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INTRODUCTION TO CORPORATE
FINANCE
1. Agency Problems Who owns a corporation? Describe the process whereby the
owners control the firm’s management. What is the main reason that an agency
relationship exists in the corporate form of organization? In this context, what kinds of
problems can arise? TRONG SÁCH LÝ THUYẾT
2. Not-for-Profit Firm Goals Suppose you were the financial manager of a not-for-
profit business (a not-for-profit hospital, perhaps). What kinds of goals do you think
would be appropriate?
3. Goal of the Firm Evaluate the following statement: Managers should not focus on
the current stock value because doing so will lead to an overemphasis on short-term
profits at the expense of long-term profits.
4. Ethics and Firm Goals Can the goal of maximizing the value of the stock conflict
with other goals, such as avoiding unethical or illegal behavior? In particular, do you
think subjects like customer and employee safety, the environment, and the general
good of society fit in this framework, or are they essentially ignored? Think of some
specific scenarios to illustrate your answer.
5. International Firm Goal Would the goal of maximizing the value of the stock
differ for financial management in a foreign country? Why or why not?
6. Agency Problems Suppose you own stock in a company. The current price per
share is $25. Another company has just announced that it wants to buy your company
and will pay $35 per share to acquire all the outstanding stock. Your company’s
management immediately begins fighting off this hostile bid. Is management acting in
the shareholders’ best interests? Why or why not?
7. Agency Problems and Corporate Ownership Corporate ownership varies around
the world. Historically, individuals have owned the majority of shares in public
corporations in the United States. In Germany and Japan, however, banks, other large
financial institutions, and other companies own most of the stock in public
corporations. Do you think agency problems are likely to be more or less severe in
Germany and Japan than in the United States?
8. Agency Problems and Corporate Ownership In recent years, large financial
institutions such as mutual funds and pension funds have become the dominant
owners of stock in the United States, and these institutions are becoming more active
in corporate affairs. What are the implications of this trend for agency problems and
corporate control?
9. Executive Compensation Critics have charged that compensation to top managers
in the United States is simply too high and should be cut back. For example, focusing
on large corporations, Larry Ellison of Oracle has been one of the best-compensated
CEOs in the United States, earning about $76.9 million in 2013. Are such amounts
excessive? In answering, it might be helpful to recognize that superstar athletes such
as Cristiano Ronaldo, top earners in the entertainment field such as James Cameron
and Oprah Winfrey, and many others at the top of their respective fields earn at least
as much, if not a great deal more.
10. Goal of Financial Management Why is the goal of financial management to
maximize the current value of the company’s stock? In other words, why isn’t the goal
to maximize the future value?
CHAPTER 2
ACCOUNTING STATEMENTS AND
CASH
FLOW
Concept Questions
1. Liquidity True or false: All assets are liquid at some price. Explain.
2. Accounting and Cash Flows Why might the revenue and cost figures shown
ona standard income statement not represent the actual cash inflows and
outflows thatoccurred during a period?
3. Accounting Statement of Cash Flows Looking at the accounting statement of
cashflows, what does the bottom line number mean? How useful is this number
for analyzinga company?
4. Cash Flows How do financial cash flows and the accounting statement of cash
flowsdiffer? Which is more useful for analyzing a company?
5. Book Values versus Market Values Under standard accounting rules, it is
possiblefor a company’s liabilities to exceed its assets. When this occurs, the
owners’ equity isnegative. Can this happen with market values? Why or why not?
6. Cash Flow from Assets Why is it not necessarily bad for the cash flow from
assets tobe negative for a particular period?
7. Operating Cash Flow Why is it not necessarily bad for the operating cash flow
to benegative for a particular period?
8. Net Working Capital and Capital Spending Could a company’s change in
networking capital be negative in a given year? (Hint: Yes.) Explain how this
might comeabout. What about net capital spending?
9. Cash Flow to Stockholders and Creditors Could a company’s cash flow
tostockholders be negative in a given year? (Hint: Yes.) Explain how this might
comeabout. What about cash flow to creditors?
10. Firm Values Referring back to the Ford example at the beginning of the
chapter,note that we suggested that Ford’s stockholders probably didn’t suffer as
a result of thereported loss. What do you think was the basis for our conclusion?
