Showing 1648–1656 of 1959 results
-
Identifying Relevant Cash Flows
$1.00
Text: Hunter Industries is evaluating a capital budgeting project and has come across a few issues that require special attention. Classify each item as a sunk cost, externality, opportunity cost, or a change in net operating working capital (NOWC). Then, in the last column, indicate whether the item should be included in the project’s analysis or Suppose Hunter will be issuing debt to support this project and other capital budgeting projects this year. The firm’s interest expense will increase by $700,000. Should the change in interest expense be included in the analysis?
-
The basics of capital budgeting
$1.00
Text: One of the most important financial management activities that a firm undertakes is its evaluation and allocation of investment funds to support its future survival and growth. These activities may be motivated by the desire to expand the firm?s revenues, reduce its costs, or satisfy its mandatory or voluntary legal, health, and safety requirements. They may have, more or less, multiyear effects on the organization and may or may not be considered as capital budgeting activities. Capital budgeting is the process of planning and controlling investments in assets that are expected to produce cash flows for one year or less. This statement is . The capital budgeting process in a company involves evaluation of cash flows, risk analysis, correlation with the portfolio of projects in the company etc. To make this process more streamlined, firms identify whether the projects qualify as a capital budgeting project or not and generally analyze them in different vertical categories. Which of the following are examples of a capital budgeting project? Check all that apply. Fresno Furniture Manufacturing Inc.?s replacement of an existing piece of equipment Collins Construction Co.?s acquisition of a new parcel of real estate Florence Fashion Footwear Inc.?s financing of its monthly average amount of accounts receivable For which of the following reasons are capital budgeting decisions important to a business organization? Check all that apply. Capital investments have relatively short life spans, so mistakes are worked through rather quickly. Capital investments tend to reflect the firm?s future activities, markets, and productive technologies. Capital investments tend to require sizable cash outlays.
-
Identifying Incremental Cash Flows
$2.00When firms make capital budgeting decisions, they should concern themselves with incremental cash flows, not net income, when evaluating projects. Indirect cash flows often affect a firm?s capital budgeting decisions. However, some of these indirect cash flows are relevant to capital budgeting decisions (because they represent marginal cash flows that depend on the project?s acceptance), but others should be ignored. are cash flows that the firm forgoes as a result of accepting the project under consideration. In general, these are cash flows of the next best alternative to the project. Consider the case of Bumbly Products Inc. The company is evaluating a capital budgeting project and has come across a few issues that require special attention. Classify each item as a sunk cost, cannibalization, opportunity cost, or a change in net working capital (NWC). Then, in the last column, indicate whether the item should be included in the project?s analysis or not. Suppose Bumbly will be issuing debt to support this project and other capital budgeting projects this year. The firm?s interest expense will increase by $700,000. Should the change in interest expense be included in the analysis? Yes No
-
Respond to the following independent issues concerning the capital stock of corporations in your initial post:
$2.50- Why are paid-in-capital and retained earnings displayed separately in the stockholder’s equity section of the balance sheet?
- Why would investors buy common stock when preferred stock is available?
- If you owned 5,000 shares of common stock in Microsoft Corporation and someone offered to buy the stock for its book value, would you accept the offer? Provide rationale for your decision.
-
Cost of Capital: Multiple Choice Questions
$20.00- A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?
A. dividend yield
B. cost of equity
C. capital gains yield
D. cost of capital
E. income return
- Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
A. compound rate.
B. current yield.
C. cost of debt.
D. capital gains yield.
E. cost of capital.
- The average of a firm’s cost of equity and aftertax cost of debt that is weighted based on the firm’s capital structure is called the:
A. reward to risk ratio.
B. weighted capital gains rate.
C. structured cost of capital.
D. subjective cost of capital.
E. weighted average cost of capital.
- When a manager develops a cost of capital for a specific project based on the cost of capital for another firm which has a similar line of business as the project, the manager is utilizing the _____ approach.
A. subjective risk
B. pure play
C. divisional cost of capital
D. capital adjustment
E. security market line
- A firm’s cost of capital:
A. will decrease as the risk level of the firm increases.
B. for a specific project is primarily dependent upon the source of the funds used for the project.
C. is independent of the firm’s capital structure.
D. should be applied as the discount rate for any project considered by the firm.
E. depends upon how the funds raised are going to be spent.
- The weighted average cost of capital for a wholesaler:
A. is equivalent to the aftertax cost of the firm’s liabilities.
B. should be used as the required return when analyzing a potential acquisition of a retail outlet.
C. is the return investors require on the total assets of the firm.
D. remains constant when the debt-equity ratio changes.
E. is unaffected by changes in corporate tax rates.
- Which one of the following is the primary determinant of a firm’s cost of capital?
A. debt-equity ratio
B. applicable tax rate
C. cost of equity
D. cost of debt
E. use of the funds
- Scholastic Toys is considering developing and distributing a new board game for children. The project is similar in risk to the firm’s current operations. The firm maintains a debt-equity ratio of 0.40 and retains all profits to fund the firm’s rapid growth. How should the firm determine its cost of equity?
A. by adding the market risk premium to the aftertax cost of debt
B. by multiplying the market risk premium by (1 – 0.40)
C. by using the dividend growth model
D. by using the capital asset pricing model
E. by averaging the costs based on the dividend growth model and the capital asset pricing model
- All else constant, which one of the following will increase a firm’s cost of equity if the firm computes that cost using the security market line approach? Assume the firm currently pays an annual dividend of $1 a share and has a beta of 1.2.
