange in that there is no central trading location. OTC security transactions are made via phone or computer as opposed to on the floor of an exchange.

Which of the following theories states that security prices reflect all public information, but not all private information?

Semistrong-form efficiency.

Anne Morgan wants to borrow $6,000 for a period of four years. She has two choices. Her bank is offering to lend her the amount at 7.25 percent compounded annually. She can also borrow from her firm and will have to repay a total of $8,130.93 at the end of four years. Should Anne go with her bank or the firm, and what is the interest rate if she borrows from her firm?

She should borrow from the bank as the bank is charging a higher interest of 8%.

Anne Morgan wants to borrow $6,100 for a period of four years. She has two choices. Her bank is offering to lend her the amount at 7.25 percent compounded annually. She can also borrow from her firm and will have to repay a total of $8,150.76 at the end of four years. Should Anne go with her bank or the firm, and what is the interest rate if she borrows from her firm?

She should borrow from the bank as the firm is charging a higher interest of 7.51%.

Investor A holds a 10-year bond, while investor B holds an 8-year bond. If interest rate increases by 1 percent, which investor has the higher interest rate risk? Explain.

Since A holds the longer-term bond, he or she will face the higher interest rate risk. Longer-term bonds are more price volatile than shorter-term bonds.

An investor holds a 10-year bond paying a coupon rate of 9 percent. The yield to maturity of the bond is 7.8 percent. Would you expect the investor to be holding a par-value, premium, or discount bond? What if the yield to maturity were 10.2 percent? Explain.

Since the bond's coupon of 9 percent is greater than the yield to maturity, the bond will be a premium bond. As market rates of interest drop below the coupon rate of the 9 percent bond, demand for the bond increases, driving up the price of the bond above face value. If the yield to maturity is at 10.2 percent, then the bond is paying a lower coupon than the going market rate and will be less attractive to investors. The demand for the 9 percent bond will decline, driving its price below the face value. This will be a discount bond.

You lent $100 to a friend for one year at a nominal rate of interest of 3 percent. Inflation during that year was 2 percent. Did you experience an increase or decrease in the purchasing power of your money? How much did it increase or decrease?

Since the interest rate that you received (3 percent) exceeded the rate of inflation, the amount that you received from your friend when the loan was repaid had greater purchasing power than $100. The amount by which the purchasing power increased can be calculated using Equation 2.1: 1 + i = (1 + r) × (1+ DPe) Solving for r yields: r = (1 + i)/(1 + DPe) - 1 r = (1 + 0.03)/(1 + 0.02) - 1 r = 0.0098, or 0.98% Therefore, the purchasing power increased by slightly less than 1 percent.

Which of the following investment classes had the greatest average return based on recent historical data?

Small U.S. Stocks

Given the historical information in the chapter, which of the following investment classes had the greatest average return?

Small US Stocks

What are some of the regulations that pertain to boards of directors that were put in place to reduce agency conflicts?

Some of the regulations include: - The majority of board members must be outsiders. - A separation of the CEO and chairman of the board positions is recommended. - Firm is required to have a code of ethics approved by the board.

Phoenix Industries has pulled off a miraculous recovery. Four years ago it was near bankruptcy. Today, it announced a $2 per share dividend to be paid a year from now, the first dividend since the crisis. Analysts expect dividends to increase by $1 a year for another 2 years. After the third year (in which dividends are $4 per share) dividend growth is expected to settle down to a more moderate long-term growth rate of 5%. If the firm's investors expect to earn a return of 17% on this stock, what must be its price?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. DIV1 = $2 DIV2 = $3 DIV3 = $4 g = 0.05 P3 = ($4 × 1.05) / (0.17 − 0.05) = $35.00 P0=$2/1.17 +$3/(1.17)^2 +$4 + $35.00/(1.17)^3 =$28.25

Steady As She Goes Inc. will pay a year-end dividend of $2.60 per share. Investors expect the dividend to grow at a rate of 6% indefinitely. a. If the stock currently sells for $26.00 per share, what is the expected rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. If the expected rate of return on the stock is 18.50%, what is the stock price? (Do not round intermediate calculations. Enter your answers rounded to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. a. P0=DIV1 / (r − g) $26=$2.60 / (r − 0.06) r=0.16, or 16% b. P0=DIV1 / (r − g) =$2.60 / (0.185 − 0.06) =$20.80

BMM Industries pays a dividend of $1.10 per quarter. The dividend yield on its stock is reported at 3.90%. What is the stock price?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. Dividend yield=Next annual dividend / Stock price =DIV1 / P0 0.039=($1.10 × 4) / P0 P0=$112.82

Favorita Candy's stock is expected to earn $4.40 per share this year. Its P/E ratio is 22. What is the stock price?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. P/E ratio=Price / Earnings per share 22.0=P0 / $4.40 P0=$96.80

Arts and Crafts, Inc. will pay a dividend of $7 per share in 1 year. It sells at $70 a share, and firms in the same industry provide an expected rate of return of 14%. What must be the expected growth rate of the company's dividends?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. P0 = DIV1 / (r − g) This formula can be rearranged to: r = DIV1 / P0 + g This states that the total rate of return is equal to the dividend yield plus the capital gains yield. You will find it useful to know both versions of this equation. r=DIV1 / P0 + g 0.14=$7 / $70 + g g=0.04, or 4%

Integrated Potato Chips just paid a $1.1 per share dividend. You expect the dividend to grow steadily at a rate of 5% per year. a. What is the expected dividend in each of the next 3 years? b. If the discount rate for the stock is 11%, at what price will the stock sell today? c. What is the expected stock price 3 years from now? d. If you buy the stock and plan to sell it 3 years from now, what are your expected cash flows in (i) year 1; (ii) year 2; (iii) year 3? e. What is the present value of the stream of payments you found in part (d)?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. DIV1=DIV0 × (1 + g) =$1.10 × 1.05 =$1.16 DIV2=DIV0 × (1 + g)2 =$$1.10 × 1.052 =$1.21 DIV2=DIV0 × (1 + g)3 =$1.10 × 1.053 =$1.27 b. To calculate P0, you must use DIV1 as the dividend must be one year ahead of the price: P0=DIV1 / (r - g) =($1.10 × 1.05) / (0.11 - 0.05) =$19.25 c. To calculate P3, you must use DIV4 as the dividend must be one year ahead of the price: P3=DIV4 / (r - g) =($1.10 × 1.054) / (0.11 - 0.05) =$22.28 d. Your payments will be the sum of dividends plus the sales price (in year 3): Year 1 DIV$1.16 Year 2 $1.21 Year 3 $1.27 Selling price $22.28 Total cash flow $1.16 $1.21 $23.56 e. Now we discount the cash flows using a discount rate of 11% Year 1 PV of cash flow $1.16 1.11 $1.04 Year 2 $1.21 1.11^2 $0.98 Year 3 $23.56 1.11^3 $17.23 Sum of PV = $19.25, the same as the answer to part (b).

No-Growth Industries pays out all of its earnings as dividends. It will pay its next $3 per share dividend in a year. The discount rate is 16%. a. What is the price-earnings ratio of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. What would the P/E ratio be if the discount rate were 10%? (Round your answer to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. Earnings = DIV1 = $3 Growth rate = g = 0 P0 =$3/0.16 − 0 = $18.75 P/E = $18.75 / $3 = 6.25 b. If r = 0.10 ⇒⇒ P0 =$3 /0.10 = $30 ⇒⇒ P/E increases to $30 / $3 = 10

You expect a share of stock to pay dividends of $1.70, $1.95, and $2.20 in each of the next 3 years. You believe the stock will sell for $29.00 at the end of the third year. a. What is the stock price if the discount rate for the stock is 20%? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. What is the dividend yield for year 1? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) c. What will be the dividend yield at the start of year 2? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. P0=DIV1 / (1 + r) + DIV2 / (1 + r)2 + (DIV3 + P3) / (1 + r)3 =$1.70 / 1.20 + $1.95 / 1.202 + ($2.20 + 29) / 1.203 =$20.83 Calculator computations: CF0 = $0 CO1 = $1.70, FO1 = 1 CO2 = $1.95, FO2 = 1 CO3 = $31.20, FO3 = 1 I = 10% NPV CPT = $20.83 b. Dividend yield=DIV1 / P0 =$1.70 / $20.83 =0.0816, or 8.16% C. P1=$1.95 / 1.20 + ($2.20 + $29) / 1.202 =$23.29 DIV2 / P1=$1.95 / $23.29 = 0.0837 =8.37%

Gentleman Gym just paid its annual dividend of $3 per share, and it is widely expected that the dividend will increase by 5% per year indefinitely. a. What price should the stock sell at if the discount rate is 12%. (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. What price should the stock sell at if the discount rate is 10%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. P0=DIV1 / (r − g) =[DIV0 × (1 + g)] / (r − g) =($3 × 1.05) / (0.12 − 0.05) =$45.00 b. P0=DIV1 / (r − g) =[DIV0 × (1 + g)] / (r − g) =($3 × 1.05) / (0.10 − 0.05) =$63.00

Trend-Line Inc. has been growing at a rate of 8% per year and is expected to continue to do so indefinitely. The next dividend is expected to be $3 per share. a. If the market expects a 10% rate of return on Trend-Line, at what price must it be selling? (Do not round intermediate calculations.) b. If Trend-Line's earnings per share will be $10 next year, what part of its value is due to assets in place? (Do not round intermediate calculations.) c. If Trend-Line's earnings per share will be $10 next year, what part of its value is due to growth opportunities? (Do not round intermediate calculations.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. P0=DIV1 / (r − g) =$3 / (0.10 − 0.08) =$150 b. If Trend-Line followed a zero-plowback strategy, it could pay a perpetual dividend of $10. Its value would be: P=DIV / r =$10 / 0.10 =$100 c. The remainder of its value must be due to growth opportunities, so: PVGO=$150 - 100 =$50

Fincorp will pay a year-end dividend of $3.90 per share, which is expected to grow at a rate of 2% for the indefinite future. The discount rate is 12%. a. What is the stock selling for? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. If earnings are $4.20 a share, what is the implied value of the firm's growth opportunities? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. P0=DIV1 / (r − g) =$3.90 / (0.12 − 0.02) =$39.00 b. No-growth value = E / r = $4.20 / 0.12 = $35.00 PVGO = P0 − No-growth value = $39 − 35.00 = $4.00

Castles in the Sand generates a rate of return of 20% on its investments and maintains a plowback ratio of 0.30. Its earnings this year will be $5 per share. Investors expect a rate of return of 15% on the stock. a. Find the price and P/E ratio of the firm. (Do not round intermediate calculations. Round your answers to 2 decimal places.) b. Find the price and P/E ratio of the firm if the plowback ratio is reduced to 0.20. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a. g = 20% × 0.30 = 6% P0 = $5(1 − 0.30) / (0.15 − 0.060) = $38.89 P/E = $38.89 / $5 = 7.78 b. g = 20% × 0.20 = 4% P0 = $5(1 − 0.20) / (0.15 − 0.04) = $36.36 P/E = $36.36 / $5 = 7.27 P/E falls because the firm's value of growth opportunities is now lower: It takes less advantage of its attractive investment opportunities.