Exercises
1. Building a Balance Sheet Sankey, Inc., has current assets of $4,900, net fixed
assets of $25,000, current liabilities of $4,100, and long-term debt of $10,300.
What is the value of the shareholders’ equity account for this firm? How much is
net working capital?
3. Market Values and Book Values Klingon Cruisers, Inc., purchased new
cloaking machinery three years ago for $9.5 million. The machinery can be sold
to the Romulans today for $6.5 million. Klingon’s current balance sheet shows
net fixed assets of $5.2 million, current liabilities of $2.4 million, and net working
capital of $800,000. If all the current assets were liquidated today, the company
would receive $2.6 million cash.What is the book value of Klingon’s assets today?
What is the market value?
4. Calculating Taxes The Stefani Co. had $198,000 in taxable income. Using the
rates from Table 2.3 in the chapter, calculate the company’s income taxes. What
is the average tax rate? What is the marginal tax rate?
5. Cash Flow to Creditors The 2014 balance sheet of Jordan’s Golf Shop, Inc.,
showed long-term debt of $1.625 million, and the 2015 balance sheet showed
long-term debt of $1.73 million. The 2015 income statement showed an interest
expense of $185,000. What was the firm’s cash flow to creditors during 2015?
6. Cash Flow to Stockholders The 2014 balance sheet of Jordan’s Golf Shop, Inc.,
showed $510,000 in the common stock account and $3.6 million in the additional
paid-in surplus account. The 2015 balance sheet showed $545,000 and $3.85
million in the same two accounts, respectively. If the company paid out $275,000
in cash dividends during 2015, what was the cash flow to stockholders for the
year?
7. Cash Flows Ritter Corporation’s accountants prepared the following financial
statements for year-end 2015:
a. Explain the change in cash during 2015.
b. Determine the change in net working capital in 2015.
c. Determine the cash flow generated by the firm’s assets during 2015.
INCOME STATEMENT 2015 BALANCE SHEET
Revenue $790 December 31
Expenses 575 2015 2014
Depreciation 90 Assets
Net income $125 Cash 80 60
Dividends $95 Other current assets 185 170
Net fixed assets 405 385
Total assets $670 $615
Liabilities and Equity
Accounts Payable 140 125
Long-term debt 160 150
Stockholders' equity 370 340
Total liabilities and $670 $615
equity
2015
8. Building an Income Statement During the year, the Senbet Discount Tire
Company had gross sales of $925,000. The firm’s cost of goods sold and selling
expenses were $490,000 and $220,000, respectively. Senbet also had notes
payable of $740,000. These notes carried an interest rate of 4 percent.
Depreciation was $120,000. Senbet’s tax rate was 35 percent.
9. Calculating Total Cash Flows Schwert Corp. shows the following information
on its 2015 income statement: sales = $215,000; costs = $117,000; other
expenses = $6,700; depreciation expense = $18,400; interest expense = $10,000;
taxes = $25,370; dividends = $9,500. In addition, you’re told that the firm =sued
$8,100 in new equity during 2015 and redeemed $7,200 in outstanding long-
term debt.
d. If net fixed assets increased by $28,400 during the year, what was the addition
to networking capital (NWC)?
10. Using Income Statements Given the following information for O’Hara
Marine Co., calculate the depreciation expense: sales = $44,000; costs = $27,500;
addition to retained earnings = $5,200; dividends paid = $1,670; interest expense
= $1,850; tax rate = 40 percent.
CHAPTER 3
DISCOUNTED CASH FLOW
VALUATION
Exercises
1. Simple Interest versus Compound Interest First City Bank pays 7.5 percent
simple interest on its savings account balances, whereas Second City Bank pays 7.5
percent interest compounded annually. If you made a $7,000 deposit in each bank,
how much more money would you earn from your Second City Bank account at the
end of 10 years?
2. Calculating Future Values Compute the future value of $1,000 compounded
annually for
a. 10 years at 6 percent.
b. 10 years at 12 percent.
c. 20 years at 6 percent.
d. Why is the interest earned in part (c) not twice the amount earned in part (a)?