A. a reduction in the dividend amount
B. an increase in the dividend amount
C. a reduction in the market rate of return
D. a reduction in the firm’s beta
E. a reduction in the risk-free rate
- A firm’s overall cost of equity is:
A. is generally less that the firm’s WACC given a leveraged firm.
B. unaffected by changes in the market risk premium.
C. highly dependent upon the growth rate and risk level of the firm.
D. generally less than the firm’s aftertax cost of debt.
E. inversely related to changes in the firm’s tax rate.
- The cost of equity for a firm:
A. tends to remain static for firms with increasing levels of risk.
B. increases as the unsystematic risk of the firm increases.
C. ignores the firm’s risks when that cost is based on the dividend growth model.
D. equals the risk-free rate plus the market risk premium.
E. equals the firm’s pretax weighted average cost of capital.
- The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?
I. firms that have a 100 percent retention ratio
II. firms that pay a constant dividend
III. firms that pay an increasing dividend
IV. firms that pay a decreasing dividend
A. I and II only
B. I and III only
C. II and III only
D. I, II, and III only
E. II, III, and IV only
- The dividend growth model:
A. is only as reliable as the estimated rate of growth.
B. can only be used if historical dividend information is available.
C. considers the risk that future dividends may vary from their estimated values.
D. applies only when a firm is currently paying dividends.
E. uses beta to measure the systematic risk of a firm.
- Which one of the following statements related to the SML approach to equity valuation is correct? Assume the firm uses debt in its capital structure.
A. This model considers a firm’s rate of growth.
B. The model applies only to non-dividend paying firms.
C. The model is dependent upon a reliable estimate of the market risk premium.
D. The model generally produces the same cost of equity as the dividend growth model.
E. This approach generally produces a cost of equity that equals the firm’s overall cost of capital.
- Which of the following statements are correct?
I. The SML approach is dependent upon a reliable measure of a firm’s unsystematic risk.
II. The SML approach can be applied to firms that retain all of their earnings.
III. The SML approach assumes a firm’s future risks are similar to its past risks.
IV. The SML approach assumes the reward-to-risk ratio is constant.
A. I and III only
B. II and IV only
C. III and IV only
D. I, II, and III only
E. II, III, and IV only
- The pre-tax cost of debt:
A. is based on the current yield to maturity of the firm’s outstanding bonds.
B. is equal to the coupon rate on the latest bonds issued by a firm.
C. is equivalent to the average current yield on all of a firm’s outstanding bonds.
D. is based on the original yield to maturity on the latest bonds issued by a firm.
E. has to be estimated as it cannot be directly observed in the market.
- The aftertax cost of debt generally increases when:
I. a firm’s bond rating increases.
II. the market rate of interest increases.
III. tax rates decrease.
IV. bond prices rise.
A. I and III only
B. II and III only
C. I, II, and III only
D. II, III, and IV only
E. I, II, III, and IV
- The cost of preferred stock is computed the same as the:
A. pre-tax cost of debt.
B. return on an annuity.
C. aftertax cost of debt.
D. return on a perpetuity.
E. cost of an irregular growth common stock.
- The cost of preferred stock:
A. is equal to the dividend yield.
B. is equal to the yield to maturity.
C. is highly dependent on the dividend growth rate.
D. is independent of the stock’s price.
E. decreases when tax rates increase.
- The capital structure weights used in computing the weighted average cost of capital:
A. are based on the book values of total debt and total equity.
B. are based on the market value of the firm’s debt and equity securities.
C. are computed using the book value of the long-term debt and the book value of equity.
D. remain constant over time unless the firm issues new securities.
E. are restricted to the firm’s debt and common stock.
- Morris Industries has a capital structure of 55 percent common stock, 10 percent preferred stock, and 45 percent debt. The firm has a 60 percent dividend payout ratio, a beta of 0.89, and a tax rate of 38 percent. Given this, which one of the following statements is correct?
A. The aftertax cost of debt will be greater than the current yield-to-maturity on the firm’s bonds.
B. The firm’s cost of preferred is most likely less than the firm’s actual cost of debt.
C. The firm’s cost of equity is unaffected by a change in the firm’s tax rate.
D. The cost of equity can only be estimated using the SML approach.
E. The firm’s weighted average cost of capital will remain constant as long as the capital structure remains constant.
- The aftertax cost of debt:
A. varies inversely to changes in market interest rates.
B. will generally exceed the cost of equity if the relevant tax rate is zero.
C. will generally equal the cost of preferred if the tax rate is zero.
D. is unaffected by changes in the market rate of interest.
E. has a greater effect on a firm’s cost of capital when the debt-equity ratio increases.
- The weighted average cost of capital for a firm may be dependent upon the firm’s:
I. rate of growth.
II. debt-equity ratio.
III. preferred dividend payment.
IV. retention ratio.
A. I and III only
B. II and IV only
C. I, II, and IV only
D. I, III, and IV only
E. I, II, III, and IV
- The weighted average cost of capital for a firm is the:
A. discount rate which the firm should apply to all of the projects it undertakes.
B. rate of return a firm must earn on its existing assets to maintain the current value of its stock.
C. coupon rate the firm should expect to pay on its next bond issue.
D. minimum discount rate the firm should require on any new project.
E. rate of return shareholders should expect to earn on their investment in this firm.
- Which one of the following statements is correct for a firm that uses debt in its capital structure?
A. The WACC should decrease as the firm’s debt-equity ratio increases.
B. When computing the WACC, the weight assigned to the preferred stock is based on the coupon rate multiplied by the par value of the preferred.
C. The firm’s WACC will decrease as the corporate tax rate decreases.
D. The weight of the common stock used in the computation of the WACC is based on the number of shares outstanding multiplied by the book value per share.