Web Cites Research projects a rate of return of 20% on new projects. Management plans to plow back 20% of all earnings into the firm. Earnings this year will be $6 per share, and investors expect a rate of return of 12% on stocks facing the same risks as Web Cites. a. What is the sustainable growth rate? b. What is the stock price? c. What is the present value of growth opportunities (PVGO)? d. What is the P/E ratio? e. What would the price and P/E ratio be if the firm paid out all earnings as dividends?

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations. a.g = ROE × Plowback ratio = 20% × 0.20 = 4.00% b. EPS = $6, r = 0.12 P0 =$6 × (1 − 0.20)/ 0.12 − 0.04 =$60.00 c. No-growth value = EPS / r = $6 / 0.12 = $50.00 PVGO = P0 − No-growth value = $60 − $50 = $10.00 d. P/E = $60 / $6 = 10.00 e. If all earnings were paid as dividends, price would equal the no-growth value ($50) and P/E would be $50 / $6 = 8.33.

Explain whether or not each of the following statements is correct. a. A 15-year mortgage will have larger monthly payments than a 30-year mortgage of the same amount and same interest rate. b. If an investment pays 10 percent interest compounded annually, its effective rate will also be 10 percent.

Statement A is a true statement. The 15-year mortgage will have higher monthly payments since more of the principal will have to be paid each month than in the case of a 30-year mortgage. Statement B is true since the frequency of compounding is annual and hence the rate for a single period is the same as the rate for a year.

Stock A and Stock B are both priced at $50 per share. Stock A has a P/E ratio of 17, while Stock B has a P/E ratio of 24. Which is the more attractive investment, considering everything else to be the same, and why?

Stock A is the more attractive investment because it has a lower P/E ratio. The lower the P/E ratio, the larger the amount of earnings supporting the stock price. This makes Stock A a more attractive investment than Stock B.

What is the difference between stockholders and stakeholders?

Stockholders, also referred to as shareholders, are the owners of the company. A stakeholder, on the other hand, is anyone with a claim on the assets of the firm, including, but not limited to, shareholders. Stakeholders include the firm's employees, suppliers, creditors, and the government.

Which one of the following statements is NOT true?

Strong-form market efficiency implies that investors who have access to inside or private information will be able to earn abnormal returns.

What is strong-form market efficiency? Semistrong-form market efficiency? Weak-form market efficiency?

Strong-form market efficiency is a market in which all information, private and public, is reflected in the price of the security. The semistrong-form of market efficiency suggests that only public information is reflected in a security's price, while the weak-form of market efficiency holds that only information contained in the past price of a security is reflected in its current price (it does not reflect public or private information).

Which one is riskier (rank them from highest to lowest): Debentures , subordinated debentures, Mortgage bonds?

Subordinated debentures, debentures, mortgage bonds

An annuity due can use the ordinary annuity table if one extra period is added and

Subtract one payment from total value

Explain how compound interest differs from simple interest.

Suppose I invest $100 for three years at a rate of 10 percent. Simple interest would imply that I will earn $10 for each of the three years for a total of $30 interest. At the end of three years I would have $130. Compound interest recognizes that the interest earned in years 1 and 2 will also earn interest over the remaining period. Thus, the $10 earned in the first year would earn interest at 10 percent for the next two years, and the $10 earned in the second year would earn interest for the third year. Thus the total amount that I would have at the end of three years would be: . By compounding, I have earned additional interest of $3.10. The total compound interest is the $33.10 earned on the $100 invested, while the simple interest earned is equal to $30.00.

What is the Fisher equation, and how is it used?

The Fisher equation reflects the expected, not the reported or actual, annualized change in commodity prices (∆Pe). It is used to protect the buying power from changes in inflation, and it is incorporated into a loan contract by including the real interest rate that would exist in the absence of inflation.

Which of the following statements about IRR is false?

The IRR is the discount rate that makes the NPV greater than zero.

Management of Sunland Measures, Inc., is evaluating two independent projects. The company uses a 10.06 percent discount rate for such projects. The costs and cash flows for the projects are shown in the following table. Year Project 1 Project 2 0. - $9,010,103. - $12,929,629 1 3,309,890 2,281,630 2 1,709,190 3,693,490 3 1,477,200 3,433,680 4 1,092,600 3,936,300 5 1,293,180 4,145,580 6 1,499,140 7 1,301,690 a. What are the IRRs for the projectS? b. Does the IRR criterion indicate a different decision than the NPV criterion?

The IRR of Project 1 is 8.31%, and the IRR of Project 2 is 10.11% No.

Sheridan, Inc., a resort management company, is refurbishing one of its hotels at a cost of $7,156,793. Management expects that this will lead to additional cash flows of $1,650,000 for the next six years. What is the IRR of this project? If the appropriate cost of capital is 12 percent, should Sheridan go ahead with this project?

The IRR of this project is 10.14% Reject

Management of Cullumber, Inc., an aviation firm, is considering purchasing three aircraft for a total cost of $183,899,219. The company would lease the aircraft to an airline. Cash flows from the proposed leases are shown in the following table. Years. Cash Flow 1-4. $29,225,000 5-7. 86,690,000 8-10. 69,690,000. What is the IRR of this project?

The IRR of this project is 22.56%

If the investors' required rate of return is constant all the time, then the shorter the time to maturity,:

The LOWER THE PRICE OF THE BOND if the bond is sold at premium

What is NASDAQ?

The NASDAQ system is one of the largest electronic stock markets in the world, listing over three thousand companies. It was created in 1971 by the National Association of Securities Dealers.

Sandhill Industries management is planning to replace some existing machinery in its plant. The cost of the new equipment and the resulting cash flows are shown in the accompanying table. The firm uses an 18 percent discount rate for projects like this. Should management go ahead with the project? Year. Cash Flow 0. -$3,100,100 1. 874,910 2. 942,400 3. 1,202,000 4. 1,294,560 5. 1,541,800 What is the NPV of this project? Should management go ahead with the project?

The NPV is $391,395The firm should accept the project.

Crane Corp. management is planning to spend $650,000 on a new marketing campaign. They believe that this action will result in additional cash flows of $339,000 each year for three years. If the discount rate is 17.5 percent, what is the NPV on this project?

The NPV is $93,023

What is the annuity transformation method?

The annuity transformation method refers to the conversion of an ordinary annuity to annuity due. In this process, you first plot all the cash flows on a time line as if the cash flows were an ordinary annuity. Then you calculate the present or future value factor as you would with an ordinary annuity, and finally, you multiple your answer by (1 + i). Conveniently, this relationship works for both present and future value calculations.

What is the appropriate goal of financial managers? How do managers' decisions affect how successful the firm is in achieving this goal?

The appropriate goal of financial managers should be to maximize the current value of the firm's stock price. Managers' decisions affect the stock price in many ways as the value of the stock is determined by the future cash flows the firm can generate. Managers can affect the cash flows by, for example, selecting what products or services to produce, what type of assets to purchase, or what advertising campaign to undertake.

What is the primary responsibility of the board of directors in a corporation?

The board of directors of a corporation is responsible for serving the interests of stockholders in managing the corporation. It is possible that the interest of managers may deviate from those of the stockholders. The board's objective is to monitor and correct any management decisions that might not be in the best interest of the stockholders. For example, board duties include hiring and firing the CEO, setting CEO pay, and monitoring the investment decisions of managers.

The Corner Grocer has a 7-year, 6 percent annual coupon bond outstanding with a $1,000 par value. The bond has a yield to maturity of 5.5 percent. Which one of the following statements is correct if the market yield suddenly increases to 7 percent?

The bond price will decrease by 8% find each pv then do % change formula to find -8.00 change

Why are capital budgeting decisions among the most important decisions in the life of a firm?

The capital budgeting decisions are considered the most important in the life of the firm because these decisions determine which productive assets the firm purchases and these assets generate most of the firm's cash flows. Furthermore, capital budgeting decisions are long-term decisions and if you make a mistake in selecting a productive asset, you are stuck with the decision for a long time.

Define interest rate risk. How can the CFOs manage this risk?

The change in a bond's prices caused by changes in interest rates is called interest rate risk. In other words, we can measure the interest rate risk to a bond's investor by measuring the percentage change in the bond's price caused by a 1 percent change in the market interest rates. The key to managing interest rate risk is to understand the relationships between interest rates, bond prices, the coupon rate, and the bond's term to maturity. Portfolio managers need to understand that as interest rates rise bond prices decline, and it declines more for low-coupon bonds and longer-term bonds than for the others. In such a scenario, bond portfolio managers can reduce the size and maturity of their portfolio to reduce the impact of interest rate increases. When interest rates decline, bond prices increase and rise more for longer-term bonds and higher coupon bonds. At such times, CFOs can increase the size and maturity of their portfolios to take advantage of the inverse relationship between interest rates and bond prices.

What are the common forms of business organization discussed in this chapter?

The common forms of business organization discussed are sole proprietorship, partnership, corporation, and limited liability company and partnership.

Explain why the growth rate g must always be less than the rate of return R for the constant-growth rate model?

The constant-growth rate model assumes that the firm will grow at a constant rate forever. Any growth rate that is greater than this sum would imply that the firm will eventually take over the entire economy. This is of course not possible. Mathematically, according to the model, if g becomes greater than R, then the value of the stock would be negative.

