Finance #3

A firm must make its dividend payments to preferred shareholdersbefore it makes any interest payments to its bondholders.
Most preferred stock has dividends that are cumulative.
According to the constant growth model, the dividend yield is equalto the required return minus the dividend growth rate.
The NASDAQ acts as both a primary market and a secondary market forshares of stock.
A broker and a dealer are the same thing.
Over the past four years, a company has paid dividends of $1.00,$1.10, $1.20, and $1.30 respectively. This pattern is expected tocontinue into the future. This is an example of a company paying a:
dividend that grows at a decreasing rate.
You are considering investing in a firm and wish to place a value onthe common stock. The dividend on the firm's stock has not changedin the last five years. Absent any information suggesting future changesin the dividend rate, the most appropriate stock valuation model wouldbe the _____ model.
zero growth
The dividend yield on a stock is similar to the current yield on abond in that both:
represent the security's annual income divided by its price
Which one of the following is true about the differences between debtand common stock?
Interest payments are promised while dividend payments are not.
Which one of the following is a violation of the rights of one ormore classes of a firm's stakeholders?
paying common dividends when preferred dividends are in arrears
Which one of the following has lost the most importance in recentyears because of the SuperDOT system of trading?
floor broker
Suppose you own 250 shares of MIKO common stock. Two directors areto be elected. Since the firm uses cumulative voting, you can cast asmany as _____ votes for a single director.
PROBLEM: ABC's common stock dividend yield is 2.1 percent. The company just paid a dividend of $1, it is expected to pay a dividend of $1.07one year from now, and dividends are expected to grow at this same rate in definitely. What is the required rate of return on ABC's stock?
9.1 percent
PROBLEM: Boomer Products, Inc., manufactures "no-inhale" cigarettes. As theirtarget customers age and pass on, sales of the product are expected todecline. Thus, demographics suggest that earnings and dividends willdecline at a rate of 3 percent annually forever. The firm just paid adividend of $1.50. Given a required return of 12 percent, the stockshould sell for:
A web site which allows investors to trade directly with each otheris referred to as:
an electronic communications network, or ECN.
A firm that only accepts projects for which the internal rate of return (IRR) is equal to the firm's required return will, on average, neither create nor destroy wealth for its shareholders.
The net present value (NPV) decision rule is considered the best in theory.
An advantage of the payback rule is that it is easy to understand
Two projects that are mutually exclusive are said to be independent
If a project has conventional cash flows, it may also have more than one IRR.
The financial manager acts in the shareholders' best interests by identifying and taking positive NPV projects.
NPV is the difference between the market value of an investment and its cost.
Net present value (NPV) is one of the two or three most important concepts in finance.
Which one of the following statements accurately describes an advantage of the average accounting return (AAR) method of analysis?
AAR is relatively easy to compute.
A project should be accepted according to the average accounting return (AAR) whenever the AAR:
exceeds the firm's required AAR.
Your firm's CFO presents you with two capital budgeting proposals: one that involves buying a new delivery truck and one that involves building additional warehouse space. You are to determine which, if either, or both, of these projects should be accepted. This is an example of a decision involving:
independent projects
The management of a firm wishes to accept projects with a high degree of liquidity; wishes to avoid the higher forecasting error associated with cash flows a long way into the future; and wishes to avoid projects that require a large amount of research and development. The firm would be justified in using the _____ to evaluate its projects.
payback method
A project that requires an initial cash outlay and for which all remaining cash flows are inflows is said to be:
A manager will prefer the internal rate of return (IRR) rule over the net present value (NPV) rule if the manager:
prefers to talk in terms of rates of return.
PROBLEM: You undertake a project that requires an initial investment of $9,000. You expect to receive $3,100 a year for the next 4 years. If the required return is 15 percent, what is the net present value (NPV)?
You are trying to choose between two projects as you do not have sufficient funding to accept both projects. Each project costs $80,000. Project A pays $25,000 a year for 4 years and project B pays $20,000 a year for 5 years. If your required return is 14 percent, which project should you choose and why?
You should reject both projects
A project requires an initial investment of $220,000, which will be depreciated on a straight-line basis over 4 years to a zero book value. A 20 percent average accounting return (AAR) and a 15 percent internal rate of return (IRR) have been assigned to the project. The estimated annual net income from the project is $18,100, $20,500, $21,500, and $22,500, respectively. Which one of the following statements is correct concerning this project?