E. The WACC will remain constant unless a firm retires some of its debt.
- If a firm uses its WACC as the discount rate for all of the projects it undertakes then the firm will tend to:
I. reject some positive net present value projects.
II. accept some negative net present value projects.
III. favor high risk projects over low risk projects.
IV. increase its overall level of risk over time.
A. I and III only
B. III and IV only
C. I, II, and III only
D. I, II, and IV only
E. I, II, III, and IV
- Preston Industries has two separate divisions. Each division is in a separate line of business. Division A is the largest division and represents 70 percent of the firm’s overall sales. Division A is also the riskier of the two divisions. Division B is the smaller and least risky of the two. When management is deciding which of the various divisional projects should be accepted, the managers should:
A. allocate more funds to Division A since it is the largest of the two divisions.
B. fund all of Division B’s projects first since they tend to be less risky and then allocate the remaining funds to the Division A projects that have the highest net present values.
C. allocate the company’s funds to the projects with the highest net present values based on the firm’s weighted average cost of capital.
D. assign appropriate, but differing, discount rates to each project and then select the projects with the highest net present values.
E. fund the highest net present value projects from each division based on an allocation of 70 percent of the funds to Division A and 30 percent of the funds to Division B.
- Markley and Stearns is a multi-divisional firm that uses its WACC as the discount rate for all proposed projects. Each division is in a separate line of business and each presents risks unique to those lines. Given this, a division within the firm will tend to:
A. receive less project funding if its line of business is riskier than that of the other divisions.
B. avoid risky projects so it can receive more project funding.
C. become less risky over time based on the projects that are accepted.
D. have equal probability of receiving funding as compared to the other divisions.
E. prefer higher risk projects over lower risk projects.
- The discount rate assigned to an individual project should be based on:
A. the firm’s weighted average cost of capital.
B. the actual sources of funding used for the project.
C. an average of the firm’s overall cost of capital for the past five years.
D. the current risk level of the overall firm.
E. the risks associated with the use of the funds required by the project.
- Assigning discount rates to individual projects based on the risk level of each project:
A. may cause the firm’s overall weighted average cost of capital to either increase or decrease over time.
B. will prevent the firm’s overall cost of capital from changing over time.
C. will cause the firm’s overall cost of capital to decrease over time.
D. decreases the value of the firm over time.
E. negates the firm’s goal of creating the most value for the shareholders.
- Which one of the following statements is correct?
A. Firms should accept low risk projects prior to funding high risk projects.
B. Making subjective adjustments to a firm’s WACC when determining project discount rates unfairly punishes low-risk divisions within a firm.
C. A project that is unacceptable today might be acceptable tomorrow given a change in market returns.
D. The pure play method is most frequently used for projects involving the expansion of a firm’s current operations.
E. Firms that elect to use the pure play method for determining a discount rate for a project cannot subjectively adjust the pure play rate.
- Phil’s is a sit-down restaurant that specializes in home-cooked meals. Theresa’s is a walk-in deli that specializes in specialty soups and sandwiches. Both firms are currently considering expanding their operations during the summer months by offering pre-wrapped donuts, sandwiches, and wraps at a local beach. Phil’s currently has a WACC of 14 percent while Theresa’s WACC is 10 percent. The expansion project has a projected net present value of $12,600 at a 10 percent discount rate and a net present value of -$2,080 at a 14 percent discount rate. Which firm or firms should expand and offer food at the local beach during the summer months?
A. Phil’s only
B. Theresa’s only
C. both Phil’s and Theresa’s
D. neither Phil’s nor Theresa’s
E. cannot be determined from the information provided
- Wilderness Adventures specializes in back-country tours and resort management. Travel Excitement specializes in making travel reservations and promoting vacation travel. Wilderness Adventures has an aftertax cost of capital of 13 percent and Travel Excitement has an aftertax cost of capital of 11 percent. Both firms are considering building wilderness campgrounds complete with man-made lakes and hiking trails. The estimated net present value of such a project is estimated at $87,000 at a discount rate of 11 percent and -$12,500 at a 13 percent discount rate. Which firm or firms, if either, should accept this project?
A. Wilderness Adventures only
B. Travel Excitement only
C. both Wilderness Adventures and Travel Excitement
D. neither Wilderness Adventures nor Travel Excitement
E. cannot be determined without further information
- The subjective approach to project analysis:
A. is used only when a firm has an all-equity capital structure.
B. uses the WACC of firm X as the basis for the discount rate for a project under consideration by firm Y.
C. assigns discount rates to projects based on the discretion of the senior managers of a firm.
D. allows managers to randomly adjust the discount rate assigned to a project once the project’s beta has been determined.
E. applies a lower discount rate to projects that are financed totally with equity as compared to those that are partially financed with debt.
- Which one of the following statements is correct?
A. The subjective approach assesses the risks of each project and assigns an adjustment factor that is unique just for that project.
B. Overall, a firm makes better decisions when it uses the subjective approach than when it uses its WACC as the discount rate for all projects.
C. Firms will correctly accept or reject every project if they adopt the subjective approach.
D. Mandatory projects should only be accepted if they produce a positive NPV when the firm’s WACC is used as the discount rate.
E. The pure play approach should only be used with low-risk projects.
- When a firm has flotation costs equal to 7 percent of the funding need, project analysts should:
A. increase the project’s discount rate to offset these expenses by multiplying the firm’s WACC by 1.07.
B. increase the project’s discount rate to offset these expenses by dividing the firm’s WACC by (1 – 0.07).
C. add 7 percent to the firm’s WACC to get the discount rate for the project.
D. increase the initial project cost by multiplying that cost by 1.07.
E. increase the initial project cost by dividing that cost by (1 – 0.07).
- The flotation cost for a firm is computed as:
A. the arithmetic average of the flotation costs of both debt and equity.
B. the weighted average of the flotation costs associated with each form of financing.
C. the geometric average of the flotation costs associated with each form of financing.
D. one-half of the flotation cost of debt plus one-half of the flotation cost of equity.
E. a weighted average based on the book values of the firm’s debt and equity.
- Incorporating flotation costs into the analysis of a project will:
A. cause the project to be improperly evaluated.
B. increase the net present value of the project.
C. increase the project’s rate of return.
D. increase the initial cash outflow of the project.
E. have no effect on the present value of the project.
- Flotation costs for a levered firm should:
A. be ignored when analyzing a project because they are not an actual project cost.
B. be spread over the life of a project thereby reducing the cash flows for each year of the project.
C. only be considered when two projects are mutually exclusive.
D. be weighted and included in the initial cash flow.
E. be totally ignored when internal equity funding is utilized.
- Chelsea Fashions is expected to pay an annual dividend of $0.80 a share next year. The market price of the stock is $22.40 and the growth rate is 5 percent. What is the firm’s cost of equity?
A. 7.58 percent
B. 7.91 percent
C. 8.24 percent
D. 8.57 percent
E. 9.00 percent
- The Shoe Outlet has paid annual dividends of $0.65, $0.70, $0.72, and $0.75 per share over the last four years, respectively. The stock is currently selling for $26 a share. What is this firm’s cost of equity?
A. 7.56 percent
B. 7.93 percent
C. 10.38 percent
D. 10.53 percent
E. 11.79 percent
- Sweet Treats common stock is currently priced at $19.06 a share. The company just paid $1.15 per share as its annual dividend. The dividends have been increasing by 2.5 percent annually and are expected to continue doing the same. What is this firm’s cost of equity?
A. 6.03 percent
B. 6.18 percent
C. 8.47 percent
D. 8.68 percent
E. 8.82 percent
- The common stock of Metal Molds has a negative growth rate of 1.5 percent and a required return of 18 percent. The current stock price is $11.40. What was the amount of the last dividend paid?
A. $2.07
B. $2.11
C. $2.19
D. $2.22
E. $2.26
- Highway Express has paid annual dividends of $1.16, $1.20, $1.25, $1.10, and $0.95 over the past five years respectively. What is the average dividend growth rate?
A. -4.51 percent
B. -3.60 percent
C. 2.28 percent
D. 2.47 percent
E. 4.39 percent
- Southern Home Cookin’ just paid its annual dividend of $0.65 a share. The stock has a market price of $13 and a beta of 1.12. The return on the U.S. Treasury bill is 2.5 percent and the market risk premium is 6.8 percent. What is the cost of equity?
A. 9.98 percent
B. 10.04 percent
C. 10.12 percent
D. 10.37 percent
E. 10.45 percent
- National Home Rentals has a beta of 1.38, a stock price of $19, and recently paid an annual dividend of $0.94 a share. The dividend growth rate is 4.5 percent. The market has a 10.6 percent rate of return and a risk premium of 7.5 percent. What is the firm’s cost of equity?
A. 7.05 percent
B. 8.67 percent
C. 9.13 percent
D. 10.30 percent
E. 11.56 percent
- Henessey Markets has a growth rate of 4.8 percent and is equally as risky as the market. The stock is currently selling for $17 a share. The overall stock market has a 10.6 percent rate of return and a risk premium of 8.7 percent. What is the expected rate of return on this stock?
A. 8.7 percent
B. 9.2 percent
C. 10.6 percent
D. 11.3 percent
E. 11.7 percent
- Tidewater Fishing has a current beta of 1.48. The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent. By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.60?
A. 0.88 percent
B. 1.07 percent
C. 1.50 percent
D. 2.10 percent
E. 2.26 percent
- Wind Power Systems has 20-year, semi-annual bonds outstanding with a 5 percent coupon. The face amount of each bond is $1,000. These bonds are currently selling for 114 percent of face value. What is the company’s pre-tax cost of debt?
A. 3.98 percent
B. 4.42 percent
C. 4.71 percent
D. 5.36 percent
E. 5.55 percent
- Boulder Furniture has bonds outstanding that mature in 13 years, have a 6 percent coupon, and pay interest annually. These bonds have a face value of $1,000 and a current market price of $1,040. What is the company’s aftertax cost of debt if its tax rate is 32 percent?
A. 2.97 percent
B. 3.24 percent
C. 3.78 percent
D. 5.21 percent
E. 5.53 percent
- Handy Man, Inc. has zero coupon bonds outstanding that mature in 8 years. The bonds have a face value of $1,000 and a current market price of $640. What is the company’s pre-tax cost of debt?
A. 2.55 percent
B. 5.09 percent
C. 5.66 percent
D. 7.31 percent
E. 7.48 percent
- Dog Gone Good Engines has a bond issue outstanding with 17 years to maturity. These bonds have a $1,000 face value, a 9 percent coupon, and pay interest semi-annually. The bonds are currently quoted at 87 percent of face value. What is the company’s pre-tax cost of debt if the tax rate is 38 percent?
A. 4.10 percent
B. 4.42 percent
C. 6.61 percent
D. 8.90 percent
E. 10.67 percent
- The Corner Bakery has a bond issue outstanding that matures in 7 years. The bonds pay interest semi-annually. Currently, the bonds are quoted at 101.4 percent of face value and carry a 9 percent coupon. What is the firm’s aftertax cost of debt if the tax rate is 30 percent?
A. 4.88 percent
B. 5.36 percent
C. 5.45 percent
D. 6.11 percent
E. 8.74 percent
- The outstanding bonds of Tech Express are priced at $989 and mature in 8 years. These bonds have a 6 percent coupon and pay interest annually. The firm’s tax rate is 39 percent. What is the firm’s aftertax cost of debt?
A. 3.01 percent
B. 3.22 percent
C. 3.35 percent
D. 3.77 percent
E. 4.41 percent
- Simple Foods has a zero coupon bond issue outstanding that matures in 9 years. The bonds are selling at 42 percent of par value. What is the company’s aftertax cost of debt if the tax rate is 38 percent?
A. 5.48 percent
B. 5.73 percent
C. 6.12 percent
D. 7.73 percent
E. 9.88 percent
- Grill Works and More has 8 percent preferred stock outstanding that is currently selling for $49 a share. The market rate of return is 14 percent and the firm’s tax rate is 37 percent. What is the firm’s cost of preferred stock?
A. 14.77 percent
B. 15.29 percent
C. 15.67 percent
D. 16.33 percent
E. 16.54 percent
- Samuelson Plastics has 7.5 percent preferred stock outstanding. Currently, this stock has a market value per share of $52 and a book value per share of $38. What is the cost of preferred stock?
A. 7.50 percent
B. 13.88 percent
C. 14.42 percent
D. 19.29 percent
E. 19.74 percent
- New York Deli’s has 7 percent preferred stock outstanding that sells for $36 a share. This stock was originally issued at $50 per share. What is the cost of preferred stock?
A. 13.68 percent
B. 14.00 percent
C. 14.29 percent
D. 19.44 percent
E. 19.80 percent
- Nelson’s Landscaping has 1,200 bonds outstanding that are selling for $990 each. The company also has 2,500 shares of preferred stock at a market price of $28 a share. The common stock is priced at $37 a share and there are 28,000 shares outstanding. What is the weight of the common stock as it relates to the firm’s weighted average cost of capital?
A. 43.08 percent
B. 45.16 percent
C. 47.11 percent
D. 54.00 percent
E. 55.45 percent
- Mangrove Fruit Farms has a $200,000 bond issue outstanding that is selling at 92 percent of face value. The firm also has 1,500 shares of preferred stock and 15,000 shares of common stock outstanding. The preferred stock has a market price of $35 a share compared to a price of $24 a share for the common stock. What is the weight of the preferred stock as it relates to the firm’s weighted average cost of capital?
A. 6.75 percent
B. 7.20 percent
C. 7.75 percent
D. 8.30 percent
E. 8.80 percent
- Electronics Galore has 950,000 shares of common stock outstanding at a market price of $38 a share. The company also has 40,000 bonds outstanding that are quoted at 106 percent of face value. What weight should be given to the debt when the firm computes its weighted average cost of capital?
A. 42 percent
B. 46 percent
C. 50 percent
D. 54 percent
E. 58 percent
- Phillips Equipment has 80,000 bonds outstanding that are selling at par. Bonds with similar characteristics are yielding 6.75 percent. The company also has 750,000 shares of 7 percent preferred stock and 2.5 million shares of common stock outstanding. The preferred stock sells for $53 a share. The common stock has a beta of 1.34 and sells for $42 a share. The U.S. Treasury bill is yielding 2.8 percent and the return on the market is 11.2 percent. The corporate tax rate is 38 percent. What is the firm’s weighted average cost of capital?
A. 10.39 percent
B. 10.64 percent
C. 11.18 percent
D. 11.30 percent
E. 11.56 percent
- Wayco Industrial Supply has a pre-tax cost of debt of 7.6 percent, a cost of equity of 14.3 percent, and a cost of preferred stock of 8.5 percent. The firm has 220,000 shares of common stock outstanding at a market price of $27 a share. There are 25,000 shares of preferred stock outstanding at a market price of $41 a share. The bond issue has a face value of $550,000 and a market quote of 101.2. The company’s tax rate is 37 percent. What is the firm’s weighted average cost of capital?
A. 10.18 percent
B. 10.84 percent
C. 11.32 percent
D. 12.60 percent
E. 12.81 percent
- Central Systems, Inc. desires a weighted average cost of capital of 8 percent. The firm has an aftertax cost of debt of 4.8 percent and a cost of equity of 15.2 percent. What debt-equity ratio is needed for the firm to achieve its targeted weighted average cost of capital?
A. 0.38
B. 0.44
C. 1.02
D. 2.25
E. 2.63
- R.S. Green has 250,000 shares of common stock outstanding at a market price of $28 a share. Next year’s annual dividend is expected to be $1.55 a share. The dividend growth rate is 2 percent. The firm also has 7,500 bonds outstanding with a face value of $1,000 per bond. The bonds carry a 7 percent coupon, pay interest semiannually, and mature in 7.5 years. The bonds are selling at 98 percent of face value. The company’s tax rate is 34 percent. What is the firm’s weighted average cost of capital?
A. 5.4 percent
B. 6.2 percent
C. 7.5 percent
D. 8.5 percent
E. 9.6 percent
- Kelso’s has a debt-equity ratio of 0.55 and a tax rate of 35 percent. The firm does not issue preferred stock. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.8 percent. What is the weighted average cost of capital?
A. 10.46 percent
B. 10.67 percent
C. 11.06 percent
D. 11.38 percent
E. 11.57 percent
- Granite Works maintains a debt-equity ratio of 0.65 and has a tax rate of 32 percent. The firm does not issue preferred stock. The pre-tax cost of debt is 9.8 percent. There are 25,000 shares of stock outstanding with a beta of 1.2 and a market price of $19 a share. The current market risk premium is 8.5 percent and the current risk-free rate is 3.6 percent. This year, the firm paid an annual dividend of $1.10 a share and expects to increase that amount by 2 percent each year. Using an average expected cost of equity, what is the weighted average cost of capital?
A. 8.44 percent
B. 8.78 percent
C. 8.96 percent
D. 9.13 percent
E. 9.20 percent
- Delta Lighting has 30,000 shares of common stock outstanding at a market price of $17.50 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?
A. 11.07 percent
B. 13.14 percent
C. 14.36 percent
D. 15.29 percent
E. 15.47 percent
- The Market Outlet has a beta of 1.38 and a cost of equity of 14.945 percent. The risk-free rate of return is 4.25 percent. What discount rate should the firm assign to a new project that has a beta of 1.25?
A. 13.54 percent.
B. 13.72 percent.
C. 13.94 percent.
D. 14.14 percent.
E. 14.36 percent.
- Silo Mills has a beta of 0.87 and a cost of equity of 11.9 percent. The risk-free rate of return is 2.8 percent. The firm is currently considering a project that has a beta of 1.03 and a project life of 6 years. What discount rate should be assigned to this project?
A. 13.33 percent.
B. 13.57 percent.
C. 13.62 percent.
D. 13.84 percent.
E. 14.09 percent.
- Travis & Sons has a capital structure which is based on 40 percent debt, 5 percent preferred stock, and 55 percent common stock. The pre-tax cost of debt is 7.5 percent, the cost of preferred is 9 percent, and the cost of common stock is 13 percent. The company’s tax rate is 39 percent. The company is considering a project that is equally as risky as the overall firm. This project has initial costs of $325,000 and annual cash inflows of $87,000, $279,000, and $116,000 over the next three years, respectively. What is the projected net present value of this project?
A. $68,211.04
B. $68,879.97
C. $69,361.08
D. $74,208.18
E. $76,011.23
- Panelli’s is analyzing a project with an initial cost of $102,000 and cash inflows of $65,000 in year one and $74,000 in year two. This project is an extension of the firm’s current operations and thus is equally as risky as the current firm. The firm uses only debt and common stock to finance its operations and maintains a debt-equity ratio of 0.45. The aftertax cost of debt is 4.8 percent, the cost of equity is 12.7 percent, and the tax rate is 35 percent. What is the projected net present value of this project?
A. $15,411
B. $15,809
C. $16,333
D. $16,938
E. $17,840
- Carson Electronics uses 70 percent common stock and 30 percent debt to finance its operations. The aftertax cost of debt is 5.4 percent and the cost of equity is 15.4 percent. Management is considering a project that will produce a cash inflow of $36,000 in the first year. The cash inflows will then grow at 3 percent per year forever. What is the maximum amount the firm can initially invest in this project to avoid a negative net present value for the project?
A. $299,032
B. $382,979
C. $411,406
D. $434,086
E. $441,414
- The Bakery is considering a new project it considers to be a little riskier than its current operations. Thus, management has decided to add an additional 1.5 percent to the company’s overall cost of capital when evaluating this project. The project has an initial cash outlay of $62,000 and projected cash inflows of $17,000 in year one, $28,000 in year two, and $30,000 in year three. The firm uses 25 percent debt and 75 percent common stock as its capital structure. The company’s cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent. What is the projected net present value of the new project?
A. -$6,208
B. -$5,964
C. -$2,308
D. $1,427
E. $1,573
- The Oil Derrick has an overall cost of equity of 13.6 percent and a beta of 1.28. The firm is financed solely with common stock. The risk-free rate of return is 3.4 percent. What is an appropriate cost of capital for a division within the firm that has an estimated beta of 1.18?
A. 12.37 percent
B. 12.41 percent
C. 12.54 percent
D. 12.67 percent
E. 12.80 percent
- Miller Sisters has an overall beta of 0.64 and a cost of equity of 11.2 percent for the firm overall. The firm is 100 percent financed with common stock. Division A within the firm has an estimated beta of 1.08 and is the riskiest of all of the firm’s operations. What is an appropriate cost of capital for division A if the market risk premium is 9.5 percent?
A. 15.12 percent
B. 15.38 percent
C. 15.63 percent
D. 15.77 percent
E. 16.01 percent
- Deep Mining and Precious Metals are separate firms that are both considering a silver exploration project. Deep Mining is in the actual mining business and has an aftertax cost of capital of 12.8 percent. Precious Metals is in the precious gem retail business and has an aftertax cost of capital of 10.6 percent. The project under consideration has initial costs of $575,000 and anticipated annual cash inflows of $102,000 a year for ten years. Which firm(s), if either, should accept this project?
A. Company A only
B. Company B only
C. both Company A and Company B
D. neither Company A or Company B
E. cannot be determined without further information
- Sister Pools sells outdoor swimming pools and currently has an aftertax cost of capital of 11.6 percent. Al’s Construction builds and sells water features and fountains and has an aftertax cost of capital of 10.8 percent. Sister Pools is considering building and selling its own water features and fountains. The sales manager of Sister Pools estimates that the water features and fountains would produce 20 percent of the firm’s future total sales. The initial cash outlay for this project would be $85,000. The expected net cash inflows are $16,000 a year for 7 years. What is the net present value of the Sister Pools project?
A. -$11,044
B. -$9,115
C. -$7,262
D. -$4,508
E. $1,219
- Decker’s is a chain of furniture retail stores. Furniture Fashions is a furniture maker and a supplier to Decker’s. Decker’s has a beta of 1.38 as compared to Furniture Fashion’s beta of 1.12. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Decker’s use if it considers a project that involves the manufacturing of furniture?
A. 12.46 percent
B. 12.92 percent
C. 13.50 percent
D. 14.08 percent
E. 14.54 percent
- Bleakly Enterprises has a capital structure of 55 percent common stock, 10 percent preferred stock, and 35 percent debt. The flotation costs are 4.5 percent for debt, 7 percent for preferred stock, and 9.5 percent for common stock. The corporate tax rate is 34 percent. What is the weighted average flotation cost?
A. 5.8 percent
B. 6.2 percent
C. 6.7 percent
D. 7.0 percent
E. 7.5 percent
- Justice, Inc. has a capital structure which is based on 30 percent debt, 5 percent preferred stock, and 65 percent common stock. The flotation costs are 11 percent for common stock, 10 percent for preferred stock, and 7 percent for debt. The corporate tax rate is 37 percent. What is the weighted average flotation cost?
A. 8.97 percent
B. 9.48 percent
C. 9.62 percent
D. 9.75 percent
E. 10.00 percent
- The Daily Brew has a debt-equity ratio of 0.72. The firm is analyzing a new project which requires an initial cash outlay of $420,000 for equipment. The flotation cost is 9.6 percent for equity and 5.4 percent for debt. What is the initial cost of the project including the flotation costs?
A. $302,400
B. $368,924
C. $455,738
D. $456,400
E. $583,333
- You are evaluating a project which requires $230,000 in external financing. The flotation cost of equity is 11.6 percent and the flotation cost of debt is 5.4 percent. What is the initial cost of the project including the flotation costs if you maintain a debt-equity ratio of 0.45?
A. $248,494
B. $249,021
C. $254,638
D. $255,551
E. $255,646
- Western Wear is considering a project that requires an initial investment of $274,000. The firm maintains a debt-equity ratio of 0.40 and has a flotation cost of debt of 7 percent and a flotation cost of equity of 10.5 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?
A. $279,592
B. $281,406
C. $288,005
D. $297,747
E. $302,762
- Yesteryear Productions is considering a project with an initial start up cost of $960,000. The firm maintains a debt-equity ratio of 0.50 and has a flotation cost of debt of 6.8 percent and a flotation cost of equity of 11.4 percent. The firm has sufficient internally generated equity to cover the equity cost of this project. What is the initial cost of the project including the flotation costs?
A. $979,417
B. $982,265
C. $992,386
D. $1,038,513
E. $1,065,089
Essay Questions
- What role does the weighted average cost of capital play when determining a project’s cost of capital?
- What are some advantages of the subjective approach to determining the cost of capital and why do you think that approach is utilized?
- Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project.
- Suppose your boss comes to you and asks you to re-evaluate a capital budgeting project. The first evaluation was in error, he explains, because it ignored flotation costs. To correct for this, he asks you to evaluate the project using a higher cost of capital which incorporates these costs. Is your boss’ approach correct? Why or why not?
- Explain how the use of internal equity rather than external equity affects the analysis of a project.
- The City Street Corporation’s common stock has a beta of 1.2. The risk-free rate is 3.5 percent and the expected return on the market is 13 percent. What is the firm’s cost of equity?
A. 11.4 percent
B. 12.8 percent
C. 14.9 percent
D. 17.6 percent
E. 19.1 percent
- Stock in Country Road Industries has a beta of 0.97. The market risk premium is 10 percent while T-bills are currently yielding 5.5 percent. Country Road’s most recent dividend was $1.70 per share, and dividends are expected to grow at a 7 percent annual rate indefinitely. The stock sells for $32 a share. What is the estimated cost of equity using the average of the CAPM approach and the dividend discount approach?
A. 13.94 percent
B. 14.06 percent
C. 14.21 percent
D. 14.38 percent
E. 14.50 percent
- Holdup Bank has an issue of preferred stock with a $5 stated dividend that just sold for $92 per share. What is the bank’s cost of preferred?
A. 4.60 percent
B. 4.64 percent
C. 5.39 percent
D. 5.43 percent
E. 5.54 percent
- Decline, Inc. is trying to determine its cost of debt. The firm has a debt issue outstanding with 15 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 11 percent annually. What is the aftertax cost of debt if the tax rate is 33 percent?
A. 6.76 percent
B. 6.90 percent
C. 7.17 percent
D. 7.37 percent
E. 7.42 percent
- Jiminy’s Cricket Farm issued a 30-year, 8 percent, semiannual bond 6 years ago. The bond currently sells for 114 percent of its face value. What is the aftertax cost of debt if the company’s tax rate is 31 percent?
A. 4.63 percent
B. 4.70 percent
C. 4.75 percent
D. 4.82 percent
E. 4.86 percent
- Mullineaux Corporation has a target capital structure of 41 percent common stock, 4 percent preferred stock, and 55 percent debt. Its cost of equity is 19 percent, the cost of preferred stock is 6.5 percent, and the pre-tax cost of debt is 7.5 percent. What is the firm’s WACC given a tax rate of 34 percent?
A. 9.87 percent
B. 10.43 percent
C. 10.77 percent
D. 13.38 percent
E. 15.17 percent
- Cookie Dough Manufacturing has a target debt-equity ratio of 0.5. Its cost of equity is 15 percent, and its cost of debt is 11 percent. What is the firm’s WACC given a tax rate of 31 percent?
A. 12.53 percent
B. 12.78 percent
C. 13.11 percent
D. 13.48 percent
E. 13.67 percent
- Fama’s Llamas has a weighted average cost of capital of 10.5 percent. The company’s cost of equity is 15.5 percent, and its pretax cost of debt is 8.5 percent. The tax rate is 34 percent. What is the company’s target debt-equity ratio?
A. 0.89
B. 0.92
C. 0.98
D. 1.01
E. 1.02
- Jungle, Inc. has a target debt-equity ratio of 0.72. Its WACC is 11.5 percent and the tax rate is 34 percent. What is the cost of equity if the aftertax cost of debt is 5.5 percent?
A. 13.75 percent
B. 13.84 percent
C. 14.41 percent
D. 14.79 percent
E. 15.82 percent
- Titan Mining Corporation has 14 million shares of common stock outstanding, 900,000 shares of 9 percent preferred stock outstanding and 210,000 ten percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.15, the preferred stock currently sells for $80 per share, and the bonds have 17 years to maturity and sell for 91 percent of par. The market risk premium is 11.5 percent, T-bills are yielding 7.5 percent, and the firm’s tax rate is 32 percent. What discount rate should the firm apply to a new project’s cash flows if the project has the same risk as the firm’s typical project?
