## Info

Valuation equations measure the stock value at a point in time based on expected return and risk. Any decisions of the financial manager that affect these variables can cause the value of the firm to change. Figure 7.4 depicts the relationship among financial decisions, return, risk, and stock value. financial decisions, return, risk, and stock value Assuming that economic conditions remain stable, any management action that would cause current and prospective stockholders to raise their...

## Microsoft Corporation

Can a company have too much cash For years since its founding in 1975 Microsoft Corporation had paid no dividends. With assets in cash and short-term investments of over 49 billion, the company was faced with a decision of how to deploy that capital. Finally, in 2003, recognizing that it was no longer a young fast-growing company that needed every penny for growth, the company dipped its toe into the dividend waters, issuing an annual dividend of 0.08 per share, which it increased to SO. 16 per...

## External Assessment of Capital Structure

We saw earlier that financial leverage results from the use of fixed-cost financing, such as debt and preferred stock, to magnify return and risk. The amount of leverage in the firm's capital structure can affect its value by affecting return and risk. Those outside the firm can make a rough assessment of capital structure by using measures found in the firm's financial statements. Some of these important debt ratios were presented in Chapter 2. For example, a direct measure of the degree of...

## Summary

The growing interdependence of world markets has increased the importance of international finance in managing the multinational company (MNC). As a result, the financial manager must deal with international issues related to taxes, financial markets, accounting and profit measurement and repatriation, exchange rate risks caused by doing business in more than one currency, political risks, financing (both debt and equity) and capital structure, short-term financing, cash management issues...

## International Transactions

The important difference between international and domestic transactions is that payments are often made or received in a foreign currency. Not only must a U.S. company pay the costs of doing business in the foreign exchange market, but it also is exposed to exchange rate risk. A U.S.-based company that exports goods and has accounts receivable denominated in a foreign currency faces the risk that the U.S. dollar will appreciate in value relative to the foreign currency. The risk to a U.S....

## Ios3

(1) New financing or investment (Fig. 13.2) (2) Retained earnings available (given) In this case, additional new common stock io the amount of 440,000 ( 2,240,000 needed - 1,800,000 available) would have to be sold no dividends would be paid. In this case, additional new common stock io the amount of 440,000 ( 2,240,000 needed - 1,800,000 available) would have to be sold no dividends would be paid. Table 13.1 shows that if IOSi exists, the firm will pay out 750,000 in dividends, because only...

## Lines of Credit

A line of credit is an agreement between a commercial bank and a business, specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time. It is similar to the agreement under which issuers of bank credit cards, such as MasterCard, Visa, and Discover, extend preapproved credit to cardholders. A line-of-credit agreement is typically made for a period of 1 year and often places certain constraints on the borrower. It is not a...

## Trust Receipt Inventory Loans

A trust receipt inventory loan often can be made against relatively expensive automotive, consumer durable, and industrial goods that can be identified by serial number. Under this agreement, the borrower keeps the inventory, and the lender may advance 80 to 100 percent of its cost. The lender files a lien on all the items financed. The borrower is free to sell the merchandise but is trusted to remit the amount lent, along with accrued interest, to the lender immediately after the sale. The...

## Risk Adjusted Discount Rates

The approaches for dealing with risk that have been presented so far enable the financial manager to get a feel for project risk. Unfortunately, they do not explicitly recognize project risk. We will now illustrate the most popular risk-adjustment technique that employs the net present value (NPV) decision method.2 The NPV decision rule of accepting only those projects with NPVs > 0 will continue to hold. Close examination of the basic equation for NPV, Equation 9.1, should make it clear that...

## Investing in Marketable Securities

Marketable securities are short-term, interest-earning, money market instruments that can easily be converted into cash.7 Marketable securities are classified as part of the firm's liquid assets. The firm uses them to earn a return on temporarily idle funds. To be truly marketable, a security must have (1) a ready market so as to minimize the amount of time required to convert it into cash, and (2) safety of principal, which means that it experiences little or no loss in value over time. The...

## International Risk Considerations

Exchange rate risk The danger that an unexpected change in the exchange rate between the dollar and the currency in which a project's cash flows are denominated will reduce the market value of that project's cash flow. transfer prices Prices that subsidiaries charge each other for the goods and services traded between them. Although the basic techniques of capital budgeting are the same for multinational companies MNCs as for purely domestic firms, firms that operate in several countries face...

## Weighted Marginal Cost of Capital WMCC

The weighted average cost of capital may vary over time, depending on the volume of financing that the firm plans to raise. As the volume of financing increases, the costs of the various types of financing will increase, raising the firm's weighted average cost of capital. Therefore, it is useful to calculate the weighted marginal cost of capital WMCC , which is simply the firm's weighted average cost of capital WACC associated with its next dollar of total new financing. This marginal cost is...

## H171

Toni's Typesetters is analyzing a possible merger with Pete's Print Shop. Toni's has a tax loss carryforward of 200,000, which it could apply to Pete's expected earnings before taxes of 100,000 per year for the next 5 years. Using a 34 tax rate, compare the earnings after taxes for Pete's over the next 5 years both without and with the merger Cautionary Tales, Inc., is considering the acquisition of Danger Corp. at its asking price of 150,000. Cautionary would immediately sell some of Danger's...

## Web Exercise

Go to the book's companion website at www.preiihail.com gitman to find the Web Exercise for this chapter. Remember to check the book's website at www.prenhaSI.com giimaii to find additional resources, including Web Exercises and a Web Case. In January 2010, Teresa Leal was named treasurer of Casa de Dise o. She decided that she could best orient herself by systematically examining each area of the company's financial operations. She began by studying the firm's short-term financial activities....