The project should be rejected based on the available information.
Assume a project requires additions to net working capital in each year of its life, all of which will be recovered at the end of the project. In this case, the present value of the net working capital recovery will equal the total dollar outlays for net working capital.
To accurately reflect the costs associated with a project, you should exclude interest expenses in the computation of operating cash flows.
Sunk costs and opportunity costs are often the same thing.
If net working capital grows from $1,000 to $1,500 as a result of taking on a new project, the $500 increase should be included in the initial outlay for the new project.
For a cost cutting project, the net present value will generally be negative, but the project should still be accepted.
A company that has a policy of making only cash sales is considering allowing customers to buy on credit. Which one of the following will probably occur?
The accounts receivable will likely increase.
It is important to identify and use only incremental cash flows in capital investment decisions:
because ultimately it is the change in a firm's overall future cash flows that matter.
You are advising Peter who is attempting to decide whether or not to drop one of the college courses he is currently enrolled in. If he drops the course, he will forfeit half of the money spent on tuition. If he stays in the class, he will have to give up his part-time job. His textbook is being replaced by a new edition, so is worthless at this time. Which of the following conclusions is consistent with capital budgeting principles?
Remaining in the class incurs an opportunity cost and The cost of the book is a sunk cost.
PROBLEM: Consider a $10,000 machine that will reduce pretax operating costs by $3,000 per year over a 5-year period. Assume no changes in net working capital and a zero scrap value after five years. For simplicity, assume straight-line depreciation to zero, a marginal tax rate of 34 percent, and a required return of 10 percent. The net present value of acquiring this machine is:
PROBLEM: Given the following information and assuming straight-line depreciation to zero, what is the payback period for this project? The project requires an initial investment of $900,000; has a life of 6 years; produces cost savings of $190,000 per year; has a tax rate of 35 percent; and a discount rate of 9 percent. The fixed assets will be sold for $50,000 at the end of year 6.
5.10 years
PROBLEM: Your firm needs a computerized line-boring machine that costs $90,000 and requires $16,000 in maintenance costs for each year of its 3-year life. After 3 years, this machine will be replaced. The machine falls into the MACRS 3-year class life category. The MACRS percentages for each year are 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent, respectively. Assume a tax rate of 35 percent and a discount rate of 10 percent. Assume the machine can be sold for $12,000 at the end of year 3. What is the aftertax salvage value of the machine?
PROBLEM: Your company just bought a new distillation unit for $175,000 to be used for research and development. Such equipment has a 3-year MACRS classification. The MACRS percentages are 33.33 percent, 44.44 percent, 14.82 percent, and 7.41 percent, respectively. What is the book value of the distillation unit at the end of year 2?
A condominium developer buys three times as much land as is needed to build a planned 50-unit development so that, if things go well, two additional 50-unit developments can be built without having to acquire additional land. The developer is prepared to exercise the option to:
PROBLEM: The Sedgwick Company estimates sales of a new product at 5,000 units and $3.00 per unit. Management feels the sales quantity is accurate within a 10 percent plus-or-minus range while the sales price is accurate within a 5 percent plus-or-minus range. What dollar amount should the company use for total sales in their worst-case scenario analysis of this product?
Options for future, related business products or strategies are known as:
strategic options.
PROBLEM: The Bringa Penski Co. has just paid a cash dividend of $2 per share. Investors require a 16% return from investments such as this. If the dividend is expected to grow at a steady 8% per year, what is the current value stock? What will the stock be worth in 5 years?
- $2.94
- $39.67
PROBLEM: Alexander Corp. will pay a dividend of $2.60 next year. The company has stated that it will maintain a consent growth rate of 4.5% a year forever. If you want a 15% rate of return. How much will you pay for the stock? What if you want 10% rate of return? What does this tell you about the relationship[ between required rate and stock price?
1. R=15% Po= $24.76
2. R=10% Po=$47.27
The rate of return are inversely proportion to each other
PROBLEM: Taylor Corp. is growing quickly. Dividends are expected to grow at a 30% rate for the next 3 years, with the growth rate falling off to a constant 6% therefore if the required return is 13% and the company just paid a $2.75 dividend, what is the correct share price?