3. Calculating Present Values For each of the following, compute the present value:
4. Calculating Interest Rates Solve for the unknown interest rate in each of the
following:
5. Calculating the Number of Periods Solve for the unknown number of years in
each of the following:
6. Calculating the Number of Periods At 6.5 percent interest, how long does it take
to double your money? To quadruple it?
7. Calculating Present Values Imprudential, Inc., has an unfunded pension liability
of $550 million that must be paid in 20 years. To assess the value of the firm’s stock,
financial analysts want to discount this liability back to the present. If the relevant
discount rate is 6.4 percent, what is the present value of this liability?
8. Calculating Rates of Return Although appealing to more refined tastes, art as a
collectible has not always performed so profitably. During 2010, Deutscher-Menzies
sold Arkie under the Shower, a painting by renowned Australian painter Brett
Whiteley, at auction for a price of $1,100,000. Unfortunately for the previous owner,
he had purchased it three years earlier at a price of $1,680,000. What was his annual
rate of return on this painting?
9. Perpetuities An investor purchasing a British consol is entitled to receive annual
payments from the British government forever. What is the price of a consol that pays
$125 annually if the next payment occurs one year from today? The market interest
rate is 3.9 percent.
10. Simple Interest versus Compound Interest First Simple Bank pays 4.1 percent
simple interest on its investment accounts. If First Complex Bank pays interest on its
accounts compounded annually, what rate should the bank set if it wants to match
First Simple Bank over an investment horizon of 10 years?
11. Calculating Annuities You are planning to save for retirement over the next 30
years. To do this, you will invest $750 per month in a stock account and $250 per
month in a bond account. The return of the stock account is expected to be 11 percent
per year, and the bond account will earn 6 percent per year. When you retire, you will
combine your money into an account with an annual return of 8 percent. How much
can you withdraw each month from your account assuming a 25-year withdrawal
period?
12. Growing Perpetuities Mark Weinstein has been working on an advanced
technology in laser eye surgery. His technology will be available in the near term. He
anticipates his first annual cash flow from the technology to be $215,000, received
two years from today. Subsequent annual cash flows will grow at 3.8 percent in
perpetuity. What is the present value of the technology if the discount rate is 10
percent?
13. Perpetuities A prestigious investment bank designed a new security that pays a
quarterly dividend of $2.75 in perpetuity. The first dividend occurs one quarter from
today. What is the price of the security if the APR is 5.3 percent, compounded
quarterly?
14. Annuity Present Values What is the present value of an annuity of $5,500 per
year, with the first cash flow received three years from today and the last one received
25 years from today? Use a discount rate of 8 percent.
15. Growing Annuity Southern California Publishing Company is trying to decide
whether to revise its popular textbook, Financial Psychoanalysis Made Simple. The
company has estimated that the revision will cost $135,000. Cash flows from
increased sales will be $48,000 the first year. These cash flows will increase by 4
percent per year. The book will go out of print five years from now. Assume that the
initial cost is paid now and revenues are received at the end of each year. If the
company requires a return of 10 percent for such an investment, should it undertake
the revision?
16. Calculating Loan Payments You need a 30-year, fixed-rate mortgage to buy a
new home for $250,000. Your mortgage bank will lend you the money at an APR of
4.5 percent for this 360-month loan. However, you can only afford monthly payments
of $950, so you offer to pay off any remaining loan balance at the end of the loan in
the form of a single balloon payment. How large will this balloon payment have to be
for you to keep your monthly payments at $950?
17. EAR versus APR You have just purchased a new warehouse. To finance the
purchase, you’ve arranged for a 30-year mortgage for 80 percent of the $5,200,000
purchase price. The monthly payment on this loan will be $27,500. What is the APR
on this loan? The EAR?
CHAPTER4
INVESTMENT CRITERIAS
1. Calculating Payback Period and NPV Maxwell Software, Inc., has the following
mutually exclusive projects.
a. Suppose the company’s payback period cutoff is two years. Which of these two
projects should be chosen?
b. Suppose the company uses the NPV rule to rank these two projects. Which project
should be chosen if the appropriate discount rate is 15 percent?
