公司理财英文版题库

CHAPTER 8MAKING CAPITAL INVESTMENT DECISIONSAnswers to Concepts Review and Critical Thinking Questions1. In this context, an opportunity cost refers to the value of anasset or other input that will be used in a project. The relevant cost is what the asset or input is actually worth today, not, for example, what it cost to acquire.2. a.Yes, the reduction in the sales of the company’s otherproducts, referred to as erosion, and should be treated as an incremental cash flow. These lost sales are included because they are a cost (a revenue reduction) that the firm must bear if it chooses to produce the new product.b. Yes, expenditures on plant and equipment should be treatedas incremental cash flows. These are costs of the new product line. However, if these expenditures have already occurred, they are sunk costs and are not included as incremental cash flows.c. No, the research and development costs should not be treatedas incremental cash flows. The costs of research and development undertaken on the product during the past 3 years are sunk costs and should not be included in the evaluation of the project. Decisions made and costs incurred in the past cannot be changed. They should not affect the decision to accept or reject the project.d. Yes, the annual depreciation expense should be treated as anincremental cash flow. Depreciation expense must be taken into account when calculating the cash flows related to a given project. While depreciation is not a cash expense that directly affects c ash flow, it decreases a firm’s netincome and hence, lowers its tax bill for the year. Because of this depreciation tax shield, the firm has more cash on hand at the end of the year than it would have had without expensing depreciation.e.No, dividend payments should not be treated as incrementalcash flows. A firm’s decision to pay or not pay dividends is independent of the decision to accept or reject any given investment project. For this reason, it is not an incremental cash flow to a given project. Dividend policy is discussed in more detail in later chapters.f.Yes, the resale value of plant and equipment at the end of aproject’s life should be treated as an incremental cashflow. The price at which the firm sells the equipment is a cash inflow, and any difference between the book value ofthe equipment and its sale price will create gains or losses that result in either a tax credit or liability.g.Yes, salary and medical costs for production employees hiredfor a project should be treated as incremental cash flows.The salaries of all personnel connected to the project must be included as costs of that project.3.I tem I is a relevant cost because the opportunity to sell theland is lost if the new golf club is produced. Item II is also relevant because the firm must take into account the erosion of sales of existing products when a new product is introduced. If the firm produces the new club, the earnings from the existing clubs will decrease, effectively creating a cost that must be included in the decision. Item III is not relevant because the costs of Research and Development are sunk costs. Decisions made in the past cannot be changed. They are not relevant to the production of the new clubs.4. For tax purposes, a firm would choose MACRS because it providesfor larger depreciation deductions earlier. These larger deductions reduce taxes, but have no other cash consequences.Notice that the choice between MACRS and straight-line is purely a time value issue; the total depreciation is the same;only the timing differs.5.It’s probably only a mild over-simplification. Currentliabilities will all be paid, presumably. The cash portion of current assets will be retrieved. Some receivables won’t be collected, and some inventory will not be sold, of course.Counterbalancing these losses is the fact that inventory sold above cost (and not replaced at the end of the project’s life) acts to increase working capital. These effects tend to offset one another.6.Management’s discretion to set the firm’s capital structureis applicable at the firm level. Since any one particular project could be financed entirely with equity, another project could be financed with debt, and the firm’s overall capital structure remains unchanged, financing costs are not relevant in the analysis of a project’s incremental cash flows according to the stand-alone principle.7. The EAC approach is appropriate when comparing mutuallyexclusive projects with different lives that will be replaced when they wear out. This type of analysis is necessary so that the projects have a common life span over which they can be compared; in effect, each project is assumed to exist over an infinite horizon of N-year repeating projects. Assuming that this type of analysis is valid implies that the project cash flows remain the same forever, thus ignoring the possible effects of, among other things: (1) inflation, (2) changing economic conditions, (3) the increasing unreliability of cash flow estimates that occur far into the future, and (4) the possible effects of future technology improvement that could alter the project cash flows.8. Depreciation is a non-cash expense, but it is tax-deductible onthe income statement. Thus depreciation causes taxes paid, an actual cash outflow, to be reduced by an amount equal to the depreciation tax shield, t c D. A reduction in taxes that would otherwise be paid is the same thing as a cash inflow, so the effects of the depreciation tax shield must be added in to get the total incremental aftertax cash flows.9. There are two particularly important considerations. The firstis erosion. Will the “essentialized”book simply displace copies of the existing book that would have otherwise been sold?This is of special concern given the lower price. The second consideration is competition. Will other publishers step in and produce such a product? If so, then any erosion is much less relevant. A particular concern to book publishers (and producers of a variety of other product types) is that the publisher only makes money from the sale of new books. Thus, it is important to examine whether the new book would displace sales of used books (good from the publisher’s perspective) or new books (not good). The concern arises any time there is an active market for used product.10.D efinitely. The damage to Porsche’s reputation is definitely afactor the company needed to consider. If the reputation was damaged, the company would have lost sales of its existing car lines.11.O ne company may be able to produce at lower incremental cost ormarket better. Also, of course, one of the two may have made a mistake!12.P orsche would recognize that the outsized profits would dwindleas more products come to market and competition becomes more intense.Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1. Using the tax shield approach to calculating OCF, we get:OCF = (Sales – Costs)(1 – t C) + t C DepreciationOCF = [($5 × 2,000 –($2 × 2,000)](1 –0.35) +0.35($10,000/5)OCF = $4,600So, the NPV of the project is:NPV = –$10,000 + $4,600(PVIFA17%,5)NPV = $4,7172. We will use the bottom-up approach to calculate the operatingcash flow for each year. We also must be sure to include the net working capital cash flows each year. So, the total cash flow each year will be:Year 1 Year 2 Year 3 Year 4 Sales Rs.7,000 Rs.7,000 Rs.7,000 Rs.7,000Costs 2,000 2,000 2,000 2,000Depreciation 2,500 2,500 2,500 2,500EBT Rs.2,500 Rs.2,500 Rs.2,500 Rs.2,500Tax 850 850 850 850Net income Rs.1,650 Rs.1,650 Rs.1,650 Rs.1,650OCF 0 Rs.4,150 Rs.4,150 Rs.4,150 Rs.4,150Capital spending –Rs.10,000 0 0 0 0NWC –200 –250 –300 –200 950 Incremental cashflow –Rs.10,200 Rs.3,900 Rs.3,850 Rs.3,950 Rs.5,100The NPV for the project is:NPV = –Rs.10,200 + Rs.3,900 / 1.10 + Rs.3,850 / 1.102+ Rs.3,950 / 1.103 + Rs.5,100 / 1.104NPV = Rs.2,978.333. U sing the tax shield approach to calculating OCF, we get:OCF = (Sales – Costs)(1 – t C) + t C DepreciationOCF = (R2,400,000 – 960,000)(1 – 0.30) + 0.30(R2,700,000/3) OCF = R1,278,000So, the NPV of the project is:NPV = –R2,700,000 + R1,278,000(PVIFA15%,3)NPV = R217,961.704.T he cash outflow at the beginning of the project will increasebecause of the spending on NWC. At the end of the project, the company will recover the NWC, so it will be a cash inflow. The sale of the equipment will result in a cash inflow, but we also must account for the taxes which will be paid on this sale. So, the cash flows for each year of the project will be:Year Cash Flow0 – R3,000,000 = –R2.7M – 300K1 1,278,0002 1,278,0003 1,725,000 = R1,278,000 + 300,000 + 210,000 + (0 – 210,000)(.30)And the NPV of the project is:NPV = –R3,000,000 + R1,278,000(PVIFA15%,2) + (R1,725,000 / 1.153) NPV = R211,871.465. First we will calculate the annual depreciation for theequipment necessary for the project. The depreciation amount each year will be:Year 1 depreciation = R2.7M(0.3330) = R899,100Year 2 depreciation = R2.7M(0.4440) = R1,198,800Year 3 depreciation = R2.7M(0.1480) = R399,600So, the book value of the equipment at the end of three years, which will be the initial investment minus the accumulated depreciation, is:Book value in 3 years = R2.7M –(R899,100 + 1,198,800 + 399,600)Book value in 3 years = R202,500The asset is sold at a gain to book value, so this gain is taxable.Aftertax salvage value = R202,500 + (R202,500 – 210,000)(0.30) Aftertax salvage value = R207,750To calculate the OCF, we will use the tax shield approach, so the cash flow each year is:OCF = (Sales – Costs)(1 – t C) + t C DepreciationYear Cash Flow0 – R3,000,000 = –R2.7M – 300K1 1,277,730.00 = (R1,440,000)(.70) + 0.30(R899,100)2 1,367,640.00 = (R1,440,000)(.70) + 0.30(R1,198,800)3 1,635,630.00 = (R1,440,000)(.70) + 0.30(R399,600) + R207,750 + 300,000Remember to include the NWC cost in Year 0, and the recovery of the NWC at the end of the project. The NPV of the project with these assumptions is:NPV = – R3.0M + (R1,277,730/1.15) + (R1,367,640/1.152) +(R1,635,630/1.153)NPV = R220,655.206. First, we will calculate the annual depreciation of the newequipment. It will be:Annual depreciation charge = €925,000/5Annual depreciation charge = €185,000The aftertax salvage value of the equipment is:Aftertax salvage value = €90,000(1 – 0.35)Aftertax salvage value = €58,500Using the tax shield approach, the OCF is:OCF = €360,000(1 – 0.35) + 0.35(€185,000)OCF = €298,750Now we can find the project IRR. There is an unusual feature that is a part of this project. Accepting this project means that we will reduce NWC. This reduction in NWC is a cash inflow at Year 0. This reduction in NWC implies that when the project ends, we will have to increase NWC. So, at the end of theproject, we will have a cash outflow to restore the NWC to its level before the project. We also must include the aftertax salvage value at the end of the project. The IRR of the project is:NPV = 0 = –€925,000 + 125,000 + €298,750(PVIFA IRR%,5) + [(€58,500 – 125,000) / (1+IRR)5]IRR = 23.85%7. First, we will calculate the annual depreciation of the newequipment. It will be:Annual depreciation = £390,000/5Annual depreciation = £78,000Now, we calculate the aftertax salvage value. The aftertax salvage value is the market price minus (or plus) the taxes on the sale of the equipment, so:Aftertax salvage value = MV + (BV – MV)t cVery often, the book value of the equipment is zero as it is in this case. If the book value is zero, the equation for the aftertax salvage value becomes:Aftertax salvage value = MV + (0 – MV)t cAftertax salvage value = MV(1 – t c)We will use this equation to find the aftertax salvage value since we know the book value is zero. So, the aftertax salvage value is:Aftertax salvage value = £60,000(1 – 0.34)Aftertax salvage value = £39,600Using the tax shield approach, we find the OCF for the project is:OCF = £120,000(1 – 0.34) + 0.34(£78,000)OCF = £105,720Now we can find the project NPV. Notice that we include the NWC in the initial cash outlay. The recovery of the NWC occurs in Year 5, along with the aftertax salvage value.NPV = –£390,000 –28,000 + £105,720(PVIFA10%,5) + [(£39,600 + 28,000) / 1.15]NPV = £24,736.268. To find the BV at the end of four years, we need to find theaccumulated depreciation for the first four years. We could calculate a table with the depreciation each year, but an easier way is to add the MACRS depreciation amounts for each of the first four years and multiply this percentage times the cost of the asset. We can then subtract this from the asset cost. Doing so, we get:BV4 = $9,300,000 – 9,300,000(0.2000 + 0.3200 + 0.1920 + 0.1150) BV4 = $1,608,900The asset is sold at a gain to book value, so this gain is taxable.Aftertax salvage value = $2,100,000 + ($1,608,900 –2,100,000)(.40)Aftertax salvage value = $1,903,5609. We will begin by calculating the initial cash outlay, that is,the cash flow at Time 0. To undertake the project, we will have to purchase the equipment and increase net working capital. So, the cash outlay today for the project will be:Equipment –€2,000,000NWC –100,000Total –€2,100,000Using the bottom-up approach to calculating the operating cash flow, we find the operating cash flow each year will be:Sales €1,200,000Costs 300,000Depreciation 500,000EBT €400,000Tax 140,000Net income €260,000The operating cash flow is:OCF = Net income + DepreciationOCF = €260,000 + 500,000OCF = €760,000To find the NPV of the project, we add the present value of the project cash flows. We must be sure to add back the net working capital at the end of the project life, since we are assuming the net working capital will be recovered. So, the project NPV is:NPV = –€2,100,000 + €760,000(PVIFA14%,4) + €100,000 / 1.144NPV = €173,629.3810.W e will need the aftertax salvage value of the equipment tocompute the EAC. Even though the equipment for each product hasa different initial cost, both have the same salvage value. Theaftertax salvage value for both is:Both cases: aftertax salvage value = $20,000(1 –0.35) = $13,000To calculate the EAC, we first need the OCF and NPV of each option. The OCF and NPV for Techron I is:OCF = – $34,000(1 – 0.35) + 0.35($210,000/3) = $2,400NPV = –$210,000 + $2,400(PVIFA14%,3) + ($13,000/1.143) = –$195,653.45EAC = –$195,653.45 / (PVIFA14%,3) = –$84,274.10And the OCF and NPV for Techron II is:OCF = – $23,000(1 – 0.35) + 0.35($320,000/5) = $7,450NPV = –$320,000 + $7,450(PVIFA14%,5) + ($13,000/1.145) = –$287,671.75EAC = –$287,671.75 / (PVIFA14%,5) = –$83,794.05The two milling machines have unequal lives, so they can only be compared by expressing both on an equivalent annual basis, which is what the EAC method does. Thus, you prefer the Techron II because it has the lower (less negative) annual cost.Intermediate11.F irst, we will calculate the depreciation each year, which willbe:D1 = ¥480,000(0.2000) = ¥96,000D2 = ¥480,000(0.3200) = ¥153,600D3 = ¥480,000(0.1920) = ¥92,160D4 = ¥480,000(0.1150) = ¥55,200The book value of the equipment at the end of the project is:BV4= ¥480,000 –(¥96,000 + 153,600 + 92,160 + 55,200) = ¥83,040The asset is sold at a loss to book value, so this creates a tax refund.After-tax salvage value = ¥70,000 + (¥83,040 – 70,000)(0.35) = ¥74,564.00So, the OCF for each year will be:OCF1 = ¥160,000(1 – 0.35) + 0.35(¥96,000) = ¥137,600.00OCF2 = ¥160,000(1 – 0.35) + 0.35(¥153,600) = ¥157,760.00OCF3 = ¥160,000(1 – 0.35) + 0.35(¥92,160) = ¥136,256.00OCF4 = ¥160,000(1 – 0.35) + 0.35(¥55,200) = ¥123,320.00Now we have all the necessary information to calculate the project NPV. We need to be careful with the NWC in this project.Notice the project requires ¥20,000 of NWC at the beginning, and ¥3,000 more in NWC each successive year. We will subtract the ¥20,000 from the initial cash flow, and subtract ¥3,000 each year from the OCF to account for this spending. In Year 4, we will add back the total spent on NWC, which is ¥29,000. The ¥3,000 spent on NWC capital during Year 4 is irrelevant. Why?Well, during this year the project required an additional ¥3,000, but we would get the money back immediately. So, thenet cash flow for additional NWC would be zero. With all this, the equation for the NPV of the project is:NPV = –¥480,000 –20,000 + (¥137,600 –3,000)/1.14 + (¥157,760 – 3,000)/1.142+ (¥136,256 –3,000)/1.143+ (¥123,320 + 29,000 + 74,564)/1.144NPV = –¥38,569.4812.I f we are trying to decide between two projects that will notbe replaced when they wear out, the proper capital budgeting method to use is NPV. Both projects only have costs associated with them, not sales, so we will use these to calculate the NPV of each project. Using the tax shield approach to calculate the OCF, the NPV of System A is:OCF A = –元120,000(1 – 0.34) + 0.34(元430,000/4)OCF A = –元42,650NPV A = –元430,000 –元42,650(PVIFA20%,4)NPV A = –元540,409.53And the NPV of System B is:OCF B = –元80,000(1 – 0.34) + 0.34(元540,000/6)OCF B = –元22,200NPV B = –元540,000 –元22,200(PVIFA20%,6)NPV B = –元613,826.32If the system will not be replaced when it wears out, then System A should be chosen, because it has the more positive NPV.13.If the equipment will be replaced at the end of its useful life,the correct capital budgeting technique is EAC. Using the NPVs we calculated in the previous problem, the EAC for each system is:EAC A = –元540,409.53 / (PVIFA20%,4)EAC A = –元208,754.32EAC B = –元613,826.32 / (PVIFA20%,6)EAC B = –元184,581.10If the conveyor belt system will be continually replaced, we should choose System B since it has the more positive NPV.14.S ince we need to calculate the EAC for each machine, sales areirrelevant. EAC only uses the costs of operating the equipment, not the sales. Using the bottom up approach, or net income plus depreciation, method to calculate OCF, we get:Machine A Machine BVariable costs –₪3,150,000 –₪2,700,000Fixed costs –150,000 –100,000Depreciation –350,000 –500,000EBT –₪3,650,000 –₪3,300,000Tax 1,277,500 1,155,000Net income –₪2,372,500 –₪2,145,000+ Depreciation 350,000 500,000OCF –₪2,022,500 –₪1,645,000The NPV and EAC for Machine A is:NPV A = –₪2,100,000 –₪2,022,500(PVIFA10%,6) NPV A = –₪10,908,514.76EAC A = –₪10,908,514.76 / (PVIFA10%,6)EAC A = –₪2,504,675.50And the NPV and EAC for Machine B is:NPV B = –₪4,500,000 – 1,645,000(PVIFA10%,9)NPV B = –₪13,973,594.18EAC B = –₪13,973,594.18 / (PVIFA10%,9)EAC B = –₪2,426,382.43You should choose Machine B since it has a more positive EAC.15.W hen we are dealing with nominal cash flows, we must be carefulto discount cash flows at the nominal interest rate, and we must discount real cash flows using the real interest rate.Project A’s cash flows are in real terms, so we need to find the real interest rate. Using the Fisher equation, the real interest rate is:1 + R = (1 + r)(1 + h)1.15 = (1 + r)(1 + .04)r = .1058 or 10.58%So, the NPV of Project A’s real cash flows, discounting at the real interest rate, is:NPV = –฿40,000 + ฿20,000 / 1.1058 + ฿15,000 / 1.10582 + ฿15,000 / 1.10583NPV = ฿1,448.88Project B’s cash flow are in nominal terms, so the NPV discount at the nominal interest rate is:NPV = –฿50,000 + ฿10,000 / 1.15 + ฿20,000 / 1.152+ ฿40,000 /1.153NPV = ฿119.17We should accept Project A if the projects are mutually exclusive since it has the highest NPV.16.T o determine the value of a firm, we can simply find thepre sent value of the firm’s future cash flows. No depreciation is given, so we can assume depreciation is zero. Using the tax shield approach, we can find the present value of the aftertax revenues, and the present value of the aftertax costs. The required return, growth rates, price, and costs are all given in real terms. Subtracting the costs from the revenues will give us the value of the firm’s cash flows. We must calculate the present value of each separately since each is growing at a different rate. First, we will find the present value of the revenues. The revenues in year 1 will be the number of bottles sold, times the price per bottle, or:Aftertax revenue in year 1 in real terms = (2,000,000 ×$1.50)(1 – 0.34)Aftertax revenue in year 1 in real terms = $1,650,000Revenues will grow at six percent per year in real terms forever. Apply the growing perpetuity formula, we find the present value of the revenues is:PV of revenues = C1 / (R–g)PV of revenues = $1,650,000 / (0.10 – 0.06)PV of revenues = $41,250,000The real aftertax costs in year 1 will be:Aftertax costs in year 1 in real terms = (2,000,000 ×$0.65)(1 – 0.34)Aftertax costs in year 1 in real terms = $858,000Costs will grow at five percent per year in real terms forever.Applying the growing perpetuity formula, we find the present value of the costs is:PV of costs = C1 / (R–g)PV of costs = $858,000 / (0.10 – 0.05)PV of costs = $17,160,000Now we can find the value of the firm, which is:Value of the firm = PV of revenues – PV of costsValue of the firm = $41,250,000 – 17,160,000Value of the firm = $24,090,00017.To calculate the nominal cash flows, we simple increase eachitem in the income statement by the inflation rate, except for depreciation. Depreciation is a nominal cash flow, so it does not need to be adjusted for inflation in nominal cash flow analysis. Since the resale value is given in nominal terms as of the end of year 5, it does not need to be adjusted for inflation. Also, no inflation adjustment is needed for either the depreciation charge or the recovery of net working capital since these items are already expressed in nominal terms. Note that an increase in required net working capital is a negative cash flow whereas a decrease in required net working capital isa positive cash flow. The nominal aftertax salvage value is:Market price $30,000Tax on sale –10,200Aftertax salvage value $19,800Remember, to calculate the taxes paid (or tax credit) on the salvage value, we take the book value minus the market value, times the tax rate, which, in this case, would be:Taxes on salvage value = (BV – MV)t CTaxes on salvage value = ($0 – 30,000)(.34)Taxes on salvage value = –$10,200Now we can find the nominal cash flows each year using the income statement. Doing so, we find:Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Sales $200,000 $206,000 $212,180 $218,545 $225,102Expenses 50,000 51,500 53,045 54,636 56,275Depreciation 50,000 50,000 50,000 50,000 50,000EBT $100,000 $104,500 $109,135 $113,909 $118,826Tax 34,000 35,530 37,106 38,729 40,401Net income $66,000 $68,970 $72,029 $75,180 $78,425OCF $116,000 $118,970 $122,029 $125,180 $128,425Capital spending –$250,000 $19,800NWC –10,000 10,000Total cash flow –$260,000 $116,000 $118,970 $122,029 $125,180 $158,22518.T he present value of the company is the present value of thefuture cash flows generated by the company. Here we have real cash flows, a real interest rate, and a real growth rate. The cash flows are a growing perpetuity, with a negative growth rate. Using the growing perpetuity equation, the present value of the cash flows are:PV = C1 / (R–g)PV = $120,000 / [.11 – (–.07)]PV = $666,666.6719.T o find the EAC, we first need to calculate the NPV of theincremental cash flows. We will begin with the aftertax salvage value, which is:Taxes on salvage value = (BV – MV)t CTaxes on salvage value = (€0 – 10,000)(.34)Taxes on salvage value = –€3,400Market price €10,000Tax on sale –3,400Aftertax salvage value €6,600Now we can find the operating cash flows. Using the tax shield approach, the operating cash flow each year will be:OCF = –€5,000(1 – 0.34) + 0.34(€45,000/3)OCF = €1,800So, the NPV of the cost of the decision to buy is:NPV = –€45,000 + €1,800(PVIFA12%,3) + (€6,600/1.123)NPV = –€35,987.95In order to calculate the equivalent annual cost, set the NPV of the equipment equal to an annuity with the same economic life. Since the project has an economic life of three years and is discounted at 12 percent, set the NPV equal to a three-year annuity, discounted at 12 percent.EAC = –€35,987.95 / (PVIFA12%,3)EAC = –€14,979.8020.W e will find the EAC of the EVF first. There are no taxes sincethe university is tax-exempt, so the maintenance costs are the operating cash flows. The NPV of the decision to buy one EVF is:NPV = –₩8,000 –₩2,000(PVIFA14%,4)NPV = –₩13,827.42In order to calculate the equivalent annual cost, set the NPV of the equipment equal to an annuity with the same economic life. Since the project has an economic life of four years and is discounted at 14 percent, set the NPV equal to a three-year annuity, discounted at 14 percent. So, the EAC per unit is:EAC = –₩13,827.42 / (PVIFA14%,4)EAC = –₩4,745.64Since the university must buy 10 of the word processors, the total EAC of the decision to buy the EVF word processor is:Total EAC = 10(–₩4,745.64)Total EAC = –₩47,456.38Note, we could have found the total EAC for this decision by multiplying the initial cost by the number of word processors needed, and multiplying the annual maintenance cost of each by the same number. We would have arrived at the same EAC.We can find the EAC of the AEH word processors using the same method, but we need to include the salvage value as well. Thereare no taxes on the salvage value since the university is tax-exempt, so the NPV of buying one AEH will be:NPV = –₩5,000 –₩2,500(PVIFA14%,3) + (₩500/1.143)NPV = –₩10,466.59So, the EAC per machine is:EAC = –₩10,466.59 / (PVIFA14%,3)EAC = –₩4,508.29Since the university must buy 11 of the word processors, the total EAC of the decision to buy the AEH word processor is:Total EAC = 11(–₩4,508.29)Total EAC = –₩49,591.21The university should buy the EVF word processors since the EAC is lower. Notice that the EAC of the AEH is lower on a per machine basis, but because the university needs more of these word processors, the total EAC is higher.21.W e will calculate the aftertax salvage value first. Theaftertax salvage value of the equipment will be:Taxes on salvage value = (BV – MV)t CTaxes on salvage value = (₫0 – 100,000)(.34)Taxes on salvage value = –₫34,000Market price ₫100,000Tax on sale –34,000Aftertax salvage value ₫66,000Next, we will calculate the initial cash outlay, that is, the cash flow at Time 0. To undertake the project, we will have to purchase the equipment. The new project will decrease the net working capital, so this is a cash inflow at the beginning of the project. So, the cash outlay today for the project will be:Equipment –₫500,000NWC 100,000Total –₫400,000Now we can calculate the operating cash flow each year for the project. Using the bottom up approach, the operating cash flow will be:Saved salaries ₫120,000Depreciation 100,000EBT ₫20,000。