## C

Webster Manufacturing, Inc., a small manufacturer of kitchen knives, has before-tax earnings of 250,000. The tax on these earnings can be found by using the tax rate schedule in Table 1.4 Total taxes due 22,250 0.39 X 250,000 - 100,000 - 22,250 0.39 X 150,000 22,250 58,500 80,750 From a financial point of view, it is important to understand the difference between average and marginal tax rates, the treatment of interest arid dividend income, and the effects of tax deductibility. average tax...

## Problems

A blue box indicates problems available in myTuiaiicelab Tax credits A U.S.-based MNC has a foreign subsidiary that earns 250,000 before local taxes, with all the after-tax funds to be available to the parent in the form of dividends. The applicable taxes consist of a 33 foreign income tax rate, a foreign dividend withholding tax rate of 9 , and a U.S. tax rate of 34 . Calculate the net funds available to the parent MNC if a. Foreign taxes can be applied as a credit against the MNC's U.S. tax...

## Spreadsheet Exercise

The current balance in accounts receivable for Eboy Corporation is 443,000. This level was achieved with annual 365 days credit sales of 3,544,000. The firm offers its customers credit terms of net 30. However in an effort to help its cash flow position and to follow the actions of its rivals, the firm is considering changing its credit terms from net 30 to 2 10 net 30. The objective is to speed up the receivable collections and thereby improve the firm's cash flows. Eboy would like to increase...

## The Model CAPM

The capital asset pricing model CAPM links nondiversifiable risk and return for all assets. We will discuss the model in five sections. The first deals with the beta coefficient, which is a measure of nondiversifiable risk. The second section presents an equation of the model itself, and the third graphically describes the relationship between risk and return. The fourth section discusses the effects of changes in inflationary expectations and risk aversion on the relationship between risk and...

## Lyman Nurseries Purchased Seeds Costing 25 000 With Terms Of 3 15 Net 30 Eom On January 12. How Much Will The Firm Pay

Self-Test Problem Solution in Appendix B Cash discount decisions The credit terms for each of three suppliers are shown in the following table. Note Assume a 365-day year. . ' Supplier ' Credit terras X 1 10 net 55 EOM Y 2 10 act 30 EOM Z 2 20 net 60 EOM a. Determine the approximate cost of giving up the cash discount from each supplier b. Assuming that the firm needs short-term financing, indicate whether it would be better to give up the cash discount or take the discount and borrow from a...

## Stock Splits Nathan Detroit

If the firm's dividend policy were based on a constant payout ratio of 40 for all years with positive earnings and 0 otherwise, what would be the annual dividend for each year b. If the firm had a dividend payout of 1.00 per share, increasing by 0.10 per share whenever the dividend payout fell below 50 for two consecutive years, what annual dividend would the firm pay each year c. If the firm's policy were to pay 0.50 per share each period except when earnings per share exceed 3.00, when an...

## Cost of Common Stock

The cost of common stock is the return required on the stock by investors in the marketplace. There are two forms of common stock financing 1 retained earnings and 2 new issues of common stock. As a first step in finding each of these costs, we must estimate the cost of common stock equity. The rate at which investors discount the expected dividends of the firm to determine its share value. Finding the Cost of Common Stock Equity The cost of common stock equity, rs, is the rate at which...

## Cost of Preferred Stock

Preferred stock represents a special type of ownership interest in the firm. It gives preferred stockholders the right to receive their stated dividends before the firm can distribute any earnings to common stockholders. Because preferred stock is a form of ownership, the proceeds from its sale are expected to be held for an infinite period of time. The key characteristics of preferred stock were described in Chapter 7. However, the one aspect of preferred stock that requires review is...

## Flooded with Claims

In the wake of Hurricane Katrina, which struck the Gulf Coast in 2005, claims flooded into State Farm Insurance. More than 295,000 homeowner and commercial claims and 99,000 auto claims were reported as a result of Katrina State Farm handled more than 600,000 claims arising from the four hurricanes that made landfall on the Gulf Coast that year. The company paid more than 6 billion in claims for damage done by those hurricanes. Not everyone was satisfied with the claims process, though State...

## Can We Trust Bond Raters

Some ratings may be modified to show relative standing within a major rating category for example, Moody's uses numerical modifiers 1,2,3 , whereas Standard amp Poor's uses plus and minus signs. Sourcesi Moody's Investors Service, Inc. and Standard amp Poor's Corporation. Some ratings may be modified to show relative standing within a major rating category for example, Moody's uses numerical modifiers 1,2,3 , whereas Standard amp Poor's uses plus and minus signs. Sourcesi Moody's Investors...

## Npv Present Value Of Cash Inflows -initial Investment

Because net present value NPV gives explicit consideration to the time value of money, it is considered a sophisticated capital budgeting technique. All such techniques in one way or another discount the firm's cash flows at a specified rate. This rate often called the discount rate, required return, cost of capital, or opportunity cost is the minimum return that must be earned on a project to leave the firm's market value unchanged. In this chapter we take this rate as a given. In Chapter 11...

## Weighted Average Cost of Capital

Weighted average cost of capital WACC , ra Reflects the expected average future cost of funds over the long run found by weighting the cost of each specific type of capital by its proportion in the firm's capital structure. Now that we have calculated the cost of specific sources of financing, we can determine the overall cost of capital. As noted earlier the weighted average cost of capital WACC , ra, reflects the expected average future cost of hinds over the long run. It is found by...

## Case

Making Star Products7 Financing Investment Decision Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter OTC market. During 2009, the Dallas-based company experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa Jen, the company's treasurer, wants to make sure that available funds are being used to their fullest. Management policy is to maintain the current capital structure...

## Corporate Bonds

Corporate bond A long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms. coupon interest rate The percentage of a bond's par value that will be paid annually, typically in two equal semiannual payments, as interest A corporate bond is a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined...

