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All Textbook Solutions for Fundamentals of Financial Management (MindTap Course List)

What is a firms intrinsic value? Its current stock price? Is the stocks true long-run value more closely related to its intrinsic value or to its current price?When is a stock said to be in equilibrium? Why might a stock at any point in time not be in equilibrium?3Q 4Q 5Q 6Q 7Q 8Q The president of Southern Semiconductor Corporation (SSC) made this statement in the companys annual report SSCs primary goal is to increase the value of our common stockholders' equity. Later in the report the following announcements were made: a. The company contributed 1.5 million to the symphony orchestra in Birmingham, Alabama, its headquarters city. b. The company is spending 5500 million to open a new plant and expand operations in China. No profits will be produced by the Chinese operation for 4 years, so earnings will be depressed during this period versus what they would have been had the decision been made not to expand in China. c. The company holds about half of its assets in the form of U.S. Treasury bonds, and it keeps these funds available for use in emergencies. In the future, though, SSC plans to shift its emergency funds from Treasury bonds to common stocks. Discuss how SSCs stockholders might view each of these actions and how the actions might affect the stock price.10Q 11Q 12Q 13Q Bedrock Company has 70 million in debt and 30 million in equity. The debt matures in 1 year and has a 10% interest rate, so the company is promising to pay back 77 million to its debtholders 1 year from now. The company is considering two possible investments, each of which will require an upfront cost of 100 million. Each investment will last for 1 year, and the payoff from each investment depends on the strength of the overall economy. There is a 50% chance that the economy will be weak and a 50% chance it will be strong. Here are the expected payoffs (all dollars are in millions) from the two investments: Note that the two projects have the same expected payoff, but Project H has higher risk. The debtholders always get paid first and the stockholders receive any money that is available after the debtholders have been paid. Assume that if the company doesnt have enough funds to pay off its debtholders 1 year from now, then Bedrock will declare bankruptcy. If bankruptcy is declared, the debtholders will receive all available funds, and the stockholders will receive nothing. a. Assume that the company selects Investment L. What is the expected payoff to the firms debtholders? What is the expected payoff to the firms stockholders? b. Assume that the company selects Investment H. What is the expected payoff to the firms debtholders? What is the expected payoff to the firms stockholders? c. Would the debtholders prefer that the companys managers select Project L or Project H? Briefly explain your reason. d. Explain why the companys managers, acting on behalf of the stockholders, might select Project H, even though it has greater risk. e. What actions can debtholders take to protect their interests?How does a cost-efficient capital market help reduce the prices of goods and services?Describe the different ways in which capital can be transferred from suppliers of capital to those who are demanding capital.3Q Indicate whether the following instruments are examples of money market or capital market securities. a. U.S. Treasury bills b. Long-term corporate bonds c. Common stocks d. Preferred stocks e. Dealer commercial paper 5Q 6Q Differentiate between dealer markets and stock markets that have a physical location.Identify and briefly compare the two leading stock exchanges in the United States today.Briefly explain what is meant by the term efficiency continuum.10Q 1IC What four financial statements are contained in most annual reports?Who are some of the basic users of financial statements, and how do they use them?If a typical firm reports 20 million of retained earnings on its balance sheet, could its directors declare a 20 million cash dividend without having any qualms about what they were doing? Explain your answer.Explain the following statement: Although the balance sheet can be thought of as a snapshot of a firms financial position at a point in time, the income statement reports on operations over a period of time.5Q 6Q 7Q 8Q How are managements actions incorporated in EVA and MVA? How are EVA and MVA interconnected?Explain the following statement: Our tax rates are progressive.11Q How does the deductibility of interest and dividends by the paying corporation affect the choice of financing (i.e., the use of debt versus equity)?BALANCE SHEET The assets of Dallas Associates consist entriely of current assets and net plant and equipment. The firm has total assets of 25 million and net plant and equipment equals 2 million. It has notes payable of 150.000, long-term debt of 750,000, and total common equity of 15 million. The firm does have accounts payable and accruals on its balance sheet the firm only finances with debt and common equity, so it has no preferred stock on its balance sheet. a. What is the companys total debt? b. What is the amount of total liabilities and equity that appears on the firms balance sheet? c. What is the balance of current assets on the firms balance sheet? d. What is the balance of current liabilities on the firms balance sheet? e. What is the amount of accounts payable and accruals on its balance sheet? (Him: Consider this as a single line item on the firms balance sheet.) f. What is the firms net working capital? g. What is the firms net operating working capital? h. What is the explanation for the difference in your answers to parts f and g?INCOME STATEMENT Little Books Inc. recently reported 3 million of net income. Its EBIT was 6 million, and its tax rate was 40%. What was its interest expense? [Hint: Write out the headings for an income statement and fill in the known values. Then divide 3 million of net income by (1 T) = 0 6 to find the pretax income. The difference between EBIT and taxable income must be interest expense. Use this same procedure to complete similar problems.]INCOME STATEMENT Pearson Brothers recently reported an EBITDA of 7.5 million and net income of 1.8 million. It had 2.0 million of interest expense, and its corporate tax rate was 40%. What was its change for depreciation and amortization?STATEMENT OF STOCKHOLDERS' EQUITY In its most recent financial statements, New-house Inc. reported 50 million of net income and 810 million of retained earnings. The previous retained earnings were 780 million. How much in dividends were paid to shareholders during the year? Assume that all dividends declared were actually paid.5P 6P EVA Britton Industries has operating income for the year of 3,000,000 and a 40% tax rate. Its total invested capital is 20,000,000 and its after-tax percentage cost of capital is 8%. What is the firm's EVA?PERSONAL TAXES Joe and Jane Keller are a married couple who file a joint income tax return, where the tax rates are based on the tax tables presented in the chapter. Assume that their taxable income this year was 165,000. a. What is their federal tax liability? b. What is their marginal tax rate? c. What is their average tax rate?9P 10P EVA For 2015, Everyday Electronics reported 22 5 million of sales and 18 million of operating costs (including depreciation). The company has 15 million of total invested capital. Its after-tax cost of capital is 9%, and its federal-plus-state income tax rate was 35%. What was the firms economic value added (EVA), that is, how much value did management add to stockholders wealth during 2015?STATEMENT OF CASH FLOWS W.C. Cycling had 55,000 in cash at year-end 2014 and 25,000 in cash at year-end 2015. The firm invested in property, plant, and equipment totaling 250,000. Cash flow from financing activities totaled 170,000. a. What was the cash flow from operating activities? b. If accruals increased by 25,000, receivables and inventories increased by 100,000, and depreciation and amortization totaled 10,000, what was the firms net income?STATEMENT OF CASH FLOWS You have just been hired as a financial analyst for Basel Industries. Unfortunately, company headquarters (where all of the firms records are kept) has been destroyed by fire. So, your first job will be to recreate the firms cash flow statement for the year just ended. The firm had 100,000 in the bank at the end of the prior year, and its working capital accounts except cash remained constant during the year. It earned 5 million in net income during the year but paid 750,000 in dividends to common shareholders. Throughout the year, the firm purchased 5 5 million of machinery that was needed for a new project. You have just spoken to the firms accountants and learned that annual depreciation expense for the year is 450,000; however, the purchase price for the machinery represents additions to property, plant, and equipment before depreciation. Finally, you have determined that the only financing done by the firm was to issue long-term debt of 1 million at a 6% interest rate. What was the firms end-of-year cash balance? Recreate the firms cash flow statement to arrive at your answer.14P INCOME STATEMENT Hermann Industries is forecasting the following income statement: Sales 8,000,000 Operating costs excluding depreciation amortization 4,400,000 EBITDA 3,600,000 Depreciation and amortization 800,000 EBIT 2,800,000 Interest 600,000 EBT 2,200,000 Taxes (40%) 880,000 Net income 1,320,000 The CEO would like to see higher sales and a forecasted net income of 2,500,000. Assume that operating costs (excluding depreciation and amortization) are 55% of sales and that depreciation and amortization and interest expenses will increase by 10%. The tax rate, which is 40%, will remain the same. (Note that while the tax rate remains constant, the taxes paid will change.) What level of sales would generate 2,500,000 in net income?16P 17P 18P FINANCIAL STATEMENTS, CASH FLOW, AND TAXES Laiho Industriess 2014 and 2015 balance sheets (in thousands of dollars) are shown. 