CHAPTER 7Net Present Value and Other Investment Rules Multiple Choice Questions:I. DEFINITIONSNET PRESENT VALUEa 1. The difference between the present value of an investment and its cost is the:a. net present value.b. internal rate of return.c. payback period.d. profitability index.e. discounted payback period.Difficulty level: EasyNET PRESENT VALUE RULEc 2. Which one of the following statements concerning net present value (NPV) is correct?a. An investment should be accepted if, and only if, the NPV is exactlyequal to zero.b. An investment should be accepted only if the NPV is equal to the initialcash flow.c. An investment should be accepted if the NPV is positive and rejected ifit is negative.d. An investment with greater cash inflows than cash outflows, regardlessof when the cash flows occur, will always have a positive NPV andtherefore should always be accepted.e. Any project that has positive cash flows for every time period after theinitial investment should be accepted.Difficulty level: EasyPAYBACKc 3. The length of time required for an investment to generate cash flowssufficient to recover the initial cost of the investment is called the:a. net present value.b. internal rate of return.c. payback period.d. profitability index.e. discounted cash period.Difficulty level: EasyPAYBACK RULEa 4. Which one of the following statements is correct concerning thepayback period?a. An investment is acceptable if its calculated payback period is less thansome pre-specified period of time.b. An investment should be accepted if the payback is positive andrejected if it is negative.c. An investment should be rejected if the payback is positive andaccepted if it is negative.d. An investment is acceptable if its calculated payback period is greaterthan some pre-specified period of time.e. An investment should be accepted any time the payback period is lessthan the discounted payback period, given a positive discount rate.Difficulty level: EasyDISCOUNTED PAYBACKe 5. The length of time required for a project’s discounted cash flows toequal the initial cost of the project is called the:a. net present value.b. internal rate of return.c. payback period.d. discounted profitability index.e. discounted payback period.Difficulty level: EasyDISCOUNTED PAYBACK RULEd 6. The discounted payback rule states that you should accept projects:a. which have a discounted payback period that is greater than some pre-specified period of time.b. if the discounted payback is positive and rejected if it is negative.c. only if the discounted payback period equals some pre-specified periodof time.d. if the discounted payback period is less than some pre-specified periodof time.e. only if the discounted payback period is equal to zero.Difficulty level: EasyAVERAGE ACCOUNTING RETURNc 7. An investment’s average net income divided by its average book valuedefines the average:a. net present value.b. internal rate of return.c. accounting return.d. profitability index.e. payback period.Difficulty level: EasyAVERAGE ACCOUNTING RETURN RULEb 8. An investment is acceptable if its average accounting return (AAR):a. is less than a target AAR.b. exceeds a target AAR.c. exceeds the firm’s return on equity (ROE).d. is less than the firm’s return on assets (ROA).e. is equal to zero and only when it is equal to zero.Difficulty level: EasyINTERNAL RATE OF RETURNb. 9. The discount rate that makes the net present value of an investmentexactly equal tozero is called the:a. external rate of return.b. internal rate of return.c. average accounting return.d. profitability index.e. equalizer.Difficulty level: EasyINTERNAL RATE OF RETURN RULEd 10. An investment is acceptable if its IRR:a. is exactly equal to its net present value (NPV).b. is exactly equal to zero.c. is less than the required return.d. exceeds the required return.e. is exactly equal to 100 percent.Difficulty level: EasyMULTIPLE RATES OF RETURNe 11. The possibility that more than one discount rate will make the NPV ofan investment equal to zero is called the _____ problem.a. net present value profilingb. operational ambiguityc. mutually exclusive investment decisiond. issues of scalee. multiple rates of returnDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSc 12. A situation in which accepting one investment prevents the acceptanceof another investment is called the:a. net present value profile.b. operational ambiguity decision.c. mutually exclusive investment decision.d. issues of scale problem.e. multiple choices of operations decision.Difficulty level: EasyPROFITABILITY INDEXd. 13. The present value of an investment’s future cash flows divided by theinitial cost of the investment is called the:a. net present value.b. internal rate of return.c. average accounting return.d. profitability index.e. profile period.Difficulty level: EasyPROFITABILITY INDEX RULEa 14. An investment is acceptable if the profitability index (PI) of theinvestment is:a. greater than one.b. less than one.c. greater than the internal rate of return (IRR).d. less than the net present value (NPV).e. greater than a pre-specified rate of return.Difficulty level: EasyII. CONCEPTSNET PRESENT VALUEd 15. All else constant, the net present value of a project increases when:a. the discount rate increases.b. each cash inflow is delayed by one year.c. the initial cost of a project increases.d. the rate of return decreases.e. all cash inflows occur during the last year of a project’s life instead ofperiodically throughout the life of the project.Difficulty level: EasyNET PRESENT VALUEa 16. The primary reason that company projects with positive net present values areconsidered acceptable is that:a. they create value for the owners of the firm.b. the project’s rate of return exceeds the rate of inflation.c. they return the initial cash outlay within three years or less.d. the required cash inflows exceed the actual cash inflows.e. the investment’s cost exceeds the present value of the cash inflows.Difficulty level: EasyNET PRESENT VALUEd 17. If a project has a net present value equal to zero, then:I. the present value of the cash inflows exceeds the initial cost of the project.II. the project produces a rate of return that just equals the rate required to accept theproject.III. the project is expected to produce only the minimally required cash inflows.IV. any delay in receiving the projected cash inflows will cause the project to have a negative net present value.a. II and III onlyb. II and IV onlyc. I, II, and IV onlyd. II, III, and IV onlye. I, II, and III onlyDifficulty level: MediumNET PRESENT VALUEb 18. Net present value:a. cannot be used when deciding between two mutually exclusive projects.b. is more useful to decision makers than the internal rate of return when comparingdifferent sized projects.c. is easy to explain to non-financial managers and thus is the primary method of analysisused by the lowest levels of management.d. is not an as widely used tool as payback and discounted paybacke. is very similar in its methodology to the average accounting return.Difficulty level: EasyPAYBACKc 19. Payback is frequently used to analyze independent projects because:a. it considers the time value of money.b. all relevant cash flows are included in the analysis.c. it is easy and quick to calculate.d. it is the most desirable of all the available analytical methods from a financialperspective.e. it produces better decisions than those made using either NPV or IRR.Difficulty level: EasyPAYBACKc 20. The advantages of the payback method of project analysis include the:I. application of a discount rate to each separate cash flow.II. bias towards liquidity.III. ease of use.IV. arbitrary cutoff point.a. I and II onlyb. I and III onlyc. II and III onlyd. II and IV onlye. II, III, and IV onlyDifficulty level: MediumPAYBACKd 21. All else equal, the payback period for a project will decrease whenever the:a. initial cost increases.b. required return for a project increases.c. assigned discount rate decreases.d. cash inflows are moved forward in time.e. duration of a project is lengthened.Difficulty level: MediumDISCOUNTED PAYBACKd 22. The discounted payback period of a project will decrease whenever the:a. discount rate applied to the project is increased.b. initial cash outlay of the project is increased.c. time period of the project is increased.d. amount of each project cash flow is increased.e. costs of the fixed assets utilized in the project increase.Difficulty level: MediumDISCOUNTED PAYBACKa 23. The discounted payback rule may cause:a. some positive net present value projects to be rejected.b. the most liquid projects to be rejected in favor of less liquid projects.c. projects to be incorrectly accepted due to ignoring the time value of money.d. projects with negative net present values to be accepted.e. some projects to be accepted which would otherwise be rejected under the paybackrule.Difficulty level: EasyINTERNAL RATE OF RETURNb 24. The internal rate of return (IRR):I. rule states that a project with an IRR that is less than the required rate should beaccepted.II. is the rate generated solely by the cash flows of an investment.III. is the rate that causes the net present value of a project to exactly equal zero.IV. can effectively be used to analyze all investment scenarios.a. I and IV onlyb. II and III onlyc. I, II, and III onlyd. II, III, and IV onlye. I, II, III, and IVDifficulty level: MediumINTERNAL RATE OF RETURNa 25. The internal rate of return for a project will increase if:a. the initial cost of the project can be reduced.b. the total amount of the cash inflows is reduced.c. each cash inflow is moved such that it occurs one year later than originally projected.d. the required rate of return is reduced.e. the salvage value of the project is omitted from the analysis.Difficulty level: MediumINTERNAL RATE OF RETURNc 26. The internal rate of return is:a. more reliable as a decision making tool than net present value whenever you areconsidering mutually exclusive projects.b. equivalent to the discount rate that makes the net present value equal to one.c. difficult to compute without the use of either a financial calculator or a computer.d. dependent upon the interest rates offered in the marketplace.e. a better methodology than net present value when dealing with unconventional cashflows.Difficulty level: MediumINTERNAL RATE OF RETURNa 27. The internal rate of return tends to be:a. easier for managers to comprehend than the net present value.b. extremely accurate even when cash flow estimates are faulty.c. ignored by most financial analysts.d. used primarily to differentiate between mutually exclusive projects.e. utilized in project analysis only when multiple net present values apply.Difficulty level: EasyINCREMENTAL INTERNAL RATE OF RETURNe 28. You are trying to determine whether to accept project A or project B. These projectsare mutually exclusive. As part of your analysis, you should computethe incremented IRR by determining:a. the internal rate of return for the cash flows of each project.b. the net present value of each project using the internal rate of return as the discountrate.c. the discount rate that equates the discounted payback periods for each project.d. the discount rate that makes the net present value of each project equal to 1.e. the internal rate of return for the differences in the cash flows of the two projects.Difficulty level: MediumINCREMENTAL INTERNAL RATE OF RETURNb 29. Graphing the incremental IRR helps explain:a. why one project is always superior to another project.b. how decisions concerning mutually exclusive projects are derived.c. how the duration of a project affects the decision as to which project to accept.d. how the net present value and the initial cash outflow of a project are related.e. how the profitability index and the net present value are related.Difficulty level: MediumPROFITABILITY INDEXd 30. The profitability index is closely related to:a. payback.b. discounted payback.c. the average accounting return.d. net present value.e. mutually exclusive projects.Difficulty level: EasyPROFITABILITY INDEXb 31. Analysis using the profitability index:a. frequently conflicts with the accept and reject decisions generated bythe application ofthe net present value rule.b. is useful as a decision tool when investment funds are limited.c. is useful when trying to determine which one of two mutually exclusive projectsshould be accepted.d. utilizes the same basic variables as those used in the average accounting return.e. produces results which typically are difficult to comprehend or apply.Difficulty level: MediumPROFITABILITY INDEXe 32. If you want to review a project from a benefit-cost perspective, you should use the_____ method of analysis.a. net present valueb. paybackc. internal rate of returnd. average accounting returne. profitability indexDifficulty level: EasyPROFITABILITY INDEXb 33. When the present value of the cash inflows exceeds the initial cost of a project, thenthe project should be:a. accepted because the internal rate of return is positive.b. accepted because the profitability index is greater than 1.c. accepted because the profitability index is negative.d. rejected because the internal rate of return is negative.e. rejected because the net present value is negative.Difficulty level: EasyMUTUALLY EXCLUSIVE PROJECTSc 34. Which one of the following is the best example of two mutually exclusive projects?a. planning to build a warehouse and a retail outlet side by sideb. buying sufficient equipment to manufacture both desks and chairs simultaneouslyc. using an empty warehouse for storage or renting it entirely out to another firmd. using the company sales force to promote sales of both shoes and sockse. buying both inventory and fixed assets using funds from the same bond issueDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSd 35. The Liberty Co. is considering two projects. Project A consists of building a wholesalebook outlet on lot #169 of the Englewood Retail Center. Project B consists of buildinga sit-down restaurant on lot #169 of the Englewood Retail Center. When trying todecide whether or build the book outlet or the restaurant, management should relymost heavily on the analysis results from the _____ method of analysis.a. profitability indexb. internal rate of returnc. paybackd. net present valuee. accounting rate of returnDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSc 36. When two projects both require the total use of the same limited economic resource,the projects are generally considered to be:a. independent.b. marginally profitable.c. mutually exclusive.d. acceptable.e. internally profitable.Difficulty level: EasyMUTUALLY EXCLUSIVE PROJECTSc 37. Matt is analyzing two mutually exclusive projects of similar size and has prepared thefollowing data. Both projects have 5 year lives.Project A Project B Net present value $15,090$14,693Payback period 2.76 years 2.51 yearsAverage accounting return 9.3 percent 9.6 percent Required return 8.3 percent8.0 percentRequired AAR 9.0 percent 9.0 percentMatt has been asked for his best recommendation given thisinformation. His recommendation should be to accept:a. project B because it has the shortest payback period.b. both projects as they both have positive net present values.c. project A and reject project B based on their net present values.d. project B and reject project A based on their average accounting returns.e. project B and reject project A based on both the payback period andthe averageaccounting return.Difficulty level: MediumINVESTMENT ANALYSISa 38. Given that the net present value (NPV) is generally considered to be the best methodof analysis, why should you still use the other methods?a. The other methods help validate whether or not the results from the net present value analysis are reliable.b. You need to use the other methods since conventional practice dictates that you onlyaccept projects after you have generated three accept indicators.c. You need to use other methods because the net present value method is unreliable when a project has unconventional cash flows.d. The average accounting return must always indicate acceptance since this is the bestmethod from a financial perspective.e. The discounted payback method must always be computed to determine if a projectreturns a positive cash flow since NPV does not measure this aspect of a project.Difficulty level: MediumINVESTMENT ANALYSISe 39. In actual practice, managers frequently use the:I. AAR because the information is so readily available.II. IRR because the results are easy to communicate and understand.III. payback because of its simplicity.IV. net present value because it is considered by many to be the best method of analysis.a. I and III onlyb. II and III onlyc. I, III, and IV onlyd. II, III, and IV onlye. I, II, III, and IVDifficulty level: MediumINVESTMENT ANALYSISa 40. No matter how many forms of investment analysis you do:a. the actual results from a project may vary significantly from the expected results.b. the internal rate of return will always produce the most reliable results.c. a project will never be accepted unless the payback period is met.d. the initial costs will generally vary considerably from the estimated costs.e. only the first three years of a project ever affect its final outcome.Difficulty level: EasyINVESTMENT ANALYSISb 41. Which of the following methods of project analysis are biased towards short-termprojects?I. internal rate of returnII. accounting rate of returnIII. paybackIV. discounted paybacka. I and II onlyb. III and IV onlyc. II and III onlyd. I and IV onlye. II and IV onlyDifficulty level: MediumINVESTMENT ANALYSISa 42. If a project is assigned a required rate of return equal to zero, then:a. the timing of the project’s cash flows has no bearing on the value of the project.b. the project will always be accepted.c. the project will always be rejected.d. whether the project is accepted or rejected will depend on the timing of the cash flows.e. the project can never add value for the shareholders.Difficulty level: MediumDECISION RULESe 43. You are considering a project with the following data:Internal rate of return 8.7 percentProfitability ratio .98Net present value -$393Payback period 2.44 yearsRequired return 9.5 percentWhich one of the following is correct given this information?a. The discount rate used in computing the net present value must have been less than 8.7percent.b. The discounted payback period will have to be less than 2.44 years.c. The discount rate used to compute the profitability ratio was equal to the internal rate of return.d. This project should be accepted based on the profitability ratio.e. This project should be rejected based on the internal rate of return.Difficulty level: MediumNET PRESENT VALUEc 44. A ccepting positive NPV projects benefits the stockholders because:a. it is the most easily understood valuation process.b. the present value of the expected cash flows are equal to the cost.c. the present value of the expected cash flows are greater than the cost.d. it is the most easily calculated.e. None of the above.Difficulty level: EasyNET PRESENT VALUEa 45. W hich of the following does not characterize NPV?a. NPV does not incorporate risk into the analysis.b. NPV incorporates all relevant information.c. NPV uses all of the project's cash flows.d. NPV discounts all future cash flows.e. Using NPV will lead to decisions that maximize shareholder wealth.Difficulty level: EasyPAYBACKe 46. T he payback period rule:a. discounts cash flows.b. ignores initial cost.c. always uses all possible cash flows in its calculation.d. Both A and C.e. None of the above.Difficulty level: EasyPAYBACKc 47. T he payback period rule accepts all investment projects in which thepayback period for the cash flows is:a. equal to the cutoff point.b. greater than the cutoff point.c. less than the cutoff point.d. positive.e. None of the above.Difficulty level: EasyPAYBACKd 48. T he payback period rule is a convenient and useful tool because:a. it provides a quick estimate of how rapidly the initial investment will berecouped.b. results of a short payback rule decision will be quickly seen.c. it does not take into account time value of money.d. All of the above.e. None of the above.Difficulty level: EasyDISCOUNTED PAYBACKa 49. T he discounted payback period rule:a. considers the time value of money.b. discounts the cutoff point.c. ignores uncertain cash flows.d. is preferred to the NPV rule.e. None of the above.Difficulty level: EasyPAYBACKc 50. T he payback period rule:a. determines a cutoff point so that all projects accepted by the NPV rulewill be accepted by the payback period rule.b. determines a cutoff point so that depreciation is just equal to positivecash flows in the payback year.c. requires an arbitrary choice of a cutoff point.d. varies the cutoff point with the interest rate.e. Both A and D.Difficulty level: EasyAVERAGE ACCOUNTING RETURNc 51. T he average accounting return is determined by:a. dividing the yearly cash flows by the investment.b. dividing the average cash flows by the investment.c. dividing the average net income by the average investment.d. dividing the average net income by the initial investment.e. dividing the net income by the cash flow.Difficulty level: EasyAVERAGE ACCOUNTING RETURNb 52. T he investment decision rule that relates average net income to averageinvestment is the:a. discounted cash flow method.b. average accounting return method.c. average payback method.d. average profitability index.e. None of the above.Difficulty level: EasyMODIFIED INTERNAL RATE OF RETURNd 53. M odified internal rate of return:a. handles the multiple IRR problem by combining cash flows until onlyone change in sign change remains.b. requires the use of a discount rate.c. does not require the use of a discount rate.d. Both A and B.e. Both A and C.Difficulty level: MediumAVERAGE ACCOUNTING RETURNd 54. T he shortcoming(s) of the average accounting return (AAR) method is(are):a. the use of net income instead of cash flows.b. the pattern of income flows has no impact on the AAR.c. there is no clear-cut decision rule.d. All of the above.e. None of the above.Difficulty level: MediumINTERNAL RATE OF RETURNe 55. T he two fatal flaws of the internal rate of return rule are:a. arbitrary determination of a discount rate and failure to consider initialexpenditures.b. arbitrary determination of a discount rate and failure to correctlyanalyze mutually exclusive investment projects.c. arbitrary determination of a discount rate and the multiple rate ofreturn problem.d. failure to consider initial expenditures and failure to correctly analyzemutually exclusive investment projects.e. failure to correctly analyze mutually exclusive investment projects andthe multiple rate of return problem.Difficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSd 56. A mutually exclusive project is a project whose:a. acceptance or rejection has no effect on other projects.b. NPV is always negative.c. IRR is always negative.d. acceptance or rejection affects other projects.e. cash flow pattern exhibits more than one sign change.Difficulty level: EasyINTERNAL RATE OF RETURNd 57. A project will have more than one IRR if:a. the IRR is positive.b. the IRR is negative.c. the NPV is zero.d. the cash flow pattern exhibits more than one sign change.e. the cash flow pattern exhibits exactly one sign change.Difficulty level: EasyINTERNAL RATE OF RETURN RULESb 58. U sing internal rate of return, a conventional project should be acceptedif the internal rate of return is:a. equal to the discount rate.b. greater than the discount rate.c. less than the discount rate.d. negative.e. positive.Difficulty level: EasyINTERNAL RATE OF RETURNa 59. The internal rate of return may be defined as:a. the discount rate that makes the NPV cash flows equal to zero.b. the difference between the market rate of interest and the NPV.c. the market rate of interest less the risk-free rate.d. the project acceptance rate set by management.e. None of the above.Difficulty level: MediumMULTIPLE INTERNAL RATE OF RETURNSd 60. The problem of multiple IRRs can occur when:a. there is only one sign change in the cash flows.b. the first cash flow is always positive.c. the cash flows decline over the life of the project.d. there is more than one sign change in the cash flows.e. None of the above.Difficulty level: EasyTIMING AND SCALE ISSUES WITH INTERNAL RATE OF RETURNb 61. T he elements that cause problems with the use of the IRR in projectsthat are mutually exclusive are:a. the discount rate and scale problems.b. timing and scale problems.c. the discount rate and timing problems.d. scale and reversing flow problems.e. timing and reversing flow problems.Difficulty level: MediumNET PRESENT VALUE DECISIONc 62. If there is a conflict between mutually exclusive projects due to the IRR,one should:a. drop the two projects immediately.b. spend more money on gathering information.c. depend on the NPV as it will always provide the most value.d. depend on the AAR because it does not suffer from these sameproblems.e. None of the above.Difficulty level: MediumPROFITABILITY INDEXe 63. The profitability index is the ratio of:a. average net income to average investment.b. internal rate of return to current market interest rate.c. net present value of cash flows to internal rate of return.d. net present value of cash flows to average accounting return.e. present value of cash flows to initial investment cost.Difficulty level: EasyINVESTMENT DECISION RULESa 64. Which of the following statement is true?a. One must know the discount rate to compute the NPV of a project butone can compute the IRR without referring to the discount rate.b. One must know the discount rate to compute the IRR of a project butone can compute the NPV without referring to the discount rate.c. Payback accounts for time value of money.d. There will always be one IRR regardless of cash flows.e. Average accounting return is the ratio of total assets to total net income.Difficulty level: MediumCAPITAL BUDGETING PRACTICEb 65. Graham and Harvey (2001) found that ___ and ___ were the two mostpopular capital budgeting methods.a. Internal Rate of Return; Payback Periodb. Internal Rate of Return; Net Present Valuec. Net Present Value; Payback Periodd. Modified Internal Rate of Return; Internal Rate of Returne. Modified Internal Rate of Return; Net Present Value。

EXAM PAPER 1I. True(T) or False(F). Please fill in the bracket with T or F. (15%)1. In financial management, the more appropriate goal of the firm is maximization of shareholderwealth. ( )2. The component cost of preferred stock must be adjusted for taxes which the stockholdersmust pay on the dividends. ( )3. If an investment project has a profitability index of 1.15, the project’s internal rate of returnexceeds its net present value. ( )4. With an annuity due the payments occur at the end of each period. ( )5. If the firm decides to impose a capital constraint on investment projects, the appropriatedecision criterion is to select the set of projects with the highest NPV subject to the capital constraint. ( )6. Business risk refers to the relative dispersion in the firm’s EBIT. ( )7. Net working capital equals current assets less current liabilities. ( )8. Under MM’s model with corporate taxes, the benefits of debt financing stem solely from the taxdeductibility of interest payments. ( )9. Investors can only expect to receive a return for incurring unsystematic risk. ( )10. The Security Market Line is a risk-return trade-off for combinations of the market portfolio andthe riskless asset. ( )II. Multiple Choice (15%)1. Dorset Ltd wishes to calculate its weighted average cost of capital for use in investmentappraisal. The company is financed by 150 million $1 ordinary shares, which have a current market value of $2, and $100 million 12 per cent irredeemable debentures, which are currently quoted at $150 per $100 nominal value. The cost of ordinary share capital is 11 per cent and the rate of corporation tax is 25 per cent.What is the weighted average cost of capital for Dorset Ltd? (To one decimal place)A. 9·0 per centB. 9·3 per centC. 10·4 per centD. 11·4 per cent2. Cheshire Ltd has developed a revolutionary form of tyre gauge at a cost of $300,000 to date.To produce the tyre gauge, a new machine will be acquired immediately at a cost of $750,000.The machine will be sold at the end of the five years for $350,000 and will be depreciated over its life using the straight-line method.The tyre gauge has an expected life of five years and estimated future profits from the product are: Years1 2 3 4 5$000 $000 $000 $000 $000Estimated profit 80 160 240 140 130What is the payback period for the new tyre gauge? (To the nearest month)A. 3 years 2 monthsB. 4 years 2 monthsC. 4 years 3 monthsD. 4 years 11 months3. Cumbria Ltd has $1 ordinary shares in issue that have a current market value of $3. Thedividend expected for next year is $0·40 and future dividends are expected to grow at the rate of 5 per cent per annum. The rate of corporation tax is 20 per cent and the dividend Growth model is used to calculate the cost of ordinary shares.What is the cost of ordinary shares to the business?A. 6·1%B. 15·7%C. 18·3%D. 19·0%4. Calcite Ltd used the NPV and IRR methods of investment appraisal to evaluate a project thathas an initial cash outlay followed by annual net cash inflows over its life. After the evaluationhad been undertaken, it was discovered that the cost of capital had been incorrectly calculated and that the correct cost of capital figure was in fact higher than that used.What will be the effect on the NPV and IRR figures of correcting for this error?Effect onNPV IRRA. Decrease DecreaseB. Decrease No changeC. Increase IncreaseD. Increase No Change5. A business evaluates an investment project that has an initial outlay followed by annual netcash inflows of $10 million throughout its infinite life. The evaluation of the inflows produced a present value of $50 million and a profitability (present value) index of 2·0.What is the internal rate of return and initial outlay of this project?IRR Initial outlay% $mA. 20 25B. 20 100C. 40 25D. 10 1006. Quartz Ltd pays an annual dividend of 30 cent per share to shareholders, which is expected tocontinue in perpetuity. The average rate of return for the market is 9% and the company has a beta coefficient of 1·5. The risk-free rate of return is 4%.What is the expected rate of return for the shareholders of the company and the predicted value of the shares in the company?Expected rate Predictedof return value(%) (cent)A. 23·5 705B. 17·5 171C. 16·5 182D. 11·5 2617. Tourmaline Ltd pays its major credit supplier 40 days after receiving the goods and receives nosettlement discount. The supplier has recently offered the company revised credit terms of 3/10, net 40.If Tourmaline Ltd refuses the settlement discount and pays in full after 40 days, what is the approximate, implied, interest cost that is incurred by the company per year?A. 10·3%B. 27·4%C. 28·2%D. 37·6%8. Carrickfergus Ltd wishes to forecast its financial performance and position for the forthcomingyear. The forecast model used by the company incorporates the following relationships: Sales: total assets employed 2·5:1Current assets: current liabilities 1·8:1Quick assets: current liabilities 1·2:1Fixed assets: current assets 1·0:1If sales for the forthcoming year are expected to be $800,000, what is the forecast closing stock figure?A. $53,333B. $71,111C. $85,926D. $96,000.9. The Modigliani and Miller (no taxes) proposition concerning capital gearing states that, as thelevel of capital gearing increases from zero,A. the cost of equity capital will remain unchangedB. the weighted average cost of capital will decreaseC. the value of the business will remain unchangedD. the cost of loan capital will increase.10. A study of the shares of companies listed on a particular stock market found that:(i) share prices were independent of past share price movements and followed a random path. (ii) some investors used the published accounts of the companies to analyse performance and, by doing so, made abnormal gains over many years.Which of the following would be consistent with these findings?A. The stock market is inefficientB. The stock market is efficient in the weak formC. The stock market is efficient in the semi-strong formD. The stock market is efficient in the strong form11. The economic order quantity (EOQ) for stocks can be calculated by using an equation of theform:)/2(ZXY EOQ=What is Z in the above equation?A. Cost of placing an orderB. Annual demand for the item of stockC. Cost of holding one unit of stock for one yearD. The lead time between placing an order and receiving the goods12. Which of the following is associated with the problem of “overtrading”?A. Higher-than-normal earnings per shareB. Higher-than-normal sales to capital employed ratioC. Lower-than-normal gearing ratioD. Lower-than-normal stock turnover ratio13. Investors have an expected rate of return of 8% from ordinary shares in Algol Ltd, which have abeta of 1·2. The expected returns to the market are 7%.What will be the expected rate of return from ordinary shares in Rigel Ltd, which have a beta of 1.8?A. 9·0%B. 10·5%C. 11·0%D. 12·6%.14. Chrysotile Ltd has ordinary shares with a par value of $0·50 in issue. The company generatedearnings per share of 45c for the financial year that has just ended. The dividend cover ratio is 2·5 times and the gross dividend yield is 2% (Ignore taxation).What is the price/earnings ratio of the company?A. 2·8 timesB. 5·0 timesC. 20·0 timesD. 40·0 times15. Ethical behavior is important because it:A. builds customer loyaltyB. builds a good reputationC. avoids fines and legal expensesD. all of the aboveIII. Solving the following problems. (60 marks)1. Brambling (Electronics) Ltd is a research-led business that specialises in the development of surveillance equipment. The company has recently developed a new form of camera with a powerful fibre-optic lens and is currently considering whether or not to produce the camera. The Board of Directors will soon meet to make a final decision and has the following information available to help it decide:(i) The cost of developing the camera has been $1,400,000 to date and the company iscommitted to spending a further $350,000 within the next two months.(ii) The company has spare production capacity and can produce the camera using machinery that will cost $4,700,000 and which will be purchased immediately. It isexpected to be sold at the end of four years for $800,000.(iii) Total fixed costs identified with the production of the camera are $1,725,000 per year.This includes a depreciation charge in respect of the machinery of $975,000 per yearand a charge allocated to represent a fair share of the fixed costs of the business as awhole of $250,000 per year.(iv) The cameras are expected to sell for $10,000 each and the marketing department believes that the business can sell 800 cameras per year over the next four years.(v) The variable costs of production are $7,000 per camera.(vi) If the business decides not to produce the camera it can sell the patents immediately for $1,300,000.The company has a cost of capital of 12%.Ignore taxation.Required:(a) Calculate the net present value of producing and selling the new camera versus thealternative of selling the patent. (6 marks)(b) Carry out a separate sensitivity analysis to show by how much the following factorswould have to change before the proposal to produce and sell the new camera has an NPV of zero:(i) the initial outlay on the machinery;(ii) the discount rate;(iii) the residual value of the machinery;(iv) the annual net operating cash flows. (11 marks)(c) Briefly evaluate your findings in (a) and (b) above. (3 marks)(20 marks)2.Grebe Ltd operates a chain of cellular telephone stores in the UK. An abbreviated profit and loss account and balance sheet of the business for the year that has just ended is as follows: Abbreviated profit and loss account for the year ended 31 May 2003$000SalesOperating profit for the year Debenture interest payable 6,450 800 160Net profit before taxation Corporation tax (20%)Net profit after taxation Dividends proposed Retained profit for the year 640 128 512 256 256Abbreviated balance sheet as at 31 May 2003$000$000 Fixed assets at written down valuesCurrent assetsLess Creditors: amounts falling due within one yearLess Creditors: amounts falling due after more than one yearCapital and reserves$0·50 Ordinary sharesRetained profit 1,8001,1003,5007004,2002,0002,2006001,6002,200The company is expecting a surge in sales following advances in cellular telephone technology that should translate into additional operating profits of $180,000 per year for the foreseeable future. However, the company will need to invest $1,200,000 immediately in expanding the asset base of the business if it is to achieve these additional profits.The business has approached a large supplier that already has an equity investment in the business to see whether it would be prepared to provide further funds for the business. The supplier has indicated it would be willing to provide the necessary funds by either:(i) an issue of $0·50 ordinary shares at a premium of $1·50 per share, or(ii) an issue of $1,200,000 10% debentures at par.The Board of Directors of Grebe Ltd has already announced that it will maintain the same dividend payout ratio in future years as in the past and that this policy will be unaffected by the form of finance raised.Required:(a) For each of the financing options, calculate the forecast earnings per share for theforthcoming year;(10 marks)(b) Calculate the level of operating profit at which the earnings per share will be the sameunder each financing option. (10 marks)(20 marks)3. Bartok Ltd produces a single product. Financial data concerning the product is as follows:$ $Selling price per unit 20Variable cost per unit 17Fixed costs per unit 2 19Net profit 1At present, total credit sales for the product are $1·2m and the average collection period is one month. In order to stimulate sales for the product, the company is considering liberalising its credit policy so as to allow an average collection period of 1 1/2 months. This change of policy will allow the company to break into the US market where, currently, it has no presence. As a result of this breakthrough, sales will increase by 25%. However, there would be an additional investment required in stocks of $150,000 and an increase in trade creditors of $50,000.The company requires a 25% rate of return on its investments.Ignore taxation.Required:(a) Evaluate the proposal to increase the average collection period for debtorsassuming:(i) all customers take advantage of the longer credit period (8 marks)(ii) only new customers take advantage of the longer credit period. (8 marks)(b) Identify and discuss the main factors which influence the credit terms granted tocustomers by a company. (4 marks)(20 marks)ANSWERS FOR EXAM PAPER 1I. (10%, 1 mark each)1. T2. F3. F4. F5. T6. T7. T8. T9. F 10. FII. (30%, two marks each)1. B2. A3. C4. B5. C6. D7. D8. A9. C 10. B 11. C 12. B 13. C 14. C 15. DIII. (60%, 20marks each)1. (a) Annual operating cash flows can be calculated as follows:$m $m Sales (800 x $10,000) LessVariable costs (800 x $7,000) Fixed costs5·6 0·58·0 6·1 1·9(2 marks)Cash flows relating to the project are as follows:Year0 $m1 $m 2$m 3 $m 4 $m Machinery Opportunity cost Annual cash flows(4·7) (1·3) (6·0)1·9 1·91·9 1·91·9 1·90.8 1·9 2·7(2 marks)The net present value of the project is:$m $m $m $m $mCash flows Discount rate (12%) Present valueNPV (6·0)1·0(6·0)0·291·90·891·691·90·801·521·90·711·352·70·641·73(2maks)(b) (i) The increase required in the initial outlay on machinery before the project becomes nolonger profitable will be $0·29m. The machinery is already expressed in present value terms and so this figure is the same as the net present value of the project. This figure is 6·2% higher than the initial cost figure stated. (2 marks)(ii) If the discount rate is increased to 14%, the NPV of the project is:$m $m $m $m $mCash flows Discount rate (14%) Present valueNPV (6·0)1·0(6·0)0·011·90·881·671·90·771·461·90·681·292·70·591·59Thus, the project will become unprofitable at approximately 14% cost of capital.This represents a 16·7% increase in the cost of capital. (3 marks)(iii) The decrease in the residual value of the equipment (R) that will make the project no longer profitable is calculated as follows:(R x discount factor at the end of four years) – NPV of the project = 0This can be rearranged as follows:(R x discount factor at the end of four years) = NPV of the projectR x 0.64 = $0·29 mR = $0·29m/0·64= $0·45mThis represents a 43·8% decrease in the estimated residual value. (3marks)(iv) The decrease in annual net operating cash flows (C) to make the project no longer profitable is calculated as follows:(C x annuity factor for a four-year period) – NPV = 0This can be rearranged as follows:(C x annuity factor for a four-year period) = NPV C x 3·04 = $0·29m C = $0·29m/3·04 C = $0·095mThis represents a decrease of 5·0% on the estimated annual net operating cash flows. (3marks)(c) The net present value calculations in (a) above indicate that the project will increaseshareholder wealth if it is accepted. The sensitivity calculations in (b) above show by how much each of the key variables will have to change before the project becomes no longer profitable. It can be seen that the most sensitive factor is the annual net operating cash flows followed by the initial cost of the machinery, the discount rate and finally the residual value of the machinery. The annual net operating cash flows will require only a five per cent decrease before the project ceases to be profitable. (3marks)2 (a) Forecast profit and loss account for the year ended 31 May 2004Shares $000Debentures$000 Profit before interest and taxation Debenture interest payable Profit before taxation Corporation tax (20%) Profit after taxation DividendRetained profit for the year Forecast earnings per share980 160 820 164 656 328 328$656,000/1,800,000=36·4c (5marks)980 280 700 140 560 280 280$560,000/1,200,000 46·7c (5marks)(b) The level of operating profit, or profit before interest and taxation (PBIT), at which earnings per share under each method are equal (PBIT = x) is calculated as follows:Shares Debentures(x – B/E PBIT)(1 – tax rate) (x – B/E PBIT)(1 – tax rate)––––––––––––––––––––––– = –––––––––––––––––––––––No. of shares No. of sharesThe level of PBIT at which earnings per share are equal is:(x – $0·16m)(1 – 0·20) (x – $0·28m)(1 – 0·20)–––––––––––––––––––– = –––––––––––––––––––– (3 marks)1·8m 1·2m(0·8 x – $0·128m) (0·8 x – $0·224m)––––––––––––––––– = ––––––––––––––––1·8m 1·2m0·96m x – $0·1536m = 1·44m x – $0·4032m0·48m x = $0·2496mx = $0·52m (2 marks)3. (a) (i) The contribution per unit is $3 (i.e. $20 - $17). A 25% increase in sales will lead to anincrease of sales revenue of $0·3m or 15,000 units (i.e. $0·3m/$20). Hence the increase in contribution and profit will be:15,000 x $3 = $45,000 (4marks)The additional investment required will be:$Increase in stocksIncrease in debtors [($1·5m/12 ) x 11/2m] - [(1·2m/12) x 1m)]Increase in creditorsNet increase in working capitalReturn on investment 150,00087,500237,50050,000187,500= 45,000 x 100% 187,500= 24·0 %(6 marks)(ii) The additional investment required will be:$Increase in stocksIncrease in debtors [($0·3m/12) x 11/2]Increase in creditorsNet increase in working capital Return on investment 150,00037,500187,50050,000137,500= 45,000 x 100% 137,500= 32·7 %(6 marks)Thus, it is if new customers only take advantage of the longer credit period that the proposed change in policy will meet the profit requirements of the company.(b) The main factors that influence the credit terms granted to customers are: Management policies/Market strength /Order size and frequency /Profitability /Resources of the business /Resources of the customer/Industry norms, etc.(4 marks)。

公司理财习题答案第十一章Chapter 11: An Alternative View of Risk and Return: The Arbitrage Pricing Theory 11.1Real GNP was higher than anticipated. Since returns are positively related to the level of GNP, returns should rise based on this factor.Inflation was exactly the amount anticipated. Since there was no surprise in this announcement, it will not affect Lewis-Striden returns.Interest Rates are lower than anticipated. Since returns are negatively related to interest rates, the lower than expected rate is good news. Returns should rise due to interest rates.The President’s death is bad news. Although the president was expected to retire, his retirement would not be effective for six months. During that period he would still contribute to the firm. His untimely death mean that thosecontributions would not be made. Since he was generally considered an asset to the firm, his death will cause returns to fall.The poor research results are also bad news. Since Lewis-Striden must continue to test the drug as early as expected. The delay will affect expected future earnings, and thus it will dampen returns now.The research breakthrough is positive news for Lewis Striden. Since it was unexpected, it will cause returns to rise.The competitor’s announcement is also unexpected, but it is not a welcome surprise. this announcement will lower the returns on Lewis-Striden.Systematic risk is risk that cannot be diversified away through formation of a portfolio. Generally, systematic risk factors are those factors that affect a large number of firms in the market. Note those factors do not have to equally affect the firms. The systematic factors in the list are real GNP, inflation and interest rates.Unsystematic risk is the type of risk that can be diversified away throughportfolio formation. Unsystematic risk factors are specific to the firm or industry.Surprises in these factors will affect the returns of the firm in which you are interested, but they will have no effect on the returns of firms in a different industry and perhaps little effect on other firms in the same industry. For Lewis-Striden, the unsystematic risk factors are the president’s ability to contribute to the firm, the research results and the competitor.11.2a.Systematic Risk = 0.042(4,480– 4,416) –1.4(4.3%– 3.1%)– 0.67(11.8% –9.5%)= –0.53%b.Unsystematic Risk = – 2.6%c.Total Return = 9.5% – 0.53% – 2.6% = 6.37%11.3()()()11.81%1.440.3710.0Return Total c.1.44%=23-270.36=Return ic Unsystemat b.0.372%=14.0%15.2%1.903.5%-4.8%2.04=Risk Systematic a.=++=--11.4 a.Stock A:()()R R R R R A A A m m Am A=+-+=+-+βεε105%12142%...Stock B:()()R R R R R B B m m Bm B=+-+=+-+βεε130%098142%...Stock C:()R R R R R C C C m m Cm C=+-+=+-+βεε157%137142%)..(.b.()[]()[]()[]()()()()()()[]()()CB A m cB A m c m B m A m CB A P 25.045.030.0%2.14R 1435.1%925.1225.045.030.0%2.14R 37.125.098.045.02.130.0%7.1525.0%1345.0%5.1030.0%2.14R 37.1%7.1525.0%2.14R 98.0%0.1345.0%2.14R 2.1%5.1030.0R 25.0R 45.0R 30.0R ε+ε+ε+-+=ε+ε+ε+-+++++=ε+-++ε+-++ε+-+=++=c.i.()R R R A B C =+-==+-==+-=105%1215%142%)1113%09815%142%)137%157%13715%142%168%..(..46%.(......ii.R P =+-=12925%1143515%142%)138398%..(..11.5a.Since five stocks have the same expected returns and the same betas, theportfolio also has the same expected return and beta.()R F F E E E E E p =+++++++110084169151212345...b.公司理财习题答案第十一章R F F E N E N E NAs N s are fini F F p N =++++++→∞→=++1100841690110084169121212......,...,1Nbut E te,Thus, R j p 11.6To determine which investment investor would prefer, you must compute the variance of portfolios created by many stocks from either market. Note, because you know that diversification is good, it is reasonable to assume that once an investor chose the market in which he or she will invest, he or she will buy many stocks in that market.Known:E EF ====001002 and and for all i.i σσεε..Assume: The weight of each stock is 1/N; that is, for all i.X N i =1/If a portfolio is composed of N stocks each forming 1/N proportion of the portfolio, thereturn on the portfolio is 1/N times the sum of the returns on the N stocks. Recall that the return on each stock is 0.1+βF+ε.()()()()()()[]()()()()()()()[]()[]()[]()()[]()()()()()j i 2j i 22j i i 2222222222P P P P iP ,0.04Corr 0.01,Cov s =isvariance the ,N as limit In the ,Cov 1/N 1s 1/N s )(1/N 1/N F 2F E 1/N F E 0.10.1/N F 0.1E R E R E R Var 0.101/N 00.1E 1/N F E 0.11/N F 0.1E R E 1/N F 0.1F 0.1(1/N)R 1/N R εε+β=εε+β∞⇒εε-+ε+β=ε∑+εβ+β=ε+β=-ε+β+=-==+β+=ε+β+=ε∑+β+=ε+β+=ε+β+==∑∑∑∑∑∑∑∑()()()()()()Thus,F R f E R E R Var R Corr Var R Corr ii ip P pi jPijR 1i =++=++===+=+010*********002250040002500412212111222.........,,εεεεεεa.()()()()Corr Corr Var R Var R i j i j ppεεεε112212000225000225,,..====Since Var , a risk averse investor will prefer to invest()()R p 1 Var R 2p 〉in the second market.b.Corr ()()εεεε112090i j j ,.,== and Corr 2i ()()Var R Var R pp120058500025==..Since Var averse investor will prefer to invest()()risk a ,R Var R 2p p 1〉in the second market.c.()()()()Corr Var R Var R i j j ppεεεε112120050022500225,,...==== and Corr 2i Since , a risk averse investor will be indifferent ()()Var R Var R pp12=between investing in the two market.d.Indifference implies that the variances of the portfolio in the two markets are equal.()()()()()()Var R Var R Corr Corr Corr Corr p pijiji jij1211222211002250040002500405=+=+=+..,..,,,.εεεεεεεε公司理财习题答案第十一章This is exactly the relationship used in part c.11.7()()()()()()()()()()()() 2.7225%1.211.5s 1.7424%1.211.2s 0.5929%1.210.7s R Var R Var 0/N Var ,N As i.b.22.30%0.22304.9725/100s 4.9725%2.251.211.5s 17.84%0.17843.1824/100s 3.1824%1.441.211.2s 12.62%1.5929/100s 1.5929%1.001.210.7s Var R Var R Var a.22C 22B 22A m 2i i j C 22C B 2B 2A 2A 2i m 2i j ======β=∴→ε∞→===⇒=+====⇒=+===⇒=+=∴ε+β=ii.APT Model:()R R R R i F m F i=+-β%25.14)5.1)(3.36.10(3.3R %06.12)2.1)(3.36.10(3.3R %41.8)7.0)(3.36.10(3.3R C B A =-+==-+==-+=APT Model shows that assets A & B are accurately priced but asset C isoverpriced. Thus, rational investors will not hold asset C.iii.If short selling is allowed, all rational investors will sell short asset C so that the price of asset C will decrease until no arbitrage opportunity exists. In other words, price of asset C should decrease until the return become 14.25%.11.8 a.Let X= the proportion of security of one in the portfolio and (1-X) = the proportion of security two in the portfolio.()()[]()()[]t 222t 121t 2t 212t 111t 1t2t 1pt F F R E x 1F F R E x R X 1XR R β+β+-++β+=-+=The condition that the return of the portfolio does not depend on implies:F 1()05.0)X 1(X 0X 1X 2111=-+=β-+βThus, P=(-1,2); i.e. sell short security one and buy security two.()()()()()()5.2225.11%20%202%201R E 2p p =+-=β=+-=b.Follow the same logic as in part a, we have()()3X 05.1X 1X 0X 1X 4131==-+=β-+βWhere X is the proportion of security three in the portfolio. Thus, sell short security four and buy security three.()()()()()()075.025.03%10%102%103R E 2p p =-=β=-+=this is a risk free portfolio!c.The portfolio in part b provides a risk free return of 10% which is higher than the5% return provided by the risk free security. To take advantage of this opportunity, borrow at the risk free rate of 5% and invest the funds in a portfolio built by selling short security four and buying security three with weights (3,-2).d.Assuming that the risk free security will not change. The price of security four ( that everyone is trying to sell short) will decrease and the price of security three ( that everyone is trying to buy ) will increase. Hence the return of security four will increase and the return of security three will decrease.The alternative is that the prices of securities three and four will remain the same, and the price of the risk-free security drops until its return is 10%.Finally, a combined movement of all security prices is also possible. The prices of security four and the risk-free security will decrease and the price of security four will increase until the opportunity disappears.E (R j 20%10%5%()ββ1210i =2.5。