What is the correct way to annualize an interest rate in financial decision making?

The correct way to annualize interest rates is by computing the effective annual interest rate (EAR). This is the annual growth rate that allows for compounding, which means you earn interest on interest. To calculate the EAR, take the quoted rate and divide it by the number of compounding periods (quoted rate/m). Then take the resulting interest rate, add 1 to it, and raise it to the power equal to m. Finally, subtract 1 and the result is EAR. Show formula: SEE IMAGE

Explain conceptually how bonds are priced.

The current price of a bond is equal to the present value of all the cash flows that will be received from the investment. There are two sets of cash flows from a bond investment. First, there are the coupon payments to be received either annually or semiannually throughout the life of the bond. Second, there is the principal or face value of $1,000 that will be received when the bond matures. In order to find the price of the bond, we must find the present value of the coupons and the present value of the face value. We do this by discounting the entire cash flow stream at the current market rate and adding them up. This gives us the current price of the bond. Recognize that the coupons represent an annuity and that we can use the equation for the present value of an annuity from Chapter 6 to calculate the present value of this cash flow stream.

What is the discount rate? How does the discount rate differ from the interest rate in the future value equation?

The discount rate is the rate of return used in a discounted cash flow analysis to determine the present value of future cash flows. Both discount and interest rates essentially represent the same concept. The only difference is the context in which they are used.

Which of the following statements is NOT true about constant-growth stocks?

The dividends grow at a constant rate from one period to the next forever.

What is the difference between simple interest and compound interest?

The effect of compounding, where interest is earned on interest, makes an investment grow to a larger value than it would if it only paid simple interest. Simple interest is interest earned only on the original principal.

What are the major factors that affect a firm's stock price?

The factors affecting the stock price include: the characteristics of the firm, the economy, economic shocks, the business environment, expected cash flows, and current market conditions.

What are the two factors to be considered in time value of money?

The factors that are critical in time value of money are the size of the cash flows and the timing of the cash flows.

What are some of the working capital decisions that a financial manager faces?

The financial manager must make working capital decisions regarding the level of inventory to hold, the terms of granting credit (accounts receivable), and the firm's policy on paying accounts payable.

Why are direct financial markets also called wholesale markets?

The financial markets are also called wholesale markets because the minimum transaction or security denomination is $1 million or more.

Why is it difficult for individuals to participate in the direct financial markets?

The financial markets where direct transactions take place are wholesale markets with a typical minimum transaction size of $1 million. Major buyers and sellers of securities in direct financial markets include commercial banks, large corporations, the federal government, hedge funds, and some wealthy individuals.

Identify three financial officers who typically report to the CFO and describe their duties.

The financial officers discussed in the chapter who report to the CFO are the controller, the treasurer, and the internal auditor. The controller is the firm's chief accounting officer, and thus prepares the financial statements and taxes. This position also requires close cooperation with the external auditors. The treasurer's responsibility is the collection and disbursement of cash, investing excess cash, raising new capital, handling foreign exchange, and overseeing the company's pension fund management. (S)he also assists the CFO in handling important Wall Street relationships. Finally, the internal auditor is responsible for conducting risk assessment and for performing audits of high-risk areas.

What is the fundamental determinant of an asset's value?

The fundamental determinant of an asset's value is the future cash flow the asset is expected to generate. Other factors that may help determine the price of an asset are internal decisions, such as the company's expansion strategy, as well as external stimulants, such as the state of the economy.

Which of the following statements about the time value of money is true?

The further in the future you receive a dollar, the less it is worth today.

Which of the following statements is true about the future value of an investment?

The future value of an investment will be larger if the investment is for 12 years instead of 6 years.

If you were given a choice between investing in a savings account that paid quarterly interest and one that paid monthly interest, which one should you choose if they both offered the same stated interest rate and why?

The impact of compounding dictates that one should pick the account that pays interest more frequently (as long as the interest rates are the same). This allows for the interest earned in the earlier periods to earn interest and the investment to grow more.

What is the difference between the interest rate (i) and the growth rate (g) in the future value equation?

The interest rate and the growth rate in the future value equation essentially represent the same concept. The growth rate is used when we deal with numerical values such as sales or change over time. When referring to money being invested, we use the term interest rate.

Why does the internal auditor report to both the CFO and the board of directors?

The internal auditor reports to the CFO on a day-to-day basis but is ultimately accountable for reporting any accounting irregularities to the board of directors. The dual reporting system serves as a check to ensure that there are no discrepancies in the company's financial statements.

Generally, the future value of an investment will be greater if

The investment is compounded at a higher rate of return

Generally, the future value of an investment will be greater if:

The investment is compounded at a higher rate of return.

What are the key factors that most affect the level and shape of the yield curve?

The key factors that most affect the shape of the yield curve are the real rate of interest, the expected rate of inflation, and interest rate risk. If the future real rate of interest is expected to rise, it will result in an upward slope of the real rate of interest and consequently in an upward bias to the market yield curve. Similarly, increasing the expected rate of inflation will result in an upward-sloping yield curve, because long-term interest rates will contain a larger inflation premium than short-term interest rates. If these two variables are expected to decline in the future, the result will be a downward bias to the yield curve. In contrast, the longer a bond's maturity, the greater the bond's interest rate risk. Thus, interest rate risk premium always adds an upward bias to the slope of the yield curve, since the longer the maturity of a security, the greater its interest rate risk.

Which ONE of the following statements is true?

The largest investors in corporate bonds are life insurance companies and pension funds. AND The market for corporate bonds is thin. AND Prices in the corporate bond market also tend to be more volatile.

Explain why preferred stock is considered to be a hybrid of equity and debt securities.

The law considers preferred stock as equity. Thus, holders are treated as the firm's owners. Also, like common stockholders, preferred stockholders have to pay taxes on their dividend income. However, preferred stockholders do not have any voting rights. In addition, they receive only a fixed dividend just like bondholders. If a firm is liquidated, then they receive a stated value (par value) similar to bondholders. Preferred stock is rated by credit rating agencies just like bonds. Some preferred issues are convertible to the firm's common stock just as convertible bonds. Some preferred issues are not perpetual and have a fixed maturity just like bonds. Thus preferred stock is a hybrid security—like equity in some ways and like debt security in others.

Indenture

The legal agreement between the firm issuing the bond and the trustee who represents the bondholders, Provides for specific terms of the loan agreement.

Maturity

The length of time until the bond issuer returns the par value to the bondholder and terminates or redeems the bond. It is usually $1,000 per bond.

Which ONE of the following statements is true?

The longer the maturity of a security, the greater its interest rate risk.

Which of the following statements is true?

The longer the maturity of a security, the greater its interest rate risk.

Which of the following statements is true?

The longer the time period that funds are invested, the greater the future value.

Which of the following statements is true?

The lower the transaction costs are, the greater a security's marketability. AND The interest rate, or yield, on a security varies with its degree of marketability. AND U.S. Treasury bills have the largest and most active secondary market and are considered to be the most marketable of all debt securities.

Which ONE of the following statements is true?

The lower the transaction costs are, the greater a security's marketability. AND The interest rate, or yield, on a security varies inversely with its degree of marketability. AND U.S. Treasury bills have the largest and most active secondary market and are considered to be the most marketable of all securities.

What are some advantages and disadvantages of operating as a public corporation?

The main advantages of operating as a public corporation are the access to the public securities markets, which makes it easier to raise large amounts of capital, and the ease of ownership transfer. All the shareholders have to do is to call their broker to buy or sell shares of stock. And because a public corporation usually has many shares outstanding, large blocks of securities can be purchased or sold without an appreciable impact on the price of the stock. The major disadvantage of corporations is the tax situation. Not only must the corporation pay taxes on its income, but the owners of the corporation get taxed again when dividends are paid to them. This is referred to as double taxation. In addition to taxes, public corporations are subject to stringent reporting requirements, and the incentives may convince managers to focus on shorter-term profitability than longer-term wealth creation.

List the major stock market indexes, and explain what they tell us.

The major U.S. Stock market indexes are the Dow Jones Industrial Average, New York Stock Exchange, Standard & Poor's 500 Index, and NASDAQ Composite Index. A stock market index is essentially a listing of stocks that bear some commonality, such as being traded on the same market exchange. They are used to measure the stock market performance and many are used to benchmark the performance of portfolios, such as mutual funds.

What are the main differences between the corporate bond markets and stock markets?

The market for corporate bonds is very large, but smaller than the corporate equity market in the U.S. Most secondary market transactions involving corporate bonds take place in the over-the-counter market, making the corporate bond market thin relative to the more organized equity markets. Prices in the corporate bond market also tend to be more volatile than prices of securities sold in markets with greater trading volumes. This is because a few large trades can have a larger impact on a security's price than numerous trades of various sizes. The biggest investors in corporate bonds are mutual funds, life insurance companies, and pension funds, and given the size of these investors, the trades are conducted in much larger blocks than in the stock market.

Discount

The market value of a bond will be below the par or face when the investor's required rate is greater than the coupon interest rate. The bond will sell at a discount or below face value. Here the YTM would be larger than the current yield and larger than the coupon rate.

How does changing the compounding period affect the amount of interest earned on an investment?

The more frequent the compounding schedule, the higher the interest earned. For example, $100 invested for one year at 10 percent compounded annually will earn you $10 of interest at the end of the year, but if your bank compounded interest quarterly, your earnings from interest would increase to $10.38.

How are inflationary expectations accounted for in the nominal rate of interest?

The nominal interest rate is the rate that is actually observed in the financial markets, and it is equal to the real interest rate plus the expected annualized changes in commodity prices, or inflation premium. This is commonly referred to as the Fisher effect.

How does the nominal rate of interest vary over time?

The nominal rate is the rate that we observe in the marketplace. It is determined by both the real rate as well as expected inflation. Therefore, the nominal rate will fluctuate with changes in the real rate as well as changes in expected inflation.

Shouldn't the nominal rate of interest (Equation 2.1) be determined by the actual rate of inflation (∆Pa), which can be easily measured, rather than by the expected rate of inflation (∆Pe)?