2015 2014 Cash 102,850 89,725 Accounts receivable 103,365 85,527 Inventories 38,444 34.982 Total current assets 244,659 210,234 Net fixed assets 67,165 42,436 Total assets 311,824 252,670 Accounts payable 30,761 23,109 Accruals 30,477 22,656 Notes payable 16,717 14,217 Total current liabilities 77,955 59,982 Long-term debt 76,264 63,914 Total liabilities 154,219 123,896 Common stock 100,000 90,000 Retained earnings 57,605 38,774 Total common equity 157,605 128,774 Total liabilities and equity 311,824 252,670 a. Sales for 2015 were 455,150,000, and EBITDA was 15% of sales. Furthermore, depreciation and amortization were 11% of net fixed assets, interest was 8,575,000, the corporate tax rate was 40%, and Laiho pays 40% of its net income as dividends. Given this information, construct the firms 2015 income statement. b. Construct the statement of stockholders equity for the year ending December 31, 2015, and the 2015 statement of cash flows. c. Calculate 2014 and 2015 net operating working capital (NOWC) and 2015 free cash flow (FCF). d. If Laiho increased its dividend payout ratio, what effect would this have on corporate taxes paid? What effect would this have on taxes paid by the companys shareholders? e. Assume that the firms after-tax cost of capital is 10 5%. What is the firms 2015 EVA? f. Assume that the firms stock price is 22 per share and that at year-end 2015 the firm has 10 million shares outstanding. What is the firms MVA at year-end 2015?20IC Financial ratio analysis is conducted by three main groups of analysts: credit analysts, stock analysts, and managers. What is the primary emphasis of each group, and how would that emphasis affect the ratios on which they focus?2Q Over the past year, M.D. Ryngaert Co. had an increase in its current ratio and a decline in its total assets turnover ratio. However, the companys sales, cash and equivalents, DSO, and fixed assets turnover ratio remained constant. What balance sheet accounts must have changed to produce the indicated changes?Profit margins and turnover ratios vary from one industry to another. What differences would you expect to find between the turnover ratios, profit margins, and DuPont equations for a grocery chain and a steel company?How does inflation distort ratio analysis comparisons for one company over time (trend analysis) and for different companies that are being compared? Are only balance sheet items or both balance sheet and income statement items affected?6Q Give some examples that illustrate how (a) seasonal factors and (b) different growth rates might distort a comparative ratio analysis. How might these problems be alleviated?Why is it sometimes misleading to compare a company's financial ratios with those of other firms that operate in the same industry?Suppose you were comparing a discount merchandiser with a high-end merchandiser. Suppose further that both companies had identical ROEs. If you applied the DuPont equation to both firms, would you expect the three components to be the same? for each company? If not, explain what balance sheet and income statement items might lead to the component differences.10Q Differentiate between ROE and ROIC.12Q DAYS SALES OUTSTANDING Baker Brothers has a DSO of 40 days, and its annual sales are 7,300,000. What is its accounts receivable balance? Assume that it uses a 365-day year.DEBT TO CAPITAL RATIO Bartley Barstools has a market/book ratio equal to 1. Its stock price is 14 per share and it has 5 million shares outstanding. The firms total capital is 125 million and it finances with only debt and common equity. What is its debt-to-capital ratio?DuPONT ANALYSIS Doublewide Dealers has an ROA of 10%, a 2% profit margin, and an ROE of 15%. What is its total assets turnover? What is its equity multiplier?MARKET/BOOK RATIO Jaster Jets has 10 billion in total assets. Its balance sheet shows 1 billion in current liabilities, 3 billion in long-term debt, and 6 billion in common equity. It has 800 million shares of common stock outstanding, and its stock price is 32 per share. What is Jasters market/book ratio?PRICE/EARNINGS RATIO A company has an EPS of 2.00, a book value per share of 20, and a market/book ratio of 1.2x. What is its P/E ratio?DuPONT AND ROE A firm has a profit margin of 2% and an equity multiplier of 2.0. Its sales are 100 million, and it has total assets of 50 million. What is its ROE?7P DuPONT AND NET INCOME Ebersoll Mining has 6 million in sales, its ROE is 12%, and its total assets turnover is 3.2x. Common equity on the firms balance sheet is 50% of its total assets. What is its net income?BEP, ROE, AND ROIC Duval Manufacturing recently reported the following information: Net income 600,000 ROA 8% Interest expense 225,000 Accounts payable and accruals 1,000,000 Duvals tax rate is 35%. Duval finances with only debt and common equity, so it has no preferred stock. 40% of its total invested capital is debt, while 60% of its total invested capital is common equity. Calculate its basic earning power (BEP), its return on equity (ROE), and its return on invested capital (ROIC).M/B AND SHARE PRICE You are given the following information: Stockholders equity as reported on the firms balance sheet = 3.75 billion, price/earnings ratio = 3.5, common shares outstanding = 50 million, and market/book ratio = 1.9. Calculate the price of a share of the companys common stock.RATIO CALCULATIONS Assume the following relationships for the Brauer Corp.: Sales/Total assets 1.5x Return on assets (ROA) 3.0% Return on equity (ROE) 5.0% Calculate Brauers profit margin and debt-to-capital ratio assuming the firm uses only debt and common equity, so total assets equal total invested capital.RATIO CALCULATIONS Graser Trucking has 12 billion in assets, and its tax rate is 40%. Its basic earning power (BEP) ratio is 15%, and its return on assets (ROA) is 5%. What is its times-interest-earned (TIE) ratio?TIE AND ROIC RATIOS The H.R. Pickett Corp. has 500,000 of interest-bearing debt out-standing, and it pays an annual interest rate of 10%. In addition, it has 700,000 of common stock on its balance sheet. It finances with only debt and common equity, so it has no preferred stock. Its annual sales are 2 million, its average tax rate is 30%, and its profit margin is 5%. What are its TIE ratio and its return on invested capital (ROIC)?14P RETURN ON EQUITY AND QUICK RATIO Lloyd Inc. has sales of 200,000, a net income of 15,000, and the following balance sheet: The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio is equal to the industry average, 25, without affecting sales or net income. If inventories are sold and not replaced (thus reducing the current ratio to 25); if the funds generated are used to reduce common equity (stock can be repurchased at book value); and if no other changes occur, by how much will the ROE change? What will be the firms new quick ratio?16P CONCEPTUAL: RETURN ON EQUITY Which of the following statements is most correct? (Hint: Work Problem 4-16 before answering 4-17, and consider the solution setup for 4-16 as you think about 4-17.) a. If a firms expected basic earning power (BEP) is constant for all of its assets and exceeds the interest rate on its debt, adding assets and financing them with debt will raise the firms expected return on common equity (ROE). b. The higher a firms tax rate, the lower its BEP ratio, other things held constant. c. The higher the interest rate on a firms debt, the lower its BEP ratio, other things held constant. d. The higher a firms debt ratio, the lower its BEP ratio, other things held constant. e. Statement a is false; but statements b, c, and d are true.TIE RATIO AEI Incorporated has 5 billion in assets, and its tax rate is 40%. Its basic earning power (BEP) ratio is 10%, and its return on assets (ROA) is 5%. What is AEIs times-interest-earned (TIE) ratio?CURRENT RATIO The Petry Company has 1312,500 in current assets and 525,000 in current liabilities. Its initial inventory level is 375,000, and it will raise funds as additional notes payable and use them to increase inventory. How much can its short-term debt (notes payable) increase without pushing its current ratio below 2.0?DSO AND ACCOUNTS RECEIVABLE Harrelson Inc. currently has 750,000 in accounts receivable, and its days sales outstanding (DSO) is 55 days. It wants to reduce its DSO to 35 days by pressuring more of its customers to pay their bills on time. If this policy adopted, the companys average sales will fall by 15%. What will be the level of accounts receivable following the change? Assume a 365-day year.P/E AND STOCK PRICE Fontaine Inc. recently reported net income of 2 million. It has 500,000 shares of common stock, which currently trades at 40 a share. Fontaine continues to expand and anticipates that 1 year from now, its net income will be 3.25 million. Over the next year, it also anticipates issuing an additional 150,000 shares of stock so that 1 year from now it will have 650,000 shares of common stock. Assuming Fontaines price/earnings ratio remains at its current level, what will be its stock price 1 year from now?BALANCE SHEET ANALYSIS Complete the balance sheet and sales information using the following financial data: Total assets turnover: 15 Days sales outstanding: 36.5 daysa Inventory turnover ratio: 5 Fixed assets turnover: 3.0 Current ratio: 2.0 Gross profit margin on sales: (Sales Cost of goods sold)/Sales = 25% aCalculation is based on a 365-day year.RATIO ANALYSIS Data for Barry Computer Co. and its industry averages follow. a. Calculate the indicated ratios for Barry. b. Construct the DuPont equation for both Barry and the industry. c. Outline Barrys strengths and weaknesses as revealed by your analysis. d. Suppose Barry had doubled its sales as well as its inventories, accounts receivable, and common equity during 2015. How would that information affect the validity of your ratio analysis? (Hint: Think about averages and the effects of rapid growth on ratios if averages are not used. No calculations are needed.) Barry Computer Company: Balance Sheet as of December 31, 2015 (in Thousands) Cash 77,500 Accounts payable 129,000 Receivables 336,000 Other current liabilities 117,000 Inventories 241,500 Notes payable to bank 84,000 Total current assets 655,000 Total current liabilities 330,000 Long-term debt 256,500 Net fixed assets 292,500 Common equity 361,000 Total assets 947,500 Total liabilities and equity 947,500 Barry Computer Company: Income Statement for Year Ended December 31, 2015 (in Thousands) Sales 1,607,500 Cost of goods sold Materials 717,000 Labor 453,000 Heat, light, and power 68,000 Indirect labor 113,000 Depreciation 41,500 1,392,500 Gross profit 215,000 Selling expenses 115,000 General and administrative expenses 30,000 Earnings before interest and taxes (EBIT) 70,000 Interest expense 24,500 Earnings before taxes (EBT) 45,500 Federal and state income taxes (40%) 18,200 Net income 27,300 Ratio Barry Industry Average Current _____ 2.0 Quick _____ 1.3 Days sales outstandinga _____ 35 days Inventory turnover _____ 6.7 aCalculation is based on a 365-day year Total assets turnover _____ 3.0 Profit margin _____ 1.20% ROA _____ 0 ROE _____ 9.00% ROIC _____ 0 TIE _____ 3.0 Debt/Total capital _____ 47.00%DUPONT ANALYSIS A firm has been experiencing low profitability in recent years. Perform an analysis of the firms financial position using the DuPont equation. The firm has no lease payments but has a 2 million sinking fund payment on its debt. The most recent industry average ratios and the firms financial statements are as follows: Industry Average Ratios Current ratio 3 Fixed assets turnover 6 Debt-to-capital ratio 20% Total assets turnover 3 Times interest earned 7 Profit margin 3% EBITDA coverage 9 Return on total assets 9% Inventory turnover 10 Return on common equity 12.86% Days sales outstandinga 24 days Return on invested capital 11.50% aCalculation is based on a 365-day year. Balance Sheet as of December 31, 2015 (Millions of Dollars) Cash and equivalents 78 Accounts payable 45 Accounts receivable 6600% Other current liabilities 11 Inventories 159 Notes payable 2900% Total current assets 303 Total current liabilities 85 Long-term debt 5000.00% Total liabilities 135 Gross fixed assets 225 Common stock 114 Less depreciation 78 Retained earnings 201 Net fixed assets 147 Total stockholders equity 315 Total assets 450 Total liabilities and equity 450 Income Statement for Year Ended December 31, 2015 (Millions of Dollars) Net sales 795.0 Cost of goods sold 660.0 Gross profit 135.0 Selling expenses 73.5 EBITDA 61.5 Depreciation expense 12.0 Earnings before interest and taxes (EBIT) 49.5 Interest expense 4.5 Earnings before taxes (EBT) 45.0 Taxes (40%) 18.0 Net income 27.0 a. Calculate the ratios you think would be useful in this analysis. b. Construct a DuPont equation, and compare the companys ratios to the industry average ratios. c. Do the balance sheet accounts or the income statement figures seem to be primarily responsible for the low profits? d. Which specific accounts seem to be most out of line relative to other firms in the industry? e. If the firm had a pronounced seasonal sales pattern or if it grew rapidly during the year, how might that affect the validity of your ratio analysis? How might you correct for such potential problems?RATIO ANALYSIS The Corrigan Corporations 2014 and 2015 financial statements follow, along with some industry average ratios. a. Assess Corrigans liquidity position, and determine how it compares with peers and how the liquidity position has changed over time. b. Assess Corrigans asset management position, and determine how it compares with peers and how its asset management efficiency has changed over time. c. Assess Corrigans debt management position, and determine how it compares with peers and how its debt management has changed over time. d. Assess Corrigans profitability ratios, and determine how they compare with peers and how its profitability position has changed over time. e. Assess Corrigans market value ratios, and determine how its valuation compares with peers and how it has changed over time. f. Calculate Corrigans ROE as well as the industry average ROE, using the DuPont equation. From this analysis, how does Corrigans financial position compare with the industry average numbers? g. What do you think would happen to its ratios if the company initiated cost-cutting measures that allowed it to hold lower levels of inventory and substantially decreased the cost of goods sold? No calculations are necessary. Think about which ratios would be affected by changes in these two accounts. Corrigan Corporation: Balance Sheets as of December 31 2015 2014 Cash 72,000 65,000 Accounts receivable 439,000 328,000 Inventories 894,000 813,000 Total current assets 1,405,000 1,206,000 Land and building 238,000 271,000 Machinery 132,000 133,000 Other fixed assets 61,000 57,000 Total assets 1,836,000 1,667,000 Accounts payable 80,000 72,708 Accrued liabilities 45,010 40,880 Notes payable 476,990 457,912 Total current liabilities 602,000 571,500 Long-term debt 404,290 258,898 Common stock 575,000 575,000 Retained earnings 254,710 261,602 Total liabilities and equity 1,836,000 1,667,000 Corrigan Corporation: Income Statements for Years Ending December 31 2015 2014 Sales 4,240,000 3,635,000 Cost of goods sold 368000000% 2,980,000 Gross operating profit 560,000.00 655,000 General administrative and selling expenses 303,320 297,550 Depreciation 159,000 154,500 EBIT 97,680 202,950 Interest 67,000 43,000 Earnings before taxes (EBT) 30,680 159,950 Taxes (40%) 12,272 63,980 Net income 18,408 95,970 Per-Share Data 2015 2014 EPS 1 4 Cash dividends 1.10 1 Market price (average) 12.34 24 P/E ratio 15.42 5.65 Number of shares outstanding 23,000 23,000 Industry Financial Ratiosa 2015 Current ratio 2.7 Inventory turnoverb 7.0 Days sales outstandingc 32.0 days Fixed assets turnoverb 13.0 Total assets turnoverb 2.6 Return on assets 0 Return on equity 0 Return on invested capital 0 Profit margin 0 Debt-to-capital ratio 1 P/E ratio 6.0 aIndustry average ratios have been constant for the past 4 years. bBased on year-end balance sheet figures. cCalculation is based on a 365-day year.26IC Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com/finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a freer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary" to find definitions for the different ratios. For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns." Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for the specific term selected. 1. Looking at Morningstar's Financial Health ratios, what has happened to HPs liquidity position over the past 10 years?Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com/finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a freer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary" to find definitions for the different ratios. For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns." Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for tire specific term selected. 2. Looking at Morningstar's Financial Health ratios, what has happened to HP's financial leverage position over tire past 10 years?3TCL Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com / finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a peer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary" to find definitions for the different ratios. For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns." Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for the specific term selected. 4. Identify Google Finance's list of related companies to HP. Which is the largest in terms of market capitalization? Which is the smallest? Where does HT rank (in terms of market capitalization)?Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com/finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a peer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary" to find definitions for the different ratios. For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns." Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for tire specific term selected. 5. From the Google Finance site, look at HP's liquidity position (as measured by its current ratio). How does this ratio compare with those of its peers?Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com / finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a freer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary to find definitions for the different ratios For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns." Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for tire specific term selected. 6. From the Google Finance site, look at HP's profitability ratios (as measured by its profit margin, ROA, and ROE). How do these ratios compare with those of its peers?Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and wnvcv.google.com/finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a peer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability, Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary to find definitions for the different ratios For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firms financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firms peer analysis. Notice that when you go to the "Related Companies" screen, you can add or remove columns. Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for the specific term selected. 7. From the Google Finance site, use the DuPont analysis to determine the total assets turnover ratio for each of tire peer companies. (Hint ROA = Profit margin Total assets turnover.) Once you've calculated each peer 's total assets turnover ratio, then you can use the DuPont analysis to calculate each peer's equity multiplier.Conducting a Financial Ratio Analysis on HP INC. Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In Chapter 3, we looked at Dunkin' Brands' financial statements. In this chapter, we will use financial Internet websites (specifically, www.morningstar.com and www.google.com/finance) to analyze HP Inc., a computer hardware company. Once on either website, you simply enter HP Inc.'s ticker symbol (HPQ) to obtain the financial information needed. The text mentions that financial statement analysis has two major components: a trend analysis, where we evaluate changes in key ratios over time, and a freer analysis, where we compare financial ratios with firms that are in the same industry and/or line of business. We will do both of these types of analysis in this problem. Through the Morningstar website, you can find the firm's financials (Income Statement, Balance Sheet, and Cash Flow) on an annual or quarterly basis for the five most recent time periods. In addition, the site contains Key Ratios (Profitability', Growth, Cash Flow, Financial Health, and Efficiency) for 10 years. We will use the Key Ratios on this site to conduct the firm's trend analysis. (At the bottom of the screen you will see that you can click "Glossary to find definitions for the different ratios. For example, Morningstar's Financial Leverage ratio is the same as the Equity multiplier that we use in the textbook.) On the Google Finance site, you can find the firm's financial statements for the four most recent years or the five most recent quarters and key financial data for related companies for the most recent year or quarter. We will use the related companies' annual data to conduct the firm's peer analysis. Notice that when you go to the "Related Companies" screen, you can "add or remove columns, Click on that phrase, and you can check which peer data items you'd like to show on tire computer screen. Also, once you have chosen the data, you can click on a term, and the companies will be ranked in either ascending or descending order for tire specific term selected. 8. From tire information gained in question 7 and using the DuPont analysis, what are HP's strengths and weaknesses compared to those of its competitors?1Q Explain whether the following statement is true or false: 100 a year for 10 years is an annuity; but 5100 in Year 1, 200 in Year 2, and 400 in Years 3 through 10 does not constitute an annuity. However, the second series contains an annuity.If a firms earnings per share grew from 1 to 2 over a 10-year period, the total growth would be 100%, but the annual growth rate would be less than 10%. True or false? Explain. (Hint: If you arent sure, plug in some numbers and check it out.)4Q 5Q The present value of a perpetuity is equal to the payment on the annuity, PMT, divided by the interest rate, I: PV PMT/I. What is the future value of a perpetuity of PMT dollars per year? (Hint: The answer is infinity, but explain why.)Banks and other lenders are required to disclose a rate called the APR. What is this rate? Why did Congress require that it be disclosed? Is it the same as the effective annual rate? If you were comparing the costs of loans from different lenders, could you use their APRs to determine the loan with the lowest effective interest rate? Explain.What is a loan amortization schedule, and what are some ways these schedules are used?1P 2P FINDING THE REQUIRED INTEREST RATE Your parents will retire in 18 years. They currently have 250,000 saved, and they think they will need 1,000,000 at retirement. What annual interest rate must they earn to reach their goal, assuming they dont save any additional funds?TIME FOR A LUMP SUM TO DOUBLE If you deposit money today in an account that pays 6.5% annual interest how long will it take to double your money?TIME TO REACH A FINANCIAL GOAL You have 42,180.53 in a brokerage account, and you plan to deposit an additional 5,000 at the end of every future year until your account totals 250,000. You expect to earn 12% annually on the account. How many years will it take to reach your goal?6P 7P LOAN AMORTIZATION AND EAR You want to buy a car. and a local bank will lend you 20,000. The loan will be fully amortized over 5 years (60 months), and the nominal interest rate will be 12% with interest paid monthly. What will be