2. Calculating Discounted Payback An investment project has annual cash inflows
of $5,000, $5,500, $6,000, and $7,000, and a discount rate of 12 percent. What is the
discounted payback period for these cash flows if the initial cost is $8,000? What if
the initial cost is $12,000? What if it is $16,000?
3. Calculating IRR Compute the internal rate of return for the cash flows of the
following two projects:
4. Calculating Profitability Index Bill plans to open a self-serve grooming center in
storefront. The grooming equipment will cost $265,000, to be paid immediately. Bill
expects after tax cash inflows of $59,000 annually for seven years, after which he
plans to scrap the equipment and retire to the beaches of Nevis. The first cash inflow
occurs at the end of the first year. Assume the required return is 13 percent. What is
the project’s PI? Should it be accepted?
5. NPV versus IRR Consider the following cash flows on two mutually exclusive
projects for the Bahamas Recreation Corporation (BRC). Both projects require an
annual return of 14 percent.
b
As a financial analyst for BRC, you are asked the following questions:
a. If your decision rule is to accept the project with the greater IRR, which project
should you choose?
b. Because you are fully aware of the IRR rule’s scale problem, you calculate the
incremental IRR for the cash flows. Based on your computation, which project should
you choose?
c. To be prudent, you compute the NPV for both projects. Which project should you
choose? Is it consistent with the incremental IRR rule?
6. Comparing Investment Criteria Wii Brothers, a game manufacturer, has a new
idea for an adventure game. It can market the game either as a traditional board game
or as an interactive DVD, but not both. Consider the following cash flows of the two
mutually
exclusive projects for the company. Assume the discount rate for both projects is 10
percent.
1. Stock Values The next dividend payment by ECY, Inc., will be $2.90 per share.
The dividends are anticipated to maintain a growth rate of 5.5 percent, forever. If the
stock currently sells for $53.10 per share, what is the required return?
2. Stock Values For the company in the previous problem, what is the dividend yield?
What is the expected capital gains yield?
3. Stock Values Shiller Corporation will pay a $2.75 per share dividend next year.
The company pledges to increase its dividend by 5 percent per year, indefinitely. If
you require a return of 11 percent on your investment, how much will you pay for the
company’s stock today?
4. Stock Valuation Suppose you know that a company’s stock currently sells for $67
per share and the required return on the stock is 10.8 percent. You also know that the
total return on the stock is evenly divided between a capital gains yield and a dividend
yield. If it’s the company’s policy to always maintain a constant growth rate in its
dividends, what is the current dividend per share?
5. Growth Rate The newspaper reported last week that Bennington Enterprises
earned $29 million this year. The report also stated that the firm’s return on equity is
17 percent. Bennington retains 80 percent of its earnings. What is the firm’s earnings
growth rate? What will next year’s earnings be?
6. Stock Valuation Universal Laser, Inc., just paid a dividend of $2.90 on its stock.
The growth rate in dividends is expected to be a constant 6 percent per year,
indefinitely. Investors require a 15 percent return on the stock for the first three years,
a 13 percentreturn for the next three years, and then an 11 percent return thereafter.
What is the current share price for the stock?
7. Nonconstant Growth Metallica Bearings, Inc., is a young start-up company. No
dividends will be paid on the stock over the next nine years, because the firm needs to
plow back its earnings to fuel growth. The company will pay a dividend of $17.50
pers hare in 10 years and will increase the dividend by 5.5 percent per year thereafter.
If the required return on this stock is 12 percent, what is the current share price?
8. Nonconstant Dividends Bucksnort, Inc., has an odd dividend policy. The company
has just paid a dividend of $9 per share and has announced that it will increase the
dividend by $4 per share for each of the next five years, and then never pay another
dividend. If you require a return of 12 percent on the company’s stock, how much will
you pay for a share today?
9. Differential Growth Synovec Corp. is experiencing rapid growth. Dividends are
expected to grow at 30 percent per year during the next three years, 18 percent over
the following year, and then 8 percent per year indefinitely. The required return on
this stock is 11 percent, and the stock currently sells for $65 per share. What is the
projected dividend for the coming year?
