FINANCE 601 ACCESS CODE (CUSTOM)
16th Edition
ISBN: 9781259867668
Author: Ross
Publisher: MCG CUSTOM
expand_more
expand_more
format_list_bulleted
Textbook Question
Chapter 5, Problem 9CQ
The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake Project A. At a luncheon for shareholders, the manager of a pension fund that owns a substantial amount of the firm’s stock asks you why the firm chose Project A instead of Project B when Project B has a higher profitability index.
How would you, the CFO, justify your firm’s action? Are there any circumstances under which Global Investments should choose Project B?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solutionStudents have asked these similar questions
Net Present Value versus Profitability Index Consider the following two mutually exclusive projects available to Global Investments, Inc.:
C0
C1
C2
Profitability Index
NPV
A
-$1,000
-$1,000
$500
1.32
$322
B
-500
500
400
1.57
285
The appropriate discount rate for the projects is 10 percent. Global Investments chose to undertake Project A. At a luncheon for shareholders, the manager of a pension fund that owns a substantial amount of the firm’s stock asks you why the firm chose Project A instead of Project B when Project B has a higher profitability index. How would you, the CFO, justify your firm’s action? Are there any circumstances under which Global Investments should choose Project B?
Relative valuation lecture: What happens if we apply a 20% discount for a private company when valuing Helix instead of the other discount used in the slides? Recall that the average EBITDA multiple for comparable firms is 10.48. If Helix anticipates earning $10 million in EBITDA this year (same as in the lecture), then we estimate the equity value of Helix to be what, using a private company discount of 20%? [Reminder: Helix has $2.4 million in cash and $21 million in interest bearing debt] Can someone explain the math please?
Optimal Capital Structure. Queen Industries, which has no debt outstanding, has a beta of 0.95 for its common stock. Management is considering a change in the capital structure to 40% debt and 60% equity. This change would increase the beta on the stock to 1.15, and the after-tax cost of debt will be 7.5%. The expected return on the equity market is 15%, and the risk-free rate is 5%. Recommend whether Queen’s management should proceed with the capital structure change.
Chapter 5 Solutions
FINANCE 601 ACCESS CODE (CUSTOM)
Ch. 5 - Payback Period and Net Present Value If a project...Ch. 5 - Net Present Value Suppose a project has...Ch. 5 - Comparing Investment Criteria Define each of the...Ch. 5 - Payback and Internal Rate of Return A project has...Ch. 5 - International Investment Projects In March 2014,...Ch. 5 - Capital Budgeting Problems What are some of the...Ch. 5 - Prob. 7CQCh. 5 - Prob. 8CQCh. 5 - Net Present Value versus Profitability Index...Ch. 5 - Internal Rate of Return Projects A and B have the...
Ch. 5 - Net Present Value You are evaluating Project A and...Ch. 5 - Modified Internal Rate of Return One of the less...Ch. 5 - Net Present Value It is sometimes stated that the...Ch. 5 - Prob. 14CQCh. 5 - Calculating Payback Period and NPV Maxwell...Ch. 5 - Calculating Payback An investment project provides...Ch. 5 - Calculating Discounted Payback An investment...Ch. 5 - Calculating Discounted Payback An investment...Ch. 5 - Prob. 5QPCh. 5 - Calculating IRR Compute the internal rate of...Ch. 5 - Calculating Profitability Index Bill plans to open...Ch. 5 - Calculating Profitability Index Suppose the...Ch. 5 - Cash Flow Intuition A project has an initial cost...Ch. 5 - Prob. 10QPCh. 5 - NPV versus IRR Consider the following cash flows...Ch. 5 - Problems with Profitability Index The Coris...Ch. 5 - Prob. 13QPCh. 5 - Comparing Investment Criteria Wii Brothers, a game...Ch. 5 - Profitability Index versus NPV Hanmi Group, a...Ch. 5 - Comparing Investment Criteria Consider the...Ch. 5 - Comparing Investment Criteria The treasurer of...Ch. 5 - Comparing Investment Criteria Consider the...Ch. 5 - Prob. 19QPCh. 5 - NPV and Multiple IRRs You are evaluating a project...Ch. 5 - Payback and NPV An investment under consideration...Ch. 5 - Multiple IRRs This problem is useful for testing...Ch. 5 - NPV Valuation The Yurdone Corporation wants to set...Ch. 5 - Calculating IRR The Utah Mining Corporation is set...Ch. 5 - Prob. 25QPCh. 5 - Calculating IRR Consider two streams of cash...Ch. 5 - Calculating Incremental Cash Flows Darin Clay, the...Ch. 5 - Prob. 28QPCh. 5 - Prob. 1MCCh. 5 - Seth Bullock, the owner of Bullock Gold Mining, is...