the monthly loan payment? What will be the loans EAR?PRESENT AND FUTURE VALUES FOR DIFFERENT PERIOOS Find the following values using the equations and then a financial calculator. Compounding/discounting occurs annually. a. An initial 5500 compounded for 1 year at 6% b. An initial 5500 compounded for 2 years at 6% c. The present value of 5500 due in 1 year at a discount rate of 6% d. The present value of 5500 due in 2 years at a discount rate of 6%10P GROWTH RATES Shalit Corporations 2014 sales were 12 million. Its 2009 sales were 6 million. a. At what rate have sales been growing? b. Suppose someone made this statement: Sales doubled in 5 years. This represents a growth of 100% in 5 years; so dividing 100% by 5, we find the growth rate to be 20% per year. Is the statement correct?EFFECTIVE RATE OF INTEREST Find the interest rates earned on each of the following: a. You borrow 700 and promise to pay back 749 at the end of 1 year. b. You lend 700 and the borrower promises to pay you 749 at the end of 1 year. c. You borrow 85,000 and promise to pay back 201,229 at the end of 10 years. d. You borrow 9,000 and promise to make payments of 2,684.80 at the end of each year for 5 years.13P FUTURE VALUE OF AN ANNUITY Find the future values of these ordinary annuities. Compounding occurs once a year. a. 400 per year for 10 years at 10% b. 200 per year for 5 years at 5% c. 400 per year for 5 years at 0% d. Rework Parts a, b, and c assuming they are annuities due.15P 16P EFFECTIVE INTEREST RATE You borrow 85,000; the annual loan payments are 8,273.59 for 30 years. What interest rate arc you being charged?18P FUTURE VALUE OF AN ANNUITY Your client is 40 years old. She wants to begin saving for retirement with the first payment to come one year from now. She can save 5,000 per year, and you advise her to invest it in the stock market, which you expect to provide an average return of 9% in the future. a. If she follows your advice, how much money will she have at 65? b. How much will she have at 70? c. She expects to live for 20 years if she retires at 65 and for 15 years if she retires at 70. If her investments continue to cam the same rate, how much will she be able to withdraw at the end of each year after retirement at each retirement age?20P 21P 22P FUTURE VALUE FOR VARIOUS COMPOUNDING PERIODS Find the amount to which 500 will grow under each of these conditions: a. 12% compounded annually for 5 years b. 12% compounded semiannually for 5 years c. 12% compounded quarterly for 5 years d. 12% compounded monthly for 5 years e. 12% compounded daily for 5 years f. Why does the observed pattern of FVs occur?24P FUTURE VALUE OF AN ANNUITY Kind the future values of the following ordinary annuities: a. FV of 400 paid each 6 months for 5 years at a nominal rate of 12% compounded semiannually b. FV of 200 paid each 3 months for 5 years at a nominal rate of 12% compounded quarterly c. These annuities receive the same amount of cash during the 5-year period and earn interest at the same nominal rate, yet the annuity in part b ends up larger than the one in part a. Why does this occur?PV AND LOAN ELIGIBILITY You have saved 4,000 for a down payment on a new car. The largest monthly payment you can afford is 350. The loan will have a 12% APR based on end-of-month payments. What is the most expensive car you can afford if you finance it for 48 months? For 60 months?EFFECTIVE VERSUS NOMINAL INTEREST RATES Bank A pays 4% interest compounded annually on deposits, while Bank B pays 35% compounded daily. a. Based on the EAR (or EFF%), which hank should you use? b. Could your choice of banks be influenced by the fact that you might want to withdraw your funds during the year as opposed to at the end of the year? Assume that your funds must be left on deposit during an entire compounding period in order to receive any interest.28P 29P 30P REQUIRED LUMP SUM PAYMENT Starting next year, you will need 10,000 annually for 4 years to complete your education. (One year from today you will withdraw the first 10,000.) Your unde deposits an amount today in a bank paying 5% annual interest, which will provide the needed 10,000 payments. a. How large must the deposit be? b. How much will be in the account immediately after you make the first withdrawal?32P FV OF UNEVEN CASH FLOW You want to buy a house within 3 years, and you are currently saving for the down payment. You plan to save 5,000 at the end of the first year, and you anticipate that your annual savings will increase by 10% annually thereafter. Your expected annual return is 7%. How much will you have for a down payment at the end of Year 3?AMORTIZATION SCHEDULE a. Set up an amortization schedule for a 25,000 loan to be repaid in equal installments at the end of each of the next 3 years. The interest rate is 10% compounded annually. b. What percentage of the payment represents interest and what percentage represents principal for each of the 3 years? Why do these percentages change over time?35P NONANNUAL COMPOUNDING a. You plan to make five deposits of 1,000 each, one every 6 months, with the first payment being made in 6 months. You Mill then make no more deposits. If the bank pays 4% nominal interest, compounded semiannually, how much will be in your account after 3 years? b. One year from today you must make a payment of 10,000. To prepare for this payment, you plan to make two equal quarterly deposits (at the end of Quarters 1 and 2) in a bank that pays 4% nominal interest compounded quarterly. How large must each of the two payments be?37P 38P REQUIRED ANNUITY PAYMENTS Your father is 50 years old and will retire in 10 years. He expects to live for 25 years after he retires, until he is 85. He wants a fixed retirement income value of his retirement income will decline annually after he retires.) His retirement income will begin the day he retires, 10 years from today, at which time he will receive 24 additional annual payments. Annual inflation is expected to be 5%. He currently has 100,000 saved, and he expects to cam 8% annually on his savings. How much must he save during each of the next 10 years (end-of-year deposits) to meet his retirement goal?40P 41SP 42IC 1Q 2Q Suppose you believe that the economy is just entering a recession. Your firm must raise capital immediately, and debt will be used. Should you borrow on a long-term or a short-term basis? Why?4Q Suppose a new process was developed that could be used to make oil out of seawater. The equipment required is quite expensive; but it would in time lead to low prices for gasoline, electricity, and other types of energy. What effect would this have on interest rates?6Q 7Q Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average companys common stock?9Q Suppose you have noticed that the slope of the corporate yield curve has become steeper over the past few months. What factors might explain the change in the slope?1P REAL RISK-FREE RATE You read in The Wall Street Journal that 30-day T-bills are currently yielding 5.5%. Your brother-in-law, a broker at Safe and Sound Securities, has given you the following estimates of current interest rate premiums: Inflation prcmium= 3.25% Liquidity premium =0.6% Maturity risk premium = 1.8% Default risk premium = 2.15% On the basis of these data, what is the real risk free rote cf return?EXPECTED INTEREST RATE The real risk-free rale is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities? What is the yield on 3-year Treasury securities?DEFAULT RISK PREMIUM A Treasury bond that matures in 10 years has a yield of 6%. A 10-year corporate bond has a yield of 8%. Assume that the liquidity premium on the corporate bond is 0.5%. What is the default risk premium on the corporate bond?MATURITY RISK PREMIUM The real risk-free rate is 3%, and inflation is expected to be 3% for the next 2 years. A 2-ycar Treasury security yields 6.2%. What is the maturity risk premium for the 2-year security?INFLATION CROSS-PRODUCT An analyst is evaluating securities in a developing nation where the inflation rate is very high. As a result, the analyst has been warned not to ignore the cross-product between the real rate and inflation. If the real risk-free rate is 5% and inflation is expected to be 16% each of the next 4 years, what is the yield on a 4-year security with no maturity, default, or liquidity risk? (Hint: Refer to The Links between Expected Inflation and Interest Rates: A Closer Look on page 201.)EXPECTATIONS THEORY One-year Treasury securities yield 5%. The market anticipates that 1 year from now, 1-year Treasury securities will yield 6%. If the pure expectations theory is correct, what is the yield today for 2-year Treasury securities? Calculate the yield using a geometric average.8P 9P 10P 11P MATURITY RISK PREMIUM An investor in Treasury securities expects inflation to be 2.5% in Year 1,3.2% in Year 2, and 3.6% each year thereafter. Assume that the real risk-free rate is 2.75% and that this rate will remain constant. Three-year Treasury securities yield 6.25%, while 5-year Treasury securities yield 6.80%. What is the difference in the maturity risk premiums (MRPs) on the two securities; that is, what is MRP5 MRP3?13P EXPECTATIONS THEORY AND INFLATION Suppose 2-year Treasury bonds yield 4.5%, while 1-year bonds yield 3%. r is 1%, and the maturity risk premium is zero. a. Using the expectations theory, what is the yield on a 1-ycar bond 1 year from now? Calculate the yield using a geometric average. b. What is the expected inflation rate in Year 1? Year 2?EXPECTATIONS THEORY Assume that the real risk-free rate is 2% and that the maturity risk premium is zero. If a 1-ycar Treasury bond yield is 5% and a 2-year Treasury bond yields 7%, what is the 1-year interest rate that is expected for Year 2? Calculate this yield using a geometric average. What inflation rate is expected during Year 2? Comment on why the average interest rate during the 2-year period differs from the 1-year interest rate expected for Year 2.16P 17P 18P 19P INTEREST RATE DETERMINATION AND YIELD CURVES a. What effect would each of the following events likely have on the level of nominal interest rates? 1. Households dramatically increase their savings rate. 2. Corporations increase their demand for funds following an increase in investment opportunities. 3. The government runs a larger-than-expected budget deficit. 4. There is an increase in expected inflation. b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 4%; and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0 02(t 1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. You may determine the default risk premium (DRP), given the companys bond rating, from the table below. Remember to subtract the bonds LP from the corporate spread given in the table to arrive at the bonds DRP. What yield would you predict for each of these two investments? Rate Corporate Bond Yield Spread = DRP + LP U.S. Treasury 0.83% ---- AAA corporate 0.93 0.10% AA corporate 1.29 0.46 A corporate 1.67 0.84 c. Given the following Treasury bond yield information, construct a graph of the yield curve. Maturity Yield 1 year 5.37% 2 years 5.47 3 years 5.65 4 years 5.71 5 years 5.64 10 years 5.75 20 years 6.33 30 years 5.94 d. Based on the information about the corporate bond provided in part b, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. e. Which part of the yield curve (the left side or right side) is likely to be most volatile over time? f. Using the Treasury yield information in part c, calculate the following rates using geometric averages: 1. The 1-year rate 1 year from now 2. The 5-year rate 5 years from now 3. The 10-year rate 10 years from now 4. The 10-year rate 20 years from now 21IC A sinking fund can be set up in one of two ways: The corporation makes annual payments to the trustee, who invests the proceeds in securities (frequently government bonds) and uses the accumulated total to retire the bond issue at maturity. The trustee uses the annual payments to retire a portion of the issue each year, calling a given percentage of the issue by a lottery and paying a specified price per bond or buying bonds on the open market, whichever is cheaper. What are the advantages and disadvantages of each procedure from the viewpoint of the firm and the bondholders?Can the following equation be used to find the value of a bond with N years to maturity that pays interest once a year? Assume that the bond was issued several years ago. V6=t=1NAnnualinterest(1+rd)t+Parvalue(1+rd)N The values of outstanding bonds change whenever the going rate of interest changes. In general, short-term interest rates are more volatile than long-term interest rates. Therefore, short-term bond prices are more sensitive to interest rate changes than are long-term bond prices. Is that statement true or false? Explain. (Hint: Make up a reasonable example based on a 1-year and a 20-year bond to help answer the question.)If interest rates rise after a bond issue, what will happen to the bonds price and YTM? Does the time to maturity affect the extent to which interest rate changes affect the bonds price? (Again, an example might help you answer this question.)Discuss the following statement: A bonds yield to maturity is the bonds promised rate of return, which equals its expected rate of return.If you buy a callable bond and interest rates decline, will the value of your bond rise by as much as it would have risen if the bond had not been callable? Explain.7Q Indicate whether each of the following actions will increase or decrease a bonds yield to maturity: a. The bonds price increases. b. The bond is downgraded by the rating agencies. c. A change in the bankruptcy code makes it more difficult for bondholders to receive payments in the event the firm declares bankruptcy. d. The economy seems to be shifting from a boom to a recession. Discuss the effects of the firms credit strength in your answer. e. Investors learn that the bonds are subordinated to another debt issue.Why is a call provision advantageous to a bond issuer? When would the issuer be likely to initiate a refunding call?Are securities that provide for a sinking fund more or less risky from the bondholders perspective than those without this type of provision? Explain.Whats the difference between a call for sinking fund purposes and a refunding call?Why are convertibles and bonds with warrants typically offered with lower coupons than similarly rated straight bonds?Explain whether the following statement is true or false: Only weak companies issue debentures.14Q A bonds expected return is sometimes estimated by its YTM and sometimes by its YTC. Under what conditions would the YTM provide a better estimate, and when would the YTC be better?Which of the following bonds has the most price risk? Explain your answer. (Hint: Refer to Table 7.2.) a. 7-year bonds with a 5% coupon. b. 1-year bonds with a 12% coupon. c. 3-year bonds with a 5% coupon. d. 15-year zero coupon bonds. e. 15-year bonds with a 10% coupon.Which of the bonds has the most reinvestment risk? Explain your answer. (Hint: Refer to Table 7.2.) a. 7-year bonds with a 5% coupon. b. 1-year bonds with a 12% coupon. c. 3-year bonds with a 5% coupon. d. 15-year zero coupon bonds. e. 15-year bonds with a 10% coupon.1P YIELD TO MATURITY AND FUTURE PRICE A bond has a 1,000 par value, 10 years to maturity, and a 7% annual coupon and sells for 985. a. What Is its yield to maturity (YTM)? b. Assume that the yield to maturity remains constant for the next 3 years. What will the price be 3 years from today?BOND VALUATION Nungesser Corporation's outstanding bonds have a 1,000 par value, a 9% semiannual coupon, 8 years to maturity, and an 8.5% YTM. What is the bond's price?YIELD TO MATURITY A firms bonds have a maturity of 10 years with a 51,000 face value, have an 8% semiannual coupon, are callable in 5 years at 1,050, and currently sell at a price of 1,100. What are their nominal yield to maturity and their nominal yield to call? What return should investors expect to earn on these bonds?BOND VALUATION An investor has two bonds in his portfolio that have a face value of 1,000 and pay a 10% annual coupon. Bond L matures in 15 years, while Bond S matures in 1 year. a. What will the value of each bond be if the going interest rate is 5%, 8%, and 12%? Assume that only one more interest payment is to be made on Bond S at its maturity and that 15 more payments are to be made on Bond L. b. Why does the longer-term bonds price vary more than the price of the shorter-term bond when interest rates change?BOND VALUATION An investor has two bonds in her portfolio. Bond C and Bond Z. Each bond matures in 4 years, has a face value of 1,000, and has a yield to maturity of 9 6%. Bond C pays a 10% annual coupon, while Bond Z is a zero coupon bond. a. Assuming that the yield to maturity of each bond remains at 9.6% over the next 4 years, calculate the price of the bonds at each of the following years to maturity: Years to Maturity Price of Bond C Price of Bond Z 4 ___________ ___________ 3 ___________ ___________ 2 ___________ ___________ 1 ___________ ___________ 0 ___________ ____________ b. Plot the time path of prices for each bond.INTEREST RATE SENSITIVITY .An investor purchased the following 5 bonds. Each bond had a par value of 1,000 and an 8% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 7% What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table:YIELD TO CALL Six years ago the Singleton Company issued 20-year bonds with a 14% annual coupon rate at their 1,000 par value. The bonds had a 9% call premium, with 5 years of call protection. Today Singleton called the bonds. Compute the realized rate of return for an investor who purchased the bonds when they were issued and held them until they were called. Explain why the investor should or should not be happy that Singleton called them.9P 10P BOND YIELDS Last year Clark Company issued a 10-year, 12% semiannual coupon bond at its par value of 1,000. Currently, the bond can be called in 4 years at a price of 1,060 and it sells for 1,100. a. What arc the bonds nominal yield to maturity and its nominal yield to call? Would an investor be more likely to earn the YTM or the YTC? b. What is the current yield? Is this yield affected by whether the bond is likely to be called? (Hint: Refer to Footnote 7 for the definition of the current yield and to Table 7.1.) c. What is the expected capital gains (or loss) yield for the coming year? Is this yield dependent on whether the bond is expected to be called? Explain your answer.YIELD TO CALL It is now January 1, 2015, and you are considering the purchase of an outstanding bond that was issued on January 1, 2013. It has a 9 5% annual coupon and had a 30-year original maturity. (It matures on December 31, 2042.) There is 5 years of call protection (until December 31, 2017), after which time it can be called at 109that is, at 109% of par, or 1,090. Interest rates have declined since it was issued, and it is now selling at 116 575% of par, or 1,165 75. a. What is the yield to maturity? What is the yield to call? b. If you bought this bond, which return would you actually earn? Explain your reasoning. c. Suppose the bond had been selling at a discount rather than a premium. Would the yield to maturity have been the most likely return, or would the yield to call have been most likely?PRICE AND YIELD An 8% semiannual coupon bond matures in 5 years. The bond has a face value of 1,000 and a current yield of 8.21%, What are the bonds price and YTM? (Hint: Refer to Footnote 7 for the definition of the current yield and to table 7.1.)14P BOND VALUATION Bond X is noncallable and has 20 years to maturity, a 9% annual coupon, and a 1,000 par value. Your required return on Bund X is 10%; if you buy it, you plan to hold it for 5 years. You (and the market) have expectations that in 5 years, the yield to maturity on a 15-year bond with similar risk will be 85%. How much should you be willing to pay for Bund X today? (Hint: You will need to know how much the bond will be worth at the end of 5 years.)16P BOND RETURNS Last year Joan purchased a 51,000 face value corporate bond with an 11% annual coupon rate and a 10-year maturity. At the time of the purchase, it had an expected yield to maturity of 9.79%. if Joan sold the bond today for 1,060.49, what rate of return would she have canted for the past year?YIELD TO MATURITY AND YIELD TO CALL Kaufman Enterprises has bonds outstanding with a 1,000 face value and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is 1,175. The bonds may be called in 5 years at 109% of face value (Call price = 1,090). a. What is the yield to maturity? b. What is the yield to call if they are called in 5 years? c. Which yield might investors expect to earn on these bonds? Why? d. The bonds indenture indicates that the call provision gives the firm the right to call the bonds at the end of each year beginning in Year 5. In Year 5, the bonds may be called at 109% of face value; but in each of the next 4 years, the call percentage will decline by 1%. Thus, in Year 6, they may be called at 108% of face value; in Year 7, they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the bonds?BOND VALUATION Clifford Clark is a recent retiree who is interested in investing some of his savings in corporate bonds. His financial planner has suggested the following bonds: Bond A has a 7% annual coupon, matures in 12 years, and has a 1,000 face value. Bond B has a 9% annual coupon, matures in 12 years, and has a 1,000 face value. Bond C has an 11% annual coupon, matures in 12 years, and has a 1,000 face value. Each bond has a yield to maturity of 9%. a. Before calculating the prices of the bonds, indicate whether each bond is trading at a premium, at a discount, or at par. b. Calculate the price of each of the three bonds. c. Calculate the current yield for each of the three bonds. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.) d. If the yield to maturity for each bond remains at 9%, what will be the price of each bond 1 year from now? What is the expected capital gains yield for each bond? What is the expected total return for each bond? e. Mr. Clark is considering another bond. Bond D. It has an 8% semiannual coupon and a 1,000 face value (i.e., it pays a 40 coupon every 6 months). Bond D is scheduled to mature in 9 years and has a price of 1,150. It is also callable in 5 years at a call price of 1,040. 1. What is the bond's nominal yield to maturity? 2. What is the bond's nominal yield to call? 3. If Mr. Clark were to purchase this bond, would he be more likely to receive the yield to maturity or yield to call? Explain your answer. f. Explain briefly the difference between price risk and reinvestment risk. Which of the following bonds has the most price risk? Which has the most reinvestment risk? A 1-year bond with a 9% annual coupon A 5-year bond with a 9% annual coupon A 5-year bond with a zero coupon A 10-year bond with a 9% annual coupon A 10-year bond with a zero coupon g. Only do this part if you are using a spreadsheet. Calculate the price of each bond (A, B, and C) at the end of each year until maturity, assuming interest rates remain constant. Create a graph showing die time path of each bonds value, similar to that shown in Figure 7.2. 1. What is the expected interest yield for each bond in each year? 2. What is the expected capital gains yield for each bond in each year? 3. What is the total return for each bond in each year?BOND VALUATION Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company's pension fund management division. A major new client, the California League of Cities, has requested that Western present an investment seminar to the mayors of the represented cities. Black and Alvarez, who will make the presentation, have asked you to help them by answering the following questions: a. What are a bond's key features? b. What are call provisions and sinking fund provisions? Do these provisions make bonds more or less risky? c. How is the value of any asset whose value is based on expected future cash flows determined? d. How is a bonds value determined? What is the value of a 10-year, 1,000 par value bond with a 10% annual coupon if its required return is 10%? e. 1. What is the value of a 13% coupon bond that is otherwise identical to the bond described in part d? Would we now have a discount or a premium bond? 2. What is the value of a 7% coupon bond with these characteristics? Would we now have a discount or premium bond? 3. What would happen to the values of the 7%, 10%, and 13% coupon bonds over time if the required return remained at 10%? (Hint: With a financial calculator, enter PMT, I/YR, FV, and N; then change (override) N to see what happens to the PV as it approaches maturity.) f. 1. What is the yield to maturity on a 10-year, 9% annual coupon, 1,000 par value bond that sells for 887.00? That sells for 1,134.20? What does the fact that it sells at a discount or at a premium tell you about the relationship between rd and the coupon rate? a. 2. What are the total return, the current yield, and the capital gains yield for the discount bond? Assume that it is held to maturity, and the company does not default on it. (Hint: Refer to footnote 6 for the definition of the current yield and to Table 7.1.) g. What is price risk? Which has more price risk, an annual payment 1-year bond or a 10-year bond? Why? h. What is reinvestment risk? Which has more reinvestment risk, a 1-year bond or a 10-vear bond? i. How does the equation for valuing a bond change if semiannual payments are made? Find the value of a 10-year, semiannual payment. 10% coupon bond if nominal rd = 13% j. Suppose for 1,000 you could buy a 10%, 10-year, annual payment bond or a 10%, 10-year, semiannual payment bond. They are equally risky. Which would you prefer? If 1,000 is the proper price for the semiannual bond, what is the equilibrium price for the annual payment bond? k. Suppose a 10-year, 10% semiannual coupon bond with a par value of 1,000 is currently selling for 1,135.90, producing a nominal yield to maturity of 8%. However, it can be called after 4 years for 1,050. 1. What is the bond's nominal yield to call (YTC)? 2. If you bought this bond, would you be more likely to earn the YTM or the YTC? Why? l. Does the yield to maturity represent the promised or expected return on the bond? Explain. m. These bonds were rated AA by SP. Would you consider them investment-grade or junk bonds? n. What factors determine a companys bond rating? o. If this firm were to default on the bonds, would the company be immediately liquidated? Would the bondholders be assured of receiving all of their promised payments? Explain.1Q 2Q 3Q Is it possible to construct a portfolio of foal-world stocks that has a required return equal to the risk-free rate? Explain.Stock A has an expected return of 7%, a standard deviation of expected returns of 35%, a correlation coefficient with the market of - 0.3, and a beta coefficient of -0.5. Stock B has an expected return of 12%, a standard deviation of returns of 10%, a 0.7 correlation with the market, and a beta coefficient of l.0. Which security is riskier? Why?A stock had a 12% return last year, a year when the overall stock market decline. Does this mean that the stock has a negative beta and thus very little risk if held in a portfolio? Explain.If investors aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.8Q In Chapter 7, we saw that if the market interest rate, rd, for a given bond increased, the price of the bond would decline. Applying this same logic to stocks, explain (a) how a decrease in risk aversion would affect stocks prices and earned rates of return, (b) how this would affect risk premiums as measured by the historical difference between returns on stocks and returns on bonds, and (c) what the implications of this would be for the use of historical risk premiums when applying the SML equation.1P PORTFOLIO BETA An individual has 35,000 invested in a stock with a beta of 0.8 and another 40,000 invested in a stock with a beta of 1.4. If these are the only two investments in her portfolio, what is her portfolios beta?REQUIRED RATE OF RETURN Assume that the risk-free rate is 6% and the required return on the market is 13%. What is the required rate of return on a stock with a beta of 0.7?EXPECTED AND REQUIRED RATES OF RETURN Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the required return for the overall stock market? What is the required rate of return on a stock with a beta of 1.2?BETA AND REQUIRED RATE OF RETURN A stock has a required return of 11%. the risk-free rate is 7%, and the market risk premium is 4%. a. What is the stocks beta? b. If the market risk premium increased to 6%, what would happen to the stocks required rate of return? Assume that the risk-free rate and the beta remain unchanged.EXPECTED RETURNS Stocks X and Y have the following probability distributions of expected future returns: Probability X Y 0.1 (10%) (35%) 0.2 2 0 0.4 12 20 0.2 20 2S 0.1 38 45 a. Calculate the expected rate of return, rY, for Stock Y (rX = 12%). b. Calculate the standard deviation of expected returns, X, for Stock X (Y = 20.35%). Now calculate the coefficient of variation for Stock Y. Is it possible that most investors will regard Stock Y as being less risky than Stock X? Explain.7P BETA COEFFICIENT Given the following information determine the beta coefficient for Stock J that is consistent with equilibrium: rJ = 12.5%; rRF = 4.5%; rM = 10.5%.REQUIRED RATE OF RETURN Stock R has a beta of 1.5, Stock S has a beta of 0.75, the required return on an average stock is 13%, and the risk-free rate of return is 7%. By how much does the required return on the riskier stock exceed the required return on the less risky stock?CAPM AND REQUIRED RETURN Bradford Manufacturing Company has a beta of 1.45, while Farley Industries has a beta of 0.85. The required return on an index fund that holds the entire stock market is 12.0%. The risk-free rate of interest is 5%. By how much does Bradfords required return exceed Farleys required return?CAPM AND REQUIRED RETURN Calculate the required rate of return for Manning Enterprises assuming that investors expect a 3.5% rate of inflation in the future. The real risk-free rate is 2.5%, and the market risk premium is 6.5%. Manning has a beta of 1.7, and its realized rate of return has averaged 13.5% over the past 5 years.REQUIRED RATE OF RETURN Suppose rRF = 9%, rM = 14% and bi = 13. a. What is ri, the required rate of return on Stock i? b. Now suppose that rRF (1) increases to 10% or (2) decreases to 8%. The slope of the SML remains constant. How would this affect rM, and ri? c. Now assume that rRF remains at 9% but rM (1) increases to 16% or (2) falls to 13%. The slope of the SML does not remain constant. How would these changes affect ri?CAPM, PORTFOLIO RISK. AND RETURN Consider the following information for Stocks X, Y, and Z. The returns on the three stocks arc positively correlated, but they are not perfectly correlated. (That is, each of the correlation coefficients is between 0 and 1.) Stock Expected Return Standard Deviation Beta X 9.00% 15% 0.8 Y 10.75 15 1.2 Z 12.50 15 1.6 Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the market is in equilibrium. (That is, required returns equal expected returns.) a. What is the market risk premium (rM rRF)? b. What is the beta of Fund Q? c. What is the required return of Fund Q? d. Would you expect the standard deviation of Fund Q to be less than 15%, equal to 15%, or greater than 15%? Explain.PORTFOLIO BETA Suppose you held a diversified portfolio consisting of a 7,500 investment in each of 20 different common stocks. The portfolios beta is 1.12. Now suppose you decided to sell one of the stocks in your portfolio with a beta of 1.0 for 7,500 and use the proceeds to buy another stock with a beta of 1.75. What would your portfolios new beta be?15P CAPM AND PORTFOLIO RETURN You have been managing a 5 million portfolio that has a beta of 1.25 and a required rate of return of 12%. The current risk-free rate is 5.25%. Assume that you receive another 500,000. If you invest the money in a stock with a beta of 0.75, what will be the required return on your 5.5 million portfolio?PORTFOLIO BETA A mutual fund manager has a 20 million portfolio with a beta of 1.5. The risk-free rate is 4.5%, and the market risk premium is 5.5%. The manager expects to receive an additional 5 million, which she plans to invest in a number of stocks. After investing the additional funds, she wants the funds required return to be 13%. What should be the average beta of the new stocks added to the portfolio?EXPECTED RETURNS Suppose you won the lottery and had two options: (1) receiving 0.5 million or (2) taking a gamble in which, at the flip of a coin, you receive 1 million if a head comes up but receive zero if a tail comes up. a. What is the expected value of the gamble? b. Would you take the sure 0.5 million or the gamble? c. If you chose the sure 0.5 million, would that indicate that you are a risk averter or a risk seeker? d. Suppose the payoff was actually 0.5 million that was the only choice. You now face the choice of investing it in a U.S. Treasury bond that will return 537,500 at the end of a year or a common stock that has a 50-50 chance of being worthless or worth 1,150,000 at the end of the year. l. The expected profit on the T-bond investment is 37,500. What is the expected dollar profit on the stock investment? 2. The expected rate of return on the T-bond investment is 7.5%. What is the expected rate of return on the stock investment? 3. Would you invest in the bond or the stock? Why? 4. Exactly how large would the expected profit (or the expected rate of return) have to be on the stock investment to make you invest in the stock, given the 7.5% return on the bond? 5. How might your decision be affected if, rather than buying one stock for 0.5 million, you could construct a portfolio consisting of 100 stocks with 5,000 invested in each? Each of these stocks has the same return characteristics as the one stock that is, a 50-50 chance of being worth zero or 11,300 at year-end. Would the correlation between returns on these stocks matter? Explain.EVALUATING RISK AND RETURN Stock X has a 10% expected return, a beta coefficient of 0.9, and a 35% standard deviation of expected returns. Stock Y has a 12.5% expected return, a beta coefficient of 1.2, and a 25% standard deviation. The risk-free rate is 6%, and the market risk premium is 5%. a. Calculate each stocks coefficient of variation. b. Which stock is riskier for a diversified investor? c. Calculate each stocks required rate of return. d. On the basis of the two stocks expected and required returns, which stock would be more attractive to a diversified investor? e. Calculate the required return of a portfolio that has 7,500 invested in Stock X and 2,500 invested in Stock Y. f. If the market risk premium increased to 6%, which of the two stocks would have the larger increase in its required return?REALIZED RATES OF RETURN Stocks A and B have the following historical returns: Year Stock A's Returns, rA Stock B's Returns, rB 2013 (18.00%) (14.50%) 2014 33.00 21.80 2015 15.00 30 5O 2016 (0.50) (7.60) 2017 27.00 26.30 a. Calculate the average rate of return for each stock during the period 2013 through 2017. b. Assume that someone held a portfolio consisting of 50% of Stock A and 50% of Stock B. What would the realized rate of return on the portfolio have been each year? What would the average return on the portfolio have been during this period? c. Calculate the standard deviation of returns for each stock and for the portfolio. d. Calculate the coefficient of variation for each stock and for the portfolio. e. Assuming you are a risk-averse investor, would you prefer to hold Stock A, Stock B, or the portfolio? Why?SECURITY MARKET LINE You plan to invest in the Kish Hedge Fund, which has total capital of 500 million invested in five stocks: Stock Investment Stocks Beta Coefficient A 160 million 0.5 B 120 million 1.2 C 80 million 1.8 D 80 million 1.0 E 60 million 1.6 Kishs beta coefficient can be found as a weighted average of its stocks betas. The risk-free rate is 6%, and you believe the following probability distribution for future market returns is realistic: Probability Market Return 0.l -28% 0.2 0 0.4 12 0.2 30 0.1 50 a. What is the equation for the security market line (SML)? (Hint First, determine the expected market return.) b. Calculate Kishs required rate of return. c. Suppose Rick Kish, the president, receives a proposal from a company seeking new capital. The amount needed to lake a position in the stock is 50 million, it has an expected return of 15%, and its estimated beta is 1.5. Should Kish invest in the new company? At what expected rate of return should Kish be indifferent to purchasing the stock?22SP 23IC 1TCL 2TCL 3TCL Using Past Information to Estimate Required Returns Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. Chapter 8 discussed the basic trade-off between risk and return. In the capital asset pricing model (CAPM) discussion, beta was identified as the correct measure of risk for diversified shareholders. Recall that beta measures the extent to which the returns of a given stock move with the stock market. When using the CAPM to estimate required returns, we would like to know how the stock will move with the market in the future, but because we dont have a crystal ball, we generally use historical data to estimate this relationship with beta. As mentioned in Web Appendix 8A, beta can be estimated by regressing the individual stock's returns against the returns of the overall market. As an alternative to running our own regressions, we can rely on reported betas from a variety of sources. These published sources make it easy for us to readily obtain beta estimates for most large publicly traded corporations. However, a word of caution is in order. Beta estimates can often be quite sensitive to the time period in which the data are estimated, the market index used, and the frequency of the data used. Therefore, it is not uncommon to find a wide range of beta estimates among the various Internet websites. 4. Select one of the four stocks listed in question 3 by entering the company's ticker symbol on the financial website you have chosen. On the screen you should see the interactive chart. Select the six-month time period and compare the stock's performance to the SP 500's performance on the graph by adding the SP 500 to the interactive chart. Has the stock outperformed or underperformed the overall market during this time period?5TCL 7TCL 8TCL It is frequently stated that the one purpose of the preemptive right is to allow individuals to maintain their proportionate share of the ownership and control of a corporation. a. How important do you suppose control is for the average stockholder of a firm whose shares are traded on the New York Stock Exchange? b. Is the control issue likely to be of more importance to stockholders of publicly owned or closely held (private) firms? Explain.Is the following equation correct for finding the value of a constant growth stock? Explain. P0=Dors+g 3Q Two investors are evaluating GEs stock for possible purchase. They agree on the expected value of D1 and on the expected future dividend growth rate. Further, they agree on the riskiness of the stock. However, one investor normally holds stocks for 2 years, while the other holds stocks for 10 years. On the basis of the type of analysis done in this chapter, should they both be willing to pay the same price for GEs stock? Explain.A bond that pays interest forever and has no maturity is a perpetual bond. In what respect is a perpetual bond similar to a no-growth common stock? Are there preferred stocks that are evaluated similarly to perpetual bonds and other preferred issues that are more like bonds with finite lives? Explain.Discuss the similarities and differences between the discounted dividend and corporate valuation models.This chapter discusses the discounted dividend and corporate valuation models for valuing common stocks. Two alternative approaches, the P/E multiple and EVA approaches, were presented. Explain each approach and how you might use each one to value a common stock.DPS CALCULATION Warr Corporation just paid a dividend of 1.50 a share (that is, D0 = 150). The dividend is expected to grow 7% a year for the next 3 years and then at 5% a year thereafter. What is the expected dividend per share for each of the next 5 years?CONSTANT GROWTH VALUATION Thomas Brothers is expected to pay a 0.50 per share dividend at the end of the year (that is, D1.= 0.50). The dividend is expected to grow at a constant rate of 7% a year. The required rate of return on the stock, rs is 15%. What is the stock's current value per share?CONSTANT GROWTH VALUATION Harmon Clothiers stock currently sells for 20.00 a share. It just paid a dividend of 1.00 a share (that is, D0 = 1.00). The dividend is expected to grow at a constant rate of 6% a year. What stock price is expected 1 year from now? What is the required rate of return?NONCONSTANT GROWTH VALUATION Hart Enterprises recently paid a dividend, D0, of 1.25. It expects to have nonconstant growth of 20% for 2 years followed by a constant rate of 5% thereafter. The firms required return is 10%. a. How far away is the horizon date? b. What is the firms horizon, or continuing, value? c. What is the firms intrinsic value today, P0?CORPORATE VALUATION Smith Technologies is expected to generate 150 million in free cash flow next year, and FCF is expected to grow at a constant rate of 5% per year indefinitely. Smith has no debt or preferred stock, and its WACC is 10%. If Smith has 50 million shares of stock outstanding, what is the stocks value per share?PREFERRED STOCK VALUATION Fee Founders has perpetual preferred stock outstanding that sells for 60 a share and pays a dividend of 5 at the end of each year. What is the required rate of return?7P PREFERRED STOCK VALUATION Ezzell Corporation issued perpetual preferred stock with a 10% annual dividend. The stock currently yields 8%, and its par value is 100. a. What is the stocks value? b. Suppose interest rates rise and pull the preferred stocks yield up to 12%. What is its new market value?PREFERRED STOCK RETURNS Bruner Aeronautics has perpetual preferred stock outstanding with a par value of 100. The stock pays a quarterly dividend of 2, and its current price is 80. a. What is its nominal annual rate of return? b. What is its effective annual rate of return?VALUATION OF A DECLINING GROWTH STOCK Martell Mining Companys ore reserves are being depleted, so its sales are falling. Also, because its pit is getting deeper each year, its costs are rising. As a result, the companys earnings and dividends are declining at the constant rate of 5% per year. If D0 = 85 and rs = 15%, what is the value of Martell Minings stock?VALUATION Of A CONSTANT GROWTH STOCK A stock is expected to pay a dividend of 0.50 at the end of the year (that is, D1 = 0.50). and it should continue to grow at a constant rate of 7% a year. If its required return is 12%. what is the stocks expected price 4 years from today?VALUATION OF A CONSTANT GROWTH STOCK Investors require a 15% rate of return on Levine Companys stock that is, rs = 15%). a. What is its value if the previous dividend was D0 = 2 and investors expect dividends to grow at a constant annual rate of (1) 5%, (2) 0%, (3) 5%, or (4) 10%? b. Using data from Part a, what would the Gordon (constant growth) model value be if the required rate of return was 15% and the expected growth rate was (1) 15% or (2) 20%? Are these reasonable results? Explain. c. Is it reasonable to think that a constant growth stock could have g rs? Why or why not?CONSTANT GROWTH You are considering an investment in Keller Corporations stock, which is expected to pay a dividend of 52.00 a share at the end of the year (D1 = 2.00) and has a beta of 0.9. The risk-free rate is 5.6%, and the market risk premium is 6%. Keller currently sells for 25.00 a share, and its dividend is expected to grow at some constant rate g. Assuming the market is in equilibrium, what does the market believe will be the stock price at the end of 3 years? (That is. what is P3?)NONCONSTANT GROWTH Microtech Corporation is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect Microtech to begin paying dividends, beginning with a dividend of 1.00 coming 3 years from today. The dividend should grow rapidlyat a rate of 50% per yearduring Years 4 and 5; but after Year 5, growth should be a constant 8% per year. If the required return on Microtech is 15%. what is the value of the stock today?CORPORATE VALUATION Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which PCF is expected to grow at a constant 7% rate. Doziers WACC is 13%. a. What is Doziers horizon, or continuing, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.) b. What is the firms value today? c. Suppose Dozier has 100 million of debt and 10 million shares of stock outstanding. What is your estimate of the current price per share?NONCONSTANT GROWTH Milts Cosmetics Co.s stock price is 58.88, and it recently paid a 2.00 dividend. This dividend is expected to grow by 25% (or the next 3 years, then grow forever at a constant rate, g; and rs = 12%. At what constant rate is the stock expected to grow after Year 3?CONSTANT GROWTH Your broker offers to sell you some shares of Bahnsen Co. common stock that paid a dividend of 2.00 yesterday. Bahnsens dividend is expected to grow at 5% per