CHAPTER 7NET PRESENT VALUE AND OTHER INVESTMENT CRITERIAAnswers to Concepts Review and Critical Thinking Questions1. A payback period less than the project’s life means that the NPV is positive for a zero discount rate,but nothing more definitive can be said. For discount rates greater than zero, the payback period will still be less than the project’s life, but the NPV may be positive, zero, or negative, depending on whether the discount rate is less than, equal to, or greater than the IRR. The discounted payback includes the effect of the relevant discount rate. If a project’s discounted payback period is less than the project’s life, it must be the case that NPV is positive.2.If a project has a positive NPV for a certain discount rate, then it will also have a positive NPV for azero discount rate; thus, the payback period must be less than the project life. Since discounted payback is calculated at the same discount rate as is NPV, if NPV is positive, the discounted payback period must be less than the project’s life. If NPV is positive, then the present value of future cash inflows is greater than the initial investment cost; thus PI must be greater than 1. If NPV is positive for a certain discount rate R, then it will be zero for some larger discount rate R*; thus, the IRR must be greater than the required return.3. a.Payback period is simply the accounting break-even point of a series of cash flows. To actuallycompute the payback period, it is assumed that any cash flow occurring during a given period isrealized continuously throughout the period, and not at a single point in time. The payback isthen the point in time for the series of cash flows when the initial cash outlays are fullyrecovered. Given some predetermined cutoff for the payback period, the decision rule is toaccept projects that payback before this cutoff, and reject projects that take longer to payback.The worst problem associated with payback period is that it ignores the time value of money. Inaddition, the selection of a hurdle point for payback period is an arbitrary exercise that lacksany steadfast rule or method. The payback period is biased towards short-term projects; it fullyignores any cash flows that occur after the cutoff point.b.The average accounting return is interpreted as an average measure of the accountingperformance of a project over time, computed as some average profit measure attributable tothe project divided by some average balance sheet value for the project. This text computesAAR as average net income with respect to average (total) book value. Given somepredetermined cutoff for AAR, the decision rule is to accept projects with an AAR in excess ofthe target measure, and reject all other projects. AAR is not a measure of cash flows and marketvalue, but a measure of financial statement accounts that often bear little resemblance to therelevant value of a project. In addition, the selection of a cutoff is arbitrary, and the time valueof money is ignored. For a financial manager, both the reliance on accounting numbers ratherthan relevant market data and the exclusion of time value of money considerations are troubling.Despite these problems, AAR continues to be used in practice because (1) the accountinginformation is usually available, (2) analysts often use accounting ratios to analyze firmperformance, and (3) managerial compensation is often tied to the attainment of targetaccounting ratio goals.c.The IRR is the discount rate that causes the NPV of a series of cash flows to be identically zero.IRR can thus be interpreted as a financial break-even rate of return; at the IRR discount rate,the net value of the project is zero. The acceptance and rejection criteria are:If C0 < 0 and all future cash flows are positive, accept the project if the internal rate ofreturn is greater than or equal to the discount rate.If C0 < 0 and all future cash flows are positive, reject the project if the internal rate ofreturn is less than the discount rate.If C0 > 0 and all future cash flows are negative, accept the project if the internal rate ofreturn is less than or equal to the discount rate.If C0 > 0 and all future cash flows are negative, reject the project if the internal rate ofreturn is greater than the discount rate.IRR is the interest rate that causes NPV for a series of cash flows to be zero. NPV is preferred in all situations to IRR; IRR can lead to ambiguous results if there are non-conventional cash flows, and it also ambiguously ranks some mutually exclusive projects. However, for stand-alone projects with conventional cash flows, IRR and NPV are interchangeable techniques. The IRR decision rule for projectsd.The profitability index is the present value of cash inflows relative to the project cost. As such,it is a benefit/cost ratio, providing a measure of the relative profitability of a project. The profitability index decision rule is to accept projects with a PI greater than one, and to reject projects with a PI less than one. The profitability index can be expressed as: PI = (NPV + cost)/cost = 1 + (NPV/cost). If a firm has a basket of positive NPV projects and is subject to capital rationing, PI may provide a good ranking measure of the projects, indicating the “bang for the buck” of each particu lar project.e.NPV is simply the present value of a project’s cash flows. NPV specifically measures, afterconsidering the time value of money, the net increase or decrease in firm wealth due to the project. The decision rule is to accept projects that have a positive NPV, and reject projects with a negative NPV. NPV is superior to the other methods of analysis presented in the text because it has no serious flaws. The method unambiguously ranks mutually exclusive projects, and can differentiate between projects of different scale and time horizon. The only drawback to NPV is that it relies on cash flow and discount rate values that are often estimates and not certain, but this is a problem shared by the other performance criteria as well. A project with NPV = $2,500 implies that the total shareholder wealth of the firm will increase by $2,500 if the project is accepted.4.For a project with future cash flows that are an annuity:Payback = I / CAnd the IRR is:0 = – I + C / IRRSolving the IRR equation for IRR, we get:IRR = C / INotice this is just the reciprocal of the payback. So:IRR = 1 / PBFor long-lived projects with relatively constant cash flows, the sooner the project pays back, the greater is the IRR.5.There are a number of reasons. Two of the most important have to do with transportation costs andexchange rates. Manufacturing in the U.S. places the finished product much closer to the point of sale, resulting in significant savings in transportation costs. It also reduces inventories because goods spend less time in transit. Higher labor costs tend to offset these savings to some degree, at least compared to other possible manufacturing locations. Of great importance is the fact that manufacturing in the U.S. means that a much higher proportion of the costs are paid in dollars. Since sales are in dollars, the net effect is to immunize profits to a large extent against fluctuations in exchange rates. This issue is discussed in greater detail in the chapter on international finance.6.The single biggest difficulty, by far, is coming up with reliable cash flow estimates. Determining anappropriate discount rate is also not a simple task. These issues are discussed in greater depth in the next several chapters. The payback approach is probably the simplest, followed by the AAR, but even these require revenue and cost projections. The discounted cash flow measures (discounted payback, NPV, IRR, and profitability index) are really only slightly more difficult in practice.7.Yes, they are. Such entities generally need to allocate available capital efficiently, just as for-profitsdo. However, it is frequently the case that the “revenues” from not-for-profit ventures are not tangible. For example, charitable giving has real opportunity costs, but the benefits are generally hard to measure. To the extent that benefits are measurable, the question of an appropriate required return remains. Payback rules are commonly used in such cases. Finally, realistic cost/benefit analysis along the lines indicated should definitely be used by the U.S. government and would go a long way toward balancing the budget!8.The statement is false. If the cash flows of Project B occur early and the cash flows of Project Aoccur late, then for a low discount rate the NPV of A can exceed the NPV of B. Observe the following example.C0C1C2IRR NPV @ 0% Project A –$1,000,000 $0 $1,440,000 20% $440,000 Project B –$2,000,000 $2,400,000 $0 20% 400,000However, in one particular case, the statement is true for equally risky Projects. If the lives of the two Projects are equal and the cash flows of Project B are twice the cash flows of Project A in every time period, the NPV of Project B will be twice the NPV of Project A.9. Although the profitability index (PI) is higher for Project B than for Project A, Project A should bechosen because it has the greater NPV. Confusion arises because Project B requires a smaller investment than Project A requires. Since the denominator of the PI ratio is lower for Project B than for Project A, B can have a higher PI yet have a lower NPV. Only in the case of capital rationing could the company’s decision have been incorrect.10. a.Project A would have a higher IRR since initial investment for Project A is less than that ofProject B, if the cash flows for the two projects are identical.b.Yes, since both the cash flows as well as the initial investment are twice that of Project B.11.Project B would have a more sensitive NPV to changes in the discount rate. The reason is the timevalue of money. Cash flows that occur further out in the future are always more sensitive to changes in the interest rate. This is similar to the interest rate risk of a bond.12.The MIRR is calculated by finding the present value of all cash outflows, the future value of all cashinflows to the end of the project, and then calculating the IRR of the two cash flows. As a result, the cash flows have been discounted or compounded by one interest rate (the required return), and then the interest rate between the two remaining cash flows is calculated. As such, the MIRR is not a true interest rate. In contrast, consider the IRR. If you take the initial investment, and calculate the future value at the IRR, you can replicate the future cash flows of the project exactly.13.The criticism is incorrect. It is true that if you calculate the future value of all intermediate cashflows to the end of the project at the required return, then calculate the NPV of this future value and the initial investment, you will get the same NPV. However, NPV says nothing about reinvestment of intermediate cash flows. The NPV is the present value of the project cash flows. The fact that the reinvestment works is an artifact of the time value of money.14.The criticism is incorrect for several reasons. It is true that if you calculate the future value of allintermediate cash flows to the end of the project at the IRR, then calculate the IRR of this future value and the initial investment, you will get the same IRR. This only occurs if the intermediate cash flows are reinvested at the IRR. However, similar to the previous question, IRR deals with the present value of the cash flows, not the future value. There is also another important point. This criticism deals with the reinvestment of the intermediate cash flows. As we will see in the next chapter, any reinvestment assumption concerning the intermediate cash flows is incorrect. The reason is that when we are calculating the cash flows for a project, we are concerned with the incremental cash flows from the project, that is, the cash flows the project creates. Reinvestment violates this principal. Consider the following example:C0C1C2IRR Project A –$100 $10 $110 10% Suppose this is a deposit into a bank account. The IRR of the cash flows is 10 percent. Does it the IRR change if the Year 1 cash flow is reinvested in the account, or if it is withdrawn and spent on pizza? No. Finally, think back to the yield to maturity calculation on a bond. The YTM is the IRR of the bond investment, but no mention of a reinvestment assumption of the bond coupons is inferred.The reason is that the reinvestment assumption is irrelevant to calculating the YTM on a bond; in the same way, the reinvestment assumption is irrelevant in the IRR calculation.Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1. a.The payback period is the time that it takes for the cumulative undiscounted cash inflows toequal the initial investment.Project A:Cumulative cash flows Year 1 = €4,000 = €4,000Cumulative cash flows Year 2 = €4,000 +3,500 = €7,500 Payback period = 2 yearsProject B:Cumulative cash flows Year 1 = €2,500 = €2,500Cumulative cash flows Year 2 = €2,500 + 1,200 = €3,700Cumulative cash flows Year 3 = €2,500 + 1,200 + 3,000 = €6,700 Companies can calculate a more precise value using fractional years. To calculate the fractionalpayba ck period, find the fraction of year 3’s cash flows that is needed for the company to have cumulative undiscounted cash flows of €5,000. Divide the difference between the initial investment and the cumulative undiscounted cash flows as of year 2 by the undiscounted cashflow of year 3.Payback period = 2 + (€5,000 –€3,700) / €3,000Payback period = 2.43Since project A has a shorter payback period than project B has, the company should chooseproject A.b.Discount each project’s cash flows at 15 percent. Choose the project with the highest NPV.Project A:NPV = –€7,500 + €4,000 / 1.15 + €3,500 / 1.152 + €1,500 / 1.153NPV = –€388.96Project B:NPV = –€5,000 + €2,500 / 1.15 + €1,200 / 1.152 + €3,000 / 1.153NPV = €53.83The firm should choose Project B since it has a higher NPV than Project A has.2.To calculate the payback period, we need to find the time that the project has recovered its initialinvestment. The cash flows in this problem are an annuity, so the calculation is simpler. If the initial cost is £3,000, the payback period is:Payback = 3 + (£300 / £900) = 3.33 yearsThere is a shortcut to calculate the payback period if the future cash flows are an annuity. Just divide the initial cost by the annual cash flow. For the £3,000 cost, the payback period is:Payback = £3,000 / £900 = 3.33 yearsFor an initial cost of £5,000, the payback period is:Payback = 5 + (£500 / £900) = 5.55 yearsThe payback period for an initial cost of £10,000 is a little trickier. Notice that the total cash inflows after nine years will be:Total cash inflows = 8(£900) = £7,200If the initial cost is £10,000, the project never pays back. Notice that if you use the shortcut forannuity cash flows, you get:Payback = £10,000 / £900 = 11.11 years.This answer does not make sense since the cash flows stop after nine years, so the payback period is never.3.When we use discounted payback, we need to find the value of all cash flows today. The value todayof the project cash flows for the first four years is:Value today of Year 1 cash flow = $7,000/1.14 = $6,140.35Value today of Year 2 cash flow = $7,500/1.142 = $5,771.01Value today of Year 3 cash flow = $8,000/1.143 = $5,399.77Value today of Year 4 cash flow = $8,500/1.144 = $5,032.68To find the discounted payback, we use these values to find the payback period. The discounted first year cash flow is $6,140.35, so the discounted payback for an $8,000 initial cost is:Discounted payback = 1 + ($8,000 – 6,140.35)/$5,771.01 = 1.32 yearsFor an initial cost of $13,000, the discounted payback is:Discounted payback = 2 + ($13,000 – 6,140.35 – 5,771.01)/$5,399.77 = 2.20 yearsNotice the calculation of discounted payback. We know the payback period is between two and three years, so we subtract the discounted values of the Year 1 and Year 2 cash flows from the initial cost.This is the numerator, which is the discounted amount we still need to make to recover our initial investment. We divide this amount by the discounted amount we will earn in Year 3 to get the fractional portion of the discounted payback.If the initial cost is $18,000, the discounted payback is:Discounted payback = 3 + ($18,000 – 6,140.35 – 5,771.01 – 5,399.77) / $5,032.68 = 3.14 years4.To calculate the discounted payback, discount all future cash flows back to the present, and use thesediscounted cash flows to calculate the payback period. Doing so, we find:R = 0%: 4 + (£1,100 / £2,100) = 4.52 yearsDiscounted payback = Regular payback = 4.52 yearsR = 5%: £2,100/1.05 + £2,100/1.052 + £2,100/1.053 + £2,100/1.054 + £2,100/1.055 = £9,091.90 £2,100/1.056 = £1,567.05Discounted payback = 5 + (£9,500 – 9,091.90) / £1,567.05 = 5.26 years R = 15%: £2,100/1.15 + £2,100/1.152 + £2,100/1.153 + £2,100/1.154 + £2,100/1.155 + £2,100/1.156 = £7,947.41; The project never pays back.5. a.The average accounting return is the average project earnings after taxes, divided by theaverage book value, or average net investment, of the machine during its life. The book value of the machine is the gross investment minus the accumulated depreciation.Average book value = (Book Value0 + Book Value1 + Book Value2 + Book Value3 +Book Value4 + Book Value5) / (Economic Life)Average book value = ($16,000 + 12,000 + 8,000 + 4,000 + 0) / (5 years)Average book value = $8,000Average Project Earnings = $4,500To find the average accounting return, we divide the average project earnings by the average book value of the machine to calculate the average accounting return. Doing so, we find:Average Accounting Return = Average Project Earnings / Average Book ValueAverage Accounting Return = $4,500 / $8,000Average Accounting Return = 0.5625 or 56.25%6.First, we need to determine the average book value of the project. The book value is the grossinvestment minus accumulated depreciation.Purchase Date Year 1 Year 2 Year 3 Gross Investment €8,000 €8,000 €8,000 €8,000Less: Accumulated Depreciation 0 4,000 6,500 8,000Net Investment €8,000 €4,000 €1,500 €0 Now, we can calculate the average book value as:Average book value = (€8,000 + 4,000 + 1,500 + 0) / (4 years)Average book value = €3,375To calculate the average accounting return, we must remember to use the aftertax average netincome when calculating the average accounting return. So, the average aftertax net income is:Average aftertax net income = (1 – t c) Annual pretax net incomeAverage aftertax net income = (1 – 0.25) €2,000Average aftertax net income = €1,500The average accounting return is the average after-tax net income divided by the average book value, which is:Average accounting return = €1,500 / €3,375Average accounting return = 0.4444 or 44.44%7.The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that definesthe IRR for this project is:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = –¥8,000,000 + ¥4,000,000/(1 + IRR) + ¥3,000,000/(1 + IRR)2 + ¥2,000,000/(1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 6.93%Since the IRR is less than the required return we would reject the project.8.The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equation that definesthe IRR for this Project A is:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = – £2,000 + £1,000/(1 + IRR) + £1,500/(1 + IRR)2 + £2,000/(1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 47.15%And the IRR for Project B is:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = – £1,500 + £500/(1 + IRR) + £1,000/(1 + IRR)2 + £1,500/(1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that: IRR = 36.19%9.The profitability index is defined as the PV of the cash inflows divided by the PV of the cashoutflows. The cash flows from this project are an annuity, so the equation for the profitability index is:PI = C(PVIFA R,t) / C0PI = €41,000(PVIFA15%,7) / €160,000PI = 1.066110. a.The profitability index is the present value of the future cash flows divided by the initial cost.So, for Project Alpha, the profitability index is:PI Alpha = [$300 / 1.10 + $700 / 1.102 + $600 / 1.103] / $500 = 2.604And for Project Beta the profitability index is:PI Beta = [$300 / 1.10 + $1,800 / 1.102 + $1,700 / 1.103] / $2,000 = 1.519b.According to the profitability index, you would accept Project Alpha. However, remember theprofitability index rule can lead to incorrect decision when ranking mutually exclusive projects.Intermediate11. a.To have a payback equal to the project’s life, given C is a constant cash flow for N years:C = I/Nb.To have a positive NPV, I < C (PVIFA R%, N). Thus, C > I / (PVIFA R%, N).c.Benefits = C (PVIFA R%, N) = 2 × costs = 2IC = 2I / (PVIFA R%, N)12. a.The IRR is the interest rate that makes the NPV of the project equal to zero. So, the equationthat defines the IRR for this project is:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)3 + C4 / (1 + IRR)40 = ₩5,000 –₩2,500 / (1 + IRR) –₩2,000 / (1 + IRR)2–₩1,000 / (1 + IRR)3–₩1,000 / (1 +IRR)4Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:IRR = 13.99%b.This problem differs from previous ones because the initial cash flow is positive and all futurecash flows are negative. In other words, this is a financing-type project, while previous projects were investing-type projects. For financing situations, accept the project when the IRR is less than the discount rate. Reject the project when the IRR is greater than the discount rate.IRR = 13.99%Discount Rate = 12%IRR > Discount RateReject the offer when the discount rate is less than the IRR.ing the same reason as part b., we would accept the project if the discount rate is 20 percent.IRR = 13.99%Discount Rate = 19%IRR < Discount RateAccept the offer when the discount rate is greater than the IRR.d.The NPV is the sum of the present value of all cash flows, so the NPV of the project if thediscount rate is 10 percent will be:NPV = ₩5,000 –₩2,500 / 1.12 –₩2,000 / 1.122–₩1,000 / 1.123–₩1,000 / 1.124NPV = –₩173.83When the discount rate is 12 percent, the NPV of the offer is –₩359.95. Reject the offer.And the NPV of the project is the discount rate is 19 percent will be:NPV = ₩5,000 –₩2,500 / 1.19 –₩2,000 / 1.192–₩1,000 / 1.193–₩1,000 / 1.194NPV = ₩394.75When the discount rate is 19 percent, the NPV of the offer is ₩466.82. Accept the offer.e.Yes, the decisions under the NPV rule are consistent with the choices made under the IRR rulesince the signs of the cash flows change only once.13. a.The IRR is the interest rate that makes the NPV of the project equal to zero. So, the IRR foreach project is:Deepwater Fishing IRR:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = –$600,000 + $270,000 / (1 + IRR) + $350,000 / (1 + IRR)2 + $300,000 / (1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:IRR = 24.30%Submarine Ride IRR:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = –$1,800,000 + $1,000,000 / (1 + IRR) + $700,000 / (1 + IRR)2 + $900,000 / (1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:IRR = 21.46%Based on the IRR rule, the deepwater fishing project should be chosen because it has the higher IRR.b.To calculate the incremental IRR, we s ubtract the smaller project’s cash flows from the largerproject’s cash flows. In this case, we subtract the deepwater fishing cash flows from the submarine ride cash flows. The incremental IRR is the IRR of these incremental cash flows. So, the incremental cash flows of the submarine ride are:Year 0Year 1Year 2 Year 3 Submarine Ride –$1,800,000 $1,000,000 $700,000 $900,000Deepwater Fishing –600,000 270,000 350,000 300,000Submarine – Fishing –$1,200,000 $730,000 $350,000 $600,000 Setting the present value of these incremental cash flows equal to zero, we find the incremental IRR is:0 = C0 + C1 / (1 + IRR) + C2 / (1 + IRR)2 + C3 / (1 + IRR)30 = –$1,200,000 + $730,000 / (1 + IRR) + $350,000 / (1 + IRR)2 + $600,000 / (1 + IRR)3Using a spreadsheet, financial calculator, or trial and error to find the root of the equation, we find that:Incremental IRR = 19.92%For investing-type projects, accept the larger project when the incremental IRR is greater than the discount rate. Since the incremental IRR, 19.92%, is greater than the required rate of return of 15 percent, choose the submarine ride project. Note that this is the choice when evaluating only the IRR of each project. The IRR decision rule is flawed because there is a scale problem.That is, the submarine ride has a greater initial investment than does the deepwater fishing project. This problem is corrected by calculating the IRR of the incremental cash flows, or by evaluating the NPV of each project.c.The NPV is the sum of the present value of the cash flows from the project, so the NPV of eachproject will be:Deepwater fishing:NPV = –$600,000 + $270,000 / 1.15 + $350,000 / 1.152 + $300,000 / 1.153NPV = $96,687.76Submarine ride:NPV = –$1,800,000 + $1,000,000 / 1.15 + $700,000 / 1.152 + $900,000 / 1.153NPV = $190,630.39Since the NPV of the submarine ride project is greater than the NPV of the deepwater fishingproject, choose the submarine ride project. The incremental IRR rule is always consistent withthe NPV rule.14. a.The profitability index is the PV of the future cash flows divided by the initial investment. Thecash flows for both projects are an annuity, so:PI I = 元15,000(PVIFA10%,3 ) / 元30,000 = 1.243PI II = 元2,800(PVIFA10%,3) / 元5,000 = 1.393The profitability index decision rule implies that we accept project II, since PI II is greater thanthe PI I.b.The NPV of each project is:NPV I = –元30,000 + 元15,000(PVIFA10%,3) = 元7,302.78NPV II = –元5,000 + 元2,800(PVIFA10%,3) = 元1,963.19The NPV decision rule implies accepting Project I, since the NPV I is greater than the NPV II.ing the profitability index to compare mutually exclusive projects can be ambiguous whenthe magnitudes of the cash flows for the two projects are of different scale. In this problem,project I is roughly 3 times as large as project II and produces a larger NPV, yet the profit-ability index criterion implies that project II is more acceptable.15. a.The equation for the NPV of the project is:NPV = –₦28,000,000 + ₦53,000,000/1.11 –₦8,000,000/1.112 = ₦13,254,768.28The NPV is greater than 0, so we would accept the project.b.The equation for the IRR of the project is:0 = –₦28,000,000 + ₦53,000,000/(1+IRR) –₦8,000,000/(1+IRR)2From Descartes rule of signs, we know there are two IRRs since the cash flows change signstwice. From trial and error, the two IRRs are:IRR = 72.75%, –83.46%。

公司理财习题答案第三十章Chapter 30: Mergers and Acquisitions30.1 The new corporation issues $300,000 in new debt. The merger creates $100,000 ofgoodwill because the merger is a purchase.Balance SheetLager Brewing(in $ thousands)Current assets$480Current liabilities$200Other assets140Long-term debt400Net fixed assets580Equity700Goodwill100Total assets$1,300Total liabilities$1,300 30.2 If the balance sheet for Philadelphia Pretzel shows assets at book value instead of marketvalue, the goodwill will be only $60,000 (=$300,000 - $240,000). Thus, the net fixed assetsare $620,000 (=$1,300,000 - $480,000 - $140,000 - $60,000).Balance SheetLager Brewing(in $ thousands)Current assets$480Current liabilities$200Other assets140Long-term debt400Net fixed assets620Equity700Goodwill60Total assets$1,300Total liabilities$1,300 30.3Balance SheetLager Brewing(in $ thousands)Current assets$480Current liabilities$280Other assets140Long-term debt100Net fixed assets580Equity820Total assets$1,200Total liabilities$1,200 30.4 a. False. Although the reasoning seems correct, the Stillman-Eckbo data do not supportthe monopoly power theory.b. True. When managers act in their own interest, acquisitions are an important controldevice for shareholders. It appears that some acquisitions and takeovers are theconsequence of underlying conflicts between managers and shareholders.c. False. Even if markets are efficient, the presence of synergy will make the value ofthe combined firm different from the sum of the values of the separate firms.Incremental cash flows provide the positive NPV of the transaction.d. False. In an efficient market, traders will value takeovers based on “Fundamentalfactors” regardless of the time horizon. Recall that the evidence as a whole suggestsefficiency in the markets. Mergers should be no different.e. False. The tax effect of an acquisition depends on whether the merger is taxable ornon-taxable. In a taxable merger, there are two opposing factors to consider, thecapital gains effect and the write-up effect. The net effect is the sum of these twoeffects.f. True. Because of the coinsurance effect, wealth might be transferred from thestockholders to the bondholders. Acquisition analysis usually disregards this effectand considers only the total value.30.5(in $ millions)Net Cash FlowPer Year(Perpetual)DiscountRate (%)ValueSmall Fry816%50Whale2010%200Benefits from Acquisition:511.76%42.5Revenue Enhancement 2.520%12.5Cost Reduction210%20Tax Shelters0.55%10Whale-Fry$3311.28%$292.5Per share price = ($292.5-100)/5 = $38.530.6 a. The weather conditions are independent. Thus, the joint probabilities are theproducts of the individual probabilities.Possible states Joint probabilityRain Rain0.1 x 0.1=0.01Rain Warm0.1 x 0.4=0.04Rain Hot0.1 x 0.5=0.05Warm Rain0.4 x 0.1=0.04Warm Warm0.4 x 0.4=0.16Warm Hot0.4 x 0.5=0.20Hot Rain0.5 x 0.1=0.05Hot Warm0.5 x 0.4=0.20Hot Hot0.5 x 0.5=0.25Since the state Rain Warm has the same outcome (revenue) as Warm Rain, theirprobabilities can be added. The same is true of Rain Hot, Hot Rain and Warm Hot,Hot Warm. Thus the joint probabilities arePossiblestatesJoint probabilityRain Rain0.01Rain Warm0.08Rain Hot0.10Warm Warm0.16Warm Hot0.40Hot Hot0.25公司理财习题答案第三十章The joint values are the sums of the values of the two companies for the particular state.Possible states Joint valueRain Rain$200,000Rain Warm300,000Warm Warm400,000Rain Hot500,000Warm Hot600,000Hot Hot800,000b. Recall, if a firm cannot service its debt, the bondholders receive the value of theassets. Thus, the value of the debt is the value of the company if the face value of the debt is greater than the value of the company. If the value of the company is greater than the value of the debt, the value of the debt is its face value. Here the value of the common stock is always the residual value of the firm over the value of the debt.Joint Prob.Joint Value Debt Value Stock Value0.01$200,000$200,000$00.08300,000300,00000.16400,000400,00000.10500,000400,000100,0000.40600,000400,000200,0000.25800,000400,000400,000c. To show that the value of the combined firm is the sum of the individual values, youmust show that the expected joint value is equal to the sum of the separate expected values.Expected joint value= 0.01($200,000) + 0.08($300,000) + 0.16($400,000) + 0.10($500,000) +0.40($600,000) + 0.25($800,000)= $580,000Since the firms are identical, the sum of the expected values is twice the expectedvalue of either.Expected individual value = 0.1($100,000) + 0.4($200,000) + 0.5($400,000) = $290,000 Expected combined value = 2($290,000) = $580,000d. The bondholders are better off if the value of the debt after the merger is greater thanthe value of the debt before the merger.Value of the debt before the merger:The value of debt for either company= 0.1($100,000) + 0.4($200,000) + 0.5($200,000) = $190,000Total value of debt before the merger = 2($190,000) = $380,000Value of debt after the merger= 0.01($200,000) + 0.08($300,000) + 0.16($400,000) + 0.10($400,000) + 0.40($400,000) +0.25($400,000) = $390,000The bondholders are $10,000 better off after the merger.30.7 The decision hinges upon the risk of surviving. The final decision should hinge on thewealth transfer from bondholders to stockholders when risky projects are undertaken. High-risk projects will reduce the expected value of the bondholders’ claims on the firm. The telecommunications business is riskier than the utilities business. If the total value of the firm does not change, the increase in risk should favor the stockholder. Hence, management should approve this transaction. Note, if the total value of the firm drops because of the transaction and the wealth effect is lower than the reduction in total value, management should reject the project.30.8 If the market is “smart,” the P/E ratio will not be constant.a. Value = $2,500 + $1,000 = $3,500b. EPS = Post-merger earnings / Total number of shares=($100 + $100)/200 =$1c. Price per share = Value/Total number of shares=$3,500/200 =$17.50d. If the market is “fooled,” the P/E ratio will be constant at $25.Value = P/E * Total number of shares= 25 * 200 = $5,000EPS = Post-merger earnings / Total number of shares=$5,000/200 = $25.0030.9 a. After the merger, Arcadia Financial will have 130,000 [=10,000 + (50,000)(6/10)]shares outstanding. The earnings of the combined firm will be $325,000. The earnings per share of the combined firm will be $2.50 (=$325,000/130,000). The acquisition will increase the EPS for the stockholders from $2.25 to $2.50.b. There will be no effect on the original Arcadia stockholders. No synergies exist in this merger since Arcadia is buying Coldran at its market price. Examining the relative values of the two firms sees the latter point.Share price of Arcadia = (16 * $225,000) / 100,000=$36Share price of Coldran = (10.8 * $100,000) / 50,000=$21.60The relative value of these prices is $21.6/$36 = 0.6. Since Coldran’s shareholders receive 0.6 shares of Arcadia for every share of Coldran, no synergies exist.30.10 a. The synergy will be the discounted incremental cash flows. Since the cash flows areperpetual, this amount is000,500,7$08.0000,600$公司理财习题答案第三十章b.The value of Flash-in-the-Pan to Fly-by-Night is the synergy plus the current marketvalue of Flash-in-the-Pan.V = $7,500,000 + $20,000,000= $27,500,000c. Cash alternative = $15,000,000Stock alternative = 0.25($27,500,000 + $35,000,000)= $15,625,000d. NPV of cash alternative = V - Cost=$27,500,000 - $15,000,000=$12,500,000NPV of stock alternative = V - Cost=$27,500,000 - $15,625,000=$11,875,000e. Use the cash alternative, its NPV is greater.30.11 a. The value of Portland Industries before the merger is $9,000,000 (=750,000x12). Thisvalue is also the discounted value of the expected future dividends.$9,000,000 = $1.80250,000)1.05(r0.05)⨯-r = 0.1025 = 10.25%r is the risk-adjusted discount rate for Portland’s expected future dividends. the value of Portland Industries after the merger is385,815,14$) 07.01025 .0(07.1) 000 ,25080.1($V =-⨯=This is the value of Portland Industries to Freeport.b. NPV= Gain - Cost= $14,815,385 - ($40x250, 000)= $4,815,385c. If Freeport offers stock, the value of Portland Industries to Freeport is the same, but thecost differs.Cost = (Fraction of combined firm owned by Portland’s stockholders)x(Value of the combined firm)Value of the combined firm = (Value of Freeport before merger)+ (Value of Portland to Freeport)= $15x1,000,000 + $14,815,385= $29,815,385Fraction of ownership600,0001,000,000600,0000.375 =+=Cost= 0.375x$29,815,385= $11,180,769NPV= $14,815,385 - $11,180,769=$3,634,616d. The acquisition should be attempted with a cash offer since it provides a higher NPV.e. The value of Portland Industries after the merger isV($1.80250,000)1.06(0.10250.06)$11,223,529 =⨯-=This is the value of Portland Industries to Freeport.NPV= Gain-Cost=$11,223,529 - ($40x250,000)=$1,223,529If Freeport offers stock, the value of Portland Industries to Freeport is the same, but the cost differs.Cost = (Fraction of combined firm owned by Portland’s stockholders)x(Value of the combined firm)Value of the combined firm = (Value of Freeport before merger)+ (Value of Portland to Freeport)= $15x1,000,000 + $11,223,529= $26,223,529Fraction of ownership600,0001,000,000600,0000.375 =+=Cost = 0.375 * $26,223,529=$9,833,823NPV = $11,223,529 - $9,833,823=$1,389,706The acquisition should be attempted with a stock offer since it provides a higher NPV.30.12a. Number of shares after acquisition=30 + 15 = 45 milStock price of Harrods after acquisition = 1,000/45=22.22 poundsb.Value of Selfridge stockholders after merger:α * 1,000 = 300α = 30%30%New Shares IssuedNew Shares Issued Old SharesNew Shares IssuedNew Shares Issued30=+=+New shares issued = 12.86 mil12.86:20 = 0.643:1The proper exchange ratio should be 0.643 to make the stock offer’s value to Selfridge equivalent to the cash offer.30.13To evaluate this proposal, look at the present value of the incremental cash flows.公司理财习题答案第三十章Cash Flows to Company A(in $ million)Year012345 Acquisition of B-550Dividends from B150325203045 Tax-loss carryforwards2525Terminal value600 Total-40032304530645 The additional cash flows from the tax-loss carry forwards and the proposed level of debt should be discounted at the cost of debt because they are determined with very little uncertainty.The after-tax cash flows are subject to normal business risk and must be discounted at a normal rate.Beta coefficient for the bond = 0.25 = [(8%-6%)/8%].Beta coefficient for the company = 1 = [(0.25)2 + (1.25)(0.75)]Discount rate for normal operations:r = 6% + 8% (1) = 14%Discount rate for dividends:The new beta coefficient for the company, 1, must be the weighted average of the debt beta and the stock beta.1 = 0.5(0.25) + 0.5(βs)βs = 1.75r = 6% + 8%(1.75) = 20%2. 21 $17.204$43.467$85.19$43.21$08.18$47.14$57.11$47.3$67.26$400 $)08.1(300$)14.1(900$)08.1(25$)08.1(25$)2.1(45$)2.1(30$2.1(20$)2.1(5$2.132$400$NPV5532543)2-=-++++++++-=-++++++++-=Because the NPV of the acquisition is negative, Company A should not acquireCompany B.30.14 The commonly used defensive tactics by target-firm managers include:i. corporate charter amendments like super-majority amendment or staggering theelection of board members.ii. repurchase standstill agreements.iii. exclusionary self-tenders.iv. going private and leveraged buyouts.v. other devices like golden parachutes, scorched earth strategy, poison pill, ..., etc.Mini Case: U.S.Steel’s case.You have 3 choices: tender, or do not tender or sell in the market. If you do sell your shares in the market, at some point, somebody else would need to make a decision in “tender” or “not tender” as well.It is important to recognize that the firm has about 60 million shares outstanding (since 30million shares will give US Steel 50.1% of Marathon shares). Let’s consider the possible selling prices, which you will receive for each of the following scenarios:US Steel Tender offerSucceeds FailsTenderA pro-ratedPrice between $125 and $85Market priceDo not Tender$85Market priceIf US Steel’s tender offer fails, you are equally well off since your share value is determined by the market price.If you choose not to tender, and 30 million shares were tendered US Steel succeeds to gain50.1% control, you will only receive $85 a share. If you do tender, the price you will receive will be no worse than $85 a share and can be as high as $125 a share. Depending on the number of shares tendered, you will receive one of the following prices.1.If only 50.1% tendered, you will get $125 per share.2.If the shares tendered exceed 50.1% but less than 100%, you will get more than $105 ashare.3.If all 60 million shares were tendered, you will get $105 per share. (which is)()()85$6030125$6030+It is clear that, in the above 3 cases, when you are not sure about whether US Steel will succeed or not, you will be better off to tender your shares than not tender. This is because at best, you will only receive $85 per share if you choose not to tender.。