- Po=$74.40
PROBLEM: You are looking at a 3 year project with a projected net income of $1000 in year 1, $2000 in year 2, and $4000 in year 3. The cost is $9000 which will be depreciated Striaghtline to zero over the 3 year life of the project. What is the average accounting return or AAR?
- 51.85%
PROBLEM: Suppose a project has conventional cash flows and a postive NPV. What do you know about its payback? its profitability index? Its IRR? Explain.
- If a project has a positive NPV for a discount rate = positive NPV for a zero discount rate --> payback period must be shorter than the project life

-If NPV is positive--> then the PV of future cash inflows is > initial investment cost = PI > 1

-If NPV is positive for a certain discount rate-->it will be zero for a larger discount--> IRR must be > required return
PROBLEM: Which project you chose, you require 13% return on investment.
a. Payback period
b. NPV
c. IRR
d. Profitability index
a. INVEST A= 3.44 years INVEST B=2.09 years*
b. INVEST A= 4,9346.83* INVEST B= 9,171.14
c. INVEST A= 17% INVEST B=27%
d. INVEST A=1.12 INVEST B=1.26
PROBLEM: Kenny Inc is looking at setting up a new manufacturing plant in South Park. The company bought some land 6 years ago for $7 million in anticipation of using it as a warehouse and distribution site, but the company has since decided to rent facilities elsewhere. The land would net $9.8 million if it were sold today. The company no wants to build its new manufacturing pant on this land; the plan will cost $21 million to build, and the site requires $850,000 worth of grading before it is suitable for construction. What is the proper cash flow amount to use as the intial investment in fixed assets when evaluating the project?
- $31,650,000
PROBLEM: An asset used in a 4 year project falls in the 5 year MACRS class for tax purposes. The asset has an acquisition cost of $7,100,000 and will be sold for $1,750,000 at the end of the project. If the tax rate is 34%, what is the after tax salvage value of the asset.
- $1,572,139.20
PROBLEM: In the previous problem, suppose the fixed asset actually falls into the 3 year MACRS class. All the other facts are the same. What is the projects year 1 net cash flow now? Year 2? Year 3? What is the new NPV?
PROBLEM: Use table 10.1 to calculate the average return over the years 1997-2001 for the large company stocks, long term government bonds and Treasury bills?
PROBLEM: Calculate the stand deviations using the information from problem 10.1 which of the investments was the most volatile over this period?
PROBLEM: Given that emergent biosolutions was up by 461% for 2008, why didnt all investors hold Emergent Bio Solutions?
PROBLEM: Explain why a characteristic of an efficient market is that investments in that market have zero NPVs?
PROBLEM: There are several celebrated investors and stock prices frequently mentioned in the financial press who have recorded huge returns on their investments over the past two decades. Is the success of these particular investors an invalidation of EMH? Explain.
PROBLEM: For each of the following scenarios, discuss whether profit opportunities exist from trading in the stock of the firm under the conditions that
1. the market is not weak from efficient
2. the market is weak from but not semi strong from efficient
4. the market is strong form efficient
a) the stock price has risen steadily each day for the past 30 days
b) the financial statements for a company were released three days ago, and you believe you've uncovered some anomalies in the company's inventory and cost control reporting techniques that are causing the firms true liquidity strength to be understated.
c) you observe that the senior management of a company has been buyng alot of the company stock on the open market over the past week.
EXERCISE: International Biking Corporation (IBC) has been growing at a rate of 25% per year in recent years. This same growth rate is expected to last for another two years. The growth rate will then level off to a normal rate of 6% per year indefinitely. The company just paid a dividend of $2 per share on its
common stock. How much investors will be willing to pay today for each share of IBC's common stock if they require a rate of return of 14%?
EXERCISE: The president of Airbound Inc. has asked you to evaluate the proposed acquisition of a new airplane. The aircraft's price is $39,000 and it falls into the ACRS 3-year class. The firm is also responsible for
the delivery cost of $1,000. Purchase of the plane would require an increase in net working capital of $2,000. The airplane would increase the firm's before-tax revenues by $20,000 per year but would also
increase its operating costs by $5,000 per year. The airplane is expected to be used for three years and then be sold for $25,000. The firm's marginal tax rate is 40 percent and the project's cost of capital is
14 percent. Should the project be taken? Why or why not? Justify your answer with numerical work.