Chapter 7
2. If National HealthCare Corp. reported earnings per share of $5.82 in 2000 and $21.26 in 2011, at what annual rate did earnings per share grow over this period?
4. You are looking to purchase the latest model of the BMW 750 luxury sedan. The price of the car is $82,000. However, you negotiate a six year loan, with no money down and no monthly payments during the first year. After the first year, you will pay $1,500 per month for the following five years, with a balloon payment at the end to cover the remaining principal on the loan. The APR interest rate on the loan with monthly compounding is 7 percent. What will be the amount of the balloon payment six years from now?
6. You are selling a product on commission at the rate of $1,000 per sale. To date, you have spent $800 promoting a particular prospective sale. You are confident you can complete this sale with the expenditure of an added expenditure of some undetermined amount. What is the maximum amount, over and above what you have already spent, that you should be willing to spend to assure the sale?
8. Times are tough for Auger Biotech. Having raised $85 million in an initial public offering of its stock early in the year, the company is poised to launch its product. If Auger engages in a promotional campaign costing $60 million this year, its annual after-tax cash flow over the next five years will be only $700,000. If it does not undertake the campaign, it expects its after-tax cash flow to be minus $18 million annually for the same period. Assuming the company has decided to stay in its chosen business, is this campaign worthwhile when the discount rate is 10 percent? Why or why not?
10. (Read the chapter appendix before attempting this problem.) A company is considering the following investment opportunities.
Investment A B C
Initial cost ($ millions) $5.5 $3.0 $2.0
Expected life 10 yrs 10 yrs 10 yrs
NPV @ 15% $340,000 $300,000 $200,000
IRR 20% 30% 40%
a. If the company can raise large amounts of money at an annual cost of 15 percent, and if the investments are independent of one another, which should it undertake?
b. If the company can raise large amounts of money at an annual cost of 15 percent, and if the investments are mutually exclusive, which should it undertake?
c. Considering only these three investments, if the company has a fixed capital budget of $5.5 million, and if the investments are independent of one another, which should it undertake?
Chapter 8
2. The annual standard deviation of return on Stock A’s equity is 37 percent and the correlation coefficient of these returns, with those on a well diversified portfolio, is 0.62. Comparable numbers of Stock B are 34 percent and 0.94. Which stock is riskier? Why?
4. Your company’s weighted-average cost of capital is 11 percent. It is planning to undertake a project with an internal rate of return of 14%, but you believe this project is not a wise investment. What logical arguments would you use to convince your boss to forego the project despite its high rate of return? Is it possible that making investments with returns higher than the firm’s cost of capital will destroy value? If so, how?
6. You have the following information about Burgundy Basins, a sink manufacturer.
Equity shares outstanding 20 million
Stock price per share $40.00
Yield to maturity on debt 7.5%
Book value of interest-bearing debt $320 million
Coupon interest rate on debt 4.8%
Market value of debt $290 million
Book value of equity $500 million
Cost of equity capital 14%
Tax rate 35%
Burgundy is contemplating what for the company is an average-risk investment costing $40 million and promising an annual after-tax cash flow of $6.4 million in perpetuity.
a. What is the internal rate of return on the investment?
b. What is Burgundy’s weighted-average cost of capital?
c. If undertaken, would you expect this investment to benefit share-holders? Why or why not?
8. What is the present value of a cash flow stream of $1,000 per year annually for 15 years that then grows at 4 percent per year forever when the discount rate is 13 percent?
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Input: |
15 |
13 |
1000 |
||
|
N |
I |
Pv |
Pmt |
Fv |
|
|
Output: |
-6462.38 |
14. This problem tests your understanding of the chapter appendix. Dome Appliance, Inc., a private firm that manufactures home appliances, has hired you to estimate the company’s beta. You have obtained the following equity betas for publicly traded firms that also manufacture home appliances.
($ millions)
Market Value
Firm Beta Debt of Equity
Black & Decker 1.19 $4,100 $6,300
Fedders Corp. 1.20 5 200
Helen of Troy Corp. 2.14 380 530
Salton, Inc. 3.25 375 115
Whirlpool 1.83 10,600 9,100
a. Estimate an asset beta for Dome Appliance.
b. What concerns, if any, would you have about using the betas of these firms to estimate Dome Appliance’s asset beta?
Chapter 9
2. In July 2007, Newscorp entered into an agreement to purchase all of the outstanding shares of Dow Jones and Company for $60 per share. The number of outstanding shares at the time of the announcement was 82 million. The book value of interest-bearing liabilities on the balance sheet of Dow Jones was $1.46 billion. Estimate the cost of this acquisition to the shareholders of Newscorp.
4. The following table shows the projected free cash flows of an acquisition target. The potential acquirer wants to estimate its maximum acquisition price at an 8 percent discount rate and a terminal value in year 5 based on the perpetual growth equation with a 4 percent perpetual growth rate.
Year 1 2 3 4 5
Free cash flow –$800 –$400 $0 $200 $700
a. Estimate the target’s maximum acquisition price.
b. Estimate the target’s maximum acquisition price when the discount rate is 7 percent and the perpetual growth rate is 5 percent.
c. What is the percentage change in the maximum acquisition price when the discount rate is reduced one percentage point and the perpetual growth rate is increased one percentage point?
6. A sporting goods manufacturer has decided to expand into a related business. Management estimates that to build and staff a facility of the desired size and to attain capacity operations would cost $450 million in present value terms. Alternatively, the company could acquire an existing firm or division with the desired capacity. One such opportunity is the division of another company. The book value of the division’s assets is $250 million and its earnings before interest and tax are presently $50 million. Publicly traded comparable companies are selling in a narrow range around 12 times current earnings. These companies have book value debt-to-asset ratios averaging 40 percent with an average interest rate of 10 percent.
a. Using a tax rate of 34 percent, estimate the minimum price the owner of the division should consider for its sale.
b. What is the maximum price the acquirer should be willing to pay?
c. Does it appear that an acquisition is feasible? Why or why not?
d. Would a 25 percent increase in stock prices to an industry average price-to-earnings ratio of 15 change your answer to (c)? Why or why not?
12. A venture capital company buys 400,000 shares of a start-up’s stock for $5 million. If the company has 1.6 million shares outstanding prior to the purchase, what is the company’s pre-money value? What is its post-money value?