CHAPTER 16DIVIDENDS AND DIVIDEND POLICYAnswers to Concepts Review and Critical Thinking Questions1.Dividend policy deals with the timing of dividend payments, not the amounts ultimately paid.Dividend policy is irrelevant when the timing of dividend payments doesn’t affect the present value of all future dividends.2. A stock repurchase reduces equity while leaving debt unchanged. The debt ratio rises. A firm could,if desired, use excess cash to reduce debt instead. This is a capital structure decision.3.The chief drawback to a strict dividend policy is the variability in dividend payments. This is aproblem because investors tend to want a somewhat predictable cash flow. Also, if there is information content to dividend announcements, then the firm may be inadvertently telling the market that it is expecting a downturn in earnings prospects when it cuts a dividend, when in reality its prospects are very good. In a compromise policy, the firm maintains a relatively constant dividend. It increases dividends only when it expects earnings to remain at a sufficiently high level to pay the larger dividends, and it lowers the dividend only if it absolutely has to.4.Friday, December 29 is the ex-dividend day. Remember not to count January 1 because it is aholiday, and the exchanges are closed. Anyone who buys the stock before December 29 is entitled to the dividend, assuming they do not sell it again before December 29.5.No, because the money could be better invested in stocks that pay dividends in cash which benefitthe fundholders directly.6.The change in price is due to the change in dividends, not due to the change in dividend policy.Dividend policy can still be irrelevant without a contradiction.7.The stock price dropped because of an expected drop in future dividends. Since the stock price is thepresent value of all future dividend payments, if the expected future dividend payments decrease, then the stock price will decline.8. The plan will probably have little effect on shareholder wealth. The shareholders can reinvest ontheir own, and the shareholders must pay the taxes on the dividends either way. However, the shareholders who take the option may benefit at the expense of the ones who don’t (because of the discount). Also as a result of the plan, the firm will be able to raise equity by paying a 10% flotation cost (the discount), which may be a smaller discount than the market flotation costs of a new issue for some companies.9.If these firms just went public, they probably did so because they were growing and needed theadditional capital. Growth firms typically pay very small cash dividends, if they pay a dividend at all.This is because they have numerous projects available, and they reinvest the earnings in the firm instead of paying cash dividends.B-2 SOLUTIONS10.It would not be irrational to find low-dividend, high-growth stocks. The trust should be indifferentbetween receiving dividends or capital gains since it does not pay taxes on either one (ignoring possible restrictions on invasion of principal, etc.). It would be irrational, however, to hold municipal bonds. Since the trust does not pay taxes on the interest income it receives, it does not need the tax break associated with the municipal bonds. Therefore, it should prefer to hold higher yield, taxable bonds.11.The stock price drop on the ex-dividend date should be lower. With taxes, stock prices should dropby the amount of the dividend, less the taxes investors must pay on the dividends. A lower tax rate lowers the investors’ tax liability.12.With a high tax on dividends and a low tax on capital gains, investors, in general, will prefer capitalgains. If the dividend tax rate declines, the attractiveness of dividends increases.13.Knowing that share price can be expressed as the present value of expected future dividends doesnot make dividend policy relevant. Under the growing perpetuity model, if overall corporate cash flows are unchanged, then a change in dividend policy only changes the timing of the dividends.The PV of those dividends is the same. This is true because, given that future earnings are held constant, dividend policy simply represents a transfer between current and future stockholders.In a more realistic context and assuming a finite holding period, the value of the shares should represent the future stock price as well as the dividends. Any cash flow not paid as a dividend will be reflected in the future stock price. As such the PV of the flows will not change with shifts in dividend policy; dividend policy is still irrelevant.14.T he bird-in-the-hand argument is based upon the erroneous assumption that increased dividendsmake a firm less risky. If capital spending and investment spending are unchanged, the firm’s overall cash flows are not affected by the dividend policy.15.This argument is theoretically correct. In the real world, with transaction costs of security trading,home-made dividends can be more expensive than dividends directly paid out by the firms. However, the existence of financial intermediaries, such as mutual funds, reduces the transaction costs for individuals greatly. Thus, as a whole, the desire for current income shouldn’t be a major factor favoring high-current-dividend policy.16. a.Cap’s past behavior suggests a preference for capital gains, while Widow Jones exhibits apreference for current income.b. Cap could show the Widow how to construct homemade dividends through the sale of stock.Of course, Cap will also have to convince her that she lives in an MM world. Remember thathomemade dividends can only be constructed under the MM assumptions.c.Widow Jones may still not invest in Neotech because of the transaction costs involved inconstructing homemade dividends. Also, the Widow may desire the uncertainty resolutionwhich comes with high dividend stocks.17.To minimize her tax burden, your aunt should divest herself of high dividend yield stocks and investin low dividend yield stock. Or, if possible, she should keep her high dividend stocks, borrow an equivalent amount of money and invest that money in a tax-deferred account.CHAPTER 16 B-3 18. The capital investment needs of small, growing companies are very high. Therefore, payment ofdividends could curtail their investment opportunities. Their other option is to issue stock to pay the dividend, thereby incurring issuance costs. In either case, the companies and thus their investors are better off with a zero dividend policy during the firms’ rapid growth phases. This fact makes these firms attractive only to low dividend clienteles.This example demonstrates that dividend policy is relevant when there are issuance costs. Indeed, it may be relevant whenever the assumptions behind the MM model are not met.19. Unless there is an unsatisfied high dividend clientele, a firm cannot improve its share price byswitching policies. If the market is in equilibrium, the number of people who desire high dividend payout stocks should exactly equal the number of such stocks available. The supplies and demands of each clientele will be exactly met in equilibrium. If the market is not in equilibrium, the supply of high dividend payout stocks may be less than the demand. Only in such a situation could a firm benefit from a policy shift.20. This finding implies that firms use initial dividends to “signal” their potential growth and positiveNPV prospects to the stock market. The initiation of regular cash dividends also serves to convince the market that their high current earnings are not temporary.Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1.The aftertax dividend is the pretax dividend times one minus the tax rate, so:Aftertax dividend = $6.00(1 – .20) = $4.80The stock price should drop by the aftertax dividend amount, or:Ex-dividend price = $80 – 4.80 = $75.202. a.The shares outstanding increases by 10 percent, so:New shares outstanding = 10,000(1.10) = 11,000New shares issued = 1,000Since the par value of the new shares is £1, the capital surplus per share is £24. The total capital surplus is therefore:B-4 SOLUTIONSCapital surplus on new shares = 1,000(£24) = £24,000Common stock (£1 par value) £ 11,000Capital surplus 204,000Retained earnings 561,500£776,500b.The shares outstanding increases by 25 percent, so:New shares outstanding = 10,000(1.25) = 12,500New shares issued = 2,500Since the par value of the new shares is £1, the capital surplus per share is £24. The total capital surplus is therefore:Capital surplus on new shares = 2,500(£24) = £60,000Common stock (£1 par value) £ 12,500Capital surplus 240,000Retained earnings 524,000£776,5003. a.To find the new shares outstanding, we multiply the current shares outstanding times the ratioof new shares to old shares, so:New shares outstanding = 10,000(3/1) = 30,000The equity accounts are unchanged except that the par value of the stock is changed by the ratio of new shares to old shares, so the new par value is:New par value = £1(1/3) = £.3333 per share.b.To find the new shares outstanding, we multiply the current shares outstanding times the ratioof new shares to old shares, so:New shares outstanding = 10,000(1/5) = 2,000.The equity accounts are unchanged except that the par value of the stock is changed by the ratio of new shares to old shares, so the new par value is:New par value = £1(5/1) = £5.00 per share.CHAPTER 16 B-5 4.To find the new stock price, we multiply the current stock price by the ratio of old shares to newshares, so:a.€65(2/5) = €26.00b.€65(1/1.18) = €55.08c.€65(1/1.40) = €46.43d.€65(7/4) = €113.75e.To find the new shares outstanding, we multiply the current shares outstanding times the ratioof new shares to old shares, so:a: 150,000(5/2) = 375,000b: 150,000(1.18) = 177,000c: 150,000(1.40) = 210,000d: 150,000(4/7) = 85,7145.The stock price is the total market value of equity divided by the shares outstanding, so:P0 = Au$175,000 equity/5,000 shares = Au$35.00 per shareIgnoring tax effects, the stock price will drop by the amount of the dividend, so:P X = Au$35.00 – 1.50 = Au$33.50The total dividends paid will be:Au$1.50 per share(5,000 shares) = Au$7,500The equity and cash accounts will both decline by Au$7,500.6.Repurchasing the shares will reduce shareholders’ equity by Au$4,025. The shares repurchased willbe the total purchase amount divided by the stock price, so:Shares bought = Au$4,025/Au$35.00 = 115And the new shares outstanding will be:New shares outstanding = 5,000 – 115 = 4,885B-6 SOLUTIONSAfter repurchase, the new stock price is:Share price = Au$170,975/4,885 shares = Au$35.00The repurchase is effectively the same as the cash dividend because you either hold a share worth Au$35.00, or a share worth Au$33.50 and Au$1.50 in cash. Therefore, you participate in the repurchase according to the dividend payout percentage; you are unaffected.7. The stock price is the total market value of equity divided by the shares outstanding, so:P0 = ₦360,000 equity/15,000 shares = ₦24 per shareThe shares outstanding will increase by 25 percent, so:New shares outstanding = 15,000(1.25) = 18,750The new stock price is the market value of equity divided by the new shares outstanding, so:P X = ₦360,000/18,750 shares = ₦19.208.With a stock dividend, the shares outstanding will increase by one plus the dividend amount, so:New shares outstanding = 350,000(1.12) = 392,000The capital surplus is the capital paid in excess of par value, which is €1, so:Capital surplus for new shares = 42,000(€19) = €798,000The new capital surplus will be the old capital surplus plus the additional capital surplus for the new shares, so:Capital surplus = €1,650,000 + 798,000 = €2,448,000The new equity portion of the balance sheet will look like this:Common stock (€1 par value) € 392,000Capital surplus 2,448,000Retained earnings 2,160,000€5,000,0009.The only equity account that will be affected is the par value of the stock. The par value will changeby the ratio of old shares to new shares, so:New par value = €1(1/5) = €0.20 per share.CHAPTER 16 B-7The total dividends paid this year will be the dividend amount times the number of shares outstanding. The company had 350,000 shares outstanding before the split. We must remember to adjust the shares outstanding for the stock split, so:Total dividends paid this year = €0.70(350,000 shares)(5/1 split) = €1,225,000The dividends increased by 10 percent, so the total dividends paid last year were:Last year’s dividends = €1,225,000/1.10 = €1,113,636.36And to find the dividends per share, we simply divide this amount by the shares outstanding last year. Doing so, we get:Dividends per share last year = €1,113,636.36/350,000 shares = €3.1810.The equity portion of capital outlays is the retained earnings. Subtracting dividends from net income,we get:Equity portion of capital outlays = $1,200 – 600 = $600Since the debt-equity ratio is .80, we can find the new borrowings for the company by multiplying the equity investment by the debt-equity ratio, so:New borrowings = .80($600) = $480And the total capital outlay will be the sum of the new equity and the new debt, which is:Total capital outlays = $600 + 480 =$1,080.11. a.The payout ratio is the dividend per share divided by the earnings per share, so:Payout ratio = ₩0.80/₩7Payout ratio = .1143 or 11.43%b.Under a residual dividend policy, the additions to retained earnings, which is the equity portionof the planned capital outlays, is the retained earnings per share times the number of shares outstanding, so:Equity portion of capital outlays = 7M shares (₩7 – .80) = ₩43.4MThis means the total investment outlay will be:Total investment outlay = ₩43.4M + 18MTotal investment outlay = ₩61.4MThe debt-equity ratio is the new borrowing divided by the new equity, so:D/E ratio = ₩18M/₩43.4M = .4147B-8 SOLUTIONSCHAPTER 16 B-9 12. a.Since the company has a debt-equity ratio of 3, they can raise ₡3 in debt for every ₡1 of equity.The maximum capital outlay with no outside equity financing is:Maximum capital outlay = ₡180,000 + 3(₡180,000) = ₡720,000.b.If planned capital spending is ₡800,000, then no dividend will be paid and new equity will beissued since this exceeds the amount calculated in a.c.No, they do not maintain a constant dividend payout because, with the strict residual policy,the dividend will depend on the investment opportunities and earnings. As these two things vary, the dividend payout will also vary.13. a.We can find the new borrowings for the company by multiplying the equity investment by thedebt-equity ratio, so we get:New debt = 2(₪56M) = ₪112MAdding the new retained earnings, we get:Maximum investment with no outside equity financing = ₪56M + 2(₪56M) = ₪168Mb. A debt-equity ratio of 2 implies capital structure is 2/3 debt and 1/3 equity. The equity portionof the planned new investment will be:Equity portion of investment funds = 1/3(₪72M) = ₪24MThis is the addition to retained earnings, so the total available for dividend payments is:Residual = ₪56M – 24M = ₪32MThis makes the dividend per share:Dividend per share = ₪32M/12M shares = ₪2.67c.The borrowing will be:Borrowing = ₪72M – 24M = ₪48MAlternatively, we could calculate the new borrowing as the weight of debt in the capital structure times the planned capital outlays, so:Borrowing = 2/3(₪72M) = ₪48MThe addition to retained earnings is ₪24M, which we calculated in part b.B-10 SOLUTIONSd.If the company plans no capital outlays, no new borrowing will take place. The dividend pershare will be:Dividend per share = ₪56M/12M shares = ₪4.6714. a.If the dividend is declared, the price of the stock will drop on the ex-dividend date by the valueof the dividend, ¥5. It will then trade for ¥95.b.If it is not declared, the price will remain at ¥100.c.Nakumura’s outflows for inves tments are ¥5,000,000. These outflows occur immediately. Oneyear from now, the firm will realize ¥1,000,000 in net income and it will pay ¥500,000 in dividends, but the need for financing is immediate. Nakumura must finance ¥2,000,000 through the sale of shares worth ¥100. It must sell ¥5,000,000 / ¥100 = 50,000 shares.d.The MM model is not realistic since it does not account for taxes, brokerage fees, uncertaintyover future cash flows, investors’ preferences, signaling effects, and agency costs.Intermediate15.The price of the stock today is the PV of the dividends, so:P0 = Rs.0.70/1.15 + Rs.40/1.152 = Rs.30.85To find the equal two year dividends with the same present value as the price of the stock, we set up the following equation and solve for the dividend (Note: The dividend is a two year annuity, so we could solve with the annuity factor as well):Rs.30.85 = D/1.15 + D/1.152D = Rs.18.98We now know the cash flow per share we want each of the next two years. We can find the price of stock in one year, which will be:P1 = Rs.40/1.15 = Rs.34.78Since you own 1,000 shares, in one year you want:Cash flow in Year one = 1,000(Rs.18.98) = Rs.18,979.07B ut you’ll only get:Dividends received in one year = 1,000(Rs.0.70) = Rs.700.00CHAPTER 16 B-11 Thus, in one year you will need to sell additional shares in order to increase your cash flow. The number of shares to sell in year one is:Shares to sell at time one = (Rs.18,979.07 – 700)/Rs.34.78 = 525.52 sharesAt Year 2, you cash flow will be the dividend payment times the number of shares you still own, so the Year 2 cash flow is:Year 2 cash flow = Rs.40(1,000 – 525.52) = Rs.18,979.0716.If you only want Rs.200 in Year 1, you will buy:(Rs.700 – 200)/Rs.34.78 = 14.38 sharesat Year 1. Your dividend payment in Year 2 will be:Year 2 dividend = (1,000 + 14.38)(Rs.40) = Rs.40,575Note that the present value of each cash flow stream is the same. Below we show this by finding the present values as:PV = Rs.200/1.15 + Rs.40,575/1.152 = Rs.30,854.44PV = 1,000(Rs.0.70)/1.15 + 1,000(Rs.40)/1.152 = Rs.30,854.4417. a.If the company makes a dividend payment, we can calculate the wealth of a shareholder as:Dividend per share = 元5,000/200 shares = 元25.00The stock price after the dividend payment will be:P X = 元40 – 25 = 元15 per shareThe shareholder will have a stock worth 元15 and a 元25 dividend for a total wealth of 元40.If the company makes a repurchase, the company will repurchase:Shares repurchased = 元5,000/元40 = 125 sharesIf the shareholder lets their shares be repurchased, they will have 元40 in cash. If the shareholder keeps their shares, they’re still worth 元40.b.If the company pays dividends, the current EPS is 元0.95, and the P/E ratio is:P/E = 元15/元0.95 = 15.79B-12 SOLUTIONSCHAPTER 16 B-13 If the company repurchases stock, the number of shares will decrease. The total net income is the EPS times the current number of shares outstanding. Dividing net income by the new number of shares outstanding, we find the EPS under the repurchase is:EPS = 元0.95(200)/(200 125) = 元2.53The stock price will remain at 元40 per share, so the P/E ratio is:P/E = 元40/元2.53 = 15.79c. A share repurchase would seem to be the preferred course of action. Only those shareholderswho wish to sell will do so, giving the shareholder a tax timing option that he or she doesn’t get with a dividend payment.18. a.Since the firm has a 100 percent payout policy, the entire net income, ฿32,000 will be paid as adividend. The current value of the firm is the discounted value one year from now, plus the current income, which is:Value = ฿32,000 + ฿1,545,600/1.12Value = ฿1,412,000b.The current stock price is the value of the firm, divided by the shares outstanding, which is:Stock price = ฿1,412,000/10,000Stock price = ฿141.20Since the company has a 100 percent payout policy, the current dividend per share will be the company’s net income, divided by the shares outstanding, or:Current dividend = ฿32,000/10,000Current dividend = ฿3.20The stock price will fall by the value of the dividend to:Ex-dividend stock price = ฿141.20 – 3.20Ex-dividend stock price = ฿138.00c. i.According to MM, it cannot be true that the low dividend is depressing the price. Sincedividend policy is irrelevant, the level of the dividend should not matter. Any funds notdistributed as dividends add to the value of the firm, hence the stock price. Thesedirectors merely want to change the timing of the dividends (more now, less in the future).As the calculations below indicate, the value of the firm is unchanged by their proposal.Therefore, share price will be unchanged.B-14 SOLUTIONSTo show this, consider what would happen if the dividend was increased to ฿4.25. Sinceonly the existing shareholders will get the dividend, the required baht amount to pay thedividends is:Total dividends = ฿4.25(10,000)Total dividends = ฿42,500To fund this dividend payment, the company must raise:Bahts raised = Required funds – Net incomeBahts raised = ฿42,500 – 32,000Bahts raised = ฿10,500This money can only be raised with the sale of new equity to maintain the all-equityfinancing. Since those new shareholders must also earn 12 percent, their share of the firmone year from now is:New shareholder value in one year = ฿10,500(1.12)New shareholder value in one year = ฿11,760This means that the old shareholders' interest falls to:Old shareholder value in one year = ฿1,545,600 – 11,760Old shareholder value in one year = ฿1,533,840Under this scenario, the current value of the firm is:Value = ฿42,500 + ฿1,533,840/1.12Value = ฿1,412,000Since the firm value is the same as in part a, the change in dividend policy had no effect.ii.The new shareholders are not entitled to receive the current dividend. They will receive only the value of the equity one year hence. The present value of those flows is:Present value = ฿1,533,840/1.12Present value = ฿1,369,500And the current share price will be:Current share price = ฿1,369,500/10,000Current share price = ฿136.95So, the number of new shares the company must sell will be:Shares sold = ฿10,500/฿136.95Shares sold = 76.67 sharesCHAPTER 16 B-15 19. a.The current price is the current cash flow of the company plus the present value of theexpected cash flows, divided by the number of shares outstanding. So, the current stock price is: Stock price = ($1,200,000 + 15,000,000) / 1,000,000Stock price = $16.20b.To achieve a zero dividend payout policy, he can invest the dividends back into the company’sstock. The dividends per share will be:Dividends per share = [($1,200,000)(.50)]/1,000,000Dividends per share = $0.60And the stockholder in question will receive:Dividends paid to shareholder = $0.60(1,000)Dividends paid to shareholder = $600The new stock price after the dividends are paid will be:Ex-dividend stock price = $16.20 – 0.60Ex-dividend stock price = $15.60So, the number of shares the investor will buy is:Number of shares to buy = $600 / $15.60Number of shares to buy = 38.4620. ing the formula from the text proposed by Lintner:Div1 = Div0 + s(t EPS1– Div0)Div1 = €1.25 + .3[(.4)(€4.50) –€1.25]Div1 = €1.415b.Now we use an adjustment rate of 0.60, so the dividend next year will be:Div1 = Div0 + s(t EPS1– Div0)Div1 = €1.25 + .7[(.4)(€4.50) –€1.25]Div1= €1.635c.The lower adjustment factor in part a is more conservative. The lower adjustment factor willalways result in a lower future dividend.B-16 SOLUTIONSChallenge21.Assuming no capital gains tax, the aftertax return for the Gordon Company is the capital gainsgrowth rate, plus the dividend yield times one minus the tax rate. Using the constant growth dividend model, we get:Aftertax return = g + D(1 – t) = .15Solving for g, we get:.15 = g + .06(1 – .35)g = .1110The equivalent pretax return for Gecko Company, which pays no dividend, is:Pretax return = g + D = .1110 + .06 = 17.10%22. Using the equation for the decline in the stock price ex-dividend for each of the tax ratepolicies, we get:(P0– P X)/D = (1 – T P)/(1 – T G)a.P0– P X = D(1 – 0)/(1 – 0)P0– P X = Db.P0– P X = D(1 – .15)/(1 – 0)P0– P X = .85Dc.P0– P X = D(1 – .15)/(1 – .25)P0– P X = 1.1333Dd.With this tax policy, we simply need to multiply the personal tax rate times one minus thedividend exemption percentage, so:P0– P X = D[1 – (.35)(.30)]/(1 – .35)P0– P X = 1.3769De.Since different investors have widely varying tax rates on ordinary income and capital gains,dividend payments have different after-tax implications for different investors. This differential taxation among investors is one aspect of what we have called the clientele effect.CHAPTER 16 B-17 23.Since the ¥2,000,000 cash is after corporate tax, the full amount will be invested. So, the value ofeach alternative is:Alternative 1:The firm invests in T-bills or in preferred stock, and then pays out as special dividend in 3 years If the firm invests in T-Bills:If the firm invests in T-bills, the aftertax yield of the T-bills will be:Aftertax corporate yield = .07(1 – .35)Aftertax corporate yield = .0455 or 4.55%So, the future value of the corporate investment in T-bills will be:FV of investment in T-bills = ¥2,000,000(1 + .0455)3FV of investment in T-bills = ¥2,285,609.89Since the future value will be paid to shareholders as a dividend, the aftertax cash flow will be:Aftertax cash flow to shareholders = ¥2,285,609.89(1 – .15)Aftertax cash flow to shareholders = ¥1,942,768.41If the firm invests in preferred stock:If the firm invests in preferred stock, the assumption would be that the dividends received will be reinvested in the same preferred stock. The preferred stock will pay a dividend of:Preferred dividend = .11(¥2,000,000)Preferred dividend = ¥220,000Since 70 percent of the dividends are excluded from tax:Taxable preferred dividends = (1 – .70)(¥220,000)Taxable preferred dividends = ¥66,000And the taxes the company must pay on the preferred dividends will be:Taxes on preferred dividends = .35(¥66,000)Taxes on preferred dividends = ¥23,100So, the aftertax dividend for the corporation will be:Aftertax corporate dividend = ¥220,000 – 23,100Aftertax corporate dividend = ¥196,900B-18 SOLUTIONSThis means the aftertax corporate dividend yield is:Aftertax corporate dividend yield = ¥196,900 / ¥2,000,000Aftertax corporate dividend yield = .09845 or 9.845%The future value of the company’s investment in preferred stock will be:FV of investment in preferred stock = ¥2,000,000(1 + .09845)3FV of investment in preferred stock = ¥2,650,762.85Since the future value will be paid to shareholders as a dividend, the aftertax cash flow will be: Aftertax cash flow to shareholders = ¥2,650,762.85(1 – .15)Aftertax cash flow to shareholders = ¥2,253,148.42Alternative 2:The firm pays out dividend now, and individuals invest on their own. The aftertax cash received by shareholders now will be:Aftertax cash received today = ¥2,000,000(1 – .15)Aftertax cash received today = ¥1,700,000The individuals invest in Treasury bills:If the shareholders invest the current aftertax dividends in Treasury bills, the aftertax individual yield will be:Aftertax individual yield on T-bills = .07(1 – .31)Aftertax individual yield on T-bills = .0483 or 4.83%So, the future value of the individual investment in Treasury bills will be:FV of investment in T-bills = ¥1,700,000(1 + .0483)3FV of investment in T-bills = ¥1,958,419.29The individuals invest in preferred stock:If the individual invests in preferred stock, the assumption would be that the dividends received will be reinvested in the same preferred stock. The preferred stock will pay a dividend of:Preferred dividend = .11(¥1,700,000)Preferred dividend = ¥187,000。

公司理财习题答案第十五章Chapter 15: Capital Structure: Basic Concepts15.1 a. The value of Nadus’ stock is ($20)(5,000) = $100,000. Since Nadus is an all-equityfirm, $100,000 is also the value of the firm.b. The value of any firm is the sum of the market value of its bonds and the marketvalue of its stocks, i.e. V=B+S, For Logis, the value of the stock is not yet known,nor is the value of the firm. The market value of Logis’ bonds is $25,000. Thus,the value of Logis’ stock isS=V - $25,000.c. Costs:Nadus: 0.20 ($100,000) = $20,000Logis: 0.20 (V - $25,000)Returns: You are entitled to 20% of the net income of each firm.Nadus: 0.20 ($350,000) = $70,000Logis: 0.20 [$350,000-0.12($25,000)] = $69,400d. From the standpoint of the stockholders, Logis is riskier. If you hold Logis stock,you can receive returns only after the bondholders have been paid.e. In this problem, positive signs denote negative signs denote all cash inflows and alloutflows. You should expect the immediate flows to be on net negative (anoutflow). The future flows should be on net positive (an inflow).Immediate flows:Borrow from the bank an amount equal to 20% of Logis’ debt$5,000Buy 20% of Nadus’ stock -20,000Total Immediate Flows -$15,000Future flows:Pay the interest on the loan 0.12 ($5,000) -$600Receive 20% of Nadus’ net income 70,000Total Future Flows $69,400f. Since the returns from the purchase of the Logis stock are the same as the returns inthe strategy you constructed in part e, the two investments must cost the same.Cost of the strategy = Cost of Logis stock$15,000 = 0.20 (V-$25,000)Therefore, V=$100,000Note: This is an application of MM-Proposition I, In this MM world with no taxesand no financial distress costs, the value of an levered firm will equal the value ofan un-levered firm. Thus, capital structure does not matter.g. If the value of the Logis firm is $135,000 then the value of Logis stock is $110,000(= $135,000 - $25,000). If that is true, purchasing 20% of Logis’ stock would costyou $22,000 ( = 0.20 x $110,000). You will receive the same return as before($69,400). You can receive the same return for only $15,000 by following thestrategy in part e. Thus, if Logis is worth $135,000, you should borrow on yourown account an amount equal to 20% of Logis’ debt and purchase 20% of Nadus’stock.15.2 a. B=$10 million S=$20 millionTherefore, B/S=$10 / $20 = 1/2b. The required return is the firm’s after-tax overall cost of capital. In this no tax world,that is simplyrBVrSVr 0B S =+Use CAPM to find the required return on equity. Sr = 8% + (0.9)(10%) = 17%The cost of debt is 14%.Therefore,r$10 m illion$30 m illion0.14$20 m illion$30 m illion0.1716% 0=+=15.3 You expect to earn a 20% return on your investment of $25,000. Thus, you are earning$5,000 (=$25,000 x 0.20) per year. Since you borrowed $75,000, you will be makinginterest payments of $7,500 (=$75,000 x 0.10) per annum. Your share of the stock must earn $12,500 (= $5,000 + $7,500). The return without leverage is 0.125 (=$12,500 /$100,000).15.4 The firms are identical except for their capital structures. Thus, under MM-Proposition Itheir market values must be the same regardless of their capital structures. If they are not equal, the lower valued stock is a better purchase.Market values:Levered: V=$275 million + $100 x 4.5 million = $725 millionUnlevered: V= $80 x 10 million = $800 millionSince Levered’s market value is less than Unlevered’s market value, you should buyLevered’s stock. To understand why, construct the strategies that were presented in thetext. Suppose you want to own 5% of the equity of each firm.Strategy One: Buy 5% of Unlevered’s equityStrategy Two: Buy 5% of Levered’s equityStrategy Three: Create the dollar returns of Levered through borrowing an amount equal to 5% of Levered’s debt and purchasing 5% of Unlevered’s stock. If youfollow this strategy you will own what amounts to 5% of the equity ofLevered. The reason why is that the dollar returns will be identical topurchasing 5% of Levered outright.Dollar Investment Dollar Return Strategy One: -(0.05)($800) (0.05)($96)Strategy Two: -(0.05)($450) (0.05)[$96 - (0.08)($275)]Strategy Three:Borrow (0.05)($275) -[(0.05) ($275)] (0.08)Buy Unlevered -(0.05)($800) (0.05)($96)Net $ Flows -(0.05)($525) (0.05)[$96 - (0.08)($275)] Note: Dollar amounts are in millions.Note: Negative signs denote outflows and positive denotes inflows.Since the payoffs to strategies Two and Three are identical, their costs should be the same.Yet, strategy three is more expensive than strategy two ($26.25 million versus $22.5公司理财习题答案第十五章million). Thus, Levered’s stock is underpriced relative to Unlevered’s stock. You should purchase Levered’s s tock.15.5 a. In this MM world, the market value of Veblen must be the same as the market valueof Knight. If they are not equal, an investor can improve his net returns throughborrowing and buying Veblen stock. To understand the improvement, construct thestrategies discussed in the text. The investor already owns 0.0058343 (=$10,000 /$1,714,000) of the equity of Knight. Suppose he is willing to purchase the sameamount of Veblen’s equity.Strategy One (SI): Buy 0.58343% of Veblen’s equit y.Strategy Two (SII): Continue to hold the 0.58343% of Knight’s equity.Strategy Three (SIII): Create the dollar returns of Knight through borrowing anamount equal to 0.58343% of Knight’s debt and purchasing0.58343% of Veblen’s stock. If you follow this strategy youwill own what amounts to 0.58343% of the equity of Knight.The reason why is that the dollar returns will be identical topurchasing 0.58343% of Knight outright.Dollar Investment Dollar Return SI: -(0.0058343)($2.4) (0.0058343)($0.3)SII: -(0.0058343)($1.714) (0.0058343)($0.24)SIII:Borrow (0.0058343)($1) -[(0.0058343) ($1)] (0.06)Buy Veblen -(0.0058343)($2.4) (0.0058343)($0.3)Net $ Flows -(0.0058343)($1.4) (0.0058343)($0.24) Note: Dollar amounts are in millions.Note: Negative signs denote outflows and positive denotes inflows.Since strategies Two and Three have the same payoffs, they should cost the same.Strategy three is cheaper, thus, Knight stock is overpriced relative to Veblen stock.An investor can benefit by selling the Knight stock, borrowing an amount equal to0.0058343 of Knights debt and buying the same portion of Veblen stock. Theinvestor’s dollar returns will be identical to holding the Knight stock, but the costwill be less.b. Modigliani and Miller argue that everyone would attempt to construct the strategy.Investors would attempt to follow the strategy and the act of them doing so willlower the market value of Knight and raise the market value of Veblen until theyare equal.15.6 Each lady has purchased shares of the all-equity NLAW and borrowed or lent to create thenet dollar returns she desires. Once NLAW becomes levered, the return that the ladiesreceive for owning stock will be decreased by the interest payments. Thus, to continue to receive the same net dollar returns, each lady must rebalance her portfolio. The easiestapproach to this problem is to consider each lady individually. Determine the dollarreturns that the investor would receive from an all-equity NLAW. Determine what she will receive from the firm if it is levered. Then adjust her borrowing or lending position tocreate the returns she received from the all-equity firm.Before looking at the women’s positions, look at the firm value.All-equity: V=100,000 x $50 = $5,000,000Levered: V=$1,000,000 + 80,000 x $50 = $5,000,000Remember, the firm repurchased 20,000 shares.The income of the firm is unknown. Since we need it to compute the investor’s returns, we will denote it as Y. Assume that the income of the firm does not change due to the capital restructuring and that it is constant for the foreseeable future.Ms. A before rebalancing: Ms. A owns $10,000 worth of NLAW stock. That ownership represents ownership of 0.002 (=$10,000/$5,000,000) of the all-equity firm. That ownership entitles her to receive 0.002 of the firm’s income; i.e. her dollar return is 0.002Y. Also, Ms. A has borrowed $2,000. That loan will require her to make an interest payment of $400 ($2,000 x 0.20). Thus, the dollar investment and dollar return positions of Ms. A are:Dollar Investment Dollar Return NLAW Stock -$10,000 0.002YBorrowing 2,000 -$400Net -$8,000 0.002Y-$400Note: Negative signs denote outflows and positive denotes inflows.Ms. A after rebalancing: After rebalancing, Ms. A will want to receive net dollar returnsof 0.002Y-$400. The only way to receive the 0.002Y is to own 0.002 of NLAW’s stock. Examine the returns she will receive from the levered NLAW if she owns 0.002 of thef irm’s equity. She will receive (0.002) [Y - ($1,000,000)(0.20)] = 0.002Y - $400. This is exactly the dollar return she desires! Therefore, Ms. A should own 0.002 of the levered firm’s equity and neither lends nor borrow. Owning 0.002 of the firm’s equi ty means she has $8,000 (= 0.0002 x $4,000,000) invested in NLAW stock.Dollar Investment Dollar Return NLAW stock -$8,000 0.002Y - $400Ms. B before rebalancing: Ms. B owns $50,000 worth of NLAW stock. That ownership represents ownership of 0.01 (=$50,000/$5,000,000) of the all-equity firm. That ownership entitles her to receive 0.01 of the firm’s income; i.e. her dollar return is 0.01Y. Also, Ms. B has lent $6,000. That loan will generate interest income for her of the amount $1,200 (=$6,000 x 0.20). Thus, the dollar investment and dollar return positions of Ms. B are:Dollar Investment Dollar Return NLAW Stock -$50,000 0.01YLending -6,000 $1,200Net -$56,000 0.01Y + $1,200Ms. B after rebalancing: After rebalancing, Ms. B will want to receive net dollar returns of 0.01Y + $1,200. The only way to receive the 0.01Y is to own 0.01 of NLAW’s stock. Examine the returns she will receive from the levered NLAW if she owns 0.01 of the firm’s equity. She will receive (0.01) [Y - ($1,000,000) (0.20)] = 0.01Y - $2,000. This is not the return which Ms. B desires, so she must lend enough money to generate interest income of $3,200 (=$2,000 + $1,200). Since the interest rate is 20% she must lend公司理财习题答案第十五章$16,000 (= $3,200 / 0.20). The 0.01 equity interest of Ms. B means she will have $40,000 (=0.01 x $4,000,000) invested in NLAW.Dollar Investment Dollar ReturnNLAW Stock -$40,000 0.01Y - $2,000Lending -16,000 $3,200Net -$56,000 0.01Y + $1,200Ms. C before rebalancing: Ms. C owns $20,000 worth of NLAW stock. That ownershiprepresents ownership of 0.004 (=$20,000 / $5,000,000) of the all-equity firm. Thatownership entitles her to receive 0.004 of the firm’s income; i.e. her dollar return is 0.004Y.The dollar investment and dollar return positions of Ms. A are:Dollar Investment Dollar ReturnNLAW Stock -$20,000 0.004YMs. C after rebalancing: After rebalancing, Ms. C will want to receive net dollar returns of0.004Y. The only way to receive the 0.004Y is to ow n 0.004 of NLAW’s stock. Examinethe returns she will receive from the levered NLAW if she owns 0.004 of the firm’s equity.She will receive (0.004) [Y - ($1,000,000) (0.20)] = 0.004Y - $800. This is not the dollar return she desires. Therefore, Ms. C must lend enough money to offset the $800 she loses once the firm becomes levered. Since the interest rate is 20% she must lend $4,000 (=$800 / 0.20). The 0.004 equity interest of Ms. C means she will have $16,000 (0.004 x$4,000,000) invested in NLAW.Dollar Investment Dollar ReturnNLAW Stock -$16,000 0.004Y - $800Lending -4,000 $800Net -$20,000 0.004Y15.7 a. Since Rayburn is currently an all-equity firm, the value of the firm’s assets equalsthe value of its equity. Under MM-Proposition One, the value of a firm will notchange due to a capital structure change, and the overall cost of capital will remainunchanged. Therefore, Rayburn’s overall cost of capital is 18%.b. MM-Proposition Two states r r(B/S)(r r)=+-.S00BApplying this formula you can find the cost of equity.r = 18% + ($400,000 / $1,600,000) (18% - 10%) = 20%Sc. In accordance with Proposition Two, the expected return on Rayburn’s equity willrise with the amount of leverage. This rise occurs because of the risk which the debt adds.15.8 a.b.i. According to efficient markets, Strom’s stock price will rise immediately toreflect the NPV of the project.ii. The NPV of the facilities that Strom is buying isNPV= -$300,000 + ($120,000 / 0.15) = $500,000The sum of the old assets and the NPV of the new facilities is the new value ofthe firm ($5.5 million). Since new shares have not yet been sold, the price of theoutstanding shares must rise. The new price is $5,500,000 / 250,000 = $22.iii. Strom needed to raise $300,000 through the sale of stock that sells for $22.Thus, Strom sold 13,636.364 (=$300,000 / $22) shares.iv.v.vi. The returns available to the shareholders are the sum of the returns from each portion of the firm.Total earnings = $750,000 + $120,000 = $870,000Return = ($870,000 / $5,800,000) = 15%Note: The returns to the shareholder had to be the same since r0 was unchangedand the firm added no debt.c.i.Under efficient markets the price of the shares must rise to reflect the NPV of thenew facilities. The value will be the same as with all-equity financing because1. Strom purchased the same competitor and2. In this MM world debt is no better or no worse than equity.公司理财习题答案第十五章ii.iii. The cost of equity will be the earnings after interest and taxes divided by the market value of common. Since Strom pays no taxes, the cost of equity is simplythe earnings after interest (EAI) divided by the market value of common.EAI = $750,000 + $120,000 - $300,000 (0.10) = $840,000Cost of equity = $840,000 / $5,500,000 = 15.27%iv. The debt causes the equity of the firm to be riskier. Remember, stockholders are residual owners of the firm.v. MM-Proposition Two states,r r(B/S)(r r)15%($300,000/$5,500,000)(15%10%)15.27% =+-=+-=S00Bd. Examine the final balance sheet for the firm and you will see that the price is $22under each plan.15.9 a. The market value of the firm will be the present value of Gulf’s earning s after thenew plant is built. Since the firm is an all-equity firm, the overall required return isthe required return on equity.Annual earnings = Original plant + New Plant= $27 million + $3 million = $30 millionValue = $30 million / 0.1 = $300 millionb. Gulf Power is in an MM world (no taxes, no costs of financial distress). Therefore,the value of the firm is unchanged by a change in the capital structure.c. The overall required rate of return is also unchanged by the capital structurechange. Thus, according to MM-Proposition Two, r r(B/S)(r r)=+-. TheS00B firm is valued at $300 million of which $20 million is debt. The remaining $280million is the value of the stock.r S = 10% + ($20 million / $280 million) (10% - 8%) = 10.14%15.10 a. False. Leverage increases both the risks of the stock and its expected return. MMpoint out that these two effects exactly cancel out each other and leave the price ofthe stock and the value of the firm invariant to leverage. Since leverage is beingreduced in this firm, the risk of the shares is lower; however, the price of the stockremains the same in accordance with MM.b. False. If moderate borrowing does not affect the probability of financial distress,then the required return on equity is proportional to the debt-equity ratio [i.e.=+-]. Increasing the amount of debt will increase the return on r r(B/S)(r r)S00Bequity.15.11 a.i. Individuals can borrow at the same interest rate at which firms borrow.ii. There are no taxes.iii. There are no costs of financial distress.b.i. If firms are able to borrow at a rate that is lower than that at which individualsborrow, then it is possible to increase the firm’s value through borrowing. Asthe text discussed, since investors can purchase securities on margin, theindividuals’ effective rate is probably no higher than that of the firms.ii. In the presence of corporate taxes, the value of the firm is positively related to the level of debt. Since interest payments are deductible, increasing debtminimizes tax expenditure and thus maximizes the value of the firm for thestockholders. As will be shown in the next chapter, personal taxes offset thepositive effect of debt.iii. Because these costs are substantial and stockholders eventually bear them, they are incentives to lower the amount of debt. This implies that the capital structuremay matter. This topic will also be discussed more fully in the next chapter. 15.12 a and b.Total investment in the firm’s assets = $10 x 1million x 1% = $0.1 million3 choices of financing 20% debt 40% debt 60% debtTotal asset investment 0.1 0.1 0.1x ROA (15%) 0.015 0.015 0.015- Interest 0.2 x 0.1 x0.1 0.4 x 0.1 x 0.1 0.6 x 0.1 x 0.1Profit after interest 0.013 0.011 0.009/ Investment in equity 0.1 x 0.8 0.1 x 0.6 0.1 x 0.4ROE 16.25% 18.33% 22.5%Susan can expect to earn $0.013 million, $0.011 million, and $0.009 million,respectively, from the correspondent three scenarios of financing choices, i.e.borrowing 20%, 40%, or 60% of the total investment. The respective returns onequity are 16.25%, 18.33% and 22.5%.c. From part a and b, we can see that in an MM with no tax world, higher leveragebrings about higher return on equity. The high ROE is due to the increased risk ofequity while the WACC remains unchanged. See below.WACC for 20% debt = 16.25% x 0.8 + 10% x 0.2 = 15%WACC for 40% debt = 18.33% x 0.6 + 10% x 0.4 = 15%WACC for 60% debt = 22.5% x 0.4 + 10% x 0.6 = 15%This example is a case of homemade leverage, so the results are parallel to that of aleveraged firm.15.13 Suppose individuals can borrow at the same rate as the corporation, there is no needfor the firm to change its capital structure because of the different forecasts ofearnings growth rates, as investors can always duplicate the leverage by creatinghomemade leverage. Different expectation of earnings growth rates can affect theexpected return on assets. But this change is the result of the change in expectedoperating performance of the corporation and/or other macroeconomic factors. Theleverage ratio is irrelevant here since we are in an MM without tax world.公司理财习题答案第十五章15.14 a. current debt = 0.75 / 10% = $7.5 millioncurrent equity = 7.5 / 40% = $18.75 millionTotal firm value = 7.5 + 18.75 = $26.25 millionb. r s = earnings after interest/total equity value = $(3.75 - .75)/$18.75 = 16%r B =10%r 0 = (.4/1.4)(10%) + (1/1.4)(16%) = 14.29%r S after repurchase = 14.29% + (50%)(14.29% - 10%) = 16.44%So, the return on equity would increase from 16% to 16.44% with the completion of the planned stock repurchase.c. The stock price wouldn’t change because in an MM world, there’s no added value toa change in firm leverage. In other words, it’s a zero NPV transaction.15.15 a. Since V V T B L U C =+,V =V T B U L C -. L V = $1,700,000, B = $500,000 and C T =0.34. Therefore, the value of the unlevered firm isU V = $1,700,000 - (0.34)($500,000) = $1,530,000b. Equity holders earn 20% after-tax in an all-equity firm. That amount is $306,000(=$1,530,000 x 0.20). The yearly, after-tax interest expense in the levered firm is$33,000 [=$500,000 x 0.10 (1-0.34)]. Thus, the after-tax earnings of the equityholders in a levered firm are $273,000 (=$306,000 - $33,000). This amount is thefirm’s net income.15.16 The initial market value of the equity is given as $3,500,000. On a per share basis this is$20 (=$3,500,000 / 175,000). The firm buys back $1,000,000 worth of shares, or 50,000 (= $1,000,000 / $20) shares.In this MM world with taxes,V V T B L U C =+= $3,500,000 + (0.3) ($1,000,000) = $3,800,000Since V = B + S, the market value of the equity is $2,800,000 (= $3,800,000 - $1,000,000).15.17 a. Since Streiber is an all-equity firm,V = EBIT (1 - C T ) / 0r = $2,500,000 (1 - 0.34) / 0.20 = $8,250,000b. V V T B L U C =+= $8,250,000 + (0.34)($600,000) = $8,454,000c. The presence of debt creates a tax shield for the firm. That tax shield has value andaccounts for the increase in the value of the firm.d. You are making the MM assumptions:i. No personal taxesii. No costs of financial distressiii. Debt level of the firm is constant through time15.18 a. In this MM world with no financial distress costs, the value of the levered firm isgiven by V V T B L U C =+. The value of the unlevered firm is V = EBIT (1 - C T ) / r 0.The market value of the debt of Olbet is B = $200,000 / 0.08 = $2,500,000.Therefore, V = $1,200,000 (1 - 0.35) / 0.12 + ($2,500,000) (0.35) = $7,375,000b. Since debt adds to the value of the firm, it implies that the firm should be financedentirely with debt if it wishes to maximize its value.c. This conclusion is incorrect because it does not consider the costs of financialdistress or other agency costs that might offset the positive contribution of the debt. These costs will be discussed in further detail in the next chapter.15.19 a. Since Green is currently an all-equity firm, the value of the firm is the value of itsoutstanding equity, $10 million. The value of the firm must also equal the PV ofthe after-tax earnings, discounted at the overall required return. The after-taxearnings are simply ($1,500,000) (1 - 0.4) = $900,000. Thus, $10,000,000 =$900,000 / 0r0r = 0.09b. With 500,000 shares outstanding, the current price of a share is $20 (=$10,000,000 / 500,000). Green’s market value balance sheet isTherefore, at the announcement, the value of the firm will rise by the PV of the tax shield (PVTS). The PVTS is ($2,000,000) (0.4) = $800,000. Since the value of the firm has risen $800,000 and the debt has not yet been issued, the price of Green stock must rise to reflect the increase in firm value. Since the firm is worth $10,800,000 (=$10,000,000 + 800,000) and there are 500,000 shares outstanding,the price of a share rises to $21.60 (= $10,800,000 / 500,000). price of the stock rises to $21.60. Thus, Green will retire $2,000,000 / $21.60 = $92,592.59 shares. e. After the restructuring, the value of the firm will still be $10,800,000. Debt will be $2,000,000 and the 407,407.41 (=500,000 - 92,592.59) outstanding shares of stockwill sell for $21.60. )T -)(1r (B /S)(r r r C B 00S -+= = 0.09 + ($2,000,000 / $8,800,000) (0.09 - 0.06) (1 - 0.4) = 9.41%15.20 a.million $20.83$100.3515.0)65.0(4$B T r )T EBIT(1B T V V C 0C C U L =⨯+=+-=+= b.公司理财习题答案第十五章Answers to End-of-Chapter Problems B-15112.48%V )T EBIT(1r V S )T (1r V Br L C S L C B L WACC =-=+-= c. r r (B /S)(r r )(1-T S 00B C =+-)= 0.15 + [10 / (20.83 - 10)] (0.65) (0.15 - 0.10) = 18.01%15.21 a. r S = 0r + (B / S)( 0r – B r )(1 – C T )= 15% + (2.5)(15% – 11%)(1– 35%)= 21.50%b. If there is no debt, WACC r = r S = 15%c. S r = 15% + 0.75 (15% – 11%)(1 – 35%)= 16.95%B/S = 0.75, B = 0.75SB/(B+S) = 0.75S/(0.75S +S)= 0.75 /1.75S/(B+S) = 1– (0.75 /1.75) = (1/1.75)r WACC = (0.75/1.75)(0.11)(1– 0.35) + (1/1.75)(16.95%)= 12.75%S r = 15% + 1.5 (15% – 11%)(1 – 35%)= 18.90%B/S = 1.5, B = 1.5SB/(B+S) = 1.5S/(1.5S +S)= 1.5/2.5S /(B+S) = 1 – (1.5/2.5)WACC r = (1.5/2.5)(0.11)(1 – 0.35) + (1/2.5)(0.1890)= 11.85%15.22 Since this is an all-equity firm, the WACC = S r .$240,00025.0)4.01(000,100$r )T EBIT(1V S C U =-=-=If the firm borrows to repurchase its own shares, then the value of GT will be: L V = U V + C T B()$440,000000,500$4.025.0)6.0(000,100$=⨯+=。

CHAPTER 2ACCOUNTING STATEMENTS, TAXES AND CASH FLOWAnswers to Concepts Review and Critical Thinking Questions1.Liquidity measures how quickly and easily an asset can be converted to cash without significant lossin value. It’s desirable for firms to have high liquidity so that they have a large factor of safety in meeting short-term creditor demands. However, since liquidity also has an opportunity cost associated with it - namely that higher returns can generally be found by investing the cash into productive assets - low liquidity levels are also desirable to the firm. It’s up to the firm’s financial management staff to find a reasonable compromise between these opposing needs2.The recognition and matching principles in financial accounting call for revenues, and the costsassociated with producing those revenues, to be “booked” when the revenue process is essentially complete, not necessarily when the cash is collected or bills are paid. Note that this way is not necessarily correct; it’s the way accountants have chosen to do it.3.The bottom line number shows the change in the cash balance on the balance sheet. As such, it is nota useful number for analyzing a company.4. The major difference is the treatment of interest expense. The accounting statement of cash flowstreats interest as an operating cash flow, while the financial cash flows treat interest as a financing cash flow. The logic of the accounting statement of cash flows is that since interest appears on the income statement, which shows the operations for the period, it is an operating cash flow. In reality, interest is a financing expense, which results from the company’s choice of debt/equity. We will have more to say about this in a later chapter. When comparing the two cash flow statements, the financial statement of cash flows is a more appropriate measure of the company’s performance because of its treatment of interest.5.Market values can never be negative. Imagine a share of stock selling for –$20. This would meanthat if you placed an order for 100 shares, you would get the stock along with a check for $2,000.How many shares do you want to buy? More generally, because of corporate and individual bankruptcy laws, net worth for a person or a corporation cannot be negative, implying that liabilities cannot exceed assets in market value.6.For a successful company that is rapidly expanding, for example, capital outlays will be large,possibly leading to negative cash flow from assets. In general, what matters is whether the money is spent wisely, not whether cash flow from assets is positive or negative.7.It’s probably not a good sign for an established company, but it would be fairly ordinary for a start-up, so it depends.8.For example, if a company were to become more efficient in inventory management, the amount ofinventory needed would decline. The same might be true if it becomes better at collecting its receivables. In general, anything that leads to a decline in ending NWC relative to beginning would have this effect. Negative net capital spending would mean more long-lived assets were liquidated than purchased.9.If a company raises more money from selling stock than it pays in dividends in a particular period,its cash flow to stockholders will be negative. If a company borrows more than it pays in interest and principal, its cash flow to creditors will be negative.10.The adjustments discussed were purely accounting changes; they had no cash flow or market valueconsequences unless the new accounting information caused stockholders to revalue the derivatives. Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1.To find owner’s equity, we must construct a balance sheet as follows:Balance SheetCA $5,000 CL $4,500NFA 23,000 LTD 13,000OE ??TA $28,000 TL & OE $28,000We know that total liabilities and owner’s equity (TL & OE) must equal total assets of $28,000. We also know that TL & OE is equal to current liabilities plus long-term debt plus owner’s equity, so owner’s equity is:O E = $28,000 –13,000 – 4,500 = $10,500N WC = CA – CL = $5,000 – 4,500 = $5002. The income statement for the company is:Income StatementSales S/.527,000Costs 280,000Depreciation 38,000EBIT S/.209,000Interest 15,000EBT S/.194,000Taxes (35%) 67,900Net income S/.126,100One equation for net income is:Net income = Dividends + Addition to retained earningsRearranging, we get:Addition to retained earnings = Net income – DividendsAddition to retained earnings = S/.126,100 – 48,000Addition to retained earnings = S/.78,1003.To find the book value of current assets, we use: NWC = CA – CL. Rearranging to solve for currentassets, we get:CA = NWC + CL = $900K + 2.2M = $3.1MThe market value of current assets and fixed assets is given, so:Book value CA = $3.1M Market value CA = $2.8MBook value NFA = $4.0M Market value NFA = $3.2MBook value assets = $3.1M + 4.0M = $7.1M Market value assets = $2.8M + 3.2M = $6.0M 4.Taxes = 0.15(€50K) + 0.25(€25K) + 0.34(€25K) + 0.39(€273K – 100K)Taxes = €89,720The average tax rate is the total tax paid divided by net income, so:Average tax rate = €89,720 / €273,000Average tax rate = 32.86%.The marginal tax rate is the tax rate on the next €1 of earnings, so the marginal tax rate = 39%.5.To calculate OCF, we first need the income statement:Income StatementSales 元13,500Costs 5,400Depreciation 1,200EBIT 元6,900Interest 680Taxable income 元6,220Taxes (35%) 2,177Net income 元4,043OCF = EBIT + Depreciation – TaxesOCF = 元6,900 + 1,200 – 2,177OCF = 元5,923 capital spending = NFA end– NFA beg + DepreciationNet capital spending = £4,700,000 – 4,200,000 + 925,000 Net capital spending = £1,425,0007.The long-term debt account will increase by $8 million, the amount of the new long-term debt issue.Since the company sold 10 million new shares of stock with a $1 par value, the common stock account will increase by $10 million. The capital surplus account will increase by $16 million, the value of the new stock sold above its par value. Since the company had a net income of $7 million, and paid $4 million in dividends, the addition to retained earnings was $3 million, which will increase the accumulated retained earnings account. So, the new long-term debt and stockholders’ equity portion of the balance sheet will be:Long-term debt $ 68,000,000Total long-term debt $ 68,000,000Shareholders equityPreferred stock $ 18,000,000Common stock ($1 par value) 35,000,000Accumulated retained earnings 92,000,000Capital surplus 65,000,000Total equity $ 210,000,000Total Liabilities & Equity $ 278,000,0008.Cash flow to creditors = Interest paid – Net new borrowingCash flow to creditors = €340,000 – (LTD end– LTD beg)Cash flow to creditors = €340,000 – (€3,100,000 – 2,800,000)Cash flow to creditors = €340,000 – 300,000Cash flow to creditors = €40,0009. Cash flow to stockholders = Dividends paid – Net new equityCash flow to stockholders = €600,000 – [(Common end + APIS end) – (Common beg + APIS beg)]Cash flow to stockholders = €600,000 – [(€855,000 + 7,600,000) – (€820,000 + 6,800,000)]Cash flow to stockholders = €600,000 – (€7,620,000 – 8,455,000)Cash flow to stockholders = –€235,000Note, APIS is the additional paid-in surplus.10. Cash flow from assets = Cash flow to creditors + Cash flow to stockholders= €40,000 – 235,000= –€195,000Cash flow from assets = –€195,000 = OCF – Change in NWC – Net capital spending= OCF – (–€165,000) – 760,000= –€195,000Operating cash flow = –€195,000 – 165,000 + 760,000= €400,000Intermediate11. a.The accounting statement of cash flows explains the change in cash during the year. Theaccounting statement of cash flows will be:Statement of cash flowsOperationsNet income ZW$125Depreciation 75Changes in other current assets (25)Total cash flow from operations ZW$175Investing activitiesAcquisition of fixed assets ZW$(175)Total cash flow from investing activities ZW$(175)Financing activitiesProceeds of long-term debt ZW$90Current liabilities 10Dividends (65)Total cash flow from financing activities ZW$35Change in cash (on balance sheet) ZW$35b.Change in NWC = NWC end– NWC beg= (CA end– CL end) – (CA beg– CL beg)= [(ZW$45 + 145) – 70] – [(ZW$10 + 120) – 60)= ZW$120 – 70= ZW$50c.To find the cash flow generated by the firm’s assets, we need the operating cash flow, and thecapital spending. So, calculating each of these, we find:Operating cash flowNet income ZW$125Depreciation 75Operating cash flow ZW$200Note that we can calculate OCF in this manner since there are no taxes.Capital spendingEnding fixed assets ZW$250Beginning fixed assets (150)Depreciation 75Capital spending ZW$175Now we can calculate the cash flow generated by the firm’s assets, which is:Cash flow from assetsOperating cash flow ZW$200Capital spending (175)Change in NWC (50)Cash flow from assets ZW$(25)Notice that the accounting statement of cash flows shows a positive cash flow, but the financial cash flows show a negative cash flow. The cash flow generated by the firm’s assets is a better number for analyzing the firm’s performance.12.With the information provided, the cash flows from the firm are the capital spending and the changein net working capital, so:Cash flows from the firmCapital spending $(3,000)Additions to NWC (1,000)Cash flows from the firm $(4,000)And the cash flows to the investors of the firm are:Cash flows to investors of the firmSale of short-term debt $(7,000)Sale of long-term debt (18,000)Sale of common stock (2,000)Dividends paid 23,000Cash flows to investors of the firm $(4,000)13. a. The interest expense for the company is the amount of debt times the interest rate on the debt.So, the income statement for the company is:Income StatementSales £1,000,000Cost of goods sold 300,000Selling costs 200,000Depreciation 100,000EBIT £400,000Interest 100,000Taxable income £300,000Taxes (35%) 105,000Net income £195,000b. And the operating cash flow is:OCF = EBIT + Depreciation – TaxesOCF = £400,000 + 100,000 – 105,000OCF = £395,00014.To find the OCF, we first calculate net income.Income StatementSales Au$145,000Costs 86,000Depreciation 7,000Other expenses 4,900EBIT Au$47,100Interest 15,000Taxable income Au$32,100Taxes 12,840Net income Au$19,260Dividends Au$8,700Additions to RE Au$10,560a.OCF = EBIT + Depreciation – TaxesOCF = Au$47,100 + 7,000 – 12,840OCF = Au$41,260b.CFC = Interest – Net new LTDCFC = Au$15,000 – (–Au$6,500)CFC = Au$21,500Note that the net new long-term debt is negative because the company repaid part of its long-term debt.c.CFS = Dividends – Net new equityCFS = Au$8,700 – 6,450CFS = Au$2,250d.We know that CFA = CFC + CFS, so:CFA = Au$21,500 + 2,250 = Au$23,750CFA is also equal to OCF – Net capital spending – Change in NWC. We already know OCF.Net capital spending is equal to:Net capital spending = Increase in NFA + DepreciationNet capital spending = Au$5,000 + 7,000Net capital spending = Au$12,000Now we can use:CFA = OCF – Net capital spending – Change in NWCAu$23,750 = Au$41,260 – 12,000 – Change in NWC.Solving for the change in NWC gives Au$5,510, meaning the company increased its NWC by Au$5,510.15.The solution to this question works the income statement backwards. Starting at the bottom:Net income = Dividends + Addition to ret. earningsNet income = $900 + 4,500Net income = $5,400Now, looking at the income statement:EBT –EBT × Tax rate = Net incomeRecognize that EBT × tax rate is simply the calculation for taxes. Solving this for EBT yields: EBT = NI / (1– tax rate)EBT = $5,400 / 0.65EBT = $8,308Now we can calculate:EBIT = EBT + interestEBIT = $8,308 + 1,600EBIT = $9,908The last step is to use:EBIT = Sales – Costs – DepreciationEBIT = $29,000 – 13,000 – DepreciationEBIT = $9,908Solving for depreciation, we find that depreciation = $6,092.16.The balance sheet for the company looks like this:Balance SheetCash ¥175,000 Accounts payable ¥430,000 Accounts receivable 140,000 Notes payable 180,000 Inventory 265,000 Current liabilities ¥610,000 Current assets ¥580,000 Long-term debt 1,430,000Total liabilities ¥2,040,000 Tangible net fixed assets 2,900,000Intangible net fixed assets 720,000 Common stock ??Accumulated ret. earnings 1,240,000 Total assets ¥4,200,000 Total liab. & owners’ equity¥4,200,000Total liabilities and owners’ equity is:TL & OE = CL + LTD + Common stockSolving for this equation for equity gives us:Common stock = ¥4,200,000 – 1,240,000 – 2,040,000Common stock = ¥920,00017.The market value of shareholders’ equity cannot be zero. A negative market va lue in this case wouldimply that the company would pay you to own the stock. The market value of shareholders’ equity can be stated as: Shareholders’ equity = Max [(TA – TL), 0]. So, if TA is 元4,000,000 equity is equal to 元1,000,000 and if TA is 元2,500,000 equity is equal to 元0. We should note here that the book value of shareholders’ equity can be negative.18. a. Taxes Growth = 0.15($50K) + 0.25($25K) + 0.34($10K) = $17,150Taxes Income = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) + 0.34($8.165M)= $2,890,000b. Each firm has a marginal tax rate of 34% on the next $10,000 of taxable income, despite theirdifferent average tax rates, so both firms will pay an additional $3,400 in taxes.19.Income StatementSales ₦850,000COGS 630,000A&S expenses 120,000Depreciation 130,000EBIT (₦30,000)Interest 85,000Taxable income (₦115,000)Taxes (30%) 0 income (₦115,000)b.OCF = EBIT + Depreciation – TaxesOCF = (₦30,000) + 130,000 – 0OCF = ₦100,000 income was negative because of the tax deductibility of depreciation and interest expense.However, the actual cash flow from operations was positive because depreciation is a non-cash expense and interest is a financing expense, not an operating expense.20. A firm can still pay out dividends if net income is negative; it just has to be sure there is sufficientcash flow to make the dividend payments.Change in NWC = Net capital spending = Net new equity = 0. (Given)Cash flow from assets = OCF – Change in NWC – Net capital spendingCash flow from assets = ₦100,000 – 0 – 0 = ₦100,000Cash flow to stockholders = Dividends – Net new equityCash flow to stockholders = ₦30,000 – 0 = ₦30,000Cash flow to creditors = Cash flow from assets – Cash flow to stockholdersCash flow to creditors = ₦100,000 – 30,000Cash flow to creditors = ₦70,000Cash flow to creditors is also:Cash flow to creditors = Interest – Net new LTDSo:Net new LTD = Interest – Cash flow to creditorsNet new LTD = ₦85,000 – 70,000Net new LTD = ₦15,00021. a.The income statement is:Income StatementSales $12,800Cost of good sold 10,400Depreciation 1,900EBIT $ 500Interest 450Taxable income $ 50Taxes (34%) 17Net income $33b.OCF = EBIT + Depreciation – TaxesOCF = $500 + 1,900 – 17OCF = $2,383c.Change in NWC = NWC end– NWC beg= (CA end– CL end) – (CA beg– CL beg)= ($3,850 – 2,100) – ($3,200 – 1,800)= $1,750 – 1,400 = $350Net capital spending = NFA end– NFA beg + Depreciation= $9,700 – 9,100 + 1,900= $2,500CFA = OCF – Change in NWC – Net capital spending= $2,383 – 350 – 2,500= –$467The cash flow from assets can be positive or negative, since it represents whether the firm raised funds or distributed funds on a net basis. In this problem, even though net income and OCF are positive, the firm invested heavily in both fixed assets and net working capital; it had to raise a net $467 in funds from its stockholders and creditors to make these investments.d.Cash flow to creditors = Interest – Net new LTD= $450 – 0= $450Cash flow to stockholders = Cash flow from assets – Cash flow to creditors= –$467 – 450= –$917We can also calculate the cash flow to stockholders as:Cash flow to stockholders = Dividends – Net new equitySolving for net new equity, we get:Net new equity = $500 – (–917)= $1,417The firm had positive earnings in an accounting sense (NI > 0) and had positive cash flow from operations. The firm invested $350 in new net working capital and $2,500 in new fixed assets. The firm had to raise $467 from its stakeholders to support this new investment. It accomplished this by raising $1,417 in the form of new equity. After paying out $500 of this in the form of dividends to shareholders and $450 in the form of interest to creditors, $467 was left to meet the firm’s cash flow needs for investment.22. a.Total assets 2005 = ¥650,000 + 2,900,000 = ¥3,550,000Total liabilities 2005 = ¥265,000 + 1,500,000 = ¥1,765,000Owners’ equity 2005 = ¥3,550,000 – 1,765,000 = ¥1,785,000Total assets 2006 = ¥705,000 + 3,400,000 = ¥4,105,000Total liabilities 2006 = ¥290,000 + 1,720,000 = ¥2,010,000Owners’ equity 2006 = ¥4,105,000 – 2,010,000 = ¥2,095,000b.NWC 2005 = CA05 – CL05 = ¥650,000 – 265,000 = ¥385,000NWC 2006 = CA06 – CL06 = ¥705,000 – 290,000 = ¥415,000Change in NWC = NWC06 – NWC05 = ¥415,000 – 385,000 = ¥30,000c.We can calculate net capital spending as:Net capital spending = Net fixed assets 2006 – Net fixed assets 2005 + DepreciationNet capital spending = ¥3,400,000 – 2,900,000 + 800,000Net capital spending = ¥1,300,000So, the company had a net capital spending cash flow of ¥1,300,000. We also know that net capital spending is:Net capital spending = Fixed assets bought – Fixed assets sold¥1,300,000 = ¥1,500,000 – Fixed assets soldFixed assets sold = ¥1,500,000 – 1,300,000 = ¥200,000To calculate the cash flow from assets, we must first calculate the operating cash flow. The operating cash flow is calculated as follows (you can also prepare a traditional income statement):EBIT = Sales – Costs – DepreciationEBIT = ¥8,600,000 – 4,150,000 – 800,000EBIT = ¥3,650,000EBT = EBIT – InterestEBT = ¥3,650,000 – 216,000EBT = ¥3,434,000Taxes = EBT ⨯ .35Taxes = ¥3,434,000 ⨯ .35Taxes = ¥1,202,000OCF = EBIT + Depreciation – TaxesOCF = ¥3,650,000 + 800,000 – 1,202,000OCF = ¥3,248,000Cash flow from assets = OCF – Change in NWC – Net capital spending.Cash flow from assets = ¥3,248,000 – 30,000 – 1,300,000Cash flow from assets = ¥1,918,000 new borrowing = LTD06 – LTD05Net new borrowing = ¥1,720,000 – 1,500,000Net new borrowing = ¥220,000Cash flow to creditors = Interest – Net new LTDCash flow to creditors = ¥216,000 – 220,000Cash flow to creditors = –¥4,000Net new borrowing = ¥220,000 = Debt issued – Debt retiredDebt retired = ¥300,000 – 220,000 = ¥80,00023.Balance sheet as of Dec. 31, 2005Cash €2,107 Accounts payable €2,213Accounts receivable 2,789 Notes payable 407Inventory 4,959 Current liabilities €2,620Current assets €9,855Long-term debt €7,056 Net fixed assets €17,669 Owners' equity €17,848Total assets €27,524 Total liab. & equity €27,524Balance sheet as of Dec. 31, 2006Cash €2,155 Accounts payable €2,146Accounts receivable 3,142 Notes payable 382Inventory 5,096 Current liabilities €2,528Current assets €10,393Long-term debt €8,232 Net fixed assets €18,091 Owners' equity €17,724Total assets €28,484 Total liab. & equity €28,4842005 Income Statement 2006 Income Statement Sales €4,018.00 Sales €4,312.00 COGS 1,382.00 COGS 1,569.00 Other expenses 328.00 Other expenses 274.00 Depreciation 577.00 Depreciation 578.00 EBIT €1,731.00 EBIT €1,891.00 Interest 269.00 Interest 309.00 EBT €1,462.00 EBT €1,582.00 Taxes (34%) 497.08 Taxes (34%) 537.88 Net income € 964.92 Net income €1,044.12 Dividends €490.00 Dividends €539.00 Additions to RE €474.92 Additions to RE €505.12 24.OCF = EBIT + Depreciation – TaxesOCF = €1,891 + 578 – 537.88OCF = €1,931.12Change in NWC = NWC end– NWC beg = (CA – CL) end– (CA – CL) begChange in NWC = (€10,393 – 2,528) – (€9,855 – 2,620)Change in NWC = €7,865 – 7,235 = €630Net capital spending = NFA end– NFA beg+ DepreciationNet capital spending = €18,091 – 17,669 + 578Net capital spending = €1,000Cash flow from assets = OCF – Change in NWC – Net capital spendingCash flow from assets = €1,931.12 – 630 – 1,000Cash flow from assets = €301.12Cash flow to creditors = Interest – Net new LTDNet new LTD = LTD end– LTD begCash flow to creditors = €309 – (€8,232 – 7,056)Cash flow to creditors = –€867Net new equity = Common stock end– Common stock begCommon stock + Retained earnings = T otal owners’ equityNet new equity = (OE – RE) end– (OE – RE) begNet new equity = OE end– OE beg + RE beg– RE endRE end= RE beg+ Additions to RE04Net new equity = OE end– OE beg+ RE beg– (RE beg + Additions to RE06)= OE end– OE beg– Additions to RENet new equity = €17,724 – 17,848 – 505.12 = –€629.12Cash flow to stockholders = Dividends – Net new equityCash flow to stockholders = €539 – (–€629.12)Cash flow to stockholders = €1,168.12As a check, cash flow from assets is €301.12.Cash flow from assets = Cash flow from creditors + Cash flow to stockholdersCash flow from assets = –€867 + 1,168.12Cash flow from assets = €301.12Challenge25.We will begin by calculating the operating cash flow. First, we need the EBIT, which can becalculated as:EBIT = Net income + Current taxes + Deferred taxes + InterestEBIT = £192 + 110 + 21 + 57EBIT = £380Now we can calculate the operating cash flow as:Operating cash flowEarnings before interest and taxes £380Depreciation 105Current taxes (110)Operating cash flow £375The cash flow from assets is found in the investing activities portion of the accounting statement of cash flows, so:Cash flow from assetsAcquisition of fixed assets £198Sale of fixed assets (25)Capital spending £173The net working capital cash flows are all found in the operations cash flow section of the accounting statement of cash flows. However, instead of calculating the net working capital cash flows as the change in net working capital, we must calculate each item individually. Doing so, we find:Net working capital cash flowCash £140Accounts receivable 31Inventories (24)Accounts payable (19)Accrued expenses 10Notes payable (6)Other (2)NWC cash flow £130Except for the interest expense and notes payable, the cash flow to creditors is found in the financing activities of the accounting statement of cash flows. The interest expense from the income statement is given, so:Cash flow to creditorsInterest £57Retirement of debt 84Debt service £141Proceeds from sale of long-term debt (129)Total £12And we can find the cash flow to stockholders in the financing section of the accounting statement of cash flows. The cash flow to stockholders was:Cash flow to stockholdersDividends £94Repurchase of stock 15Cash to stockholders £109Proceeds from new stock issue (49)Total £60 capital spending = NFA end– NFA beg + Depreciation= (NFA end– NFA beg) + (Depreciation + AD beg) – AD beg= (NFA end– NFA beg)+ AD end– AD beg= (NFA end + AD end) – (NFA beg + AD beg) = FA end– FA beg27. a.The tax bubble causes average tax rates to catch up to marginal tax rates, thus eliminating thetax advantage of low marginal rates for high income corporations.b.Assuming a taxable income of $100,000, the taxes will be:Taxes = 0.15($50K) + 0.25($25K) + 0.34($25K) + 0.39($235K) = $113.9KAverage tax rate = $113.9K / $335K = 34%The marginal tax rate on the next dollar of income is 34 percent.For corporate taxable income levels of $335K to $10M, average tax rates are equal to marginal tax rates.Taxes = 0.34($10M) + 0.35($5M) + 0.38($3.333M) = $6,416,667Average tax rate = $6,416,667 / $18,333,334 = 35%The marginal tax rate on the next dollar of income is 35 percent. For corporate taxable income levels over $18,333,334, average tax rates are again equal to marginal tax rates.c.Taxes = 0.34($200K) = $68K = 0.15($50K) + 0.25($25K) + 0.34($25K) + X($100K);X($100K) = $68K – 22.25K = $45.75KX = $45.75K / $100KX = 45.75%。