10. Nonconstant Growth and Quarterly Dividends Pasqually Mineral Water, Inc.,
will pay a quarterly dividend per share of $.90 at the end of each of the next 12
quarters. Thereafter, the dividend will grow at a quarterly rate of 1 percent, forever.
The appropriate rate of return on the stock is 10 percent, compounded quarterly. What
is the current stock price?
11. Stock Valuation and Cash Flows Fincher Manufacturing has projected sales of
$135 million next year. Costs are expected to be $76 million and net investment is
expected to be $15 million. Each of these values is expected to grow at 14 percent the
following year, with the growth rate declining by 2 percent per year until the growth
rate reaches 6 percent, where it is expected to remain indefinitely. There are 5.5
million shares of stock outstanding and investors require a return of 13 percent return
on the company’s stock. The corporate tax rate is 40 percent.
a. What is your estimate of the current stock price?
b. Suppose instead that you estimate the terminal value of the company using a
PE multiple. The industry PE multiple is 11. What is your new estimate of the
company’s stock price?
12. Nonconstant Growth Storico Co. just paid a dividend of $3.40 per share. The
company will increase its dividend by 20 percent next year and will then reduce its
dividend growth rate by 5 percentage points per year until it reaches the industry
average of 5 percent dividend growth, after which the company will keep a constant
growth rate forever. If the required return on Storico stock is 13 percent, what will a
share of stock sell for today?
CHAPTER 7
RISK AND RETURN
1. Calculating Returns Suppose a stock had an initial price of $64 per share, paid a dividend
of $1.20 per share during the year, and had an ending share price of $73. Compute the
percentage total return. What was the dividend yield? The capital gains yield?
2. Calculating Returns Suppose you bought a bond with a 5.8 percent coupon rate one year
ago for $1,030. The bond sells for $1,059 today.
a. Assuming a $1,000 face value, what was your total dollar return on this investment over
the past year?
b.What was your total nominal rate of return on this investment over the past year?
3. Calculating Returns and Variability Using the following returns, calculate the average
returns, the variances, and the standard deviations for X and Y:
4. Calculating Returns and Variability You’ve observed the following returns on SkyNet
Data Corporation’s stock over the past five years: 21 percent, 17 percent, 26 percent, 27
percent, and 4 percent.
a. What was the arithmetic average return on the company’s stock over this five-year period?
b. What was the variance of the company’s returns over this period? The standard deviation?
5. Holding Period Return A stock has had returns of 14.38 percent, 8.43 percent, 11.97
percent, 25.83 percent, and -9.17 percent over the past five years, respectively. What was the
holding period return for the stock?
6. Calculating Returns You purchased a zero coupon bond one year ago for $160.53. The
market interest rate is now 7.5 percent. If the bond had 25 years to maturity when you
originally purchased it, what was your total return for the past year?
7. Calculating Returns and Variability You find a certain stock that had returns of 12
percent, 215 percent, 13 percent, and 27 percent for four of the last five years. If the average
return of the stock over this period was 10.5 percent, what was the stock’s return for the
missing year? What is the standard deviation of the stock’s returns?
8. Portfolio Expected Return You own a portfolio that is 20 percent invested in Stock X, 45
percent in Stock Y, and 35 percent in Stock Z. The expected returns on these three stocks are
11 percent, 17 percent, and 14 percent, respectively. What is the expected return on the
portfolio?
9. Calculating Returns and Standard Deviations Based on the following information,
calculate the expected return and standard deviation for the two stocks:
10. Arithmetic and Geometric Returns A stock has had returns of 24 percent, 12 percent,
38 percent, 22 percent, 21 percent, and 216 percent over the last six years. What are the
arithmetic and geometric returns for the stock?
11. Arithmetic and Geometric Returns A stock has had the following year-end prices and
dividends. Determine the arithmetic and geometric returns for the stock.
12. Covariance and Correlation Based on the following information, calculate the expected
return and standard deviation of each of the following stocks. Assume each state of the
economy is equally likely to happen. What are the covariance and correlation between the
returns of the two stocks?
13. Covariance and Correlation Based on the following information, calculate the expected
return and standard deviation for each of the following stocks. What are the covariance and
correlation between the returns of the two stocks?