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Optimal Capital Structure with Hamada Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero-growth firm and pays out all of its earnings as dividends. The firm’s EBIT is $14,933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0. What is BEA’s unlevered beta? Use market value D/S (which is the same as wd/ws when unlevering. What are BEA’s new beta and cost of equity if it has 40% debt? What are BEA’s WACC and total value of the firm with 40% debt?arrow_forwardRisk-adjusted discount rates—Basic Country Wallpapers is considering investing in one of three mutually exclusive projects, E, F, and G. The firm’s cost of capital, r, is 10%, and the risk-free rate, RF, is 2%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table. Project (j) E F G Initial Investment (CF0) -$15,000 -$11,000 -$19,000 Year (t) Cash Inflows 1 $6,000 $6,000 $4,000 2 6,000 4,000 6,000 3 6,000 5,000 8,000 4 6,000 2.000 12,000 Risk index (RIj) 1.80 1.00 0.60 Find the net present value (NPV) of each project using the firm’s cost of capital. Which project is preferred in this situation? The firm uses the following equation to determine the risk-adjusted discount rate, RADR, for each project j: RADRj=Rf + [RIj x (r-Rf)] Where: Rf=risk free rate of return RIj=risk index for project j r=cost of capital Substitute…arrow_forwardpiedmont hotels is an all-equity company. its stock has a beta of 1.23. the market risk premium is 6.9 percent and the risk-free rate is 2.7 percent. the company is considering a project that it considers riskier than its current operations so it wants to apply an adjustment of 1.9 percent to the project's discount rate. what should the firm set as the required rate of return for the project?arrow_forward
- As the general manager of a firm, you are presented with an investment proposal from one of your divisions. Its net present value, if discounted at the cost of capital for your firm (which is 15 percent), is $ 1 00,000, and its internal rate of return is 20 percent. (a) What are the economic interpretations of the net present value and internal rate of return figures? In other words, what do they mean? (b) What, if any, additional information would you like to have before approving the project?arrow_forwardHello. I need help with the following question please. Wentworth Industries is 100 percent equity financed. Its current beta is 0.6. The expected market rate of return is 17 percent and the risk-free rate is 9 percent. Round your answers to two decimal places. Calculate Wentworth’s cost of equity. If Wentworth changes its capital structure to 20 percent debt, it estimates that its beta will increase to 0.8. The after-tax cost of debt will be 9 percent. Should Wentworth make the capital structure change? Based on the weighted cost of capital of %, the capital structure changed.arrow_forwardProfitability index. Given the discount rate and the future cash flow of each project listed in the following table, use the PI to determine which projects the company should accept. What is the PI of project B?(Round to two decimal places.) Cash Flow Project A Project B Year 0 −$1,800,000 −$2,400,000 Year 1 $500,000 $1,200,000 Year 2 $600,000 $1,100,000 Year 3 $700,000 $1,000,000 Year 4 $800,000 $900,000 Year 5 $900,000 $800,000 Discount rate 5% 17%arrow_forward