公司理财习题答案第十一章Chapter 11: An Alternative View of Risk and Return: The Arbitrage Pricing Theory 11.1 Real GNP was higher than anticipated. Since returns are positively related to the level of GNP, returns should rise based on this factor.Inflation was exactly the amount anticipated. Since there was no surprise in this announcement, it will not affect Lewis-Striden returns.Interest Rates are lower than anticipated. Since returns are negatively related to interest rates, the lower than expected rate is good news. Returns should rise due to interest rates.The President’s death is bad news. Although the president was expected to retire, his retirement would not be effective for six months. During that period he would still contribute to the firm. His untimely death mean that thosecontributions would not be made. Since he was generally considered an asset to the firm, his death will cause returns to fall.The poor research results are also bad news. Since Lewis-Striden must continue to test the drug as early as expected. The delay will affect expected future earnings, and thus it will dampen returns now.The research breakthrough is positive news for Lewis Striden. Since it was unexpected, it will cause returns to rise.The competitor’s announcement is also unexpected, but it is not a welcome surprise. this announcement will lower the returns on Lewis-Striden.Systematic risk is risk that cannot be diversified away through formation of a portfolio. Generally, systematic risk factors are those factors that affect a large number of firms in the market. Note those factors do not have to equally affect the firms. The systematic factors in the list are real GNP, inflation and interest rates.Unsystematic risk is the type of risk that can be diversified away throughportfolio formation. Unsystematic risk factors are specific to the firm or industry. Surprises in these factors will affect the returns of the firm in which you are interested, but they will have no effect on the returns of firms in a different industry and perhaps little effect on other firms in the same industry. For Lewis- Striden, the unsystematic risk factors are the president’s ability to contribute to the firm, the research results and the competitor.11.2 a. Systematic Risk = 0.042(4,480– 4,416) –1.4(4.3%– 3.1%)– 0.67(11.8% –9.5%) = –0.53% b. Unsystematic Risk = – 2.6%c. Total Return = 9.5% – 0.53% – 2.6% = 6.37%11.3 ()()()11.81%1.440.3710.0Return Total c.1.44%=23-270.36=Return ic Unsystemat b.0.372%=14.0%15.2%1.903.5%-4.8%2.04=Risk Systematic a.=++=--11.4 a. Stock A:()()R R R R R A A A m m Am A =+-+=+-+βεε105%12142%...Stock B:()()R R R R R B B m m Bm B=+-+=+-+βεε130%098142%...Stock C:()R R R R R C C C m m Cm C=+-+=+-+βεε157%137142%)..(.b.()[]()[]()[]()()()()()()[]()()CB A m cB A m c m B m A m CB A P 25.045.030.0%2.14R 1435.1%925.1225.045.030.0%2.14R 37.125.098.045.02.130.0%7.1525.0%1345.0%5.1030.0%2.14R 37.1%7.1525.0%2.14R 98.0%0.1345.0%2.14R 2.1%5.1030.0R 25.0R 45.0R 30.0R ε+ε+ε+-+=ε+ε+ε+-+++++=ε+-++ε+-++ε+-+=++= c.i.()R R R A B C =+-==+-==+-=105%1215%142%)1113%09815%142%)137%157%13715%142%168%..(..46%.(......ii.R P =+-=12925%1143515%142%)138398%..(..11.5 a.Since five stocks have the same expected returns and the same betas, the portfolio also has the same expected return and beta.()R F F E E E E E p =+++++++110084169151212345...b.公司理财习题答案第十一章R F F E N E N E NAs N s are fini F F p N =++++++→∞→=++1100841690110084169121212......,...,1Nbut E te,Thus, R j p11.6To determine which investment investor would prefer, you must compute the variance of portfolios created by many stocks from either market. Note, because you know that diversification is good, it is reasonable to assume that once an investor chose the market in which he or she will invest, he or she will buy many stocks in that market. Known:E EF ====001002 and and for all i.i σσεε..Assume: The weight of each stock is 1/N; that is, X N i =1/for all i.If a portfolio is composed of N stocks each forming 1/N proportion of the portfolio, thereturn on the portfolio is 1/N times the sum of the returns on the N stocks. Recall that thereturn on each stock is 0.1+βF+ε.()()()()()()[]()()()()()()()[]()[]()[]()()[]()()()()()j i 2j i 22j i i 2222222222P P P P iP ,0.04Corr 0.01,Cov s =isvariance the ,N as limit In the ,Cov 1/N 1s 1/N s )(1/N 1/N F 2F E 1/N F E 0.10.1/N F 0.1E R E R E R Var 0.101/N 00.1E 1/N F E 0.11/N F 0.1E R E 1/N F 0.1F 0.1(1/N)R 1/N R εε+β=εε+β∞⇒εε-+ε+β=ε∑+εβ+β=ε+β=-ε+β+=-==+β+=ε+β+=ε∑+β+=ε+β+=ε+β+==∑∑∑∑∑∑∑∑()()()()()()Thus,F R f E R E R Var R Corr Var R Corr ii ip P p i j PijR 1i =++=++===+=+010*********002250040002500412212111222.........,,εεεεεεa.()()()()Corr Corr Var R Var R i j i j p pεεεε112212000225000225,,..====Since Var ()()R p 1 Var R 2p 〉, a risk averse investor will prefer to invest in the second market.b.Corr ()()εεεε112090i j j ,.,== and Corr 2i()()Var R Var R pp120058500025==..Since Var ()()risk a ,R V ar R 2p p 1〉averse investor will prefer to invest in the second market.c.()()()()Corr Var R Var R i j j p pεεεε112120050022500225,,...==== and Corr 2i Since ()()Var R Var R p p12=, a risk averse investor will be indifferentbetween investing in the two market.d. Indifference implies that the variances of the portfolio in the two marketsare equal.()()()()()()Var R Var R Corr Corr Corr Corr p pijij ijij1211222211002250040002500405=+=+=+..,..,,,.εεεεεεεε公司理财习题答案第十一章This is exactly the relationship used in part c.11.7()()()()()()()()()()()() 2.7225%1.211.5s 1.7424%1.211.2s 0.5929%1.210.7s R Var R Var 0/N Var ,N As i.b.22.30%0.22304.9725/100s 4.9725%2.251.211.5s 17.84%0.17843.1824/100s 3.1824%1.441.211.2s 12.62%1.5929/100s 1.5929%1.001.210.7s Var R Var R Var a.22C 22B 22A m 2i i j C 22C B 2B 2A 2A 2i m 2i j ======β=∴→ε∞→===⇒=+====⇒=+===⇒=+=∴ε+β=ii. APT Model: ()R R R R i F m F i =+-β%25.14)5.1)(3.36.10(3.3R %06.12)2.1)(3.36.10(3.3R %41.8)7.0)(3.36.10(3.3R C B A =-+==-+==-+= APT Model shows that assets A & B are accurately priced but asset C is overpriced. Thus, rational investors will not hold asset C.iii. If short selling is allowed, all rational investors will sell short asset C so that the price of asset C will decrease until no arbitrage opportunity exists. In other words, price of asset C should decrease until the returnbecome 14.25%.11.8 a. Let X= the proportion of security of one in the portfolio and (1-X) = theproportion of security two in the portfolio.()()[]()()[]t 222t 121t 2t 212t 111t 1t2t 1pt F F R E x 1F F R E x R X 1XR R β+β+-++β+=-+=The condition that the return of the portfolio does not depend on F 1implies:()05.0)X 1(X 0X 1X 2111=-+=β-+βThus, P=(-1,2); i.e. sell short security one and buy security two.()()()()()()5.2225.11%20%202%201R E 2p p =+-=β=+-=b. Follow the same logic as in part a, we have()()3X 05.1X 1X 0X 1X 4131==-+=β-+βWhere X is the proportion of security three in the portfolio. Thus, sell short security four and buy security three.()()()()()()075.025.03%10%102%103R E 2p p =-=β=-+=this is a risk free portfolio!c. The portfolio in part b provides a risk free return of 10% which is higher than the 5% return provided by the risk free security. To take advantage of this opportunity, borrow at the risk free rate of 5% and invest the funds in a portfolio built by selling short security four and buying security three with weights (3,-2).d. Assuming that the risk free security will not change. The price of security four ( that everyone is trying to sell short) will decrease and the price of security three ( that everyone is trying to buy ) will increase. Hence the return of security four will increase and the return of security three will decrease.The alternative is that the prices of securities three and four will remain the same, and the price of the risk-free security drops until its return is 10%.Finally, a combined movement of all security prices is also possible. The prices of security four and the risk-free security will decrease and the price of security four will increase until the opportunity disappears.E ()R j20%10% 5%()ββ1210i =2.5。

CHAPTER 12RISK AND THE COST OF CAPITALAnswers to Concepts Review and Critical Thinking Questions1.It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more thanthis, value is created.2.Book values for debt are likely to be much closer to market values than are equity book values.3.No. The cost of capital depends on the risk of the project, not the source of the money.4.Interest expense is tax-deductible. There is no difference between pretax and aftertax equity costs.5.You are assuming that the new project’s risk is the same as the risk of the firm as a whole, and thatthe firm is financed entirely with equity.6.Two primary advantages of the SML approach are that the model explicitly incorporates the relevantrisk of the stock and the method is more widely applicable than is the DCF model, since the SML doesn’t make any assumptions about the firm’s dividends. The primary disadvantages of the SML method are (1) three parameters (the risk-free rate, the expected return on the market, and beta) must be estimated, and (2) the method essentially uses historical information to estimate these parameters.The risk-free rate is usually estimated to be the yield on very short maturity T-bills and is, hence, observable; the market risk premium is usually estimated from historical risk premiums and, hence, is not observable. The stock beta, which is unobservable, is usually estimated either by determining some average historical beta from the firm and the market’s return data, or by using beta estimates provided by analysts and investment firms.7.The appropriate aftertax cost of debt to the company is the interest rate it would have to pay if itwere to issue new debt today. Hence, if the YTM on outstanding bonds of the company is observed, the company has an accurate estimate of its cost of debt. If the debt is privately-placed, the firm could still estimate its cost of debt by (1) looking at the cost of debt for similar firms in similar risk classes, (2) looking at the average debt cost for firms with the same credit rating (assuming the firm’s private debt is rated), or (3) consulting analysts and investment bankers. Even if the debt is publicly traded, an additional complication is when the firm has more than one issue outstanding;these issues rarely have the same yield because no two issues are ever completely homogeneous.8. a.This only considers the dividend yield component of the required return on equity.b.This is the current yield only, not the promised yield to maturity. In addition, it is based on thebook value of the liability, and it ignores taxes.c.Equity is inherently riskier than debt (except, perhaps, in the unusual case where a firm’s assetshave a negative beta). For this reason, the cost of equity exceeds the cost of debt. If taxes are considered in this case, it can be seen that at reasonable tax rates, the cost of equity does exceed the cost of debt.B-2 SOLUTIONS= .12 + .75(.08) = .1800 or 18.00%9.RSupBoth should proceed. The appropriate discount rate does not depend on which company is investing;it depends on the risk of the project. Since Superior is in the business, it is closer to a pure play.Therefore, its cost of capital should be used. With an 18% cost of capital, the project has an NPV of $1 million regardless of who takes it.10.If the different operating divisions were in much different risk classes, then separate cost of capitalfigures should be used for the different divisions; the use of a single, overall cost of capital would be inappropriate. If the single hurdle rate were used, riskier divisions would tend to receive more funds for investment projects, since their return would exceed the hurdle rate despite the fact that they may actually plot below the SML and, hence, be unprofitable projects on a risk-adjusted basis. The typical problem encountered in estimating the cost of capital for a division is that it rarely has its own securities traded on the market, so it is difficult to observe the market’s valuation of the risk of the division. Two typical ways around this are to use a pure play proxy for the division, or to use subjective adjustments of the overall firm hurdle rate based on the perceived risk of the division.11.The discount rate for the projects should be lower that the rate implied by the security market line.The security market line is used to calculate the cost of equity. The appropriate discount rate for projects is the firm’s weighted average cost of capital. Since the firm’s cost of debt is generally less that the firm’s cost of equity, the rate implied by the security market line will be too high.12.Beta measures the responsiveness of a security's returns to movements in the market. Beta isdetermined by the cyclicality of a firm's revenues. This cyclicality is magnified by the firm's operating and financial leverage. The following three factors will impact the firm’s beta. (1) Revenues. The cyclicality of a firm's sales is an important factor in determining beta. In general, stock prices will rise when the economy expands and will fall when the economy contracts. As we said above, beta measures the responsiveness of a security's returns to movements in the market.Therefore, firms whose revenues are more responsive to movements in the economy will generally have higher betas than firms with less-cyclical revenues. (2) Operating leverage. Operating leverage is the percentage change in earnings before interest and taxes (EBIT) for a percentage change in sales. A firm with high operating leverage will have greater fluctuations in EBIT for a change in sales than a firm with low operating leverage. In this way, operating leverage magnifies the cyclicality of a firm's revenues, leading to a high beta. (3) Financial leverage. Financial leverage arises from the use of debt in the firm's capital structure. A levered firm must make fixed interest payments regardless of its revenues. The effect of financial leverage on beta is analogous to the effect of operating leverage on beta. Fixed interest payments cause the percentage change in net income to be greater than the percentage change in EBIT, magnifying the cyclicality of a firm's revenues. Thus, returns on highly-levered stocks should be more responsive to movements in the market than the returns on stocks with little or no debt in their capital structure.CHAPTER 12 B-3 Solutions to Questions and ProblemsNOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem.Basic1. With the information given, we can find the cost of equity using the CAPM. The cost of equity is:R E = .05 + 1.30 (.12 – .05) = .1410 or 14.10%2. The pretax cost of debt is the YTM of the company’s bonds, so:P0 = $1,050 = $40(PVIFA R%,24) + $1,000(PVIF R%,24)R = 3.683%YTM = 2 × 3.683% = 7.37%And the aftertax cost of debt is:R D = .0737(1 – .40) = .0442 or 4.42%3. a.The pretax cost of debt is the YTM of the company’s bonds, so:P0 = $1,080 = $50(PVIFA R%,46) + $1,000(PVIF R%,46)R = 4.58%YTM = 2 × 4.58% = 9.16%b.The aftertax cost of debt is:R D = .0916(1 – .40) = .05496 or 5.50%c.The aftertax rate is more relevant because that is the actual cost to the company.4. The book value of debt is the total par value of all outstanding debt, so:BV D = €20M + 80M = €100MTo find the market value of debt, we find the price of the bonds and multiply by the number of bonds. Alternatively, we can multiply the price quote of the bond times the par value of the bonds.Doing so, we find:MV D = 1.08(€20M) + .58(€80M) = €68MB-4 SOLUTIONSThe YTM of the zero coupon bonds is:P Z = €580 = €1,000(PVIF R%,7)R = 8.09%So, the aftertax cost of the zero coupon bonds is:R Z = .0809(1 – .35) = .0526 or 5.26%The aftertax cost of debt for the company is the weighted average of the aftertax cost of debt for all outstanding bond issues. We need to use the market value weights of the bonds. The total aftertax cost of debt for the company is:R D = .0595(€21.6/€68) + .0526(€46.4/€68) = .0548 or 5.48%5. Using the equation to calculate the WACC, we find:WACC = .60 (.16) + .40(.09)(1 – .35) = .1194 or 11.94%6. Here we need to use the debt-equity ratio to calculate the WACC. Doing so, we find:WACC = .18(1/1.60) + .10(.60/1.60)(1 – .35) = .1369 or 13.69%7.Here we have the WACC and need to find the debt-equity ratio of the company. Setting up theWACC equation, we find:WACC = .1150 = .16(E/V) + .075(D/V)(1 – .35)Rearranging the equation, we find:.115(V/E) = .16 + .075(.65)(D/E)Now we must realize that the V/E is just the equity multiplier, which is equal to:V/E = 1 + D/E.115(D/E + 1) = .16 + .04875(D/E)Now we can solve for D/E as:.06625(D/E) = .0450D/E = .6792CHAPTER 12 B-5 8. a.The book value of equity is the book value per share times the number of shares, and the bookvalue of debt is the face value of the company’s debt, so:BV E = 9.5M(£5) = £47.5MBV D = £75M + 60M = £135MSo, the total value of the company is:V = £47.5M + 135M = £182.5MAnd the book value weights of equity and debt are:E/V = £47.5/£182.5 = .2603D/V = 1 – E/V = .7397b.The market value of equity is the share price times the number of shares, so:MV E = 9.5M(£53) = £503.5MUsing the relationship that the total market value of debt is the price quote times the par value of the bond, we find the market value of debt is:MV D = .93(£75M) + .965(£60M) = £127.65MThis makes the total market value of the company:V = £503.5 + 127.65M = £631.15And the market value weights of equity and debt are:E/V = £503.5/£631.15 = .7978D/V = 1 – E/V = .2022c.The market value weights are more relevant.B-6 SOLUTIONS9.First, we will find the cost of equity for the company. The information provided allows us to solvefor the cost of equity using the CAPM, so:R E = .052 + 1.2(.09) = .1600 or 16.00%Next, we need to find the YTM on both bond issues. Doing so, we find:P1 = $930 = $40(PVIFA R%,20) + $1,000(PVIF R%,20)R = 4.54%YTM = 4.54% × 2 = 9.08%P2 = $965 = $37.5(PVIFA R%,12) + $1,000(PVIF R%,12)R = 4.13%YTM = 4.13% × 2 = 8.25%To find the weighted average aftertax cost of debt, we need the weight of each bond as a percentage of the total debt. We find:w D1 = .93($75M)/$127.65M = .546w D2 = .965($60M)/$127.65M = .454Now we can multiply the weighted average cost of debt times one minus the tax rate to find the weighted average aftertax cost of debt. This gives us:R D = (1 – .40)[(.546)(.0908) + (.454)(.0825)] = .0522 or 5.22%Using these costs and the weight of debt we calculated earlier, the WACC is:WACC = .7978(.1600) + .2022(.0522) = .1382 or 13.82%10. ing the equation to calculate WACC, we find:WACC = .105 = (1/1.8)(.15) + (.8/1.8)(1 – .35)R DR D = .0750 or 7.50%ing the equation to calculate WACC, we find:WACC = .105 = (1/1.8)R E + (.8/1.8)(.062)R E = .1394 or 13.94%CHAPTER 12 B-7 11.We will begin by finding the market value of each type of financing. We find:MV D = 4,000($1,000)(1.03) = $4,120,000MV E = 90,000($57) = $5,130,000And the total market value of the firm is:V = $4,120,000 + 5,130,000 = $9,250,000Now, we can find the cost of equity using the CAPM. The cost of equity is:R E = .06 + 1.10(.08) = .1480 or 14.80%The cost of debt is the YTM of the bonds, so:P0 = $1,030 = $35(PVIFA R%,40) + $1,000(PVIF R%,40)R = 3.36%YTM = 3.36% × 2 = 6.72%And the aftertax cost of debt is:R D = (1 – .35)(.0672) = .0437 or 4.37%Now we have all of the components to calculate the WACC. The WACC is:WACC = .0437(4.12/9.25) + .1480(5.13/9.25) = .1015 or 10.15%Notice that we didn’t include the (1 – t C) term in the WACC equation. We simply used the aftertax cost of debt in the equation, so the term is not needed here.12. a.We will begin by finding the market value of each type of financing. We find:MV D = 120,000(元1,000)(0.93) = 元111,600,000MV E = 9,000,000(元34) = 元306,000,000And the total market value of the firm is:V = 元111,600,000 + 306,000,000 = 元417,600,000So, the market value weights of the comp any’s financing is:D/V = 元111,600,000/元417,600,000 = .2672E/V = 元111,600,000/元417,600,000 = .7328B-8 SOLUTIONSb.For projects equally as risky as the firm itself, the WACC should be used as the discount rate.First we can find the cost of equity using the CAPM. The cost of equity is:R E = .05 + 1.20(.10) = .1700 or 17.00%The cost of debt is the YTM of the bonds, so:P0 = 元930 = 元42.5(PVIFA R%,30) + 元1,000(PVIF R%,30)R = 4.69%YTM = 4.69% × 2 = 9.38%And the aftertax cost of debt is:R D = (1 – .35)(.0938) = .0610 or 6.10%Now we can calculate the WACC as:WACC = .1700(.7328) + .0610 (.2672) = .1409 or 14.09%13. a.Projects X, Y and Z.ing the CAPM to consider the projects, we need to calculate the expected return of eachproject given its level of risk. This expected return should then be compared to the expected return of the project. If the return calculated using the CAPM is higher than the project expected return, we should accept the project; if not, we reject the project. After considering risk via the CAPM:E[W] = .05 + .60(.12 – .05) = .0920 < .11, so accept WE[X] = .05 + .90(.12 – .05) = .1130 < .13, so accept XE[Y] = .05 + 1.20(.12 – .05) = .1340 < .14, so accept YE[Z] = .05 + 1.70(.12 – .05) = .1690 > .16, so reject Zc. Project W would be incorrectly rejected; Project Z would be incorrectly accepted.Intermediateing the debt-equity ratio to calculate the WACC, we find:WACC = (.65/1.65)(.055) + (1/1.65)(.15) = .1126 or 11.26%Since the project is riskier than the company, we need to adjust the project discount rate for the additional risk. Using the subjective risk factor given, we find:Project discount rate = 11.26% + 2.00% = 13.26%CHAPTER 12 B-9We would accept the project if the NPV is positive. The NPV is the PV of the cash outflows plus the PV of the cash inflows. Since we have the costs, we just need to find the PV of inflows. The cash inflows are a growing perpetuity. If you remember, the equation for the PV of a growing perpetuity is the same as the dividend growth equation, so:PV of future CF = $3,500,000/(.1326 – .05) = $42,385,321The project should only be undertaken if its cost is less than $42,385,321 since costs less than this amount will result in a positive NPV.15.We will begin by finding the market value of each type of financing. We will use D1 to representthe coupon bond, and D2 to represent the zero coupon bond. So, the market value of the firm’s financing is:MV D1 = 50,000(¥1,000)(1.1980) = ¥59,900,000MV D2 = 150,000(¥1,000)(.1385) = ¥20,775,000MV P = 120,000(¥112) = ¥13,440,000MV E = 2,000,000(¥65) = ¥130,000,000And the total market value of the firm is:V = ¥59,900,000 + 20,775,000 + 13,440,000 + 130,000,000 = ¥224,115,000Now, we can find the cost of equity using the CAPM. The cost of equity is:R E = .04 + 1.10(.09) = .1390 or 13.90%The cost of debt is the YTM of the bonds, so:P0 = ¥1,198 = ¥40(PVIFA R%,50) + ¥1,000(PVIF R%,50)R = 3.20%YTM = 3.20% × 2 = 6.40%And the aftertax cost of debt is:R D2 = (1 – .40)(.0640) = .0384 or 3.84%And the aftertax cost of the zero coupon bonds is:P0 = ¥138.50 = ¥1,000(PVIF R%,60)R = 3.35%YTM = 3.35% × 2 = 6.70%R D1 = (1 – .40)(.0670) = .0402 or 4.02%Even though the zero coupon bonds make no payments, the calculation for the YTM (or price) still assumes semiannual compounding, consistent with a coupon bond. Also remember that, even though the company does not make interest payments, the accrued interest is still tax deductible for the company.B-10 SOLUTIONSTo find the required return on preferred stock, we can use the preferred stock pricing equation, which is the level perpetuity equation, so the required return on the company’s preferred stock is: R P = D1 / P0R P = ¥6.50 / ¥112R P = .0580 or 5.80%Notice that the required return in the preferred stock is lower than the required on the bonds. This result is not consistent with the risk levels of the two instruments, but is a common occurrence.There is a practical reason for this: Assume Company A owns stock in Company B. The tax code allows Company A to exclude at least 70 percent of the dividends received from Company B, meaning Company A does not pay taxes on this amount. In practice, much of the outstanding preferred stock is owned by other companies, who are willing to take the lower return since it is effectively tax exempt.Now we have all of the components to calculate the WACC. The WACC is:WACC = .0684(59.9/224.115) + .0402(20.775/224.115) + .1390(130/224.115)+ .0580(13.44/224.115)WACC = .0981 or 9.81%Challenge16.We can use the debt-equity ratio to calculate the weights of equity and debt. The debt of thecompany has a weight for long-term debt and a weight for accounts payable. We can use the weight given for accounts payable to calculate the weight of accounts payable and the weight of long-term debt. The weight of each will be:Accounts payable weight = .20/1.20 = .17Long-term debt weight = 1/1.20 = .83Since the accounts payable has the same cost as the overall WACC, we can write the equation for the WACC as:WACC = (1/2.3)(.17) + (1.3/2.3)[(.20/1.2)WACC + (1/1.2)(.09)(1 – .35)]Solving for WACC, we find:WACC = .0739 + .5652[(.20/1.2)WACC + .0488]WACC = .0739 + (.0942)WACC + .0276(.9058)WACC = .1015WACC = .1132 or 11.32%Since the cash flows go to perpetuity, we can calculate the future cash inflows using the equation for the PV of a perpetuity. The NPV is:NPV = –$45,000,000 + ($5,700,000/.1132)NPV = –$45,000,000 + 50,372,552 = $5,372,552CHAPTER 12 B-11 17.The €4 million cost of the land 3 years ago is a sunk cost and irrelevant; the €6.5 million appraisedvalue of the land is an opportunity cost and is relevant. The relevant market value capitalization weights are:MV D = 15,000(€1,000)(0.92) = €13,800,000MV E = 300,000(€75) = €22,500,000MV P = 20,000(€72) = €1,440,000The total market value of the company is:V = €13,800,000 + 22,500,000 + 1,440,000 = €37,740,000Next we need to find the cost of funds. We have the information available to calculate the cost of equity using the CAPM, so:R E = .05 + 1.3(.08) = .1540 or 15.40%The cost of debt is the YTM of the company’s outstanding bonds, so:P0 = €920 = €35(PVIFA R%,30) + €1,000(PVIF R%,30)R = 3.96%YTM = 3.96% × 2 = 7.92%And the aftertax cost of debt is:R D = (1 – .35)(.0792) = .0515 or 5.15%The cost of preferred stock is:R P = €5/€72 = .0694 or 6.94%a.The initial cost to the company will be the opportunity cost of the land, the cost of the plant,and the net working capital cash flow, so:CF0 = –€6,500,000 – 15,000,000 – 900,000 = –€22,400,000b.To find the required return on this project, we first need to calculate the WACC for thecompany. The company’s WACC is:WACC = [(€22.5/€37.74)(.1540) + (€1.44/€37.74)(.0694) + (€13.8/€37.74)(.0515)] = .1133The company wants to use the subjective approach to this project because it is located overseas.The adjustment factor is 2 percent, so the required return on this project is:Project required return = .1133 + .02 = .1333B-12 SOLUTIONSc.The annual depreciation for the equipment will be:€15,000,000/8 = €1,875,000So, the book value of the equipment at the end of five years will be:BV5 = €15,000,000 – 5(€1,875,000) = €5,625,000So, the aftertax salvage value will be:Aftertax salvage value = €5,000,000 + .35(€5,625,000 – 5,000,000) = €5,218,750ing the tax shield approach, the OCF for this project is:OCF = [(P – v)Q – FC](1 – t) + t C DOCF = [(€10,000 – 9,000)(12,000) – 400,000](1 – .35) + .35(€15M/8) = €8,196,250e.The accounting breakeven sales figure for this project is:Q A = (FC + D)/(P – v) = (€400,000 + 1,875,000)/(€10,000 – 9,000) = 2,275 unitsf.We have calculated all cash flows of the project. We just need to make sure that in Year 5 weadd back the aftertax salvage value, the recovery of the initial NWC, and the aftertax value of the land. The cash flows for the project are:Year Flow Cash0 –€22,400,0001 8,196,2502 8,196,2503 8,196,2504 8,196,2505 18,815,000Using the required return of 13.33 percent, the NPV of the project is:NPV = –€22,400,000 + €8,196,250(PVIFA13.33%,4) + €18,815,000/1.13335NPV = €11,878,610.78And the IRR is:NPV = 0 = –€22,400,000 + €8,196,250(PVIFA IRR%,4) + €18,815,000/(1 + IRR)5IRR = 30.87%。

Chapter 6: Some Alternative Investment Rules6.1 a. Payback period of Project A = 1 + ($7,500 - $4,000) / $3,500 = 2 yearsPayback period of Project B = 2 + ($5,000 - $2,500 -$1,200) / $3,000 = 2.43 yearsProject A should be chosen.b. NPVA = -$7,500 + $4,000 / 1.15 + $3,500 / 1.152 + $1,500 / 1.153 = -$388.96NPVB = -$5,000 + $2,500 / 1.15 + $1,200 / 1.152 + $3,000 / 1.153 = $53.83Project B should be chosen.6.2 a. Payback period = 6 + {$1,000,000 - ($150,000 ( 6)} / $150,000 = 6.67 yearsYes, the project should be adopted.b. $150,000 = $974,259The discounted payback period = 11 + ($1,000,000 - $974,259) / ($150,000 / 1.112)= 11.54 yearsc. NPV = -$1,000,000 + $150,000 / 0.10 = $500,0006.3 a. Average Investment:($16,000 + $12,000 + $8,000 + $4,000 + 0) / 5 = $8,000Average accounting return:$4,500 / $8,000 = 0.5625 = 56.25%b. 1. AAR does not consider the timing of the cash flows, hence it does notconsider the time value of money.2. AAR uses an arbitrary firm standard as the decision rule.3. AAR uses accounting data rather than net cash flows.6.4 Average Investment = ($2,000,000 + 0) / 2 = $1,000,000Average net income = [$100,000 {(1 + g)5 - 1} / g] / 5= {$100,000A (1.075 - 1} / 0.07} / 5= $115,014.78AAR = $115,014.78 / $1,000,000 = 11.50%No, since the machine’s AAR is less than the firm’s cutoff AAR.6.5 aPI = $40,000 / $160,000 = 1.04Since the PI exceeds one accept the project.6.7 The IRR is the discount rate at which the NPV = 0.-$3,000 + $2,500 / (1 + IRRA) + $1,000 / (1 + IRRA)2 = 0By trial and error, IRRA = 12.87%Since project B’s cash flows are two times of those of project A, the IRRB = IRRA = 12.87% 6.8 a. Solve x by trial and error:-$4,000 + $2,000 / (1 + x) + $1,500 / (1 + x)2 + $1,000 / (1 + x)3 = 0x = 6.93%b. No, since the IRR (6.93%) is less than the discount rate of 8%.6.9 Find the IRRs of project A analytically. Since the IRR is the discount rate that makes the NPV equal to zero, the following equation must hold.-$200 + $200 / (1 + r) + $800 / (1 + r)2 - $800 / (1 + r)3 = 0$200 [-1 + 1 / (1 + r)] - {$800 / (1 + r)2}[-1 + 1 / (1 + r)] = 0[-1 + 1 / (1 + r)] [$200 - $800 / (1 + r)2] = 0For this equation to hold, either [-1 + 1 / (1 + r)] = 0 or [$200 - $800 / (1 + r)2] = 0.Solve each of these factors for the r that would cause the factor to equal zero. The resulting rates are the two IRRs for project A. They are either r = 0% or r = 100%.Note: By inspection you should have known that one of the IRRs of project A is zero. Notice that the sum of the un-discounted cash flows for project A is zero. Thus, not discounting the cash flows would yield a zero NPV. The discount rate which is tantamount to not discounting is zero.Here are some of the interactions used to find the IRR by trial and error.Sophisticated calculators can compute this rate without all of the tedium involved in the trial-and-error method.NPV = -$150 + $50 / 1.3 + $100 / 1.32 + $150 / 1.33 = $15.91NPV = -$150 + $50 / 1.4 + $100 / 1.42 + $150 / 1.43 = -$8.60NPV = -$150 + $50 / 1.37 + $100 / 1.372 + $150 / 1.373 = -$1.89NPV = -$150 + $50 / 1.36 + $100 / 1.36 2 + $150 / 1.363 = $0.46NPV = -$150 + $50 / 1.36194 + $100 / 1.361942 + $150 / 1.361943= $0.0010NPV = -$150 + $50 / 1.36195 + $100 / 1.361952 + $150 / 1.361953= -$0.0013NPV = -$150 + $50 / 1.361944 + $100 / 1.3619442 + $150 / 1.3619443= $0.0000906Thus, the IRR is approximately 36.1944%.6.10 a. Solve r in the equation:$5,000 - $2,500 / (1 + r) - $2,000 / (1 + r)2 - $1,000 / (1 + r)3- $1,000 / (1 + r)4 = 0By trial and error,IRR = r = 13.99%b. Since this problem is the case of financing, accept the project if the IRR is less than the required rate of return.IRR = 13.99% > 10%Reject the offer.c. IRR = 13.99% < 20%Accept the offer.d. When r = 10%:NPV = $5,000 - $2,500 / 1.1 - $2,000 / 1.12 - $1,000 / 1.13 - $1,000 / 1.14= -$359.95When r = 20%:NPV = $5,000 - $2,500 / 1.2 - $2,000 / 1.22 - $1,000 / 1.23 - $1,000 / 1.24= $466.82Yes, they are consistent with the choices of the IRR rule since the signs of the cash flows change only once.6.11 a. Project A:NPV = -$5,000 + $3,500 / (1 + r) + $3,500 / (1 + r)2 = 0IRR = r = 25.69%Project B:NPV = -$100,000 + $65,000 / (1 + r) + $65,000 / (1 + r)2 = 0IRR = r = 19.43%b. Choose project A because it has a higher IRR.c. The difference in scale is ignored.d. Apply the incremental IRR method.e.C0C1C2B - A-$95,000$61,500$61,500NPV = -$95,000 + $61,500 / (1 + r) + $61,500 / (1 + r)2 = 0Incremental IRR = r = 19.09%f. If the discount rate is less than 19.09%, choose project B.Otherwise, choose project A.g. NPVA = -$5,000 + $3,500 / 1.15 + $3,500 / 1.152 = $689.98NPVB = -$100,000 + $65,000 / 1.15 + $65,000 / 1.152 = $5,671.08Choose project B.6.12 a. PVA = {$5,000 / (0.12 - 0.04)} / 1.122 = $49,824.61PVB = (-$6,000 / 0.12) / 1.12 = -$44,642.86b. The IRR for project C must solve{$5,000 / (x - 0.04)} / (1 + x)2 + (-$6,000 / x) / (1 + x) = 0$5,000 / (x - 0.04) - $6,000 (1 + x) / x = 025 x2 + 3.17 x - 1 =0x = {-3.17 - (110.0489)0.5} / 50 or {-3.17 + (110.0489)0.5} / 50The relevant positive root is IRR = x = 0.1464 = 14.64%c. To arrive at the appropriate decision rule, we must graph the NPV as a function of the discount rate. At a discount rate of 14.64% the NPV is zero. To determine if the graph is upward or downward sloping, check the NPV at another discount rate. At a discount rate of 10% the NPV is $14,325.07 [= $68,870.52 - $54,545.54]. Thus, the graph of the NPV is downward sloping. From the discussion in the text, if an NPV graph is downward sloping, the projectis an investing project. The correct decision rule for an investing project is to accept the project if the discount rate is below 14.64%.6.13 Generally, the statement is false. If the cash flows of project B occur early and the cash flows of project A occur late, then for a low discount rate the NPV of A can exceed the NPV of B. Examples are easy to construct.C0C1C2IRRNPV @ 0%A:-$1,000,000$0$1,440,0000.20$440,000B:-2,000,0002,400,0000.20400,000In one particular case, the statement is true for equally risky projects. If the lives of thetwo projects are equal and in every time period the cash flows of the project B are twice the cash flows of project A, then the NPV of project B will be twice as great as the NPV of project A for any discount rate between 0% and 20%.6.14 a. NPV( = $756.57 - $500 = $256.57NPV( = $2,492.11 - $2,000 = $492.11b. Choose project beta.6.15 Although the profitability index is higher for project B than for project A, the NPV is the increase in the value of the company that will occur if a particular project is undertaken. Thus, the project with the higher NPV should be chosen because it increases the value of the firm the most. Only in the case of capital rationing could the pension fund manager be correct.6.16 a. PIA = ($70,000 / 1.12 + $70,000 / 1.122) / $100,000 = 1.183PIB = ($130,000 / 1.12 + $130,000 / 1.122) / $200,000 = 1.099PIC = ($75,000 / 1.12 + $60,000 / 1.122) / $100,000 = 1.148b. NPVA = -$100,000 + $118,303.57 = $18,303.57NPVB = -$200,000 + $219,706.63 = $19,706.63NPVC = -$100,000 + $114,795.92 = $14,795.92c. Accept all three projects because PIs of all the three projects are greater than one.d. Based on the PI rule, project C can be eliminated because its PI is less than the oneof project A, while both have the same amount of the investment. We can compute the PI of the incremental cash flows between the two projects,ProjectC0C1C2PIB - A-$100,000$60,000$60,0001.014We should take project B since the PI of the incremental cash flows is greater than one.e. Project B has the highest NPV, while A has the next highest NPV.Take both projects A and B.6.17 a. The payback period is the time it takes to recoup the initial investment of a project.Accept any project that has a payback period that is equal to or shorter than the company’s standard payback period. Reject all other projects.b. The average accounting return (AAR) is defined asAverage project earnings ( Average book value of the investment.Accept projects for which the AAR is equal to or greater than the firm’s standard.Reject all other projects.c. The internal rate of return (IRR) is the discount rate which makes the net presentvalue (NPV) of the project zero. The accept / reject criteria is:If C0 < 0 and all future cash flows are positive, accept the project if IRR ( discount rate.If C0 < 0 and all future cash flows are positive, reject the project if IRR < discount rate.If C0 > 0 and all future cash flows are negative, accept the project if IRR ( discount rate.If C0 > 0 and all future cash flows are negative, reject the project if IRR > discount rate.If the project has cash flows that alternate in sign, there is likely to be more thanone positive IRR. In that situation, there is no valid IRR accept / reject rule.d. The profitability index (PI) is defined as:(The present value of the cash flows subsequent to the initial investment (The initial investment)Accept any project for which the profitability index is equal to or greater than one. Reject project for which that is not true.e. The net present value (NPV) is the sum of the present values of all project cashflows. Accept those projects with NPVs which are equal to or greater than zero.Rejects proposals with negative NPVs.6.18 Let project A represent New Sunday Early Edition; and let project B represent New Saturday Late Edition.a. Payback period of project A = 2 + ($1,200 - $1,150) / $450 = 2.11 yearsPayback period of project B = 2 + ($2,100 - $1,900) / $800 = 2.25 yearsBased on the payback period rule, you should choose project A.b. Project A:Average investment = ($1,200 + $0) / 2 = $600Depreciation = $400 / yearAverage income = [($600 - $400) + ($550 - $400) + ($450 - $400)] / 3= $133.33AAR = $133.33 / $600 = 22.22%Project B:Average investment = ($2,100 + $0) / 2 = $1,050Depreciation = $700 / yearAverage income = [($1,000 - $700) + ($900 - $700) + ($800 - $700)] / 3= $200AAR = $200 / $1,050 = 19.05%c. IRR of project A:-$1,200 + $600 / (1 + r) + $550 / (1 + r)2 + $450 / (1 + r)3 = 0IRR = r = 16.76%IRR of project B:-$2,100 + $1,000 / (1 + r) + $900 / (1 + r)2 + $800 / (1 + r)3 = 0IRR = r = 14.29%Project A has a greater IRR.d. IRR of project B-A:Incremental cash flowsYear123B - A-$900$400$350$350-$900 + $400 / (1 + r) + $350 / (1 + r)2 + $350 / (1 + r)3 = 0Incremental IRR = r = 11.02%If the required rate of return is greater than 11.02%, then choose project A.If the required rate of return is less than 11.02%, then choose project B.6.19 Let project A be Deepwater Fishing; let project B be New Submarine Ride.a. Project A:YearDiscounted CFCumulative CF-$600,000-$600,0001234,783-365,2172264,650-100,5673197,255Discounted payback period of project A = 2 + $100,567 / $197,255= 2.51 yearsProject B:YearDiscounted CFCumulative CF-$1,800,000-$1,800,0001869,565-930,4352529,301-401,1343591,765Discounted payback period of project B = 2 + $401,134 / $591,765= 2.68 yearsProject A should be chosen.b. IRR of project A:-$600,000 + $270,000 / (1 + r) + $350,000 / (1 + r)2 + $300,000 / (1 + r)3 = 0IRR = r = 24.30%IRR of project B:-$1,800,000 + $1,000,000 /(1 + r) + $700,000 / (1 + r)2 + $900,000 / (1 + r)3 = 0IRR = r = 21.46%Based on the IRR rule, project A should be chosen since it has a greater IRR.c. Incremental IRR:Year23B - A-$1,200,000$730,000$350,000$600,000-$1,200,000 + $730,000 / (1 + r) + $350,000 / (1 + r)2 + $600,000 / (1 + r)3 = 0Incremental IRR = r = 19.92%Since the incremental IRR is greater than the required rate of return, 15%, choose project B.d. NPVA = -$600,000 + $270,000 / 1.15 + $350,000 / 1.152 + $300,000 / 1.153= $96,687.76NPVB = -$1,800,000 + $1,000,000 / 1.15 + $700,000 / 1.152 + $900,000 / 1.153= $190,630.39Since NPVB > NPVA, choose project B.Yes, the NPV rule is consistent with the incremental IRR rule.6.20 a. The IRR is the discount rate at which the NPV = 0-$600,000 +IRR (18.56%b. Yes, the mine should be opened since its IRR exceeds its required return of 10%.。

.CHAPTER 7Net Present Value and Other Investment Rules Multiple Choice Questions:I. DEFINITIONSNET PRESENT VALUEa 1. The difference between the present value of an investment and its cost is the:a. net present value.b. internal rate of return.c. payback period.d. profitability index.e. discounted payback period.Difficulty level: EasyNET PRESENT VALUE RULEc 2. Which one of the following statements concerning net present value (NPV) is correct?a. An investment should be accepted if, and only if, the NPV is exactly equal to zero.b. An investment should be accepted only if the NPV is equal to the initial cash flow.c. An investment should be accepted if the NPV is positive and rejected if it is negative.d. An investment with greater cash inflows than cash outflows, regardless of when thecash flows occur, will always have a positive NPV and therefore should always beaccepted.e. Any project that has positive cash flows for every time period after the initialinvestment should be accepted.Difficulty level: EasyPAYBACKc 3. The length of time required for an investment to generate cash flows sufficient torecover the initial cost of the investment is called the:a. net present value.b. internal rate of return.c. payback period.d. profitability index.e. discounted cash period.Difficulty level: EasyPAYBACK RULEa 4. Which one of the following statements is correct concerning the payback period?a. An investment is acceptable if its calculated payback period is less than some pre-specified period of time.b. An investment should be accepted if the payback is positive and rejected if it isnegative.c. An investment should be rejected if the payback is positive and accepted if it isnegative.d. An investment is acceptable if its calculated payback period is greater than some pre-specified period of time.e. An investment should be accepted any time the payback period is less than thediscounted payback period, given a positive discount rate.Difficulty level: EasyDISCOUNTED PAYBACKe 5. The length of time required for a project’s discounted cash flows to equal the initialcost of the project is called the:a. net present value.b. internal rate of return.c. payback period.d. discounted profitability index.e. discounted payback period.Difficulty level: EasyDISCOUNTED PAYBACK RULEd 6. The discounted payback rule states that you should accept projects:a. which have a discounted payback period that is greater than some pre-specified periodof time.b. if the discounted payback is positive and rejected if it is negative.c. only if the discounted payback period equals some pre-specified period of time.d. if the discounted payback period is less than some pre-specified period of time.e. only if the discounted payback period is equal to zero.Difficulty level: EasyAVERAGE ACCOUNTING RETURNc 7. An investment’s average net income divided by its average book value defines theaverage:a. net present value.b. internal rate of return.c. accounting return.d. profitability index.e. payback period.Difficulty level: EasyAVERAGE ACCOUNTING RETURN RULEb 8. An investment is acceptable if its average accounting return (AAR):a. is less than a target AAR.b. exceeds a target AAR.c. exceeds the firm’s return on equity (ROE).d. is less than the firm’s return on assets (ROA).e. is equal to zero and only when it is equal to zero.Difficulty level: EasyINTERNAL RATE OF RETURNb. 9. The discount rate that makes the net present value of an investment exactly equal tozero is called the:a. external rate of return.b. internal rate of return.c. average accounting return.d. profitability index.e. equalizer.Difficulty level: EasyINTERNAL RATE OF RETURN RULEd 10. An investment is acceptable if its IRR:a. is exactly equal to its net present value (NPV).b. is exactly equal to zero.c. is less than the required return.d. exceeds the required return.e. is exactly equal to 100 percent.Difficulty level: EasyMULTIPLE RATES OF RETURNe 11. The possibility that more than one discount rate will make the NPV of an investmentequal to zero is called the _____ problem.a. net present value profilingb. operational ambiguityc. mutually exclusive investment decisiond. issues of scalee. multiple rates of returnDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSc 12. A situation in which accepting one investment prevents the acceptance of anotherinvestment is called the:a. net present value profile.b. operational ambiguity decision.c. mutually exclusive investment decision.d. issues of scale problem.e. multiple choices of operations decision.Difficulty level: EasyPROFITABILITY INDEXd. 13. The present value of an investment’s future cash flows divided by the initial cost of theinvestment is called the:a. net present value.b. internal rate of return.c. average accounting return.d. profitability index.e. profile period.Difficulty level: EasyPROFITABILITY INDEX RULEa 14. An investment is acceptable if the profitability index (PI) of the investment is:a. greater than one.b. less than one.c. greater than the internal rate of return (IRR).d. less than the net present value (NPV).e. greater than a pre-specified rate of return.Difficulty level: EasyII. CONCEPTSNET PRESENT VALUEd 15. All else constant, the net present value of a project increases when:a. the discount rate increases.b. each cash inflow is delayed by one year.c. the initial cost of a project increases.d. the rate of return decreases.e. all cash inflows occur during the last year of a project’s life instead ofperiodically throughout the life of the project.Difficulty level: EasyNET PRESENT VALUEa 16. The primary reason that company projects with positive net present values areconsidered acceptable is that:a. they create value for the owners of the firm.b. the project’s rate of return exceeds the rate of inflation.c. they return the initial cash outlay within three years or less.d. the required cash inflows exceed the actual cash inflows.e. the investment’s cost exceeds the present value of the cash inflows.Difficulty level: EasyNET PRESENT VALUEd 17. If a project has a net present value equal to zero, then:I. the present value of the cash inflows exceeds the initial cost of the project.II. the project produces a rate of return that just equals the rate required to accept the project.III. the project is expected to produce only the minimally required cash inflows.IV. any delay in receiving the projected cash inflows will cause the project to have a negative net present value.a. II and III onlyb. II and IV onlyc. I, II, and IV onlyd. II, III, and IV onlye. I, II, and III onlyDifficulty level: MediumNET PRESENT VALUEb 18. Net present value:a. cannot be used when deciding between two mutually exclusive projects.b. is more useful to decision makers than the internal rate of return when comparingdifferent sized projects.c. is easy to explain to non-financial managers and thus is the primary method of analysisused by the lowest levels of management.d. is not an as widely used tool as payback and discounted paybacke. is very similar in its methodology to the average accounting return.Difficulty level: EasyPAYBACKc 19. Payback is frequently used to analyze independent projects because:a. it considers the time value of money.b. all relevant cash flows are included in the analysis.c. it is easy and quick to calculate.d. it is the most desirable of all the available analytical methods from a financialperspective.e. it produces better decisions than those made using either NPV or IRR.Difficulty level: EasyPAYBACKc 20. The advantages of the payback method of project analysis include the:I. application of a discount rate to each separate cash flow.II. bias towards liquidity.III. ease of use.IV. arbitrary cutoff point.a. I and II onlyb. I and III onlyc. II and III onlye. II, III, and IV onlyDifficulty level: MediumPAYBACKd 21. All else equal, the payback period for a project will decrease whenever the:a. initial cost increases.b. required return for a project increases.c. assigned discount rate decreases.d. cash inflows are moved forward in time.e. duration of a project is lengthened.Difficulty level: MediumDISCOUNTED PAYBACKd 22. The discounted payback period of a project will decrease whenever the:a. discount rate applied to the project is increased.b. initial cash outlay of the project is increased.c. time period of the project is increased.d. amount of each project cash flow is increased.e. costs of the fixed assets utilized in the project increase.Difficulty level: MediumDISCOUNTED PAYBACKa 23. The discounted payback rule may cause:a. some positive net present value projects to be rejected.b. the most liquid projects to be rejected in favor of less liquid projects.c. projects to be incorrectly accepted due to ignoring the time value of money.d. projects with negative net present values to be accepted.e. some projects to be accepted which would otherwise be rejected under the paybackrule.Difficulty level: EasyINTERNAL RATE OF RETURNb 24. The internal rate of return (IRR):I. rule states that a project with an IRR that is less than the required rate should beaccepted.II. is the rate generated solely by the cash flows of an investment.III. is the rate that causes the net present value of a project to exactly equal zero.IV. can effectively be used to analyze all investment scenarios.a. I and IV onlyb. II and III onlyc. I, II, and III onlyd. II, III, and IV onlyDifficulty level: MediumINTERNAL RATE OF RETURNa 25. The internal rate of return for a project will increase if:a. the initial cost of the project can be reduced.b. the total amount of the cash inflows is reduced.c. each cash inflow is moved such that it occurs one year later than originally projected.d. the required rate of return is reduced.e. the salvage value of the project is omitted from the analysis.Difficulty level: MediumINTERNAL RATE OF RETURNc 26. The internal rate of return is:a. more reliable as a decision making tool than net present value whenever you areconsidering mutually exclusive projects.b. equivalent to the discount rate that makes the net present value equal to one.c. difficult to compute without the use of either a financial calculator or a computer.d. dependent upon the interest rates offered in the marketplace.e. a better methodology than net present value when dealing with unconventional cashflows.Difficulty level: MediumINTERNAL RATE OF RETURNa 27. The internal rate of return tends to be:a. easier for managers to comprehend than the net present value.b. extremely accurate even when cash flow estimates are faulty.c. ignored by most financial analysts.d. used primarily to differentiate between mutually exclusive projects.e. utilized in project analysis only when multiple net present values apply.Difficulty level: EasyINCREMENTAL INTERNAL RATE OF RETURNe 28. You are trying to determine whether to accept project A or project B. These projectsare mutually exclusive. As part of your analysis, you should compute the incrementedIRR by determining:a. the internal rate of return for the cash flows of each project.b. the net present value of each project using the internal rate of return as the discountrate.c. the discount rate that equates the discounted payback periods for each project.d. the discount rate that makes the net present value of each project equal to 1.e. the internal rate of return for the differences in the cash flows of the two projects.Difficulty level: MediumINCREMENTAL INTERNAL RATE OF RETURNb 29. Graphing the incremental IRR helps explain:a. why one project is always superior to another project.b. how decisions concerning mutually exclusive projects are derived.c. how the duration of a project affects the decision as to which project to accept.d. how the net present value and the initial cash outflow of a project are related.e. how the profitability index and the net present value are related.Difficulty level: MediumPROFITABILITY INDEXd 30. The profitability index is closely related to:a. payback.b. discounted payback.c. the average accounting return.d. net present value.e. mutually exclusive projects.Difficulty level: EasyPROFITABILITY INDEXb 31. Analysis using the profitability index:a. frequently conflicts with the accept and reject decisions generated by the application ofthe net present value rule.b. is useful as a decision tool when investment funds are limited.c. is useful when trying to determine which one of two mutually exclusive projectsshould be accepted.d. utilizes the same basic variables as those used in the average accounting return.e. produces results which typically are difficult to comprehend or apply.Difficulty level: MediumPROFITABILITY INDEXe 32. If you want to review a project from a benefit-cost perspective, you should use the_____ method of analysis.a. net present valueb. paybackc. internal rate of returnd. average accounting returne. profitability indexDifficulty level: EasyPROFITABILITY INDEXb 33. When the present value of the cash inflows exceeds the initial cost of a project, thenthe project should be:a. accepted because the internal rate of return is positive.b. accepted because the profitability index is greater than 1.c. accepted because the profitability index is negative.d. rejected because the internal rate of return is negative.e. rejected because the net present value is negative.Difficulty level: EasyMUTUALLY EXCLUSIVE PROJECTSc 34. Which one of the following is the best example of two mutually exclusive projects?a. planning to build a warehouse and a retail outlet side by sideb. buying sufficient equipment to manufacture both desks and chairs simultaneouslyc. using an empty warehouse for storage or renting it entirely out to another firmd. using the company sales force to promote sales of both shoes and sockse. buying both inventory and fixed assets using funds from the same bond issueDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSd 35. The Liberty Co. is considering two projects. Project A consists of building a wholesalebook outlet on lot #169 of the Englewood Retail Center. Project B consists of buildinga sit-down restaurant on lot #169 of the Englewood Retail Center. When trying todecide whether or build the book outlet or the restaurant, management should relymost heavily on the analysis results from the _____ method of analysis.a. profitability indexb. internal rate of returnc. paybackd. net present valuee. accounting rate of returnDifficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSc 36. When two projects both require the total use of the same limited economic resource,the projects are generally considered to be:a. independent.b. marginally profitable.c. mutually exclusive.d. acceptable.e. internally profitable.Difficulty level: EasyMUTUALLY EXCLUSIVE PROJECTSc 37. Matt is analyzing two mutually exclusive projects of similar size and has prepared thefollowing data. Both projects have 5 year lives.Project A Project B Net present value $15,090 $14,693Payback period 2.76 years 2.51 yearsAverage accounting return 9.3 percent 9.6 percentRequired return 8.3 percent 8.0 percentRequired AAR 9.0 percent 9.0 percentMatt has been asked for his best recommendation given this information. Hisrecommendation should be to accept:a. project B because it has the shortest payback period.b. both projects as they both have positive net present values.c. project A and reject project B based on their net present values.d. project B and reject project A based on their average accounting returns.e. project B and reject project A based on both the payback period and the averageaccounting return.Difficulty level: MediumINVESTMENT ANALYSISa 38. Given that the net present value (NPV) is generally considered to be the best methodof analysis, why should you still use the other methods?a. The other methods help validate whether or not the results from the net present valueanalysis are reliable.b. You need to use the other methods since conventional practice dictates that you onlyaccept projects after you have generated three accept indicators.c. You need to use other methods because the net present value method is unreliablewhen a project has unconventional cash flows.d. The average accounting return must always indicate acceptance since this is the bestmethod from a financial perspective.e. The discounted payback method must always be computed to determine if a projectreturns a positive cash flow since NPV does not measure this aspect of a project.Difficulty level: MediumINVESTMENT ANALYSISe 39. In actual practice, managers frequently use the:I. AAR because the information is so readily available.II. IRR because the results are easy to communicate and understand.III. payback because of its simplicity.IV. net present value because it is considered by many to be the best method of analysis.a. I and III onlyb. II and III onlyc. I, III, and IV onlyd. II, III, and IV onlye. I, II, III, and IVDifficulty level: MediumINVESTMENT ANALYSISa 40. No matter how many forms of investment analysis you do:a. the actual results from a project may vary significantly from the expected results.b. the internal rate of return will always produce the most reliable results.c. a project will never be accepted unless the payback period is met.d. the initial costs will generally vary considerably from the estimated costs.e. only the first three years of a project ever affect its final outcome.Difficulty level: EasyINVESTMENT ANALYSISb 41. Which of the following methods of project analysis are biased towards short-termprojects?I. internal rate of returnII. accounting rate of returnIII. paybackIV. discounted paybacka. I and II onlyb. III and IV onlyc. II and III onlyd. I and IV onlye. II and IV onlyDifficulty level: MediumINVESTMENT ANALYSISa 42. If a project is assigned a required rate of return equal to zero, then:a. the timing of the project’s cash flows has no bearing on the value of the project.b. the project will always be accepted.c. the project will always be rejected.d. whether the project is accepted or rejected will depend on the timing of the cash flows.e. the project can never add value for the shareholders.Difficulty level: MediumDECISION RULESe 43. You are considering a project with the following data:Internal rate of return 8.7 percentProfitability ratio .98Net present value -$393Payback period 2.44 yearsRequired return 9.5 percentWhich one of the following is correct given this information?a. The discount rate used in computing the net present value must have been less than 8.7percent.b. The discounted payback period will have to be less than 2.44 years.c. The discount rate used to compute the profitability ratio was equal to the internal rateof return.d. This project should be accepted based on the profitability ratio.e. This project should be rejected based on the internal rate of return.Difficulty level: MediumNET PRESENT VALUEc 44. Accepting positive NPV projects benefits the stockholders because:a. it is the most easily understood valuation process.b. the present value of the expected cash flows are equal to the cost.c. the present value of the expected cash flows are greater than the cost.d. it is the most easily calculated.e. None of the above.Difficulty level: EasyNET PRESENT VALUEa 45. Which of the following does not characterize NPV?a. NPV does not incorporate risk into the analysis.b. NPV incorporates all relevant information.c. NPV uses all of the project's cash flows.d. NPV discounts all future cash flows.e. Using NPV will lead to decisions that maximize shareholder wealth.Difficulty level: EasyPAYBACKe 46. The payback period rule:a. discounts cash flows.b. ignores initial cost.c. always uses all possible cash flows in its calculation.d. Both A and C.e. None of the above.Difficulty level: EasyPAYBACKc 47. The payback period rule accepts all investment projects in which the payback period forthe cash flows is:a. equal to the cutoff point.b. greater than the cutoff point.c. less than the cutoff point.d. positive.e. None of the above.Difficulty level: EasyPAYBACKd 48. The payback period rule is a convenient and useful tool because:a. it provides a quick estimate of how rapidly the initial investment will be recouped.b. results of a short payback rule decision will be quickly seen.c. it does not take into account time value of money.d. All of the above.e. None of the above.Difficulty level: EasyDISCOUNTED PAYBACKa 49. The discounted payback period rule:a. considers the time value of money.b. discounts the cutoff point.c. ignores uncertain cash flows.d. is preferred to the NPV rule.e. None of the above.Difficulty level: EasyPAYBACKc 50. The payback period rule:a. determines a cutoff point so that all projects accepted by the NPV rule will be acceptedby the payback period rule.b. determines a cutoff point so that depreciation is just equal to positive cash flows in thepayback year.c. requires an arbitrary choice of a cutoff point.d. varies the cutoff point with the interest rate.e. Both A and D.Difficulty level: EasyAVERAGE ACCOUNTING RETURNc 51. The average accounting return is determined by:a. dividing the yearly cash flows by the investment.b. dividing the average cash flows by the investment.c. dividing the average net income by the average investment.d. dividing the average net income by the initial investment.e. dividing the net income by the cash flow.Difficulty level: EasyAVERAGE ACCOUNTING RETURNb 52. The investment decision rule that relates average net income to average investment isthe:a. discounted cash flow method.b. average accounting return method.c. average payback method.d. average profitability index.e. None of the above.Difficulty level: EasyMODIFIED INTERNAL RATE OF RETURNd 53. Modified internal rate of return:a. handles the multiple IRR problem by combining cash flows until only one change insign change remains.b. requires the use of a discount rate.c. does not require the use of a discount rate.d. Both A and B.e. Both A and C.Difficulty level: MediumAVERAGE ACCOUNTING RETURNd 54. The shortcoming(s) of the average accounting return (AAR) method is (are):a. the use of net income instead of cash flows.b. the pattern of income flows has no impact on the AAR.c. there is no clear-cut decision rule.d. All of the above.e. None of the above.Difficulty level: MediumINTERNAL RATE OF RETURNe 55. The two fatal flaws of the internal rate of return rule are:a. arbitrary determination of a discount rate and failure to consider initial expenditures.b. arbitrary determination of a discount rate and failure to correctly analyze mutuallyexclusive investment projects.c. arbitrary determination of a discount rate and the multiple rate of return problem.d. failure to consider initial expenditures and failure to correctly analyze mutuallyexclusive investment projects.e. failure to correctly analyze mutually exclusive investment projects and the multiple rateof return problem.Difficulty level: MediumMUTUALLY EXCLUSIVE PROJECTSd 56. A mutually exclusive project is a project whose:a. acceptance or rejection has no effect on other projects.b. NPV is always negative.c. IRR is always negative.d. acceptance or rejection affects other projects.e. cash flow pattern exhibits more than one sign change.Difficulty level: EasyINTERNAL RATE OF RETURNd 57. A project will have more than one IRR if:a. the IRR is positive.b. the IRR is negative.c. the NPV is zero.d. the cash flow pattern exhibits more than one sign change.e. the cash flow pattern exhibits exactly one sign change.Difficulty level: EasyINTERNAL RATE OF RETURN RULESb 58. Using internal rate of return, a conventional project should be accepted if the internalrate of return is:a. equal to the discount rate.b. greater than the discount rate.c. less than the discount rate.d. negative.e. positive.Difficulty level: EasyINTERNAL RATE OF RETURNa 59. The internal rate of return may be defined as:a. the discount rate that makes the NPV cash flows equal to zero.b. the difference between the market rate of interest and the NPV.c. the market rate of interest less the risk-free rate.d. the project acceptance rate set by management.e. None of the above.Difficulty level: MediumMULTIPLE INTERNAL RATE OF RETURNSd 60. The problem of multiple IRRs can occur when:a. there is only one sign change in the cash flows.b. the first cash flow is always positive.c. the cash flows decline over the life of the project.d. there is more than one sign change in the cash flows.e. None of the above.Difficulty level: EasyTIMING AND SCALE ISSUES WITH INTERNAL RATE OF RETURNb 61. The elements that cause problems with the use of the IRR in projects that are mutuallyexclusive are:a. the discount rate and scale problems.b. timing and scale problems.c. the discount rate and timing problems.d. scale and reversing flow problems.e. timing and reversing flow problems.Difficulty level: MediumNET PRESENT VALUE DECISIONc 62. If there is a conflict between mutually exclusive projects due to the IRR, one should:a. drop the two projects immediately.b. spend more money on gathering information.c. depend on the NPV as it will always provide the most value.d. depend on the AAR because it does not suffer from these same problems.e. None of the above.Difficulty level: MediumPROFITABILITY INDEXe 63. The profitability index is the ratio of:a. average net income to average investment.b. internal rate of return to current market interest rate.c. net present value of cash flows to internal rate of return.d. net present value of cash flows to average accounting return.e. present value of cash flows to initial investment cost.Difficulty level: EasyINVESTMENT DECISION RULESa 64. Which of the following statement is true?a. One must know the discount rate to compute the NPV of a project but one can computethe IRR without referring to the discount rate.b. One must know the discount rate to compute the IRR of a project but one can computethe NPV without referring to the discount rate.c. Payback accounts for time value of money.d. There will always be one IRR regardless of cash flows.e. Average accounting return is the ratio of total assets to total net income.Difficulty level: MediumCAPITAL BUDGETING PRACTICE。

CHAPTER 3Financial Statement Analysis, Planning, and Growth Multiple Choice Questions:I. DEFINITIONSLONG-TERM PLANNINGc 1. One key reason a long-term financial plan is developed is because:a. the plan determines your financial policy.b. the plan determines your investment policy.c. there are direct connections between achievable corporate growth and the financialpolicy.d. there is unlimited growth possible in a well-developed financial plan.e. None of the above.PRO FORMA STATEMENTSb 2. Projected future financial statements are called:a. plug statements.b. pro forma statements.c. reconciled statements.d. aggregated statements.e. none of the above.PERCENTAGE OF SALESe 3. The percentage of sales method:a. requires that all accounts grow at the same rate.b. separates accounts that vary with sales and those that do not vary with sales.c. allows the analyst to calculate how much financing the firm will need to support thepredicted sales level.d. Both A and B.e. Both B and C.COMMON-SIZE STATEMENTSe 4. A _____ standardizes items on the income statement and balance sheet as a percentageof total sales and total assets, respectively.a. tax reconciliation statementb. statement of standardizationc. statement of cash flowsd. common-base year statemente. common-size statementFINANCIAL RATIOSa 5. Relationships determined from a firm’s financial information and used for comparisonpurposes are known as:a. financial ratios.b. comparison statements.c. dimensional analysis.d. scenario analysis.e. solvency analysis.SHORT-TERM SOLVENCY RATIOSc 6. Financial ratios that measure a firm’s ability to pay its bills over the short run withoutundue stress are known as _____ ratios.a. asset managementb. long-term solvencyc. short-term solvencyd. profitabilitye. market valueCURRENT RATIOb 7. The current ratio is measured as:a. current assets minus current liabilities.b. current assets divided by current liabilities.c. current liabilities minus inventory, divided by current assets.d. cash on hand divided by current liabilities.e. current liabilities divided by current assets.QUICK RATIOd 8. The quick ratio is measured as:a. current assets divided by current liabilities.b. cash on hand plus current liabilities, divided by current assets.c. current liabilities divided by current assets, plus inventory.d. current assets minus inventory, divided by current liabilities.e. current assets minus inventory minus current liabilities.CASH RATIOe 9. The cash ratio is measured as:a. current assets divided by current liabilities.b. current assets minus cash on hand, divided by current liabilities.c. current liabilities plus current assets, divided by cash on hand.d. cash on hand plus inventory, divided by current liabilities.e. cash on hand divided by current liabilities.LONG-TERM SOLVENCY RATIOSb 10. Ratios that measure a firm’s financial leverage are known as _____ ratios.a. asset managementb. long-term solvencyc. short-term solvencyd. profitabilitye. market valueTOTAL DEBT RATIOa 11. The financial ratio measured as total assets minus total equity, divided by total assets, isthe:a. total debt ratio.b. equity multiplier.c. debt-equity ratio.d. current ratio.e. times interest earned ratio.DEBT-EQUITY RATIOc 12. The debt-equity ratio is measured as total:a. equity minus total debt.b. equity divided by total debt.c. debt divided by total equity.d. debt plus total equity.e. debt minus total assets, divided by total equity.EQUITY MULTIPLIERe 13. The equity multiplier ratio is measured as total:a. equity divided by total assets.b. equity plus total debt.c. assets minus total equity, divided by total assets.d. assets plus total equity, divided by total debt.e. assets divided by total equity.TIMES INTEREST EARNED RATIOc 14. The financial ratio measured as earnings before interest and taxes, divided by interestexpense is the:a. cash coverage ratio.b. debt-equity ratio.c. times interest earned ratio.d. gross margin.e. total debt ratio.CASH COVERAGE RATIOa 15. The financial ratio measured as earnings before interest and taxes, plus depreciation,divided by interest expense, is the:a. cash coverage ratio.b. debt-equity ratio.c. times interest earned ratio.d. gross margin.e. total debt ratio.ASSET MANAGEMENT RATIOSa 16. Ratios that measure how efficiently a firm uses its assets to generate sales are known as_____ ratios.a. asset managementb. long-term solvencyc. short-term solvencyd. profitabilitye. market valueINVENTORY TURNOVERc 17. The inventory turnover ratio is measured as:a. total sales minus inventory.b. inventory times total sales.c. cost of goods sold divided by inventory.d. inventory times cost of goods sold.e. inventory plus cost of goods sold.DAYS’ SALES IN INVENTORYe 18. The financial ratio days’ sales in inventory is measured as:a. inventory turnover plus 365 days.b. inventory times 365 days.c. inventory plus cost of goods sold, divided by 365 days.d. 365 days divided by the inventory.e. 365 days divided by the inventory turnover.RECEIVABLES TURNOVERb 19. The receivables turnover ratio is measured as:a. sales plus accounts receivable.b. sales divided by accounts receivable.c. sales minus accounts receivable, divided by sales.d. accounts receivable times sales.e. accounts receivable divided by sales.DAYS’ SALES IN RECEIVABLESd 20. The financial ratio days’ sales in receivables is measured as:a. receivables turnover plus 365 days.b. accounts receivable times 365 days.c. accounts receivable plus sales, divided by 365 days.d. 365 days divided by the receivables turnover.e. 365 days divided by the accounts receivable.TOTAL ASSET TURNOVERb 21. The total asset turnover ratio is measured as:a. sales minus total assets.b. sales divided by total assets.c. sales times total assets.d. total assets divided by sales.e. total assets plus sales.PROFITABILITY RATIOSd 22. Ratio s that measure how efficiently a firm’s management uses its assets and equity togenerate bottom line net income are known as _____ ratios.a. asset managementb. long-term solvencyc. short-term solvencyd. profitabilitye. market valuePROFIT MARGINa 23. The financial ratio measured as net income divided by sales is known as the firm’s:a. profit margin.b. return on assets.c. return on equity.d. asset turnover.e. earnings before interest and taxes.RETURN ON ASSETSb 24. The financial ratio measured as net income divided by total assets is known as thefirm’s:a. profit margin.b. return on assets.c. return on equity.d. asset turnover.e. earnings before interest and taxes.RETURN ON EQUITYc 25. The financial ratio measured as net income divided by total equity is known as thefirm’s:a. profit margin.b. return on assets.c. return on equity.d. asset turnover.e. earnings before interest and taxes.PRICE-EARNINGS RATIOd 26. The financial ratio measured as the price per share of stock divided by earnings pershare is known as the:a. return on assets.b. return on equity.c. debt-equity ratio.d. price-earnings ratio.e. Du Pont identity.MARKET-TO-BOOK RATIOe 27. The market-to-book ratio is measured as:a. total equity divided by total assets.b. net income times market price per share of stock.c. net income divided by market price per share of stock.d. market price per share of stock divided by earnings per share.e. market value of equity per share divided by book value of equity per share.DU PONT IDENTITYa 28. The _____ breaks down return on equity into three component parts.a. Du Pont identityb. return on assetsc. statement of cash flowsd. asset turnover ratioe. equity multiplierEXTERNAL FUNDS NEEDEDc 29. The External Funds Needed (EFN) equation does not measures the:a. additional asset requirements given a change in sales.b. additional total liabilities financing raised given the change in sales.c. rate of return to shareholders given the change in sales.d. net income expected to be earned given the change in sales.e. None of the above.SUSTAINABLE GROWTH RATEe 30. To calculate sustainable growth rate, the analyst needs the:a. profit margin.b. payout ratio.c. debt-to-equity ratio.d. asset requirement ratio.e. All of the above.GROWTHb 31. Growth can be reconciled with the goal of maximizing firm value:a. because greater growth always adds to value.b. because growth must be an outcome of decisions that maximize NPV.c. because growth and wealth maximization are the same.d. because growth of any type cannot decrease value.e. none of the above.SUSTAINABLE GROWTHb 32. Sustainable growth can be determined by the:a. profit margin, total asset turnover and the price to earnings ratio.b. profit margin, the payout ratio, the debt-to-equity ratio, and the asset requirement ratio.c. Total growth less capital gains growth.d. Either A or B.e. None of the above.SUSTAINABLE GROWTHc 33. Which of the following will increase sustainable growth?a. Buy back existing stock.b. Decrease debt.c. Increase profit margin.d. Increase asset requirement ratio.e. Increase dividend payout ratio.LONG TERM PLANNINGd 34. The main objective of long-term financial planning models is to:a. determine the asset requirements given the investment activities of the firm.b. plan for contingencies or uncertain events.c. determine the external financing needs.d. all of the above are correct.e. none of the above are correct.COMMON-SIZE BALANCE SHEETd 35. On a common-size balance sheet, all _____accounts are shown as a percentage of:a. income; total assets.b.liability; net income.c.asset; sales.d.liability; total assets.e.equity; sales.RATIO ANALYSISa 36. Which one of the following statements is correct concerning ratio analysis?a. A single ratio is often computed differently by different individuals.b.Ratios do not address the problem of size differences among firms.c.There is only a very limited number of ratios which can be used for analytical purposes.d.Each ratio has a specific formula that is used consistently by all analysts.e.Ratios can not be used for comparison purposes over periods of time.LIQUIDITY RATIOSa 37. Which of the following are liquidity ratios?I.cash coverage ratioII.current ratioIII.quick ratioIV.inventory turnovera. II and III onlyb. I and II onlyc. II, III, and IV onlyd.I, III, and IV onlye.I, II, III, and IVLIQUIDITY RATIOSc 38. An increase in which one of the following accounts increases a firm’s current ratiowithout affecting its quick ratio?a. accounts payableb. cashc. inventoryd. accounts receivablee. fixed assetsLIQUIDITY RATIOSb 39. A supplier, who requires payment within ten days, is most concerned with whichone of the following ratios when granting credit?a. currentb.cashc.debt-equityd.quicke.total debtLONG-TERM SOLVENCY RATIOSd 40. A firm has a total debt ratio of .47. This means that that firm has 47 cents in debt forevery:a. $1 in equity.b. $1 in total sales.c. $1 in current assets.d.$.53 in equity.e.$.53 in total assets.LONG-TERM SOLVENCY RATIOSd 41. The long-term debt ratio is probably of most interest to a firm’s:a. credit customers.b.employees.c.suppliers.d.mortgage holder.e.shareholders.LONG-TERM SOLVENCY RATIOSe 42. A banker considering loaning a firm money for ten years would most likely prefer thefirm have a debt ratio of _____ and a times interest earned ratio of_____ .a. .75; .75.b..50; .c..45; .d..40; .e..35; .LONG-TERM SOLVENCY RATIOSb 43. From a cash flow position, which one of the following ratios best measures a firm’sability to pay the interest on its debts?a. times interest earned ratiob.cash coverage ratioc.cash ratiod.quick ratioe.interval measureASSET MANAGEMENT RATIOSa 44. The higher the inventory turnover measure, the:a. faster a firm sells its inventory.b.faster a firm collects payment on its sales.c.longer it takes a firm to sell its inventory.d.greater the amount of inventory held by a firm.e.lesser the amount of inventory held by a firm.ASSET MANAGEMENT RATIOSd 45. Which one of the following statements is correct if a firm has a receivables turnovermeasure of 10?a. It takes a firm 10 days to collect payment from its customers.b.It takes a firm days to sell its inventory and collect the payment from the sale.c.It takes a firm days to pay its creditors.d.The firm has an average collection period of days.e.The firm has ten times more in accounts receivable than it does in cash.ASSET MANAGEMENT RATIOSd 46. A total asset turnover measure of means that a firm has $ in:a. total assets for every $1 in cash.b.total assets for every $1 in total debt.c.total assets for every $1 in equity.d.sales for every $1 in total assets.e.long-term assets for every $1 in short-term assets.PROFITABILITY RATIOSc 47. Puffy’s Pastries generates five cents of net income for every $1 in sales. Thus,Puffy’s has a _____ of 5 percent.a. return on assetsb.return on equityc.profit margind.Du Pont measuree.total asset turnoverPROFITABILITY RATIOSa 48. If a firm produces a 10 percent return on assets and also a 10 percent return onequity, then the firm:a. has no debt of any kind.b.is using its assets as efficiently as possible.c.has no net working capital.d.also has a current ratio of 10.e.has an equity multiplier of 2.PROFITABILITY RATIOSc 49. If shareholders want to know how much profit a firm is making on their entireinvestment in the firm, the shareholders should look at the:a. profit margin.b.return on assets.c.return on equity.d.equity multiplier.e.earnings per share.PROFITABILITY RATIOSa 50. BGL Enterprises increases its operating efficiency such that costs decrease while salesremain constant. As a result, given all else constant, the:a. return on equity will increase.b. return on assets will decrease.c. profit margin will decline.d. equity multiplier will decrease.e. price-earnings ratio will increase.PROFITABILITY RATIOSd 51. The only difference between Joe’s and Moe’s is that Joe’s has old, fully depreciatedequipment. Moe’s just purchased all new equipment which will be depreciated overeight years. Assuming all else equal:a. Joe’s will have a lower profit margin.b. Joe’s will have a lower return on equity.c. Moe’s will have a higher net income.d. Moe’s will have a lower profit margin.e. Moe’s will have a higher return on assets.MARKET VALUE RATIOSe 52. Last year, Alfred’s Automotive had a price-earnings ratio of 15. This year, the priceearnings ratio is 18. Based on this information, it can be stated with certainty that:a. the price per share increased.b. the earnings per share decreased.c. investors are paying a higher price for each share of stock purchased.d. investors are receiving a higher rate of return this year.e. either the price per share, the earnings per share, or both changed.MARKET VALUE RATIOb 53. Turner’s Inc. has a price-earnings ratio of 16. Alfred’s Co. has a price-earnings ratio of19. Thus, you can state with certainty t hat one share of stock in Alfred’s:a. has a higher market price than one share of stock in Turner’s.b. has a higher market price per dollar of earnings than does one share of Turner’s.c. sells at a lower price per share than one share of Turner’s.d. represents a larger percentage of firm ownership than does one share of Turner’s stock.e. earns a greater profit per share than does one share of Turner’s stock.MARKET VALUE RATIOSb 54. Which two of the following are most apt to cause a firm to have a higher price-earningsratio?I. slow industry outlookII. high prospect of firm growthIII. very low current earningsIV. investors with a low opinion of the firma. I and II onlyb. II and III onlyc. II and IV onlyd. I and III onlye. III and IV onlyMARKET VALUE RATIOSd 55. Vinnie’s Motors has a market-to-book ratio of 3. The book value per share is $.This means that a $1 increase in the book value per share will:a. cause the accountants to increase the equity of the firm by an additional $2.b. increase the market price per share by $1.c. increase the market price per share by $12.d. tend to cause the market price per share to rise.e. only affect book values but not market values.MARKET VALUE RATIOSd 56. Which one of the following sets of ratios applies most directly to shareholders?a. return on assets and profit marginb.quick ratio and times interest earnedc.price-earnings ratio and debt-equity ratiod.market-to-book ratio and price-earnings ratioe.cash coverage ratio and times equity multiplierDU PONT IDENTITYb 57. The three parts of the Du Pont identity can be generally described as:I. operating efficiency, asset use efficiency and firm profitability.II. financial leverage, operating efficiency and asset use efficiency.III. the equity multiplier, the profit margin and the total asset turnover.IV. the debt-equity ratio, the capital intensity ratio and the profit margin.a. I and II onlyb. II and III onlyc. I and IV onlyd. I and III onlye. III and IV onlyDU PONT IDENTITYe 58. If a firm decreases their operating costs, all else constant, then:a. the profit margin increases while the equity multiplier decreases.b. the return on assets increases while the return on equity decreases.c. the total asset turnover rate decreases while the profit margin increases.d. both the profit margin and the equity multiplier increase.e. both the return on assets and the return on equity increase.EVALUATING FINANCIAL STATEMENTSb 59. Which one of the following statements is correct?a. Book values should always be given precedence over market values.b. Financial statements are frequently the basis used for performance evaluations.c. Historical information has no value when predicting the future.d. Potential lenders place little value on financial statement information.e. Reviewing financial information over time has very limited value.EVALUATING FINANCIAL STATEMENTSc 60. It is easier to evaluate a firm using their financial statements when the firm:a. is a conglomerate.b. is global in nature.c. uses the same accounting procedures as other firms in their industry.d. has a different fiscal year than other firms in their industry.e. tends to have one-time events such as asset sales and property acquisitions. EVALUATING FINANCIAL STATEMENTSa 61. Which two of the following represent the most effective methods ofdirectly evaluating the financial performance of a firm?I. comparing the current financial ratios to those of the same firm from prior timeperiodsII. comparing a firm’s financial ratios to those of other firms in the firm’s peergroup who have similar operationsIII. comparing the financial statements of the firm to the financial statements of similar firms operating in other countriesIV. comparing the financial ratios of the firm to the average ratios of all firms located in the same geographic areaa. I and II onlyb. II and III onlyc. III and IV onlyd. I and IV onlye. I and III onlyEVALUATING FINANCIAL STATEMENTSe 62. Which of the following represent problems encountered when comparing the financialstatements of one firm with those of another firm?I. Either one, or both, of the firms may be conglomerates and thus have unrelated lines ofbusiness.II. The operations of the two firms may vary geographically.III. The firms may use differing accounting methods for inventory purposes.IV. The two firms may be seasonal in nature and have different fiscal year ends.a. I and II onlyb. II and III onlyc. I, III, and IV onlyd. I, II, and III onlye. I, II, III, and IVEXTERNAL FUNDS NEEDEDb 63. In the financial planning model, external funds needed (EFN) is equal to changes ina. assets - (liabilities – equity).b. assets - (liabilities + equity).c. (assets + liabilities. – equity).d. (assets + equity. – liabilities).e. assets - equity.SUSTAINABLE GROWTH RATEe 64. A firm's sustainable growth rate in sales does not directly depend on itsa. debt to equity ratio.b. profit margin.c. dividend policy.d. asset efficiency.e. all of the above.SUSTAINABLE GROWTH RATEa 65. The sustainable growth rate will be equivalent to the internal growth rate when:a. a firm has no debt.b. the growth rate is positive.c. the plowback ratio is positive but less than 1.d. a firm has a debt-equity ratio exactly equal to 1.e. net income is greater than zero.SUSTAINABLE GROWTH RATEb 66. The sustainable growth rate:a. assumes there is no external financing of any kind.b. is normally higher than the internal growth rate.c. assumes the debt-equity ratio is variable.d. is based on receiving additional external debt and equity financing.e. assumes that 100 percent of all income is retained by the firm.SUSTAINABLE GROWTH RATEd 67. If a firm bases its growth projection on the rate of sustainable growth, and showspositive net income, then the:a. fixed assets will have to increase at the same rate, regardless of the current capacitylevel.b. number of common shares outstanding will increase at the same rate of growth.c. debt-equity ratio will have to increase.d. debt-equity ratio will remain constant while retained earnings increase.e. fixed assets, debt-equity ratio, and number of common shares outstanding will allincrease.SUSTAINABLE GROWTH RATEd 68. Marcie’s Mercantile wants to maintain their current dividend policy, which is a payoutratio of 40 percent. The firm does not want to increase their equity financing but arewilling to maintain their current debt-equity ratio. Given these requirements, themaximum rate at which Marcie’s can grow is equal to:a. 40 percent of the internal rate of growth.b. 60 percent of the internal rate of growth.c. the internal rate of growth.d. the sustainable rate of growth.e. 60 percent of the sustainable rate of growth.FINANCIAL PLANNING MODELSe 69. One of the primary weaknesses of many financial planning models is that they:a. rely too much on financial relationships and too little on accounting relationships.b. are iterative in nature.c. ignore the goals and objectives of senior management.d. are based solely on best case assumptions.e. ignore the size, risk, and timing of cash flows.FINANCIAL PLANNINGd 70. Financial planning, when properly executed,a. ignores the normal restraints encountered by a firm.b. ensures that the primary goals of senior management are fully achieved.c. reduces the necessity of daily management oversight of the business operations.d. helps ensure that proper financing is in place to support the desired level of growth.e. eliminates the need to plan more than one year in advance.III. PROBLEMSCOMMON-SIZE STATEMENTSb 71. A firm has sales of $1,200, net income of $200, net fixed assets of $500, and currentassets of $300. The firm has $100 in inventory. What is the common-size statementvalue of inventory?a. percentb. percentc. percentd. percente. percentCOMMON-SIZE STATEMENTSa 72. A firm has sales of $1,500, net income of $100, total assets of $1,000, and total equityof $700. Interest expense is $50. What is the common-size statement value of theinterest expense?a. percentb. percentc. percentd. percente. percentLIQUIDITY RATIOSb 73. Jessica’s Boutique has cash of $50, accounts receivable of $60, accounts payable of$200, and inventory of $150. What is the value of the quick ratio?a. .30b. .55c. .77d.e.LONG-TERM SOLVENCY RATIOSa 74. A firm has a debt-equity ratio of .40. What is the total debt ratio?a. .29b. .33c. .67d.e.LONG-TERM SOLVENCY RATIOSe 75. A firm has total debt of $1,200 and a debt-equity ratio of .30. What is the value of thetotal assets?a. $1,560b. $3,000c. $3,600d. $4,000e. $5,200LONG-TERM SOLVENCY RATIOSd 76. A firm has sales of $3,600, costs of $2,800, interest paid of $100, and depreciation of$400. The tax rate is 34 percent. What is the value of the cash coverage ratio?a. 2b. 4c. 6d. 8e. 10LONG-TERM SOLVENCY RATIOSd 77. Rosita’s Res ources paid $250 in interest and $130 in dividends last year. The timesinterest earned ratio is and the depreciation expense is $60. What is the value of thecash coverage ratio?a.b.c.d.e.ASSET MANAGEMENT RATIOSc 78. Mario’s Home Systems has sales of $2,800, costs of goods sold of $2,100, inventory of$500, and accounts receivable of $400. How many days, on average, does it takeMario’s to sell their inventory?a. daysb. daysc. daysd. dayse. daysASSET MANAGEMENT RATIOSd 79. Syed’s Industries has accounts receivable of $700, inventory of $1,200, sales of$4,200, and cost of goods sold of $3,400. How long does it take Syed’s to both selltheir inventory and then collect the payment on the sale?b. 146 daysc. 163 daysd. 190 dayse. 211 daysASSET MANAGEMENT RATIOSb 80. A firm has net working capital of $400, net fixed assets of $2,400, sales of $6,000, andcurrent liabilities of $800. How many dollars worth of sales are generated from every$1 in total assets?a. $b. $c. $d. $e. $PROFITABILITY RATIOSb 81 Rosita’s Restaurante has sales of $4,500, total debt of $1,300, total equity of $2,400,and a profit margin of 5 percent. What is the return on assets?a. percentb. percentc. percentd. percente. percentPROFITABILITY RATIOSc 82. Lee Sun’s has sales of $3,000, total assets of $2,500, and a profit margin of 5 percent.The firm has a total debt ratio of 40 percent. What is the return on equity?a. 6 percentb. 8 percentc. 10 percentd. 12 percente. 15 percentMARKET VALUE RATIOSd 83. Jupiter Explorers has $6,400 in sales. The profit margin is 4 percent. There are 6,400shares of stock outstanding. The market price per share is $. What is the price- earnings ratio?a. 13b. 14c. 21d. 30e. 48MARKET VALUE RATIOSc 84. Patti’s has net income of $1,800, a price-earnings ratio of 12, and earnings per share of$. How many shares of stock are outstanding?a. 1,200b. 1,400c. 1,500d. 1,600。

CHAPTER 6Stock Valuation I. DEFINITIONSGROWING PERPETUITYa 1. An asset characterized by cash flows that increase at a constant rate forever is called a:a. growing perpetuity.b. growing annuity.c. common annuity.d. perpetuity due.e. preferred stock.Difficulty level: EasyDIVIDEND GROWTH MODELb 2. The stock valuation model that determines the current stock price by dividing the next annualdividend amount by the excess of the discount rate less the dividend growth rate is called the_____ model.a. zero growthb. dividend growthc. capital pricingd. earnings capitalizatione. discounted dividendDifficulty level: EasyDIVIDEND YIELDc 3. Next year’s annual dividend divided by the current stock price is called the:a. yield to maturity.b. total yield.c. dividend yield.d. capital gains yield.e. earnings yield.Difficulty level: EasyCAPITAL GAINS YIELDd 4. The rate at which a stock’s price is expected to appreciate (or depreciate) is called the _____yield.a. currentb. totalc. dividendd. capital gainse. earningsDifficulty level: EasyPREFERRED STOCKd 5. A form of equity which receives preferential treatment in the payment of dividends is called_____ stock.a. dual classb. cumulativec. deferredd. preferrede. commonDifficulty level: EasyPREFERRED STOCKe 6. A _____ is a form of equity security that has a stated liquidating value.a. bondb. debenturec. proxyd. common stocke. preferred stockDifficulty level: MediumCOMMON STOCKe 7. A form of equity which receives no preferential treatment in either the payment of dividends orin bankruptcy distributions is called _____ stock.a. dual classb. cumulativec. deferredd. preferrede. commonDifficulty level: EasyCUMULATIVE VOTINGb 8. The voting procedure whereby shareholders may cast all of their votes for one member of theboard is called _____ voting.a. democraticb. cumulativec. straightd. deferrede. proxyDifficulty level: EasySTRAIGHT VOTINGc 9. The voting procedure where you must own 50% plus one of the outstanding shares of stock toguarantee that you will win a seat on the board of directors is called _____ voting.a. democraticb. cumulativec. straightd. deferrede. proxyDifficulty level: EasyPROXY VOTINGe 10. The voting procedure where a shareholder grants authority to another individual to vote his/hershares is called _____ voting.a. democraticb. cumulativec. straightd. deferrede. proxyDifficulty level: EasyPREEMPTIVE RIGHTSb 11. Preemptive rights refer to the right of shareholders to:a. share proportionately in dividends paid.b. share proportionately in any new stock issues sold.c. share proportionately in liquidated assets.d. vote at annual shareholder meetings.e. override the votes of other shareholders.Difficulty level: MediumDIVIDENDSc 12. Payments made by a corporation to its shareholders, in the form of either cash, stock orpayments in kind, are called:a. retained earnings.b. net income.c. dividends.d. redistributions.e. infused equity.Difficulty level: EasyPRIMARY MARKETe 13. The market in which new securities are originally sold to investors is called the _____ market.a. dealerb. auctionc. over-the-counterd. secondarye. primaryDifficulty level: EasySECONDARY MARKETd 14. The market in which previously issued securities are traded among investors is called the _____market.a. dealerb. auctionc. over-the-counterd. secondarye. primaryDifficulty level: EasyDEALERe 15. An agent who buys and sells securities from inventory is called a:a. broker.b. trader.c. capitalist.d. principal.e. dealer.Difficulty level: EasyBROKERa 16. An agent who arranges security transactions among investors is called a:a. broker.b. trader.c. capitalist.d. principal.e. dealer.Difficulty level: EasyNYSE MEMBERb 17. The owner of a seat on the New York Stock Exchange is called a(n) _____ of the exchange.a. friendb. memberc. agentd. trusteee. dealerDifficulty level: EasySPECIALISTc 18. A member of the New York Stock Exchange acting as a dealer in one or more securities on theexchange floor is called a:a. floor trader.b. floor post.c. specialist.d. floor broker.e. commission broker.Difficulty level: EasyFLOOR BROKERd 19. A member of the New York Stock Exchange who executes orders for commission brokers on afee basis is a:a. floor trader.b. dealer.c. specialist.d. floor broker.e. floor agent.Difficulty level: EasyCOMMISSION BROKERe 20. A member of the New York Stock Exchange who executes buy and sell orders from customersonce transmitted to the exchange floor is called a:a. floor trader.b. dealer.c. specialist.d. floor broker.e. commission broker.Difficulty level: EasyFLOOR TRADERa 21. A member of the New York Stock Exchange who trades for his or her own account, trying toanticipate temporary price fluctuations, is called a(n):a. floor trader.b. exchange customer.c. specialist.d. floor broker.e. commission broker.Difficulty level: EasySUPERDOT SYSTEMb 22. The electronic system used by the New York Stock Exchange which enables orders to betransmitted directly to a specialist is called the ______ system..a. NASDAQb. SuperDOTc. Instinetd. Internete. brokerage.Difficulty level: EasyORDER FLOWc 23. The ________ has a multiple market maker system rather than a specialist system.a. NYSE.b. AMEX.c. NASDAQ.d. NIKKEIe. None of the above.Difficulty level: EasyOVER-THE-COUNTER MARKETc 24. A securities market primarily comprised of dealers who buy and sell for their own inventoriesis generally referred to as a(n) ______ market.a. auctionb. privatec. over-the-counterd. regionale. electronic networkDifficulty level: EasyECNsd 25. Electronic communications networks, or ECNs, act to:a. increase liquidity.b. i ncrease competition.c. increase the cost to invest.d. A & B.e. A & C.Difficulty level: MediumII. CONCEPTSVALUATION OF ZERO GROWTH STOCKc 26. The James River Co. pays an annual dividend of $1.50 per share on its common stock.This dividend amount has been constant for the past 15 years and is expected to remainconstant. Given this, one share of James River Co. stock:a. is basically worthless as it offers no growth potential.b. has a market value equal to the present value of $1.50 paid one year from today.c. is valued as if the dividend paid is a perpetuity.d. is valued with an assumed growth rate of 3%.e. has a market value of $15.00.Difficulty level: EasyVALUATION OF ZERO GROWTH STOCKe 27. The common stock of the Kenwith Co. pays a constant annual dividend. Thus, the market priceof Kenwith stock will:a. also remain constant.b. increase over time.c. decrease over time.d. increase when the market rate of return increases.e. decrease when the market rate of return increases.Difficulty level: EasyDIVIDEND YIELD VS. CAPITAL GAINS YIELDc 28. The Koster Co. currently pays an annual dividend of $1.00 and plans on increasing that amountby 5% each year. The Keyser Co. currently pays an annual dividend of $1.00 and plans onincreasing their dividend by 3% annually. Given this, it can be stated with certainty that the_____ of the Koster Co. stock is greater than the _____ of the Keyser Co. stock.a. market price; market priceb. dividend yield; dividend yieldc. rate of capital gain; rate of capital gaind. total return; total returne. capital gains; dividend yieldDifficulty level: MediumDIVIDEND GROWTH MODELd 29. The dividend growth model:I. assumes that dividends increase at a constant rate forever.II. can be used to compute a stock price at any point of time.III. states that the market price of a stock is only affected by the amount of the dividend.IV. considers capital gains but ignores the dividend yield.a. I onlyb. II onlyc. III and IV onlyd. I and II onlye. I, II, and III onlyDifficulty level: MediumDIVIDEND GROWTH MODELb 30. The underlying assumption of the dividend growth model is that a stock is worth:a. the same amount to every investor regardless of their desired rate of return.b. the present value of the future income which the stock generates.c. an amount computed as the next annual dividend divided by the market rate of return.d. the same amount as any other stock that pays the same current dividend and has the samerequired rate of return.e. an amount computed as the next annual dividend divided by the required rate of return.Difficulty level: MediumDIVIDEND GROWTH MODELc 31. Assume that you are using the dividend growth model to value stocks. If you expect the marketrate of return to increase across the board on all equity securities, then you should also expectthe:a. market values of all stocks to increase, all else constant.b. market values of all stocks to remain constant as the dividend growth will offset theincrease in the market rate.c. market values of all stocks to decrease, all else constant.d. stocks that do not pay dividends to decrease in price while the dividend-paying stocks maintaina constant price.e. dividend growth rates to increase to offset this change.Difficulty level: MediumDIFFERENTIAL GROWTHc 32. Latcher’s Inc. is a relativel y new firm that is still in a period of rapid development. Thecompany plans on retaining all of its earnings for the next six years. Seven years fromnow, the company projects paying an annual dividend of $.25 a share and thenincreasing that amount by 3% annually thereafter. To value this stock as of today, you wouldmost likely determine the value of the stock _____ years from today before determining today’s value.a. 4b. 5c. 6d. 7e. 8Difficulty level: MediumDIFFERENTIAL GROWTHd 33. The Robert Phillips Co. currently pays no dividend. The company is anticipatingdividends of $0, $0, $0, $.10, $.20, and $.30 over the next 6 years, respectively. Afterthat, the company anticipates increasing the dividend by 4% annually. The first step incomputing the value of this stock today, is to compute the value of the stock when it reachesconstant growth in year:a. 3.b. 4.c. 5.d. 6.e. 7.Difficulty level: MediumDIFFERENTIAL GROWTHb 34. Supernormal growth refers to a firm that increases its dividend by:a. three or more% per year.b. a rate which is most likely not sustainable over an extended period of time.c. a constant rate of 2 or more% per year.d. $.10 or more per year.e. an amount in excess of $.10 a year.Difficulty level: MediumDIVIDEND YIELD AND CAPITAL GAINSe 35. The total rate of return earned on a stock is comprised of which two of the following?I. current yieldII. yield to maturityIII. dividend yieldIV. capital gains yielda. I and II onlyb. I and IV onlyc. II and III onlyd. II and IV onlye. III and IV onlyDifficulty level: MediumDIVIDEND YIELDc 36. The total rate of return on a stock can be positive even when the price of the stock depreciatesbecause of the:a. capital appreciation.b. interest yield.c. dividend yield.d. supernormal growth.e. real rate of return.Difficulty level: MediumDIVIDEND YIELD AND CAPITAL GAINSc 37. Fred Flintlock wants to earn a total of 10% on his investments. He recently purchased shares ofABC stock at a price of $20 a share. The stock pays a $1 a year dividend. The price of ABCstock needs to _____ if Fred is to achieve his 10% rate of return.a. remain constantb. decrease by 5%c. increase by 5%d. increase by 10%e. increase by 15%Difficulty level: MediumDIVIDEND GROWTH MODELd 38. Which one of the following correctly defines the dividend constant growth model?a. P0 = D0÷ (R-g)b. D = P0⨯ (R-g)c. R = (P0÷ D0) + gd. R = (D1÷ P0) + ge. P0 = (D1÷ R) + gDifficulty level: MediumSHAREHOLDER RIGHTSa 39. Shareholders generally have the right to:I. elect the corporate directors.II. select the senior management of the firm.III. elect the chief executive officer (CEO).IV. elect the chief operating officer (COO).a. I onlyb. I and III onlyc. II onlyd. I and II onlye. III and IV onlyDifficulty level: MediumCUMULATIVE VOTINGc 40. Jack owns 35 shares of stock in Beta, Inc. and wants to exercise as much control as possibleover the company. Beta, Inc. has a total of 100 shares of stock outstanding. Each share receives one vote. Presently, the company is voting to elect two new directors. Which one of thefollowing statements must be true given this information?a. If straight voting applies, Jack is assured one seat on the board.b. If straight voting applies, Jack can control both open seats.c. If cumulative voting applies, Jack is assured one seat on the board.d. If cumulative voting applies, Jack can control both open seats.e. Regardless of the type of voting employed, Jack does not own enough shares to control any ofthe seats.Difficulty level: MediumSTRAIGHT VOTINGa 41. ABC Co. is owned by a group of shareholders who all vote independently and who all wantpersonal control over the firm. If straight voting is utilized, a shareholder:a. must either own enough shares to totally control the elections or else he/she has no controlwhatsoever.b. will be able to elect at least one director as long as there are at least three open positions and theshareholder owns at least 25% plus one of the outstanding shares.c. must own at least two-thirds of the shares, plus one, to exercise control over the elections.d. is only permitted to elect one director, regardless of the number of shares owned.e. who owns more shares than anyone else, regardless of the number of shares owned, will controlthe elections.Difficulty level: MediumPROXY VOTINGe 42. The Zilo Corp. has 1,000 shareholders and is preparing to elect three new board members. Youdo not own enough shares to control the elections but are determined to oust the currentleadership. The most likely result of this situation is a:a. negotiated settlement where you are granted control over one of the three open positions.b. legal battle for control of the firm based on your discontent as an individual shareholder.c. arbitrated settlement whereby you are granted control over one of the three open positions.d. total loss of power for you since you are a minority shareholder.e. proxy fight for control of the firm.Difficulty level: MediumSHAREHOLDER RIGHTSe 43. Common stock shareholders are generally granted rights which include the right to:I. share in company profits.II. vote for company directors.III. vote on proposed mergers.IV. residual assets in a liquidation.a. I and II onlyb. II and III onlyc. I and IV onlyd. I, II, and IV onlye. I, II, III, and IVDifficulty level: MediumDIVIDENDSe 44. The Scott Co. has a general dividend policy whereby they pay a constant annual dividend of $1per share of common stock. The firm has 1,000 shares of stock outstanding. The company:a. must always show a current liability of $1,000 for dividends payable.b. is obligated to continue paying $1 per share per year.c. will be declared in default and can face bankruptcy if they do not pay $1 per year to eachshareholder on a timely basis.d. has a liability which must be paid at a later date should the company miss paying an annualdividend payment.e. must still declare each dividend before it becomes an actual company liability.Difficulty level: MediumDIVIDENDSb 45. The dividends paid by a corporation:I. to an individual become taxable income of that individual.II. reduce the taxable income of the corporation.III. are declared by the chief financial officer of the corporation.IV. to another corporation may or may not represent taxable income to the recipient.a. I onlyb. I and IV onlyc. II and III onlyd. I, II, and IV onlye. I, III, and IV onlyDifficulty level: MediumPREFERRED STOCKa 46. The owner of preferred stock:a. is entitled to a distribution of income prior to the common shareholders.b. has the right to veto the outcome of an election held by the common shareholders.c. has the right to declare the company bankrupt whenever there are insufficient funds topay dividends to the common shareholders.d. receives tax-free dividends if they are an individual and own more than 20% ofthe outstanding preferred shares.e. has the right to collect payment on any unpaid dividends as long as the stock isnoncumulative preferred.Difficulty level: MediumPREFERRED STOCKb 47. A 6% preferred stock pays _____ a year in dividends per share.a. $3b. $6c. $12d. $30e. $60Difficulty level: EasyPREFERRED STOCKe 48. Which one of the following statements concerning preferred stock is correct?a. Unpaid preferred dividends are a liability of the firm.b. Preferred dividends must be paid quarterly provided the firm has net income that exceeds theamount of the quarterly dividend.c. Preferred dividends must be paid timely each quarter or the unpaid dividends start accruinginterest.d. All unpaid dividends on preferred stock, regardless of the type of preferred, must be paid beforeany income can be distributed to common shareholders.e. Preferred shareholders may be granted voting rights and seats on the board if preferred dividendpayments remain unpaid.Difficulty level: MediumPREFERRED STOCKe 49. In a liquidation, each share of 5% preferred stock is generally entitled to a liquidation paymentof _____ as long as there are sufficient funds available.a. $1b. $5c. $10d. $50e. $100Difficulty level: MediumCOMMON STOCK VALUESc 50. The value of common stock today depends ona. the expected future holding period and the discount rate.b. the expected future dividends and the capital gains.c. the expected future dividends, capital gains and the discount rate.d. the expected future holding period and capital gains.e. None of the above.Difficulty level: MediumPRIMARY MARKETd 51. Which one of the following transactions occurs in the primary market?a. the sale of ABC stock by Fred Jones to Mary Smithb. the tax-free gift of DEF stock to Heather by Jenniferc. the repurchase of GHI stock from Tim by GHId. the initial sale of JKL stock by JKL to Jamiee. the transfer of MNO stock from Tom to his son, JonDifficulty level: MediumDEALERS AND BROKERSd 52. Which one of the following statements concerning dealers and brokers is correct?a. A dealer in market securities arranges sales between buyers and sellers for a fee.b. A dealer in market securities pays the asked price when purchasing securities.c. A broker in market securities earns income in the form of a bid-ask spread.d. A broker does not take ownership of the securities being traded.e. A broker deals solely in the primary market.Difficulty level: EasyPERPETUITY FORMULAd 53. The formula Po = DIV/r representsa. the present value of a stream of zero growth dividends in perpetuity.b. the value of a no growth dividend stream.c. a lower value than if a growth element was included.d. All of the above.e. None of the above.Difficulty level: EasySPECIALIST’S POSTb 54. The post is a stationary position on the floor of the New York Stock Exchange where a _____ isassigned to work.a. floor traderb. specialistc. dealerd. floor brokere. commission brokerDifficulty level: MediumSTOCK MARKET REPORTINGd 55. The closing price of a stock is quoted at 22.87, with a P/E of 26 and a net change of1.42. Based on this information, which one of the following statements is correct?a. The closing price on the previous day was $1.42 highe r than today’s closing price.b. A dealer will buy the stock at $22.87 and sell it at $26 a share.c. The stock increased in value between yesterday’s close and today’s close by $.0142.d. The earnings per share are equal to 1/26th of $22.87.e. The earnings per share have increased by $1.42 this year.Difficulty level: MediumSTOCK QUOTEb 56. A stock listing contains the following information: P/E 17.5, closing price 33.10,dividend .80, YTD% chg 3.4, and a net chg of -.50. Which of the following statementsare correct given this information?I. The stock price has increased by 3.4% during the current year.II. The closing price on the previous trading day was $32.60.III. The earnings per share are approximately $1.89.IV. The current yield is 17.5%.a. I and II onlyb. I and III onlyc. II and III onlyd. III and IV onlye. I, III, and IV onlyDifficulty level: MediumDISCOUNT RATEb 57. The discount rate in equity valuation is composed entirely ofa. the dividends paid and the capital gains yield.b. the dividend yield and the growth rate.c. the dividends paid and the growth rate.d. the capital gains earned and the growth rate.e. the capital gains earned and the dividends paid.Difficulty level: MediumNPVGOb 58. The net present value of a growth opportunity, NPVGO, can be defined asa. the present value of an investment in one new project.b. the steady growth in dividends from continual re-investment with positive NPV.c. continual reinvestment of earnings when r < g.d. a single period investment when r > g.e. None of the above.Difficulty level: MediumIII. PROBLEMSSTOCK VALUE – CONSTANT GROWTHe 59. Angelina’s made two announcements concerning their common stock today. First, thecompany announced that their next annual dividend has been set at $2.16 a share.Secondly, the company announced that all future dividends will increase by 4%annually. What is the maximum amount you should pay to purchase a share ofAngelina’s stock if your goal is to earn a 10% rate of return?a. $21.60b. $22.46c. $27.44d. $34.62e. $36.00Difficulty level: EasySTOCK VALUE – CONSTANT GROWTHd 60. How much are you willing to pay for one share of stock if the company just paid an$.80 annual dividend, the dividends increase by 4% annually and you require an8% rate of return?a. $19.23b. $20.00c. $20.40d. $20.80e. $21.63Difficulty level: EasySTOCK VALUE – CONSTANT GROWTHd 61. Lee Hong Imports paid a $1.00 per share annual dividend last week. Dividends areexpected to increase by 5% annually. What is one share of this stock worth toyou today if the appropriate discount rate is 14%?a. $7.14b. $7.50c. $11.11d. $11.67e. $12.25Difficulty level: EasySTOCK VALUE - CONSTANT GROWTHc 62. Majestic Homes stock traditionally provides an 8% rate of return. The companyjust paid a $2 a year dividend which is expected to increase by 5% per year. Ifyou are planning on buying 1,000 shares of this stock next year, how much should youexpect to pay per share if the market rate of return for this type of security is 9%at the time of your purchase?a. $48.60b. $52.50c. $55.13d. $57.89e. $70.00Difficulty level: EasySTOCK VALUE - CONSTANT GROWTHc 63. Leslie’s Unique Clothing Stores offers a common stock that pays an annual dividendof $2.00 a share. The company has promised to maintain a constant dividend. Howmuch are you willing to pay for one share of this stock if you want to earn 12%return on your equity investments?a. $10.00b. $13.33c. $16.67d. $18.88e. $20.00Difficulty level: EasySTOCK VALUE – DIFFERENTIAL GROWTHb 64. Martin’s Yachts has paid annual dividends of $1.40, $1.75, and $2.00 a share over thepast three years, respectively. The company now predicts that it will maintain aconstant dividend since its business has leveled off and sales are expected to remainrelatively constant. Given the lack of future growth, you will only buy this stock if youcan earn at least a 15% rate of return. What is the maximum amount you arewilling to pay to buy one share of this stock today?a. $10.00b. $13.33c. $16.67d. $18.88e. $20.00Difficulty level: MediumREQUIRED RETURNc 65. The common st ock of Eddie’s Engines, Inc. sells for $25.71 a share. The stock isexpected to pay $1.80 per share next month when the annual dividend is distributed.Eddie’s has established a pattern of increasing their dividends by 4% annuallyand expects to continue doing so. What is the market rate of return on this stock?a. 7%b. 9%c. 11%d. 13%e. 15%Difficulty level: MediumREQUIRED RETURNa 66. The current yield on Alpha’s common stock is 4.8%. The company just paid a$2.10 dividend. The rumor is that the dividend will be $2.205 next year. The dividendgrowth rate is expected to remain constant at the current level. What is the requiredrate of return on Alpha’s stock?a. 10.04%b. 16.07%c. 21.88%d. 43.75%e. 45.94%Difficulty level: MediumREQUIRED RETURNe 67. Martha’s Vineyard recently paid a $3.60 annual dividend on their common stock. Thisdividend increases at an average rate of 3.5% per year. The stock is currentlyselling for $62.10 a share. What is the market rate of return?a. 2.5%b. 3.5%c. 5.5%d. 6.0%e. 9.5%Difficulty level: MediumREQUIRED RETURNd 68. Bet’R Bilt Bikes just announced that their annual dividend for this coming year will be$2.42 a share and that all future dividends are expected to increase by 2.5%annually. What is the market rate of return if this stock is currently selling for $22 ashare?a. 9.5%b. 11.0%c. 12.5%d. 13.5%e. 15.0%Difficulty level: MediumDIVIDEND YIELD VS. CAPITAL GAINS YIELDb 69. Shares of common stock of the Samson Co. offer an expected total return of 12%. The dividendis increasing at a constant 8% per year. The dividend yield must be:a. - 4%.b. 4%.c. 8%.d. 12%.e. 20%.Difficulty level: MediumCAPITAL GAINc 70. The common stock of Grady Co. returned an 11.25% rate of return last year.The dividend amount was $.70 a share which equated to a dividend yield of 1.5%. What wasthe rate of price appreciation on the stock?a. 1.50%b. 8.00%c. 9.75%d. 11.25%e. 12.75%Difficulty level: EasyDIVIDEND AMOUNTb 71. Weisbro and Sons common stock sells for $21 a share and pays an annual dividend thatincreases by 5% annually. The market rate of return on this stock is 9%. What is the amount ofthe last dividend paid by Weisbro and Sons?a. $.77b. $.80c. $.84d. $.87e. $.88Difficulty level: MediumDIVIDEND AMOUNTd 72. The common stock of Energizer’s pays an annual dividend that is expected to increase by10% annually. The stock commands a market rate of return of 12% and sells for $60.50 a share.What is the expected amount of the next dividend to be paid on Energizer’s common stock?a. $.90b. $1.00c. $1.10d. $1.21e. $1.33Difficulty level: MediumDIVIDEND AMOUNTd 73. The Reading Co. has adopted a policy of increasing the annual dividend on their common stockat a constant rate of 3% annually. The last dividend they paid was $0.90 a share. What will their dividend be in six years?a. $.90b. $.93c. $1.04。