The nominal rate of interest is a forward-looking measure, and therefore it makes sense that it is using the expected rate of inflation as opposed to the actual rate of inflation. The expected rate of inflation is the market's best estimate of what the inflation rate will be in the future.

How does Exhibit 2.5 help explain why interest rates were so high during the early 1980s as compared to the relatively low interest rates in the early 1960s?

The nominal rate of interest is determined by the real rate of interest plus the expected rate of inflation, and during the 1980s, the U.S. economy experienced a very high rate of inflation and, thus, high interest rates. Looking at Exhibit 2.5, we can see that the inflation increased from less than 2 percent in the 1960s to almost 13 percent in the 1980s. This was a result of the monetary policy instituted by the U.S. government during this period of time.

When are the nominal and real interest rates equal?

The only time the nominal and real interest rates are equal is when the expected rate of inflation over the contract period is zero.

Who are the owners in a corporation, and how is their ownership represented?

The owners of a corporation are its stockholders or shareholders, and the evidence of their ownership is represented by shares of common stock. Other types of ownership do exist and include preferred stock.

Which of the following is the most typical example of a zero-growth dividend stock?

The preferred stock of a utility company.

What is the relation between the present value factor and the future value factor?

The present value factor is the reciprocal of the future value factor. To obtain the present value factor, you divide 1 by the future value factor (1 + i)^n.

Raymond Bartz is trying to choose between two equally risky annuities, each paying $5,000 per year for five years. One is an ordinary annuity, the other is an annuity due. Which of the following statements is most correct? a. The present value of the ordinary annuity must exceed the present value of the annuity due, but the future value of an ordinary annuity may be less than the future value of the annuity due. b. The present value of the annuity due exceeds the present value of the ordinary annuity, while the future value of the annuity due is less than the future value of the ordinary annuity. c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity. d. If interest rates increase, the difference between the present value of the ordinary annuity and the present value of the annuity due remains the same.

The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity. The answer is c. The present value of the annuity due exceeds the present value of the ordinary annuity, and the future value of the annuity due also exceeds the future value of the ordinary annuity.

Compare an annuity due with an ordinary annuity. The payments for both are made annually and are of the same dollar amounts. The two annuities also have the same duration in years and the same discount rate. Which of the following statements is /are correct? a. The present value of the ordinary annuity is greater. b. The present value of the annuity due is greater. c. The future value of the ordinary annuity is greater. d. The future value of the annuity due is greater.

The present value of the annuity due is greater. The future value of the annuity due is greater. b and d are both correct The cash flows of the annuity due are received at the beginning of the period, resulting in less discounting and a higher PV and more compounding and a higher FV.

You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the yield to maturity is expected to remain constant. Which of the following statements is CORRECT?

The price of Bond A will decrease over time, but the price of Bond B will increase over time.

Given a change in market interest rates, which will change more; the market price of a bond with 20 years until maturity or the market price of a bond with 5 years until maturity? Assume all the characteristics of these bonds are identical except the maturity dates.

The price of the bond with 20 years to maturity will change more. The cash flows from the longer term bond are paid further in the future. As a result, these cash flows are more heavily discounted and therefore more sensitive to interest rate changes.

What does the price-earnings ratio tell us?

The price-earnings ratio is the firm's current price divided by the current earnings. When valuing a company's stock, it is useful to look at a company's P/E ratio and compare it to that of similar firms. In general, a high P/E ratio means high projected earnings in the future. In addition, it also tells us how much investors are willing to pay per dollar of earnings.

What are the three fundamental decisions the financial manager is concerned with, and how do they affect the firm's balance sheet?

The primary financial management decisions every company faces are capital budgeting decisions, financing decisions, and working capital management decisions. Capital budgeting addresses the question of which productive assets to buy; thus, it affects the asset side of the balance sheet. Financing decisions focus on raising the money the firm needs to buy productive assets. This is typically accomplished by selling long-term debt and equity. Finally, working capital decisions involve how firms manage their current assets and liabilities. The focus here is seeing that a firm has enough money to pay its bills and that any spare money is invested to earn a return.

Explain the difference between compounding and discounting.

The process of converting an amount given at the present time into a future value is called compounding. It is the process of earning interest over time. Discounting is the process of converting future cash flows to their current or present value. In other words, present value is the current value of future cash flows that are discounted at an appropriate interest rate.

In order to use the WACC to evaluate a future project's flows, which of the following must hold?

The project will be financed with the same proportion of debt and equity as the firm. AND The systematic risk of the project is the same as the overall systematic risk of the firm.

Assume that potential projects X, Y and Z will each pay a total of $100,000 over 20 years. X pays $8,000 per year for 10 years and $2,000 per year for 10 years. Y pays $2,000 per year for 10 years and $8,000 per year for 10 years. Z pays $5,000 per year for 20 years. Which project is likely to be most attractive to an investor?

The project with large cash flows early is likely to be most attractive.

Crane Corp. management is planning to convert an existing warehouse into a new plant that will increase its production capacity by 45 percent. The cost of this project will be $9,003,696. It will result in additional cash flows of $2,167,200 for the next eight years. The discount rate is 10.43 percent. a. What is the payback period? b. What is the NPV for this project? c. What is the IRR?

The project's payback period is 4.16 years. The project's NPV is $2,379,366. The project's IRR is 17.40%.

Explain how the real rate of interest is determined.

The real rate of interest depends on interaction between the rate of return that businesses can expect to earn on investments in capital goods and savers' time preference for consumption today versus willingness to save. Therefore, the real rate of interest is determined when the desired saving level equals the desired level of investment.

What is the real rate of interest, and how is it determined?

The real rate of interest measures the return earned on savings, and it represents the cost of borrowing to finance capital goods. It is the interest rate determined in the absence of inflation. The real rate of interest is determined by the interaction between firms that invest in capital projects and the rate of return businesses can expect to earn on investments in capital goods, and individuals' time preference for consumption. Graphically, it is that point when the desired saving level equals the desired level of investment in the economy.

When determining the real interest rate, what happens to businesses that find themselves with unfunded capital projects whose rate of return exceeds the cost of capital?

The real rate of interest reflects a complex set of forces that control the desired level of lending and borrowing in the economy. In this example, businesses are not investing in projects where the rate of return exceeds the cost of capital. This means that there is reduced demand for investment funds at the current real interest rate. This will remain so until either the real interest rate changes or until something changes for the firm such as introducing a new technology that will increase the rate of return on projects for the firm.

Which one of the following statements is NOT true?

The relationship between yield and marketability is known as the term structure of interest rates.

Cost of Equity (Re)

The return that equity investors require on the firm. Must be estimated; use div growth model RE = D1 / P0 + g

If you were to compare the returns of an individual stock to a market index, select the answer below that is most true.

The returns of the individual stock will show more variability than those of the market index.

Why are investors and managers concerned about stock market efficiency?

The role of secondary markets is to bring buyers and sellers together. Ideally, we would like stock markets to be as efficient as possible. Markets are efficient when current market prices of securities traded reflect all available information relevant to the security. If this is the case, security prices will be near or at their true value. The more efficient the market, the more likely this is to happen. This makes it easier for managers to price the stocks close to their intrinsic value. What investors are most concerned about is having complete information regarding a stock's current price and where that price information can be obtained. Efficient markets allow them to trade at prices that are closer to the true value than otherwise possible. Thus, both investors who provide funds and managers (firms) who raise money are concerned when high transaction costs lead to inefficient markets.

What is the role of the financial system, and what are the two major components of the financial system?

The role of the financial system is to gather money from businesses and individuals who have surplus funds and channel funds to those who need them. The financial system consists of financial markets and financial institutions.

Which of the following represents a plot of the relation between expected return and systemic risk?

The security market line

Describe the informational differences that distinguish the three forms of market efficiency.

The strong-form of market efficiency states that all information is reflected in the security prices. In other words, there is no private or inside information, that if released would potentially change the price. The semistrong-form holds that all public information available to investors is reflected in the security's price. Therefore, insiders with access to private information could potentially profit from trading on this knowledge before it becomes public. Finally, the weak-form of market efficiency holds that there is both public and private information that is not reflected in the security's price and having access to it can lead to abnormal profits.

List the three main objectives of the Sarbanes-Oxley Act.

The three main goals of the Sarbanes-Oxley Act are to reduce agency costs in corporations, to restore ethical conduct in the business sector, and to improve the integrity of accounting reporting systems within firms.

What are the three most basic types of financial decisions managers must make?

The three most basic decisions each business must make are the capital budgeting decision, the financing decision, and the working capital management decision. These decisions determine which productive assets to buy, how to pay for or finance these purchases, and how to manage the day-to-day financial matters so the company can pay its bills.

Which of the above investments has the highest effective annual interest rate (EAR)? a. 7.12 percent interest compounded monthly b. 7.62 percent interest compounded annually c. 7.32 percent interest compounded quarterly

The three-year bank CD paying 7.62 percent interest compounded annually has the highest effective yield.

Rule of 72

The time required for a sum of money to double at a compound interest rate is approximately 72/x years

What are the two basic mechanisms through which funds flow through the financial system, and how do they differ?

The two basic mechanisms are the direct financing mechanism and the indirect financing mechanism. In the direct financing mechanism, issuers of securities (borrower-spenders) sell the securities directly to investors (lender-savers). In the indirect financing mechanism, financial institutions aggregate money from lender-savers and make this capital available through loans to borrower-spenders.

Which one of the following statements about bond price is NOT true?

The value, or price, of any asset is the future value of its cash flows.

Which one of the following statements about bonds is NOT true?

The value, or price, of any asset is the future value of its cash flows.

QN=213 (20462)54 Which of the following are aspects of independent projects?

Their cash flows are unrelated.

Which of the following statements is CORRECT?

There are 2 different ways to calculate a bond's return. The main difference is with the life-span of the bond. If an issuer can call its bonds early, the relevant return calculation is the yield to call. However, if an issuer cannot call its bonds, the relevant return calculation is the yield to maturity.

What are the two basic ways in which funds flow through the financial system from lender-savers to borrower-spenders?

There are two basic mechanisms by which funds flow through the financial system: 1) Funds can flow directly through financial markets, and (2) funds can flow indirectly through financial institutions.

Which of the following statement is correct?

There is a negative relation between changes in the level of interest rates and changes in the price of a bond.

Which of the following statements about the payback method is true?

There is no economic rational that links the payback method to shareholder wealth maximization.

Explain the importance of a time line.

Time lines are important tools used to analyze investments that involve cash flow streams over a period of time. They are horizontal lines that start at time zero (today) and show cash flows as they occur over time. Because of time value of money, it is crucial to keep track of not only the size, but also the timing of the cash flows.

Intrinsic Value

To buy or not to buy depends upon the intrinsic (calculated) value of the bond. Two investors can have different intrinsic values. If you decide not to buy the bond, it implies your intrinsic value is larger than the person whose value is lower.

Explain how to calculate the present value of a stream of cash flows.

To calculate the present value of a stream of cash flows, you should first draw a time line so that you can see that each cash flow is placed in its correct time period. Then you simply calculate the present value of each cash flow for its time period, and finally you add up all the present values.

Which of the following statement is correct?

To compute a bond's price, one needs to calculate the present value of the bond's expected cash flows.

Which ONE of the following statements is true?

To secure the conversion option on a bond, bondholders would be willing to pay a premium. AND The conversion ratio is set so that the firm's stock price must appreciate 15 to 20 percent before it is profitable to convert bonds into equity. AND Convertible bonds can be converted into shares of common stock at some predetermined ratio at the discretion of the bondholder.

Trader Inc.is a $300 million company, as measured by asset value, and Horst Corp. is a $35 million company. Both are privately held corporations. Explain which firm more likely to go public and register with the SEC, and why.

Trader Inc. is more likely to go public because of its larger size. Though the cost of SEC registration and compliance is very high, larger firms can offset these costs by the lower funding cost in public markets. Smaller companies find the cost prohibitive for the dollar amount of securities they sell.

What are the main types of securities in the money markets?

Treasury bills, bank negotiable CDs, and commercial paper.

Free cash flow equals cash flow from operations minus required investments.

True

Incremental cash flow from operations is the cash flow from a project that is expected to be generated after all operating expenses and taxes have been paid.

True

Nominal interest rates incorporate the expected rate of inflation.

True

Opportunity costs should always be included in the cash flow calculations of a project.

True

Terminal-year free cash flows may differ from the cash flows provided in the typical year of a project for reasons such as the return/repayment of increases/reductions in additional working capital in the prior years.

True

The MACRS depreciation tax schedule for three-year equipment provides a depreciation rate for a total of four years.

True

The existing stock of space cannot be adjusted in the short run, but can be increased or decreased in the long run.

True

The face or par value for most corporate bonds is equal to $1,000, and it is the principal amount owed to bondholders at maturity.

True

The future value of an ordinary annuity is less than the future value of an annuity due

True

The future value of an ordinary annuity is less than the future value of an annuity due.

True

The higher the discount rate, the lower the present value of a future cash flow.

True

The higher the interest rate on an investment, the more money that is accumulated for any time period.

True

The higher the rate of interest, the more likely you will elect to invest your funds and forego current consumption.

True

The more frequently the interest payments are compounded, the larger the future value of $1 for a given time period.

True

The present value can be thought of as the discounted value of a future amount.

True

The present value of an investment of $1,000 to be received in three years at a discount rate of 10 percent is $751.31.

True

The risk that the lender may not receive payments as promised is called default risk.

True

The stand-alone principle says that we can treat a project as if it were a stand-alone firm that has its own revenue, expenses, and investment requirements.

True

The term incremental in the context of incremental after-tax free cash flows refers to the fact that the firm's total after-tax free cash flows will change if the new project is adopted.

True

The value, or price, of any asset is the present value of its future cash flows

True

The APR represents the

True effective annual rate of interest charged by seller

If the market is strong-form efficient, then trading on tips you hear from Jim Cramer (the host of Mad Money on CNBC) will generate no excess returns (i.e., returns in excess of fair compensation for the risk you are bearing). True or false?

True. If the market is strong-form efficient then all new information gets reflected in stock prices very quickly. In such a market, there is nothing you will hear from Jim Cramer on his TV show that will enable you to consistently earn excess returns. The information in his tips will already be reflected in stock prices by the time you can trade on them.

Bonds

Type of debt or long-term promissory note, issued by a borrower, promising to its holder a predetermined and fixed amount of interest per year.

Under which of the following discounting methods will the present value of an investment be the highest, assuming the same annual interest rate?

Under the yearly discounting methods, the present value of an investment will be highest.

Why is the effective annual rate (EAR) superior to the annual percentage rate (APR) in measuring the true economic cost or return?

Unlike the APR, which reflects annual compounding, the EAR takes into account the actual number of compounding periods. For example, suppose there are two investment alternatives that both pay an APR of 10 percent. Assume that the first pays interest annually and that the second pays interest quarterly. It would be a mistake to assume that both investments will provide the same return. The real return on the first one is 10 percent, but the second investment actually provides a return of 10.38 percent because of the quarterly compounding. Thus, this is the superior investment.

If the nominal rate of interest is 4.25 percent and the expected rate of inflation is 1.75 percent, what is the real rate of interest?

Using the Fisher equation: i = r + ∆Pe + r ∆Pe where i = 0.0425 and ∆Pe = 0.0175 Solving for r, we get r = 0.02457, or 2.457%

The difference between the existing stock of space and the equilibrium occupancy is known as

Vacancy

Ten-year zero coupon bonds issued by the U.S. Treasury have a face value of $1,000 and interest is compounded semiannually. If similar bonds in the market yield 9.4 percent, what is the value of these bonds?

Value of bond. $399.09

Carla Vista Corp. is expected to grow rapidly at a rate of 35 percent for the next seven years. The company's first dividend, to be paid three years from now, will be $5. After seven years, the company (and the dividends it pays) will grow at a rate of 9.4 percent. What is the value of Carla Vista stock with a required rate of return of 14 percent?

Value of stock. $180.41

Portfolio Beta is the ______________ average of the Betas of the investments included in the portfolio.

Weighted

The time value of money refers to the issue of:

What the value of the stream of future cash flows is today

Define annuity due. Would an investment be worth more if it were an ordinary annuity or an annuity due? Explain.

When annuity cash flows occur at the beginning of each period, it is called an annuity due. Annuity due will result in a bigger investment than an ordinary annuity because each cash flow will accrue an extra interest payment.

Which of the following statements is correct?

When choosing between two investments that have the same level of risk, investors prefer the investment with the higher return.

Why is it important to adjust all cash flows to a common date?

When making economic decisions, we need to compare "apples to apples." This is possible only when we bring all the cash flows to a common date, which can either be a present time or some future date. The reason is the time value of money: a dollar today is worth more than a dollar in the future. Thus, when cash flows are converted to the same time period, the time value of money concept holds true, and we can concentrate on the economic aspects of the decision.

Irrational number

When represented by a decimal, the decimal never stops or forms any repeating pattern

Which of the following statements is NOT CORRECT?

When the market interest rate is higher than the coupon interest rate, the bond price rises above the par value and is called a premium bond.

Why is stock value maximization superior to profit maximization as a goal for management?

While profit maximization appears to be a logical goal at first glance, it has some serious drawbacks. First, since accounting profit is the difference between revenues and expenses, it can be distorted by accounting decisions. Second, accounting profits are quite different from cash flows. Since cash flows are the focus of investors, they should also be the focus of managers. Third, profit maximization does not account for when cash flows actually occur. Finally, profit maximization as a goal ignores the risk involved in generating the cash flows. Stock value maximization is superior to profit maximization because it overcomes all of the listed shortcomings of profit maximization. This is because the value of a firm's stock is determined by the cash flows that the firm is expected to produce. It accounts for (1) the size of the expected cash flows, (2) the timing of the expected cash flows, and (3) the riskiness of the expected cash flows.

YTM = 15.50% After-tax cost of debt = 10.23%

Zippy Computers announced strong fourth quarter results. Sales and earnings were both above analysts' expectations. You notice in the newspaper that Zippy's stock price went up sharply on the day of the announcement. If no other information about Zippy became public on the day of the announcement and the overall market was down, is this evidence of market efficiency?

Yes, if no other information became public and the market was down, the increase in Zippy's price most likely reflects the effects of investors trading on the good news. Investors, believing that Zippy is now more valuable than they had thought, are willing to pay a higher price for the shares.

Jane Thorpe has been offered a seven-year bond issued by Barone, Inc., for a price of $943.22. The bond has a coupon rate of 9 percent and pays the coupon semiannually. Similar bonds in the market have a yield to maturity of 10 percent today. Should she buy the bonds at the offered price?

Yes, the bond is worth more at $951.

Congress and the president have decided to increase the federal tax rate in an effort to reduce the budget deficit. Suppose that Jennifer Davis will pay 35 percent of her bonus to the federal government for taxes if she accepts the bonus of $1,801 today and 40 percent if she receives her bonus of $2,068 in 2 years. She can invest at 6 percent. Will the increase in tax rates affect her decision?

Yes. It will affect her decision.

Present value: Congress and the President have decided to increase the federal tax rate in an effort to reduce the budget deficit. Suppose that Caroline Weslin, from problem 5.29, will pay 35 percent of her bonus to the federal government for taxes if she accepts the bonus today and 40 percent if she receives her bonus in two years. Will the increase in tax rates affect her decision?

Yes. It will affect her decision. If Caroline accepts the bonus today, after paying the taxes, she will have $1,820 × (1 - 0.35) = $1,183.00 left over. If she waits two years and pays the high tax rate, the present value of what she will have left over is only $1,869 × (1 - 0.40) = $1,121.40.

Your parents have given you $1,000 a year before your graduation so that you can take a trip when you graduate. You wisely decide to invest the money in a bank CD that pays 6.75 percent interest. You know that the trip costs $1,025 right now and that the inflation for the year is predicted to be 4 percent. Will you have enough money in a year to purchase the trip?

Yes. The CD will be worth $1,067.50 at the end of the year ($1,000 x 6.75% + $1,000), and the price of the trip will be $1,066 ($1,025 x 4% + $1,025). The CD will be able to cover the trip.

In problem 2.20, if the market is efficient, would it have been possible for Zippy's stock price to go down on the day that the firm announced the strong fourth quarter results?

Yes. The last sentence in the statement of problem 2.20 suggests why this might happen. If, on the same day of the announcement, some very bad news about the future prospects for Zippy became public or if the market went down substantially, Zippy's stock price might also have gone down despite the positive sales and earnings announcement. Zippy's stock price may also go down if strong results were anticipated and this information was already reflected in the stock price, but the actual results were not as strong as anticipated.

Define yield to maturity. Why is it important?

Yield to maturity (YTM) is the rate of return earned by investors if they buy a bond today at its market price and hold it to maturity. It is important because it represents the opportunity cost to the investor or the discount rate that makes the present value of the bond's cash flows (i.e., its coupons and its principal payments) equal to the market price. So, YTM is also referred to as the going market rate or the appropriate discount rate for a bond's cash flows. It is important to understand that any investor who buys a bond and holds it to maturity will have a realized gain equal to the yield to maturity. If the investor sells before the maturity date, then realized gain will not be equal to the YTM, but will only be based on cash flows earned to that point. Similarly, for callable bonds, investors are guaranteed a gain to the point in time when the bond is first called, but they cannot be assured of the yield to maturity because the issuer could call the bond before maturity.

Carla Vista, Inc., has four-year bonds outstanding that pay a coupon rate of 7.30 percent and make coupon payments semiannually. If these bonds are currently selling at $911.89. What is the yield to maturity that an investor can expect to earn on these bonds? What is the effective annual yield?

Yield to maturity. 10.03% Effective annual yield. 10.27%

Wildhorse Corp. management plans to issue seven-year zero coupon bonds. It has learned that these bonds will sell today at a price of $442.26. What is the yield to maturity on these bonds?

Yield to maturity. 12.36%

Present value of an annuity due: You wrote a piece of software that does a better job of allowing computers to network than any other program designed for this purpose. A large networking company wants to incorporate your software into its systems and is offering to pay you $500,000 today, plus $500,000 at the begining of each of the following six years, for permission to do this. If the appropriate interest rate is 6 percent, what is the present value of the cash flow stream that the company is offering you?

You are being offered a seven year annuity due. You can solve this problem several different ways. First, you can calculate the present value of each of the individual cash flows and then add the present values together. Second, you can use the annuity transformation method discussed in the chapter. Third, you can calculate the present value of an ordinary six-year annuity and then add $500,000 to that value. Of course you can also use your calculator or Excel to do the calculations for you. Below are the calculations for the annuity transformation method. SEE IMAGE

Which of the following investments will have the highest future value at the end of three years? Assume that the effective annual rate for all investments is the same. a. You earn $3,000 at the end of three years (a total of one payment). b. You earn $1,000 at the end of every year for the next three years (a total of three payments). c. You earn $1,000 at the beginning of every year for the next three years (a total of three payments).

You earn $1,000 at the beginning of every year for the next three years (a total of three payments). The answer is c. Earning $1,000 at the beginning of each year for the next three years will have the highest future value as it is an annuity due.

Imagine you borrow $500 from your roommate, agreeing to pay her back $500 plus 7 percent nominal interest in one year. Assume inflation over the life of the contract is expected to be 4.25 percent. What is the total dollar amount you will have to pay her back in a year? What percentage of the interest payment is the result of the real rate of interest?

You will pay her back $535 ($500 × 1.07) in one year. Given an inflation of 4.25 percent, the real rate of interest is approximately 2.368 percent using the Fisher equation: 1 + i = (1 + r) × (1 + ΔPe) 1 + 0.07 = (1 + r) × (1 + 0.0425) r = (1.07/1.0425) - 1 = 0.02638, or 2.638% This means that $13.19 ($500 × 0.02638) will be a result of the real interest rate which is 37.69 percent of the total interest payment. The simplified, or approximate, Fisher equation yields a real interest rate of 2.75 percent: i = r + ΔPe r = 0.07 - 0.0425 = 0.0275, or 2.75% This means that $13.75 ($500 × 0.0275) will be a result of the real interest rate which is 39.29 percent of the total interest payment.

Explain why you would make an investment if the value of the expected cash flows exceeds the cost of the project.

You would accept an investment project whose cash flows exceed the cost of the project because such projects will increase the value of the firm, making the owners wealthier. Most people start a business to increase their wealth. Remember that the cost of capital (time value of money) will affect the decision about whether to invest.

When the discount rate:

decreases, the present value of any future cash flow increases.

Next year's annual dividend divided by the current stock price is called the:

dividend yield.

QN=196 (20451)51 The three simplifying assumptions that cover most stock growth patterns are

dividends that stay constant over time, dividends that grow at a constant rate, and dividends that have a mixed growth pattern.

Zero Bonds

don't pay interest every period. Sells at a substantial discount prior to maturity from the $1,000 face value with a zero coupon. Return comes from appreciation of the bond

Expected rate of return

is the required rate of return of investors who are willing to pay the market price for the security. The expected ror differs from investor to investor.

A benefit of a callable bond is the:

issuer may replace it with a bond that has a lower coupon rate.

QN=278 (20524)29 The capital market may not be able to fund all of a firm's positive NPV project because

it can be difficult for outside investors to accurately assess the risks and returns associated with the firm's projects.

Zero-Sum Enterprise expects to pay an annual dividend of $0.48 next year. Dividends and earnings have been growing at a compound annual rate of 8 percent and are expected to continue growing at that rate. What is the return on Zero-Sum if its price is $12?

k = $.48 / $12 + .08 = 12%

PDQ,Inc. stock is selling for $80 today. you are expecting a dividend of $3 next year and you plan to sell the stock for $95 one year from now. calculate the one-year return on PDQ stock

k= D1/Po+(P1-Po)/Po =(3/80)+((95-80)/80) =3.75%+18.75% =22.5%

TOYS4U stock is selling for $70 today. Similar stocks return 15% you have estimated a captial gains yield of 10%. calculate the next dividend expected on the stock

k=D1/Po+(P1-Po)/Po 15%=dividen yield+10% dividend yield=5%=D1/Po 5%=D1/70 D1=$3.50

What is the rate of return on a preferred stock that has a par value of $50, a market price of $46.50, and a dividend of $4.10?

kp = Dp/P = $4.10 / $46.50 = .0882 = 8.82%

Which of the following documents conveys title to a property at the time the purchaser completes the performance of the obligation called for in the document?

land contract

A financial system's primary function is funneling money from:

lender-savers to borrower-spenders.

Bonds sell at a premium over the par value when market rates for similar bonds are

less than the bond's coupon rate.

A factor will buy accounts receivable for

less than their face value

Slater Co. has very old computers and manufacturing equipment and knows it needs to upgrade them or risk losing much of its business. Slater does not have the money to purchase the computers, so it will most likely need

long-term financing

Jones Manufacturing needs $450,000 to build a new plant. It must also spend $200,000 on new equipment for the plant. Both of these needs are examples of

long-term financing needs

Agency conflicts are mainly caused by:

managers not putting shareholders' interests above their own interest.

Dealer markets are characterized by:

no time-consuming search for a fair deal. AND a guarantee of order fulfillment because the dealer holds an inventory of securities. AND improved market efficiency because dealers provide continuous bid and ask prices for securities.

Notes that do not include a stated interest rate, but still includes interest

non-interest bearing notes

which of the following organizational forms is subject to the securities and exchange commission (SEC) regulations?

public corporation

The common stock of Eddie's Engines, Inc. sells for $36.83 a share. The stock is expected to pay $2.80 per share next year. Eddie's has established a pattern of increasing their dividends by 4.9 percent annually and expects to continue doing so. What is the market rate of return on this stock?

r = $2.80 / $36.83 + 0.049 = 12.50 percent

CAPM (Capital Asset Pricing Model)

r = rf + β(rm − rf)

The percent of investment that the project costs can be referred to as ?

required return appropriate discount rate, cost of money, cost of capital

The cash remaining with the firm after paying its operating expenses, making payments to creditors, and taxes is called:

residual cash flow

The rate of return on any security is based on

risk free rate AND rate of inflation AND risk of default

QN=274 (20521)30 A change in sales price of a product sold by a firm will probably involve a reduction in the number of units sold, as well as the possibility of a change in the cost structure of the firm's product in question. If a firm were interested in the entire price change effect on the NPV of a project, then it would be interested in

scenario analysis.

In an efficient capital market,

security prices fully reflect the knowledge and expectations of all investors at a particular point in time. AND investors and financial managers have no reason to believe the securities are not priced at or near their true value. AND prices of securities adjust as new information becomes available to the market.

Which of the following theories states that security prices reflect all public information, but not all private information?

semi-strong form EMH EMH (efficient market hypothesis)

Dillon Wholesale Foods allows retailers to purchase merchandising using trade credit. For Dillon, this type of transaction

should be paid within thirty to sixty days

The expected return for a portfolio without borrowing

should never be less than the expected return of the asset with lowest expected return. AND should never be greater than the expected return of the asset with highest expected return. AND may not be an event with even a positive probability of occurrence.

Total compound interest is the:

sum of simple interest and the interest on interest

The beta for a firm can be estimated by

taking the weighted average of the beta for the individual projects of the firm.

The term free cash flows refers to the fact that:

the cash flows are left over after the firm has made the necessary investments in working capital and long-term assets.

The constant-growth dividend model will provide invalid solutions when:

the growth rate of the stock exceeds the required rate of return for the stock.

The poorer the bond rating

the higher the rate of return

Firms have no way to directly estimate the discount rate that reflects the risk of

the incremental cash flows from a particular project.

If ror is less than coupon rate...

the market value will be above par value

The cost of capital is

the minimum return that a capital project must earn to be accepted.

A highly liquid financial instrument with a maturity of 90 days would be traded in:

the money market.

With semistrong-form market efficiency,

the price of a security in the market reflects all public information only.

If you are discounting a project's cash flows using the nominal cost of capital, then that means that you have taken the following into account:

the real rate of return AND the expected rate of inflation

Cost of Debt (Rd)

the return lenders require on the firm's debt

The finance balance sheet is

the same as the accounting balance sheet, but it is based on market values.

When analysts and investors determine the value of a firm's stock, they should consider:

the size of the expected cash flows associated with owning the stock. AND the timing of the cash flows. AND the riskiness of the cash flows.

The idea that we can evaluate the cash flows from a project independently of the cash flows for the firm is known as

the stand-alone principle.

if market interest rate increases...

the value of all bonds to decreases but the long term bonds lose more in value than short term bonds

The value of the cash flows that the assets of the firm are expected to generate must equal

the value of the cash flows claimed by both the equity and debt investors.

A 10-year bond with a 9% annual coupon has a yield to maturity of 8%. Which of the following statements is CORRECT

true

If the expected return on an asset is greater than its required return given on the Security Market Line, the stock is _____

underpriced

Compound Interest

when interest is paid on both the original principal and any accumulated interest

Simple Interest

when interest is paid on the original principal only

the capital budgeting decision process can be described as

which productive assets a firm should purchase

The capital budgeting decision process can be described as

which productive assets a firm should purchase.

Portfolio Beta

the relationship between a portfolio's returns and the market returns. It is a measure of the portfolio's nondiversifiable risk

Payments in annuities must be made

Annually, semi annually, or quarterly

The present value of a future cash-flow:

Increases as the discount rate decreases

Muni-bonds are:

Often exempt from federal taxation

In order for a project to generate a positive net working capital cash flow at the conclusion of a project,

the project must have generated a cumulative negative cash flow during the life of the project.

The three economic factors that determine the shape of the yield curve are

the real rate of interest, the expected rate of inflation, and interest rate risk.

Bonds sell at a discount off the par value when market rates for similar bonds are

greater than the bond's coupon rate.

Bonds sell at a discount when the market rate of interest is:

greater than the bond's coupon rate.

The proper time to harvest an asset is when the percentage NPV increase of harvesting a project at a future point in time is at the last date where the increase is:

greater than the cost of capital.

Convertible bonds (CVs)

have a par value of $1,000, market value could be larger or smaller than $1,000. these bonds can be converted into pre-specified shares at the market value.

In regard to interest rate risk, short-term bonds:

have less interest rate risk than longer-term bonds.

Preferred Stock

is often referred to as a hybrid security because it has many characteristics of both common stock and bonds. The value of a preferred stock is the present value of all future dividends.

AAA

indicates a strong capacity to pay principal and interest and low probability of default

One of the most popular amortizing mortgages today is the constant payment mortgage. Which of the following characterizes the components of the CPM payment over the life of the loan?

interest- decreasing; amortization - increasing; payment-constant

Free Cash Flow (FCF)

is a measure of a company's financial performance. calculated as operating cash flow minus capital expenditures. FCF represents the cash that a company is able to generate after spending the money required to maintain or expand its asset base.

Most companies calculate the finance charge on credit card accounts as a percentage of the

Average daily balance

In a reasonably efficient market, if a stock has a beta of 1 we expect that it will have (______) exposure to market risk and (_______) expected returns.

Average, Average

Blossom Corporation just purchased computing equipment for $17,000. The equipment will be depreciated using a five-year MACRS depreciation schedule. If the equipment is sold at the end of its fourth year for $14,000, what are the after-tax proceeds from the sale, assuming the marginal tax rate is 35 percent? SEE IMAGE

$10,128.30

The Music Hut just paid an annual dividend of $1.05 a share. The projected dividends for the next five years are $1.07, $1.10, $1.15, $1.20, and $1.25, respectively. After that time, the dividends will be held constant at $1.40 per share. What is this stock worth today at a 12.5 percent discount rate?

$10.29

Cortez, Inc., is expecting to pay out a dividend of $2.50 next year. After that it expects its dividend to grow at 7 percent for the next four years. What is the present value of dividends over the next five-year period if the required rate of return is 10 percent?

$10.76

Dawson Electricals has borrowed $27,850 from its bank at an annual rate of 8.5 percent. It plans to repay the loan in eight equal installments, beginning in a year. What is its annual loan payment?

$4,939

Lorene Buckley wants to invest $3,500 today in a money market fund that pays a quarterly interest at 5 percent. She plans to fund a scholarship with the proceeds at her alma mater, Towson University. How much will Lorene have at the end of seven years?

$4,956 Amount invested today = PV = $3,500 Interest rate on money market account = i = 5% Duration of investment = n = 7 years Frequency of compounding = m = 4 Value of investment after 7 years = FV7 FV7 = PV × (1 + i/m)m×n = $3,500 × (1 + 0.05 / 4)4×7 = $3,500 × (1.0125)28 = $4,955.97

$4.50

Robert Kelly wants to start a business in 10 years. He hopes to have $100,000 at that time to invest in the business. To reach his goal, he plans to invest a certain amount today in a bank CD that will pay him 9.50 percent annually. How much will he have to invest today to achieve his target?

$40,351 Work: Financial Calculator- N = 10 FV = $100,000 I/Y = 9.5 PMT = $0 CPT for PV -$40,351 (Calculator says negative since it's money you are giving up)

The First Bank of Flagstaff has issued perpetual preferred stock with a $100 par value. The bank pays a quarterly dividend of $1.50 on this stock. What is the current price of this preferred stock given a required rate of return of 15.0 percent?

$40.00

You are considering purchasing a share of preferred stock that pays an annual dividend of $4.50. If you require an 11% rate of return on your investment, what is the maximum price you will pay for the stock?

$40.91

Noel Klinger is planning to invest in an insurance company product. The product will pay $12,500 at the end of this year. Thereafter, the payments will grow annually at a 2.5 annual percent rate forever. Jack will be able to invest his cash flows at an annual rate of 5.5 percent. What is the present value of this investment cash flow stream?

$416,667

You are starting college this month, and your favorite aunt has agreed to give you $4,000 at the end of each of your four years and you can save $8,000 at the end of each year for the first two years after you graduate. If all of these amounts are invested at 14%, how much will you have to start graduate school, six years from now?

$42,702

Matthew Young has just purchased some equipment for his landscaping business. For this equipment he must pay the following amounts at the end of each of the next five years: $10,280, $7,520, $9,650, $12,070, and $11,940. If the appropriate discount rate is 5.950 percent, what is the cost in today's dollars of the equipment Matthew purchased today?

$43,037.55

Asset Beta

-The unlevered beta; reflects the business risk of the assets; the asset's systematic risk. -Measures the project's market risk

Food Shoppe Galore had the following information:Total Food Shoppe Galore had the following information: Total market value of a company's stock: $650 million Total market value of the company's debt: $150 million What is the weighted average of the company's debt?market value of a company's stock: $650 millionTotal market value of the company's debt: $150 millionWhat is the weighted average of the company's debt?

-Total market value of a company's stock: $650 million -Total market value of the company's debt: $150 million -Combined value would be $700 million. -E/V = 650/800 = 81.25% -D/V = 150/800 = 18.75%

the return lenders require on the firm's debt

-YTM on those bonds is the market required rate on firm's debt.-If you know the rating of the bonds, then you just find the current rate on that bond rating

Tommie has made an investment that will generate returns that are subject to the state of the economy during the year. Use the following information to calculate the standard deviation of the return distribution for Tommie's investment

0.0467

Sea Masters Co. issued $1000 par value bonds with a 11 percent coupon. The bond pays interest semi-annually and has 13 years remaining to its maturity date. If the market demands 7.3 percent required rate on the bond, what is the price of the bond?

1,307.29

On July 1, 2014, Linden Company purchased the copyright to Norman Computer Tutorials for $140,000. It is estimated that the copyright will have a useful life of 5 years. The amount of Amortization Expense recognized for the year 2014 would be

1. $140,000 ÷ 5 = 28,000 2. 28,000 × 6/12 = $14,000

What are the advantages and disadvantages of a sole proprietorship?

Advantages: · It is the easiest business organization to start. · It is the least regulated. · Owners keep all the profits and do not have to share the decision-making authority with anyone. · All income is taxed as personal income, which is usually in a lower tax bracket than corporate income. Disadvantages: · The proprietor has an unlimited liability for all business debt and financial obligations of the firm. · The amount of capital that can be invested in the firm is limited by the proprietor's wealth. · It is difficult to transfer ownership (requires sale of the business).

A company is 43% financed by risk-free debt. The interest rate is 9%, the expected market risk premium is 7%, and the beta of the company's common stock is 0.53. What is the after-tax WACC, assuming that the company pays tax at a 30% rate?

After-tax WACC = 0.43[0.09 × (1 − 0.30)] + 0.57(0.09 + 0.53 × 0.07) After-tax WACC = 0.0995, or 9.95%.

What are agency costs? Explain.

Agency costs are costs that result from an agency relationship in which there is a conflict of interest between a principal and an agent. An agency relationship exists in a business when a firm's managers (agents) are not also its owners (principals). Agency costs are incurred when managers act in ways that harm owners' interests. The cost of mechanisms, such as audits, that help control agency conflicts are also agency costs.

Identify the sources of agency costs. What are some ways these costs can be controlled in a company?

Agency costs are the costs that result from conflicts of interest between the agent and the principal. They can either be direct, such as lavish dinners or trips, or indirect, which are usually missed investment opportunities. A company can control these costs by tying management compensation to company's performance and by establishing an independent board of directors. Outside factors that contribute to the minimization of agency costs are the threat of corporate raiders that can take over a company not performing up to expectations and the competitive nature of the managerial labor market.

Which type of secondary market provides the most efficient market for financial securities?

An auction market is the most efficient type of secondary market because the buyers and sellers in an auction market interact directly with each other and bargain over price.

How would you define an ethical business culture?

An ethical business culture means that people have a set of principles, or moral values, that helps them identify moral issues and then make ethical judgments without being told what to do.

What effect does an increase in the demand for business goods and services have on the real interest rate? What other factors can affect the real interest rate?

An increase in the demand for business goods and services will cause the borrowing schedule in Exhibit 2.4 to shift to the right, thus increasing the real rate of interest. Other factors that can affect the real interest rate include increases in productivity, changes in technology, or changes in the corporate tax rate. Demographic factors, such as growth or age of the population, and cultural differences can also affect the real rate of interest.

All public companies must hire a certified public accounting firm to perform an independent audit of their financial statements. What exactly does the term audit mean?

An independent CPA firm that performs an audit of a firm ensures that the financial numbers are reasonably accurate, that accounting principles have been adhered to year after year and not in a manner that distorts the firm's performance, and that the accounting principles used are in accordance with generally accepted accounting principles (GAAP).

Suppose you own a security that you know can be easily sold in the secondary market, but the security will sell at a lower price than you paid for it. What does this imply for the security's marketability and liquidity?

As the price of the security is lower than that you paid for it, it has a lower degree of liquidity to you, the owner. That is because the security cannot now be sold without a loss in value to the owner. Marketability refers to the ease with which a security can be sold or converted to cash. The information in the problem mentions that the security could be easily sold in secondary market, which implies it has high degree of marketability to you.

An investor will choose between Asset Q with an expected return of 6.5% and a standard deviation of 5.5%, Asset U with an expected return of 8.8% and a standard deviation of 5.5%, and Asset B with an expected return of 8.8% and a standard deviation of 6.5%. Which one should the investor prefer?

Asset U

Asset Beta Formula

Asset β = Equity Beta * [1/1 + (Debt/Equity)(1 - Tax Rate)] Asset β = (D/V Dβ) + (E/V Eβ)

Explain what you would assume the yield curve would look like during economic expansion and why.

At the beginning of an economic expansion, the yield curve tends to be rather steep as the rates begin to rise once the demand for capital is beginning to pick up due to growing economic activity. The yield curve will retain its positive slope during the economic expansion, which reflects the investors' expectations that the economy will grow in the future and that the inflation rates will also rise in the future.

In an ordinary annuity the interest on a yearly investment starts building interest

At the end of the first period

An efficient capital market is best defined as a market in which security prices reflect which on one of the following?

Available information

What is a conflict of interest in a business setting?

Conflict of interest in the business setting refers to a conflict between a person's personal or institutional gain and the obligation to serve the interest of another party. For example, the chapter discussed the problem that arises when the real estate agent helping you buy a house is also the listing agent.

Explain what a convertible bond is.

Convertible bonds are bonds that can be converted into shares of common stock at some predetermined ratio at the discretion of the bondholder. The convertible feature allows the bondholder to take advantage of the firm's prosperity if the share prices rises above a certain value.

Which one of the following statements is NOT true?

Corporate bonds are more marketable than the securities that have higher daily trading volumes.

What are corporate raiders?

Corporate raiders can make the economy more efficient by keeping the top managers on their toes. Top managers know that if the company's performance declines and its stock slips, it makes itself vulnerable to takeovers by corporate raiders who are just waiting to temporarily acquire a company, turn it around, and sell it for profit. Therefore, the role of the corporate raiders in the economy is twofold: first, the fear of takeovers pushes managers to do a better job, and second, if the managers are not performing up to expectations, the company can be rescued and restructured into a contributor again. However, the threat of a corporate raider could result in an incentive conflict for managers, inducing them to focus on short-term profitability over long-term value creation.

What ethical conflict does insider trading present?

Insider trading is an example of information asymmetry. The main idea is that investment decisions should be made on an even playing field. Insider trading is illegal because it puts one party at a significant disadvantage in trading. If insider trading were allowed, capital transfers would be much more difficult.

Management of Ivanhoe Home Furnishings is considering acquiring a new machine that can create customized window treatments. The equipment will cost $257,550 and will generate cash flows of $66,750 over each of the next six years. If the cost of capital is 10 percent, what is the MIRR on this project?

MIRR 12.2%

Management of Wildhorse Home Furnishings is considering acquiring a new machine that can create customized window treatments. The equipment will cost $313,550 and will generate cash flows of $96,750 over each of the next six years. If the cost of capital is 12 percent, what is the MIRR on this project?

MIRR 16.5%

West Street Automotive is considering adding state safety inspections to its service offerings. The equipment necessary to perform these inspections will cost $568,000 and will generate cash flows of $199,000 over each of the next five years.If the cost of capital is 18 percent, what is the MIRR on this project?

MIRR 20.2%

Crane Bakeries recently purchased equipment at a cost of $587,500. Management expects the equipment to generate cash flows of $305,250 in each of the next four years. The cost of capital is 16 percent. What is the MIRR for this project?

MIRR 27.4%

Pharoah Bakeries recently purchased equipment at a cost of $523,500. Management expects the equipment to generate cash flows of $269,250 in each of the next four years. The cost of capital is 17 percent. What is the MIRR for this project?

MIRR 27.5%

Why are many businesses operated as sole proprietorships or partnerships?

Many businesses elect to operate as sole proprietorships or partnerships because of the small operating scale and capital base of their firms. Both of these forms of business organization are fairly easy to start and impose few regulations on the owners.

Explain why maximizing the current market price of a firm's stock is an appropriate goal for the firm's management.

Maximizing the current market price of a firm's stock is an appropriate goal for the firm's management because it is an unambiguous objective and it is easy to measure. One can simply look at the value of the company's stock on any given day to determine whether it went up or down.

Sheridan Corp. paid a dividend of $2.32 yesterday. The company's dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors in stocks of companies like Sheridan require a rate of return of 25 percent, what should be the market price of Sheridan stock?

Market price. $12.18

Cullumber Corp. paid a dividend of $2.44 yesterday. The company's dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors in stocks of companies like Cullumber require a rate of return of 25 percent, what should be the market price of Cullumber stock?

Market price. $12.81

Investors are compensated based on the amount of what type of risk that they take?

Market risk

Ivanhoe, Inc., has issued a three-year bond that pays a coupon rate of 8.4 percent. Coupon payments are made semiannually. Given the market rate of interest of 4.8 percent, what is the market value of the bond?

Market value $1099.48

John Johnson is interested in purchasing the common stock of Crane, Inc., which is currently priced at $37.86. The company is expected to pay a dividend of $2.58 next year and to increase its dividend at a constant rate of 7.00 percent. What should the market value of the stock be if the required rate of return is 14 percent? Is this a good buy?

Market value of stock = $36.86 Is this a good buy? = No

Robert Williams is interested in purchasing the common stock of Cullumber, Inc., which is currently priced at $49.84. The company is expected to pay a dividend of $2.58 next year and to increase its dividend at a constant rate of 8.75 percent. What should the market value of the stock be if the required rate of return is 14 percent? Is this a good buy?

Market value of stock. $49.14No

Wildhorse, Inc., is a mature firm that is growing at a constant rate of 6.14 percent per year. The last dividend that the firm paid was $1.30 per share. If dividends are expected to grow at the same rate as the firm and the required rate of return on Wildhorse's stock is 12 percent, what is the market value of the company's stock?

Market value of the company's stock. $23.55

Blossom, Inc., is a mature firm that is growing at a constant rate of 5.19 percent per year. The last dividend that the firm paid was $1.60 per share. If dividends are expected to grow at the same rate as the firm and the required rate of return on Blossom's stock is 10 percent, what is the market value of the company's stock?

Market value of the company's stock. $34.99

Sheridan, Inc., has issued a three-year bond that pays a coupon rate of 7.0 percent. Coupon payments are made semiannually. Given the market rate of interest of 4.6 percent, what is the market value of the bond?

Market value. $1066.54

Blossom, Inc., is a consumer products firm that is growing at a constant rate of 5.0 percent. The firm's last dividend, which was just paid, was $3.36. If the required rate of return is 14.0 percent, what is the market value of this stock if dividends grow at the same rate as the firm?

Market value. $39.20

Explain what the marketability of a security is and how it is determined.

Marketability refers to the ease with which a security can be sold and converted into cash. The level of marketability depends on the cost of trading the security and the cost of searching for information. The lower these costs are, the greater the security's marketability.

In order to calculate the price of a bond, which of the following input is needed?

Maturity period.

Michael Harper has $3,000 to invest for three years. He wants to receive $5,000 at the end of the three years. What invest rate would his investment have to earn to achieve his goal?

Work: Financial Calculator- N = 3 PV = -$3,000 PMT = $0 FV = $5,000 CPT for I/Y 18.56%

Find the future value of an investment of $2,300 made today for the following rates and periods: a. 6.25% compounded semiannually for 12 years. b. 7.63% compounded quarterly for 6 years. c. 8.9% compounded monthly for 10 years. d. 10% compounded daily for 3 years. e. 8% compounded continuously for 2 years.

Work: Plug values into financial calculator, CPT FV a. Semiannually N = 12 x 2 N = 24 I/Y = 6.25 / 2 I/Y = 3.125PV = -$2,300 PMT = $0 b. Quarterly N = 6 x 4 N = 24 I/Y = 7.63 / 4 I/Y = 1.9075 PV = -$2,300 PMT = $0 c. Monthly N = 10 x 12 N = 120 I/Y = 8.9 / 12 I/Y = 0.741666 PV = -$2,300 PMT = $0 d. Daily N = 3 x 365 N = 1,095 I/Y = 10 / 365 I/Y = 0.02739726 PV = -$2,300 PMT = $0 e. Continuously FV = PV x e^ ([I/Y]x N) FV = $2,300 x e^ (0.08 x 2) FV = $2,699.08

What are some of the things that managers do to manage a firm's working capital?

Working capital management is the day-to-day management of a firm's short-term assets and liabilities. Working capital can be managed by maintaining the optimal level of inventory, managing receivables and payables, deciding to whom the firm should extend credit, and making appropriate investments with excess cash.

You own shares of Sandhill DVD Company and are interested in selling them. With so many people downloading music these days, sales, profits, and dividends at Sandhill have been declining 9 percent per year. The firm just paid a dividend of $1.65 per share. The required rate of return for a stock this risky is 12 percent. If dividends are expected to decline at 9 percent per year, what is a share of the stock worth today?

Worth of share of stock. $7.15

Sunland, Inc., management expects to pay no dividends for the next six years. It has projected a growth rate of 25 percent for the next seven years. After seven years, the firm will grow at a constant rate of 5 percent. Its first dividend, to be paid in year 7, will be $3.13. If the required rate of return is 22 percent, what is the stock worth today?

Worth of stock. $5.58

Preemptive Right

entitles the existing common shareholders to maintain a proportionate share of ownership in the firm

A portfolio with a level of systematic risk that is the same as that of the market has a beta that is

equal to one.

A portfolio with a level of systematic risk the same as that of the market has a beta that is

equal to one.

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments

equal to the price of the bond.

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments:

Basics of Financial Management Final Exam

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