## Would You Recommend That Jane Invest In The Single Stock A Or The Portfolio Con-sisting Of Stocks A And B Explain Your

In any of the possible two-stock portfolios, the weight of each stock in the portfolio will be 50 . The three possible portfolio combinations are AB, AC, and BC. Create a spreadsheet similar to Tables 5.7 and 5.8 which can be viewed at www .prenhall.com gjimaii to answer the following a. Calculate the expected return for each individual stock. b. Calculate the standard deviation for each individual stock. c. Calculate the expected returns for portfolio AB, AC, and BC. d. Calculate the standard...

## Pi

Breakeven point Algebraic Kate Rowland wishes to estimate the number of flower arrangements she must sell at 24.95 to break even. She has estimated fixed operating costs of 12,350 per year and variable operating costs of 15.45 per arrangement. How many flower arrangements must Kate sell to break even on operating costs Breakeven comparisons Algebraic Given the price and cost data shown in the accompanying table for each of the three firms, F, G, and H, answer the following questions. Sale price...

## Gronseth Drywall Systems

The cost of debt Gronseth Drywall Systems, Inc., is in discussions with its investment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different maturities will carry different coupon rates and sell at different prices. The firm must choose among several alternatives. In each case, the bonds will have a 1,000 par value and flotation costs will be 30 per bond. The company is taxed at a rate of 40 . Calculate the after-tax cost of financing with each...

## How Might The Expected Future Reappearance Of Higher Tax Rates On Individuals Receiving Dividends Affect Corporate

Retained earnings Earnings not distributed to owners as dividends a form of internal financing. Expected cash dividends are the key return variable from which owners and investors determine share value. They represent a source of cash flow to stockholders and provide information about the firm's current and future performance. Because retained earnings, earnings not distributed to owners as dividends, are a form of internal financing, the dividend decision can significantly affect the firm's...

## P12-21 Eps And Optimal Debt Ratio Williams Glassware Has Estimated At Various Debt Ratios The Expected Earnings Per

Financial leverage Max Small has outstanding school loans that require a monthly payment of 1,000. He needs to purchase a new car for work and estimates that this will add 350 per month to his existing monthly obligations. Max will have 3,000 available after meeting all of his monthly living operating expenses. This amount could vary by plus or minus 10 . a. In order to assess the potential impact of the additional borrowing on his financial leverage, calculate the DFL in tabular form for both...

## Rieger International Is Attempting To Evaluate The Feasibility Of Investing

P9-20 Payback, NPV, and ERR Rieger International is attempting to evaluate the feasibility of investing 95,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the table at the right. The firm has a 12 cost of capital, a. Calculate the payback period for the proposed investment. Calculate the net present value NPV for the proposed investment. Calculate the internal rate of return IRR , rounded to the nearest whole...

## The Federal Debt

Who is the largest debtor in the United States The federal government, of course. As of May 12, 2007, the national debt was 58,819,278,857,652, with almost 5 trillion of the debt held by the public and around 3.8 trillion of debt held by intragovernmental holdings. With annual deficits of 423 billion in 2006 and a Congressional Budget Office deficits projection of as much as 1.76 trillion over the next decade, the federal government has a huge need for outside financing which dwarfs any...

## P6-27 Bond Rating Agencies Have Invested

122221 Bond valuation Quarterly interest Calculate the value of a 5,000-par-value bond paying quarterly interest at an annual coupon interest rate of 10 and having 10 years until maturity if the required return on similar-risk bonds is currently a 12 annual rate paid quarterly. P6-27 ETHICS PROBLEM Bond rating agencies have invested significant sums of money in an effort to determine which quantitative and nonquantitative factors best predict bond defaults. Furthermore, some of the raters...

## The Best Way To Adjust For The Presence Of Fixed Costs When Using The Simplified Approach For Pro Forma Income

Preparing the Pro Forma Income Statement percent-of-sales method A simple method for developing the pro forma income statement it forecasts sales and then expresses the various income statement items as percentages of projected sales. A simple method for developing a pro forma income statement is the percent-of-sales method. It forecasts sales and then expresses the various income statement items as percentages of projected sales. The percentages used are likely to be the percentages of sales...

## Cost of Retained Earnings

As you know, dividends are paid out of a firm's earnings. Their payment, made in cash to common stockholders, reduces the firm's retained earnings. Suppose a firm needs common stock equity financing of a certain amount. It has two choices relative to retained earnings It can issue additional common stock in that amount and still pay dividends to stockholders out of retained earnings, or it can increase common stock equity by retaining the earnings not paying the cash dividends in the needed...

## Oak Enterprises Accepts Projects Earning

IRR Mutually exclusive projects Bell Manufacturing is attempting to choose the better of two mutually exclusive projects for expanding the firm's warehouse capacity. The relevant cash flows for the projects are shown in the following cable. The firm's cost of capital is 15 . V1 'I .'' ' gt i .i SProject X i ' Project Y ', Initial investment. CF0 500,000 325,000 ' '' 'Cash inflows CFr v .' ' j a. Calculate the LRR to the nearest whole percent for each of the projects. b. Assess the acqeptability...

## An Upward-sloping Yield Curve That Indicates Generally Cheaper Short-term Borrowing Costs Than Long-term Borrowing

Average annual rate of return on 3-month U.S. Treasury bills. Annual pecentage change in the consumer price index. Sources Data From selected F deral Reserve Bulletins and U.S. Department of Labor Bureau of Labor Statistics. A graph of the relationship between the debfs remaining time to maturity x axis and its yieid to maturity y axis it shows the yield to maturity for debts of equal quality and different maturities. Graphically depicts the term structure of interest rates. inverted yield...

## Behavioral Approaches for Dealing with Risk

Behavioral approaches can be used to get a feel for the level of project risk, whereas other approaches explicitly recognize project risk. Here we present a few behavioral approaches for dealing with risk in capital budgeting risk and cash inflows, scenario analysis, and simulation. In a later section, we consider a popular approach that explicitly recognizes risk. risk in capital budgeting The chance that a project will prove unacceptable or, more formally, the degree of variability of cash...