- You have assigned the following values to these three firms: Upcoming Dividend $0.50 Estee Lauder Kimco Realty Nordstrom Price $36.00 75.00 11.00 1.58 2.00 Estee Lauder required return Kimco Realty required return Nordstrom required return Assume that the market portfolio will earn 17.20 percent and the risk-free rate is 8.20 percent. Compute the required return for each company using both CAPM and the constant-growth model. (Do not round intermediate calculations and round your final answers to 2 decimal places.) CAPM Growth 11.40% 17.00 8.80 % % % Beta 0.92 1.28 1.24 Constant-Growth Model % % %arrow_forwardSuppose the following two independent investment opportunities are available to Fitz, Inc. The appropriate discount rate is 8 percent. Year Project Alpha Project Beta 0 −$5,500 −$7,100 1 2,800 1,600 2 2,700 5,500 3 1,700 4,500 a. Compute the profitability index for each of the two projects. (Do not round intermediate calculations and round your answers to 3 decimal places, e.g., 32.161.) b. Which project(s), if either, should the company accept based on the profitability index rule? multiple choice Neither project Project Beta Both projects Project Alphaarrow_forwardWentworth Industries is 100 percent equity financed. Its current beta is 1.1. The expected market rate of return is 16 percent and the risk-free rate is 11 percent. Round your answers to two decimal places. Calculate Wentworth’s cost of equity. % If Wentworth changes its capital structure to 20 percent debt, it estimates that its beta will increase to 1.3. The after-tax cost of debt will be 10 percent. Should Wentworth make the capital structure change? Based on the weighted cost of capital of %, the capital structure changed.arrow_forward
- Hardware Co. is estimating its optimal capital structure. Hardware Co. has a capital structure that consists of 80% equity and 20% debt and a corporate tax rate of 40%. Based on the short-term treasury bill rates the risk-free rate is 6% and the market return is 11%. Hardware Co. computed its cost of equity based on the CAPM – 12%. The company will shift its capital structure to 50% debt and 50% equity funded. 1. What is the levered beta on the capital structure of 50% debt and 50% equity funded?arrow_forwardOptimal Capital Structure with HamadaBeckman Engineering and Associates (BEA) is considering a change in itscapital structure. BEA currently has $20 million in debt carrying a rate of8%, and its stock price is $40 per share with 2 million shares outstanding.BEA is a zero-growth firm and pays out all of its earnings as dividends.The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-statetax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEAis considering increasing its debt level to a capital structure with 40% debt,based on market values, and repurchasing shares with the extra money thatit borrows. BEA will have to retire the old debt in order to issue new debt,and the rate on the new debt will be 9%. BEA has a beta of 1.0.a. What is BEA’s unlevered beta? Use market value D/S (which is the sameas wd/ws) when unlevering.b. What are BEA’s new beta and cost of equity if it has 40% debt?c. What are BEA’s WACC and total value of the firm with 40% debt?arrow_forwardThe three options' expected net present value (NPV) and profitability indexes (PI) has been calculated 1. Discuss which option(s) should be chosen for investment, assuming the company can invest surplus cash in the money market at 10% (Note: You should assume that the R50m expenditure limit is the absolute maximum the company wishes to spend). 2. Discuss whether the company's decision not to borrow, thereby limiting investment expenditure, is in the best interests of its shareholders.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
- Financial And Managerial AccountingAccountingISBN:9781337902663Author:WARREN, Carl S.Publisher:Cengage Learning,Managerial AccountingAccountingISBN:9781337912020Author:Carl Warren, Ph.d. Cma William B. TaylerPublisher:South-Western College Pub
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Financial And Managerial Accounting
Accounting
ISBN:9781337902663
Author:WARREN, Carl S.
Publisher:Cengage Learning,
Managerial Accounting
Accounting
ISBN:9781337912020
Author:Carl Warren, Ph.d. Cma William B. Tayler
Publisher:South-Western College Pub
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY