Owers Divestiture Corporation, a firm speculating in corporate reorganizations, has bonds
outstanding that were originally issued at par but are now selling, on September 19, 2012, for
$1,050 per $1,000 face value. The bonds have a stated interest ra
The Mini-Max Company has the following cost information on their new prospective project.
Fixed costs are $200/year. (Initial investment is $700).
Variable costs: $3/unit.
Discount rate: 12%.
Project life: 3 y
Excelsior shares are currently selling for $25.00 each. You bought 200 shares one year ago at
$24 and received dividend payments of $1.50 per share. What was your percentage capital
gain this year?
54. The empirical evidence strongly indicates that the stockholders of the target firm realize large
wealth gains as a result of a takeover bid but the stockholders in the acquiring firm gain little, if
anything. Although no definitive answer exists as to
Chapter 7 Key
A $25 investment produces $27.50 at the end of the year with no risk. Which of the following is
A. NPV is positive if the interest rate is less than 10%.
B. NPV is negative if the interest rate is less than 10%.
C. NPV is zero i
What is the conversion value of the bond?
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Learning Objective: 25-05 The Value of Convertible Bonds
Ross - Chapter 25 #23
A convertible bond has a 8% coupon and 1
Using the internal rate of return rule, a conventional project should be accepted if the internal
rate of return is:
A. only equal to the current weighted average cost of capital.
B. greater than the current weighted average cost of capital.
50. The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding
whether including debt in their capital structure would increase their value. Under consideration is
issuing $300,000 in new debt with an 8% interest rate. Na
A firm is all equity with 5,000 shares outstanding worth $7 each. They are planning on issuing
$10,000 of new perpetual debt at the 8% market rate of interest. The effective tax rate is 25%.
What is the change in equity value if they make the debt fo
The common stock of Eddie's Engines Corp. sells for $25.71 a share. The stock is expected to
pay $1.80 per share next month when the annual dividend is distributed. Eddie's has
established a pattern of increasing its dividends by 4% annually and expe
15. You have plotted the data for two securities over time on the same graph, ie., the month return of
each security for the last 5 years. If the pattern of the movements of the two securities rose and
fell as the other did, these two securities would hav
44. Jake's Sound Systems has 210,000 shares of common stock outstanding at a market price of
$36 a share. Last month, Jake's paid an annual dividend in the amount of $1.593 per share. The
dividend growth rate is 4%. Jake's also has 6,000 bonds outstanding
You can realize the same value as that derived from stock ownership if you:
A. sell a put option and invest at the risk-free rate of return.
B. buy a call option and write a put option on a stock and also borrow funds at the risk-free
C. sell a
When making financial decisions related to assets, you should:
A. always consider market values.
B. place more emphasis on book values than on market values.
C. rely primarily on the value of assets as shown on the balance sheet.
D. only consider mar
Alabaster Incorporated has a beta of 1.05, a cost of debt of 8% and a debt to value ratio of .7.
The current risk free rate is 3% and the market rate of return is 12.5%. What is the company's
cost of equity capital?
The separation theorem in financial markets is fundamental to allowing managers to maximize
all shareholders wealth. Explain the separation theorem and how the financial markets provide
for all different types of investors.
Investors have different
Firm A is paying $750,000 in interest payments a year while Firm B is paying LIBOR plus 75
basis points on $10,000,000 loans. The current LIBOR rate is 6.5%. Firm A and B have
agreed to swap interest payments, how much will be paid, to which Firm thi
23. The two fatal flaws of the internal rate of return rule are:
A. arbitrary determination of a discount rate and failure to consider initial expenditures.
B. arbitrary determination of a discount rate and failure to correctly analyze mutually exclusive
Bruno's, Inc. is analyzing two machines to determine which one it should purchase. The
company requires a 14% rate of return and uses straight-line depreciation to a zero book
value. Machine A has a cost of $290,000, annual operating costs of $8,000,
24. An industry is likely to have a low beta if the:
A. stream of revenues is unstable than the market.
B. economy is in an expansion.
C. market for its goods is affected by the market cycle.
D. stream of revenues is more volatile than the market.
27. The Tip-Top Paving Co. has a beta of 1.11, a cost of debt of 11% and a debt to value ratio of .6.
The current risk free rate is 9% and the market rate of return is 16.18%. What is the company's
cost of equity capital?
23. Including the option to expand in your project analysis will tend to:
A. extend the duration of a project but not affect the project's net present value.
B. increase the net present value of a project.
C. decrease the net present value of a project.
60. Eyes of the World Corporation has traditionally employed a firm wide discount rate for capital
budgeting purposes. However, its two divisions - publishing and entertainment - have different
degrees of risk given by P = 1.0, E = 2.0, and the beta for t
What is the present value of 10 payments of $500 each received every 24 months at a
discount rate of 12%?
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Learning Objective: 05-04 Simplificatio
Your employer contributes $25 a week to your retirement plan. Assume that you work for your
employer for another twenty years and that the applicable discount rate is 5%. Given these
assumptions, what is this employee benefit worth to you today?
6. Your best friend works in the finance office of the Delta Corporation. You are aware that this
friend trades Delta stock based on information he overhears in the office. You know that this
information is not known to the general public. Your friend con
The Alto Horns Corp. is planning on introducing a new line of saxophones. They expect sales
to be $200,000 with total fixed and variable costs representing 70% of sales. The discount rate
on the unlevered equity is 17%, but the firm plans to raise $7
Given the cash flow stream of the following mutually exclusive projects, prove through the
incremental investment that Project B, with the higher NPV, will be preferred to project A.
0 1 2 3 NPV IRR
Project A: -500 150 245 320 46.39 17.76
It has been argued that if one could perfectly synchronize a firm's cash inflows and outflows,
short-term financial planning would be unnecessary. Do you agree? What actions can the
firm's financial decision-makers take to reduce the degree of asynch
In Miller's model, when the quantity (1-Tc)(1-Ts) = (1-Tb), then:
A. the firm should hold no debt.
B. the value of the levered firm is greater than the value of the unlevered firm.
C. the tax shield on debt is exactly offset by higher personal taxes