year for the next 3 years. If you buy the stock, you plan to hold it for 3 years and then sell it. The appropriate discount rate is 12%. a. Find the expected dividend for each of the next 3 years; that is, calculate D1, D2, and D3. Note that D0 = 2.00. b. Given that the first dividend payment will occur 1 year from now, find the present value of the dividend stream; that is, calculate the PVs of D1, D2, and D3, and then sum these PVs. c. You expect the price of the stock 3 years from now to be 34.73; that is, you expect P3 to equal 34.73. Discounted at a 12% rate, what is the present value of this expected future stock price? In other words, calculate the PV of 34.73. d. If you plan to buy the stock, hold it for 3 years, and then sell it for 34.73, what is the most you should pay for it today? e. Use Equation 9.2 to calculate the present value of this stock. Assume that g = 5% and that it is constant. f. Is the value of this stock dependent upon how long you plan to hold it? In other words, if your planned holding period was 2 years or 5 years rather than 3 years, would this affect the value of the stock today, P0? Explain.NONCONSTANT GROWTH STOCK VALUATION Taussig Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth rate is expected to last for another 2 years, then decline to gn =6%. a. If D0 = 1.60 and rs = 10%, what is TICs stock worth today? What are its expected dividend, and capital gains yields at this time, that is, during Year 1? b. Now assume that ITCs period of supernormal growth is to last for 5 years rather than 2 years. Flow would this affect the price, dividend yield, and capital gains yield? Answer in words only. c. What will TTCs dividend and capital gains yields be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth; the calculations are very easy.) d. Explain why investors are interested in the changing relationship between dividend and capital gains yields over time.CORPORATE VALUATION Barrett Industries Invests a large sum of money in RD; as a result, it retains and reinvests all of its earnings. In other words. Barrett does not pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barretts stock. The pension fund manager has estimated Barretts free cash flows for the next 4 years as follows: 3 million. 6 million, 10 million, and 15 million. After the fourth year, free cash flow is projected to grow at a constant 7%. Barretts WACC is 12%, the market value of its debt and preferred stock totals 60 million, and it has 10 million shares of common stock outstanding. a. What is the present value of the free cash flows protected during the next 4 years? b. What is the firms horizon, or continuing, value? c. What b the firms total value today? d. What is an estimate of Barretts price per share?CORPORATE VALUE MODEL Assume that today is December 31, 2015, and that the following information applies to Vermeil Airlines: After-tax operating income EBIT (1T) for 2016 is expected to be 500 million. The depreciation expense for 2016 is expected to be 100 million. The capital expenditures for 2016 are expected to be 200 million. No change is expected in net operating working capital. The free cash flow is expected to grow at a constant rate of 6% per year. The required return on equity is 14%. The WACC is 10%. The market value of the companys debt is 3 billion. 200 million shares of stock are outstanding. Using the corporate valuation model approach, what should be the companys stock price today?NONCONSTANT GROWTH Assume that it is now January 1, 2016. Wayne-Martin Electric Inc. (WME) has developed a solar panel capable of generating 200% more electricity than any other solar panel currently on the market. As a result, WME is expected to experience a 15% annual growth rate for the next 5 years. Other firms will have developed comparable technology by the end of 5 years, and WMEs growth rate will slow to 5% per year indefinitely. Stockholders require a return of 12% on WMEs stock. The most recent annual dividend (D0) , which was paid yesterday, was 1 75 per share. a. Calculate WMEs expected dividends for 2016, 2017, 2018, 2019, and 2020. b. Calculate the value of the stock today, P. Proceed by finding the present value of the dividends expected at the end of 2016, 2017, 2018, 2019, and 2020 plus the present value of the stock price that should exist at the end of 2020. The year end 2020 stock price can be found by using the constant growth equation. Notice that to find the December 31, 2020, price, you must use the dividend expected in 2021, which is 5% greater than the 2020 dividend. c. Calculate the expected dividend yield (D1/P0) capital gains yield, and total return (dividend yield plus capital gains yield) expected for 2016. (Assume that P=P0and recognize that the capital gains yield is equal to the total return minus the dividend yield.) Then calculate these same three yields for 2021. d. How might an investors tax situation affect his or her decision to purchase stocks of companies in the early stages of their lives, when they are growing rapidly, versus stocks of older, more mature firms? When does WMEs stock become mature for purposes of this question? e. Suppose your boss tells you she believes that WMEs annual growth rate will be only 12% during the next 5 years and that the firms long-run growth rate will be only 4%. Without doing any calculations, what general effect would these growth rate changes have on the price of WMEs stock? f. Suppose your boss also tells you that she regards WME as being quite risky and that she believes the required rate of return should be 14%, not 12%. Without doing any calculations, determine how the higher required rate of return would affect the price of the stock, the capital gains yield, and the dividend yield. Again, assume that the longrun growth rate is 4%.Comprehensive/Spreadsheet Problem NONCONSTANT GROWTH AND CORPORATE VALUATION Rework problem 9-18, parts a, b, and c, using a spreadsheet model. For part b, calculate the price, dividend yield, and capital gains yield as called for In the problem. After completing parts a through c, answer the following additional question, using the spreadsheet model. d. TTC recently introduced a new line of products that has been wildly successful. On the basis of this success and anticipated future success, the following free cash flows were projected: After the tenth year, TTCs financial planners anticipate that its free cash flow will grow at a constant rate of 6%. Also, the firm concluded that the new product caused the WACC to fall to 9%. The market value of TTCs debt is 1,200 million; it uses no preferred stock; and there are 20 million shares of common stock outstanding. Use the corporate valuation model to value the stock. 9-18 NONCONSTANT GROWTH STOCK VALUATION Taussig Technologies Corporation (TTC) has been growing at a rate of 20% per year in recent years. This same growth rate is expected to last for another 2 years, then decline to gn =6%. a. If D0 = 1.60 and rs = 10%, what is TICs stock worth today? What are its expected dividend, and capital gains yields at this time, that is, during Year 1? b. Now assume that ITCs period of supernormal growth is to last for 5 years rather than 2 years. Flow would this affect the price, dividend yield, and capital gains yield? Answer in words only. c. What will TTCs dividend and capital gains yields be once its period of supernormal growth ends? (Hint: These values will be the same regardless of whether you examine the case of 2 or 5 years of supernormal growth; the calculations are very easy.) d. Explain why investors are interested in the changing relationship between dividend and capital gains yields over time.23IC Estimating Exxon Mobil Corporation's Intrinsic Stock Value Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In this chapter, we described the various factors that influence stock prices and the approaches that analysts use to estimate a stock's intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices for in excess of their intrinsic value may be good stocks to avoid or sell. Although estimating a stock's intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the Internet to find financial data in order to arrive at a quick "back-of-the- envelope" calculation of intrinsic value. 1. For purposes of this exercise, let's take a closer look at the stuck of Exxon Mobil Corporation (XOM). Use websites such as Yahoo! Finance, Google Finance, MSN Money (www.msn.com/en-us/money/markets). and Morningstar to find the company's current stock price and see its performance relative to the overall market in recent months. What is Exxon Mobils current stock price? How has the stock performed relative to the market over the past few months? Previous Close 73.60 Open 74.35 Bid 74.25 X 100 Ask 74.60 X 500 Day's Range 74.10-75.00 52 Week Range 73.53 - 89.30 2TCL Estimating Exxon Mobil Corporation's Intrinsic Stock Value Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In this chapter, we described the various factors that influence stock prices and the approaches that analysts use to estimate a stocks intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices far in excess of their intrinsic value may be good stocks to avoid or sell Although estimating a stock's intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the Internet to find financial data in order to arrive at a quick "back-of-the- envelope" calculation of intrinsic value. 3. To provide a starting point for gauging a company's relative valuation, analysts often look at a company's price-to-earnings (P/E) ratio. Go to the website's summary quote or key statistics screen to see XOM's forward P/E ratio, which uses XOM's next 12-month estimate of earnings in the calculation, and to see its current P/E ratio. What are the firms forward and current P/E ratios?4TCL Estimating Exxon Mobil Corporation's Intrinsic Stock Value Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions. In this chapter, we described the various factors that influence stock prices and the approaches that analysts use to estimate a stocks intrinsic value. By comparing these intrinsic value estimates to the current price, an investor can assess whether it makes sense to buy or sell a particular stock. Stocks trading at a price far below their estimated intrinsic values may be good candidates for purchase, whereas stocks trading at prices far in excess of their intrinsic value may be good stocks to avoid or sell Although estimating a stock's intrinsic value is a complex exercise that requires reliable data and good judgment, we can use the Internet to find financial data in order to arrive at a quick "back-of-the- envelope" calculation of intrinsic value. 5. To put the firm's current P/E ratio in perspective, it is useful to compare this ratio with that of other companies in the same industry. To see how XOMs P/E ratio stacks up to its peers, refer to Google Finance's Related Companies screen. (If you click "Add or remove columns, you will find that you can obtain comparisons of a number of key statistics for either the most recent year or quarter) For the most part, is XOM's P/E ratio above or below that of its peers? In Chapter -4, we discussed the various factors that may influence P/E ratios Can any of these factors explain why XOM's P/E ratio differs from its peers? Explain.6TCL 7TCL 8TCL 9TCL 10TCL

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