## To Do

Calculate the cost of each source of financing, as specified 1 Long-term debt, first 450,000. 2 Long-term debt, greater than 450,000. 3 Preferred stock, all amounts. 4 Common stock equity, first 1,500,000. 5 Common stock equity, greater than 1,500,000. b. Find the break points associated with each source of capital, and use them to specify each of the ranges of total new financing over which the firm's weighted average cost of capital WACC remains constant, c. Calculate the weighted average...

## In Spite Of The Theoretical Superiority Of Irr Financial Managers Prefer To Use Npv.

The NPV remains at 16,867 reinvestment at the 15 IRR produces an NPV of 24,213. From this result, it should be clear that the NPV technique assumes reinvestment at the cost of capital 10 in this example . Note that with reinvestment at 10 , the IRR would be 13.5 . On the other hand, the IRR technique assumes an ability to reinvest intermediate cash inflows at the IRR. If reinvestment does not occur at this rate, the IRR will differ from 15 . Reinvestment at a rate lower than the IRR would...

## Jamie Peters Invested 100 000 To Set Up The Following Portfolio One Year

Calculate the betas for portfolios A and B. b. Compare the risks of these portfolios to the market as well as to each other. Which portfolio is more risky Capital asset pricing model CAPM For each of the cases shown in the following table, use the capital asset pricing model to find the required return. Beta coefficients and the capital asset pricing model Katherine Wilson is wondering how much risk she must undertake to generate an acceptable return on her portfolio. The risk-free return...

## Q Focus on Ethics What about Moral Risk

The poster boy for moral risk, exemplifying the devastating effects of unethical behavior for a company's investors, has to be Nick Leeson. As a futures trader, Leeson violated his bank's investing rules while secretly placing huge bets on the direction of the Japanese stock market When those bets proved wrong the 1.24 billion losses resulted in the 1995 demise of the centuries-old Barings Bank. More than any other single episode in world financial history, Leeson's misdeeds proved the...

## Cost of Long Term Debt

The cost of long-term debt, r , is the after-tax cost today of raising long-term funds through borrowing. For convenience, we typically assume that the funds are raised through the sale of bonds. In addition, as we did in Chapter 6, we assume that the bonds pay annual rather than semiannual interest. Funds actually received from the sale of a security. Most corporate long-term debts are incurred through the sale of bonds. The net proceeds from the sale of a bond, or any security, are the funds...

## If Etsitty Requires A 14 Return On Its Investment What Minimum Yearly Cash Inflow Will Be Necessary For The Company To

Purchase the exclusive rights to market a quality educational television program in syndication to local markets in the European Union, a part of the firm's existing business activities. The media services business is cyclical and highly competitive. The board of directors has asked you, as chief financial officer to do the following a. Evaluate the risk of each proposed project and rank it low, medium, or high. b. Comment on why you chose each ranking. 1 21 Breakeven cash inflows Etsitty Arts,...

## Overview of the Cost of Capital

The cost of capital is the rate of return that a firm must earn on the projects in which it invests to maintain the market value of its stock. It can also be thought of as the rate of return required by the market suppliers of capital to attract their funds to the firm. If risk is held constant, projects with a rate of return above the cost of capital will increase the value of the firm, and projects with a rate of return below the cost of capital will decrease the value of the firm. The cost...

## Three Assets F G H Are Currently Being Considered By Perth Industries

1 The range of possible rates of return. 2 The expected value of return. 3 The standard deviation of the returns. 4 The coefficient of variation of the returns. b. Construct a bar chart of each distribution of rates of return. c. Which project would you consider less risky Why Integrative Expected return, standard deviation, and coefficient of variation Three assets F, G, and H are currently being considered by Perth Industries. The probability distributions of expected returns for these...

## Using Computational Tools for Compounding More Frequently Than Annually

We can use the future value interest factors for one dollar, given in Table A-l, when interest is compounded m times each year. Instead of indexing the table for i percent and n years, as we do when interest is compounded annually, we index it for i m percent and m X n periods. However the table is less useful, because it includes only selected rates for a limited number of periods. Instead, a financial calculator or an electronic spreadsheet is typically required. Finance Example Fred Moreno...

If you google the Web to find a company with lots of cash, you might just find Google, Inc In less than nine years from te founding Google has become a cash machine, generating S3.58 billion in operating cash flow in 2006 on revenues of SI0.6 billion. With more than Sn billion in cash and short-term marketable securities, Google is in a position to take advantage of any compelling acquisitions that may appear. What should the company's management do with this SI 1 billion war chest' Common uses...

## Suarez Manufacturing Risky Investment 2007

Given that Craft is expected to pay a dividend of 3.68 next year, determine the maximum cash price that Hamlin should pay for each share of Craft. b. Discuss the use of the CAPM for estimating the value of common stock, and describe the effect on the resulting value of Craft of 1 A decrease in its dividend growth rate of 2 from that exhibited over the 2004-2009 period. 2 A decrease in its beta to 1. Pra IETHICS PROBLEM Melissa is trying to value Generic Utility, Inc.'s stock, which 4 is...

## Lynn Parsons Is Considering Investing In Either Of The Two Outstanding Bonds

23528 Bond value and changing required returns Midland Utilities has outstanding a bond issue that will mature to its 1,000 par value in 12 years. The bond has a coupon interest rate of 11 and pays interest annually. a. Find the value of the bond if the required return is 1 11 , 2 15 , and 3 8 . b. Plot your findings in part a on a set of required return x axis -market value of bond y axis axes. c. Use your findings in parts a and b to discuss the relationship between the coupon interest rate...

## United Airlines

In the wake of the terrorist attacks in September 2001, airlines saw costs rise and passenger volume decline. Despite huge federal subsidies, some airlines headed straight into Chapter 11 bankruptcy. United Airlines Corporation, for example, in 2002 sought protection from creditors while attempting to reorganize. After 3 years of complex restructuring, the airline finally emerged from bankruptcy on February 1, 2006. The extensive restructuring measures 7 billion in yearly cost reductions from...

## Has Target Capital Structure Of 60 Common Stock 30 Debt And 10 Preferred Stock. The Company Wishes To Issue New 30

The effect of tax rate on WACC Equity Lighting Corp. wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 30 debt, 10 preferred stock, and 60 common stock. The cost of financing with retained earnings is 14 , the cost of preferred stock financing is 9 , and the before-tax cost of debt financing is 11 . Calculate the weighted average cost of capital WACC given the tax rate assumptions in parts a to c....

## Wells Printing Is Considerig The Purchase Of A New Printing Press. The Total Installed Cost Of The Press Is 2.2 Million

Calculate the NPV of each project, and assess its acceptability. b. Calculate the IRR for each project, and assess its acceptability. c. Draw the NPV profiles for both projects on the same set of axes. d. Evaluate and discuss the rankings of the two projects on the basis of your findings in. parts a, b, and c. e. Explain your findings in part d in light of the pattern of cash inflows associated with each project. P9-22 All techniques Decision among mutually exclusive investments Pound...

## WarmUp Exercises a blue box indicates

Exercises available in rcyfiaancelab r El 1 1 Weekend Warriors, Inc., has 35 debt and 65 equity in its capital structure. Wj The firm's estimated after-tax cost of debt is 8 and its estimated cost of equity is 13 . Determine the firm's weighted average cost of capital WACC . fPSj QH3 A firm raises capital by selling 20,000 worth of debt with flotation costs equal to Zj 2 of its par value. If the debt matures in 10 years and has a coupon interest rate of J a ET1-3 Your firm, People's Consulting...

## Review Questions

7 18 Explain the linkages among financial decisions, return, risk, and stock value. 7 19 Assuming that all other variables remain unchanged, what impact would each of the following have on stock price a The firm's beta increases, b The firm's required return decreases, c The dividend expected next year decreases, d The rate of growth in dividends is expected to increase. The price of each share of a firm's common stock is the value of each ownership interest. Although common stockholders...

## Lasting Impressions Li Company Is A Medium-sized Commercial Printer Of Promotional Advertising Brochures Booklets And

Go to the book's companion website at www.presiliaH.conn gitman to find the Web Exercise for this chapter. Remember to check the book's website at www.prenhall.com g9tiriatt to find additional resources, including Web Exercises and a Web Case. Lasting Impressions LI Company is a medium-sized commercial printer of promotional advertising brochures, booklets, and other direct-mail pieces. The firm's major clients are ad agencies based in New York and Chicago. The typical job is characterized by...

## Nominal and Effective Annual Rates of Interest

Both businesses and investors need to make objective comparisons of loan costs or investment returns over different compounding periods. To put interest rates on a common basis, so as to allow comparison, we distinguish between nominal and effective annual rates. The nominal, or stated, annual rate is the contractual annual rate of interest charged by a lender or promised by a borrower. The effective, or true, annual rate EAR is the annual rate of interest actually paid or earned. The effective...

## Four Analysts Cover The Stock Of Fluorine Chemical. One Forecasts A 5 Return For The Coming Year

An analyst predicted last year that the stock of Logistics, Inc., would offer a total return of at least 10 in the coming year. At the beginning of the year, the firm had a stock market value of 10 million. At the end of the yeax it had a market value of 12 million even though it experienced a loss, or negative net income, of 2.5 million. Did the analyst's prediction prove correct Explain using the values for total annual return. Four analysts cover the stock of Fluorine Chemical. One forecasts...

## If The Project Is Forecast To Earn 12 500 Per Year Over The 5 Years Initial Investment Of 45 000 What Is Its Irr Is The

2f 2J You wish to evaluate a project requiring an initial investment of 45,000 and having a useful life of 5 years. What minimum amount of annual cash inflow do you need if your firm has an 8 cost of capital If the project is forecast to earn 12,500 per year over the 5 years, what is its IRR Is the project acceptable El0-3 Like most firms in its industry, Yeastime Bakeries uses a subjective risk assessment tool of its own design. The tool is a simple index by which projects are ranked by level...

## Is Capm And The One Factor Model Mutally Exclusive

All the firm's cash inflows have already been adjusted for taxes. a. Evaluate the projects using risk-adjusted discount rates. b. Discuss your findings in part a, and recommend the preferred project. Mutually exclusive investments and risk Lara Fredericks is interested in two mutually exclusive investments. Both investments cover the same time horizon of 6 years. The cost of the first investment is 10,000, and Lara expects equal and consecutive year-end payments of 3,000. The second investment...

## Shell Camping Gear Inc. Is Considering Two Mutually Exclusive Projects. Each Requires An Initial Investment Of 100 000.

P9-8 NPV Simes Innovations, Inc., is negotiating to purchase exclusive rights to manufacture and market a solar-powered toy car. The car's inventor has offered Simes the choice of either a one-time payment of 1,500,000 today or a series of 5 year-end payments of 385,000. a. If Simes has a cost of capital of 9 , which form of payment should it choose b. What yearly payment would make the two offers identical in value at a cost of capital of 9 c. Would your answer to part a of this problem be...

## Npv For Varying Costs Of Capital Dane Cosmetics Is Evaluating A New Fragrance-mixing Machine. The Machine Requires An

After estimating the relevant cash flows, the financial manager must apply appropriate decision techniques to assess whether the project creates value. Net present value NPV and internal rate of return IRR are the generally preferred capital budgeting techniques. Both use the cost of capital as the required return. The appeal of NPV and IRR stems from the fact that both indicate whether a proposed investment creates or destroys shareholder value. NPV clearly indicates the expected dollar amount...

## Cushing Corporation Is Considering The Purchase

12180 Book value and taxes on sale of assets Troy Industries purchased a new machine 3 years ago for 80,000. It is being depreciated under MACRS with a 5-year recovery period using the percentages given in Table 3.2 on page 108. Assume a 40 tax rate. a. What is the book value of the machine b. Calculate the firm's tax liability if it sold the machine for each of the following amounts 100,000 56,000 23,200 and 15,000. ESQ Tax calculations For each of the following cases, determine the total...

## Masters Golf Products Inc. Spent 3 Years

Whether the projects involved are independent or mutually exclusive. b. Whether the availability of funds is unlimited or capital rationing exists. c. Whether accept-reject or ranking decisions are required. d. Whether each project's cash flows are conventional or nonconventional. ARB P8-3 Relevant cash flow pattern fundamentals For each of the following projects, Jj determine the relevant cash flows, classify the cash flow pattern, and depict the a. A project that requires an initial...

## Eleanor Burns Is Attempting To Find The Nominal Rate Of Interest For Each Of Two Securities

On the same set of axes, draw the yield curve at each of the three given times. b. Label each curve in part a with its general shape downward-sloping, upward-sloping, flat . c. Describe the general inflationary and interest rate expectation existing at each of the three times. Q2Q Risk-free rate and risk premiums The real rate of interest is currendy 3 the inflation expectation and risk premiums for a number of securities follow. i V 1 ' lJ -j 'J' v Q I P r ' V-f A l'Ml r- Vv-' j -C-' r ' 1...

## Self Test Problems

ST8-1 Book value, taxes, and initial investment Irvin Enterprises is considering the purchase of a new piece of equipment to replace the current equipment. The new equipment costs 75,000 and requires 5,000 in installation costs. It will be depreciated under MACRS using a 5-year recovery period. The old piece of equipment was purchased 4 jears ago for an installed cost of 50,000 it was being depreciated under MACRS using a 5-year recovery period. The old equipment can be sold today for 55,000...

## Zane Perelli Currently Has 100 That He Can Spend Today On Polo Shirts Costing 25 Each. Alternatively He Could Invest

Draw the supply curve and the demand curve for funds using the current data. Note Unlike the functions in Figure 6.1 on page 283, the functions here will not appear as straight lines. b. Using your graph, label and note the real rate of interest using the current data. c. Add to the graph drawn in part a the new demand curve expected in the event that the proposed tax legislation is passed. d. What is the new real rate of interest Compare and analyze this finding in light of your analysis in...

## Raina Herzig Wishes To Choose The Best Of Four Immediate Retirement Annuities

Calculate the compound annual growth rate associated with each cash flow stream. b. If year-1 values represent initial deposits in a savings account paying annual interest, what is the annual rate of interest earned on each account c. Compare and discuss the growth rate and interest rate found in parts a and b, respectively. 2031 Rate of return Rishi Singh has 1,500 to invest. His investment counselor suggests an investment that pays no stated interest but will return 2,000 at the end of 3...

## Rose Berry Is Attempting To Evaluate Two Possible

On a set of market return x axis -asset return y axis axes, use the data given to draw the characteristic line for asset A and for asset B. b. Use the characteristic lines from part a to estimate the betas for assets A and B. c. Use the betas found in part b to comment on the relative risks of assets A and B. Interpreting beta A firm wishes to assess the impact of changes in the market return on an asset that has a beta of 1.20. a. If the market return increased by 15 , what impact would...

## Evaluating Annie Heggs Proposed Investment in Atilier Industries Bonds

Annie Hegg has been considering investing in the bonds of Atilier Industries. The bonds were issued 5 years ago at their 1,000 par value and have exactly 25 years remaining until they mature. They have an 8 coupon interest rate, are convertible into 50 shares of common stock, and can be called any time at 1,080. The bond is rated Aa by Moody's. Atilier Industries, a manufacturer of sporting goods, recently acquired a small athletic-wear company that was in financial distress. As a result of the...

## Micro-pub Inc. Is Considering The Purchase Of One Of Two Microfilm Cameras R And S

P5-3 Risk preferences Sharon Smith, the financial manager' for Barnett Corporation, wishes to evaluate three prospective investments X, Y, and Z. Currently, the firm earns 12 on its investments, which have a risk index of 6 . The expected return and expected risk of the investments are as follows i- V1 ' i'i '' - Expected .yj a. If Sharon were risk-indifferent, which investments would she select Explain why. b. If she were risk-averse, which investments would she select Why c. If she were...

## Zane Perelli Currently Has 100

Use the information above to calculate the inflation expectation for each maturity. Recently, the annual inflation rate measured by the Consumer Price Index CPI was forecast to be 3.3 . How could a T-bill have had a negative real rate of return over the same period How could it have had a zero real rate of return What minimum rate of return must the T-bill have earned to meet your requirement of a 2 real rate of return Calculate the risk premium, for each of the following rating classes of...

## Analyzing Risk and Return on Chargers Products Investments

Junior Sayou, a financial analyst for Chargers Products, a manufacturer of stadium benches, must evaluate the risk and return of two assets, X and Y. The firm is considering adding these assets to its diversified asset portfolio. To assess the return and risk of each asset, Junior gathered data on the annual cash flow and beginning- and end-of-year values of each asset over the immediately preceding 10 years, 2000-2009. These data are summarized in the following table see page 276 . Junior's...

## Business Finance Bond Prices And Yields Assume That The Management

If the real rate of interest is currently 2 , find the risk-free rate of interest applicable to each security. b. Find the total risk premium attributable to each security's issuer and issue characteristics. c. Calculate the nominal rate of interest for each security. Compare and discuss your findings. 222 Bond interest payments before and after taxes Charter Corp. has issued 2,500 debentures with a total principal value of 2,500,000. The bonds have a coupon interest rate of 7 . a. What...

## Joe Martinez A U.s. Citizen Living In Brownsville Texas Invested In The Common Stock Of Telmex A Mexican Corporation.

If the returns of assets V and W are perfectly positively correlated correlation coefficient 1 , describe the range of 1 expected return and 2 risk associated with all possible portfolio combinations. b. If the returns of assets V and W are uncorrelated correlation coefficient 0 , describe the approximate range of 1 expected return and 2 risk associated with all possible portfolio combinations. c. If the returns of assets V and W are perfectly negatively correlated correlation coefficient 1...

## Mia Salto Wishes To Determine How Long It Will Take To Repay A Loan With Initial Proceeds Of 14 000

I 34-'I Time to repay installment loan Mia Salto wishes to determine how long it will take to repay a loan with initial proceeds of 14,000 where annual end-of-year installment payments of 2,450 are required. a. If Mia can borrow at a 12 annual rate of interest, how long will it take for her to repay the loan fully b. How long will it take if she can borrow at a 9 annual rate c. How long will it take if she has to pay 15 annual interest d. Reviewing your answers in parts a, b, and c, describe...

## Funding Jill Morans Retirement Annuity

Sunrise Industries wishes to accumulate funds to provide a retirement annuity for its vice president of research, Jill Moran. Ms. Moran, by contract, will retire at the end of exactly 12 years. Upon retirement, she is entitled to receive an annual end-of-year payment of 42,000 for exactly 20 years. If she dies prior to the end of the 20-year period, the annual payments will pass to her heirs. During the 12-year accumulation period, Sunrise wishes to fund the annuity by making equal, annual,...

## International Diversification

The ultimate example of portfolio diversification involves including foreign assets in a portfolio. The inclusion of assets from countries with business cycles that are not highly correlated with the U.S. business cycle reduces the portfolio's responsiveness to market movements and to foreign currency fluctuations. Returns from international Diversification Over long periods, returns from internationally diversified portfolios tend to be superior to those of purely domestic ones. This is...

## Types of Risk

To understand the basic types of risk, consider what happens to the risk of a portfolio consisting of a single security asset , to which we add securities randomly selected from, say, the population of all actively traded securities. Using the standard deviation of return, lt rTp, 'to measure the total portfolio risk, Figure 5.8 depicts the behavior of the total portfolio risk y axis as more securities are added x axis . With the addition of securities, the total portfolio risk declines, as a...

## An Iowa State Savings Bond Can Be Converted To 100

LiflBMj Present value concept Answer each of the following-questions. a. What single investment made today, earning 12 annual interest, will be worth 6,000 at the end of 6 years b. What is the present value of 6,000 tp be received at the end of 6 years if the discount rate is 12 c. What is the most you would pay today for a promise to repay you 6,000 at the end of 6 years if your opportunity cost is 12 d. Compare, contrast, and discuss your findings in parts a through c. fJEffQ Time value Jim...

## How Large Must The Single Deposit Today Into An Account Paying 8 Annual

Find the present value of each stream using a 15 discount rate. b. Compare the calculated present values and discuss them in light of the fact that the undiscounted cash flows total 150,000 in each case. P4-31 Value of a mixed stream Harte Systems, Inc., a maker of electronic surveillance equipment, is considering selling to a well-known hardware chain the rights to market its home security system. The proposed deal calls for the hardware chain to pay Harte 30,000 and 25,000 at the end of...

## You Have Decided To Endow Your Favorite University

Creating a retirement fund To supplement your planned retirement in exactly 42 years, you estimate that you need to accumulate 220,000 by the end of 42 years from today. You plan to make equal, annual, end-of-year deposits into an account paying 8 annual interest. a. How large must the annual deposits be to create the 220,000 fund by the end of 42 years b. If you can afford to deposit only 600 per year into the account, how much will you have accumulated by the end of the forty-second year...

## C. What Effect Would An Increase In The Rate You Can Earn Both During And Prior To

Future value of an annuity For each case in the accompanying table, answer the questions that follow. r.y J a. Calculate the future value of the annuity assuming that it is b. Compare your findings in parts a l and a 2 . All else being identical, which type of annuity ordinary or annuity due is preferable Explain why. P4-19 Present value of an annuity Consider the following cases. a. Calculate the present value of the annuity assuming that it is b. Compare your findings in parts a l and a 2 ....

## Spreadsheet Income Statement For Dayton

You also have the following balance sheet information as of December 31, 2009 and 2008, respectively. i'.'-'rj' ' 'V1'.'. ' .' Property, plant, and equipment, gross Accumulated depreciation and depletion a. Create a spreadsheet similar to the spreadsheet in Table 2.1 which can be viewed at www.prenhallxom gitman to model the following 1 A multiple-step comparative income statement for Dayton, Inc., for the periods ending December 31, 2009 and 2008. You must calculate the cost of goods sold for...

## WarmUp Exercises

A blue box 5BS indicates exercises available in myflnanceiaFj E4-1 Assume a firm makes a 2,500 deposit into its money market account. If this account is currendy paying 0.7 , yes, that's right, less than 1 , what will the account balance be after 1 year E23S If Bob and Judy combine their savings of 1,260 and 975, respectively, and deposit this amount into an account that pays 2 annual interest, compounded monthly, what will the account balance be after 4 years T3 E4-3 Gabrielle just won 2.5...

## As Part Of Your Financial Planning You Wish To Purchase A New Car Exactly 5 Years From Today. The Car You Wish To

Time value You have 1,500 to invest today at 7 interest compounded annually. a. Find how much you will have accumulated in the account at the end of 1 3 years, 2 6 years, and 3 9 years. b. Use your findings in part a to calculate the amount of interest earned in 1 the first 3 years years 1 to 3 , 2 the second 3 years years 4 to 6 , and 3 the third 3 years years 7 to 9 . c. Compare and contrast your findings in part b. Explain why the amount of interest earned increases in each succeeding 3-year...

## You Have Been Assigned The Task Of Putting Together A Statement For The Acme Company That Shows Its Expected Inflows

You have been assigned the task of putting together a statement for the ACME Company that shows its expected inflows and outflows of cash over the months of July 2010 through December 2010. You have been given the following data for ACME Company 1. Expected gross sales for May through December, respectively, are 300,000, 290,000, 425,000, 500,000, 600,000, 625,000, 650,000, and 700,000. 2. 12 of the sales in any given month are collected during that month. However the firm has a credit policy...

## Leonard Industries Wishes To Prepare A Pro Forma Balance Sheet

Use the percent-of-sales method to prepare a pro forma income statement for the year ended December 31, 2010. b. Use fixed and variable cost data to develop a pro forma income statement for the year ended December 31, 2010. c. Compare and contrast the statements developed in parts a and b. Which statement probably provides the better estimate of 2010 income Explain why. P3-16 Pro forma income statement Scenario analysis Alien Products, Inc., wants to do a scenario analysis for the coming...

## The Actual Sales And Purchases For Xenocore Inc. For September And October

Monthly take-home pay 4,900 Expenses Property taxes Nov. only 11.5 Entertainment for Oct. amp Nov. 6 P3-1T Cash budget Advanced The actual sales and purchases for Xenocore, Inc., for September and October 2009, along with its forecast sales and purchases for the period November 2009 through April 2010, follow.

## Track Software Inc. Integrative Case

Seven years ago, after 15 years in public accounting, Stanley Booker, CPA, resigned his position as Manager of Cost Systems for Davis, Cohen, and O'Brien Public Accountants and started Track Software, Inc. In the 2 years preceding his departure from Davis, Cohen, and O'Brien, Stanley had spent nights and weekends developing a sophisticated cost-accounting software program that became Track's initial product offering. As the firm grew, Stanley planned to develop and expand the software product...

## Activity Ratios

Activity ratios Measure the speed with which various accounts are converted into sales or cash inflows or outflows. Activity ratios measure the speed with which various accounts are converted into sales or cash inflows or outflows. With regard to current accounts, measures of liquidity are generally inadequate because differences in the composition of a firm's current assets and current liabilities can significantly affect its true liquidity. It is therefore important to look beyond measures of...

## Cash Budget Basic - Grenoble Enterprises Had Sales Of 50000

Calculate the firm's operating cash flow OCF for the year ended December 31, 2009, using Equation 3.3. d. Calculate the firm's free cash flow FCF for the year ended December 31, 2009, using Equation 3.5. e. Interpret, compare, and contrast your cash flow estimates in parts a, c, and d. I B I Cash receipts A firm has actual sales of 65,000 in April and 60,000 in May. It expects sales of 70,000 in June and 100,000 in July and in August. Assuming that sales are the only source of cash inflows...

## Preparing Martin Manufacturings 2010 Pro Forma Financial Statements

To imprbve its competitive position, Martin Manufacturing is planning to implement a major equipment modernization program. Included will be replacement and modernization of key manufacturing equipment at a cost of 400,000 in 2010. The planned program is expected to lower the variable cost per unit of finished product. Terri Spiro, an experienced budget analyst, has been charged with preparing a forecast of the firm's 2010 financial position, assuming replacement and modernization of...

## The Marketing Department Of Metroline Manufacturing Estimates

V3 P3-13 Cash budget Scenario analysis Trotter Enterprises, Inc., has gathered the fol-WJ lowing data to plan for its cash requirements and short-term investment opportuni ties for October November and December All amounts are shown in thousands of dollars. ' 'Vfr- ' October' yi' v i i December ' mistic . likely 'mistic Total cash receipts 260 342 462 200 287 366 191 294 353 Total cash disbursements 285 326 421 203 261 313 287 332 315 a. Prepare a scenario analysis of Trotter's cash budget...

## Irv Degraw Finance Wife

Gordon Dippel Carleton Donchess Thomas W. Donohue Shannon Donovan Vincent R. Driscoll Betty A. Driver Lorna Dotts David R. Durst Dwayne O. Eberhardt Ronald L. Ehresman Ted Ellis F. Barney English Greg Filbeck Ross A. Flaherty Rich Fortin Timothy J. Gallagher George W. Gallinger Sharon Garrison Gerald D. Gay Deborah Giarusso R. H. Gilmer Anthony J. Giovino Philip W. Glasgo Jeffrey W. Glazer Joel Gold Ron B. Goldfarb Dennis W. Goodwin David A. Gordon j. Charles Granicz C....

## Calculate The Following Debt And Coverage Ratios For Pelican Paper And Timberland Forest Inc 1. Debt Ratio 2. Times

Calculate the following debt and coverage ratios for the two companies. Discuss their financial risk and ability to cover the costs in relation to each other. 2 Times interest earned ratio b. Calculate the following profitability ratios for the two companies. Discuss their profitability relative to each other c. In what way has the larger debt of Timberland Forest made it more profitable than Pelican Paper What are the risks that Timberland's investors undertake when they choose to purchase...

## The Use Of Differing Accounting Treatments Especially Relative To Inventory And Depreciation

A single ratio does not generally provide sufficient information from which to judge the overall performance of the firm. However if an analysis is concerned only with certain specific aspects of a firm's financial position, one or two ratios may suffice. 3. The ratios being compared should be calculated using financial statements dated at the same point in time during the yean If they are not, the effects of seasonality may produce erroneous conclusions and decisions. 4. It is preferable to...