A. 14.59 percent
B. 14.72 percent
C. 15.17 percent
D. 15.54 percent
E. 16.41 percent
- Suppose your company needs $14 million to build a new assembly line. Your target debt-equity ratio is 0.84. The flotation cost for new equity is 9.5 percent, but the floatation cost for debt is only 2.5 percent. What is the true cost of building the new assembly line after taking flotation costs into account?
A. 14.82 million
B. 14.94 million
C. 15.07 million
D. 15.12 million
E. 15.23 million
- A group of individuals got together and purchased all of the outstanding shares of common stock of DL Smith, Inc. What is the return that these individuals require on this investment called?
-
Marketing Strategy: A luxury clothing brand entering China
$45.00Paper Contents:
A luxury clothing brand entering China
1. Introduction
1.1 Characteristics of Emerging Markets
1.2 Market Analysis
1.3 Marketing Strategy
2 Background
2.1 Economic Trends in China
2.2 China’s Luxury Brand Market
2.3 China’s Regulatory Environment
2. Political, Economic, Social & Technological (PEST) Analysis
3.1 Political Factors
3.2 Economic Factors
3.3 Social Factors
3.3 Technological
4 Marketing Strategy – Strengths, Weaknesses, Opportunities & Threats
5. Conclusion11 Pages
Harvard 14 references
-
The Caledonia Mini Case
$20.00From the Mini Case on page 329-330, parts “a” to “d,” summarize your analysis in a concise management statement not to exceed a total of 1,200 words. For parts “e” to “k,” use formulas to calculate the ratios and format the cells to insert a comma if there is more than three numbers. Round to the nearest whole number. Clearly label your analysis and your conclusions in not more than 500 words.
- Should Caledonia focus on cash flows or accounting profits in making its capital-budgeting decisions? Should the company be interested in incremental cash flows, incremental profits, total free cash flows, or total profits?
- How does depreciation affect free cash flows?
- How do sunk costs affect the determination of cash flows?
- What is the project’s initial outlay?
- What are the differential cash flows over the project’s life?
- What is the terminal cash flow?
- Draw a cash flow diagram for this project.
- What is its net present value?
- What is its internal rate of return?
- Should the project be accepted? Why or why not
- In capital budgeting, risk can be measured from three perspectives. What are those three measures of a project.
-
Business Plan for gourmet jam business
$0.00Business Plan for gourmet jam business
Paper Contents:
Company Name & Product Information
Mission Statement & Organization Objectives
Current Market Situation
Opportunities and Issues Analysis
Marketing Strategy
Marketing Action Programs
Executive Summary
Appendix -
CHAPTER 4: PARITY CONDITIONS IN INTERNATIONAL FINANCE AND CURRENCY FORECASTING
$25.00- Inflation is the logical outcome of an expansion of the money supply in excess of real output growth. As the supply of one commodity increases relative to supplies of all other commodities, the price of the first commodity must decline relative to the prices of other commodities. In other words, its value in exchange or exchange rate must decline. Similarly, as the supply of money increases relative to the supply of goods and services, the price of money in terms of goods and services must decline, i.e., the exchange rate between money and goods declines.
- The international parallel to inflation is domestic currency depreciation relative to foreign currencies. To maintain the same exchange rate between money and goods both domestically and abroad, the exchange rate must decline by (approximately) the difference between the domestic and foreign rates of inflation. This is purchasing power parity, which is itself based on the law of one price.
- Although the nominal or actual money exchange rate may fluctuate all over the place, we would normally expect the real, or inflation-adjusted exchange rate, to remain relatively constant over time. The same is true for nominal versus real rates of interest. However, although the prediction that real interest and exchange rates will remain constant over time is a reasonable one ex ante, ex post we find that these real rates wander all over the place. A changing real exchange rate is the most important source of exchange risk for companies.
- Four additional equilibrium economic relationships tend to hold in international financial markets: Purchasing Power Parity (PPP), the Fisher Effect, International Fisher Effect (IFE), Interest Rate Parity (IRP), and the forward rate as an unbiased estimate of the future spot rate.
1.a. What is purchasing power parity (PPP)?
- b. What are some reasons for deviations from purchasing power parity?
- Comment on the following statement: “It makes sense to borrow during times of high inflation because you can repay the loan in cheaper dollars.”
- Which is likely to be higher, a 150% ruble return in Russia or a 15% dollar return in the U.S.?
- The interest rate in England is 12%, while in Switzerland it is 5%. What are possible reasons for this interest rate differential? What is the most likely reason?
- Over the period 1982-1988, Peru and Chile stand out as countries whose interest rates are not consistent with their inflation experience. Specifically, Peru’s inflation and interest rates averaged about 125% and 8%, respectively, over this period, whereas Chile’s inflation and interest rates averaged about 22% and 38%, respectively.
7.a. How would you characterize the real interest rates of Peru and Chile (e.g., close to zero, highly positive, highly negative)?
Answer.
7.b. What might account for Peru’s low interest rate relative to its high inflation rate? What are the likely consequences of this low interest rate?
7.c. What might account for Chile’s high interest rate relative to its inflation rate? What are the likely consequences of this high interest rate?
7.d. During the same period, Peru had a small interest differential and yet a large average exchange rate change. How would you reconcile this experience with the IFE and with your answer to part b?
- Over the period 1982-1988 numerous countries (e.g., Pakistan, Hungary, Venezuela) had a small or negative interest rate differential and a large average annual depreciation against the dollar. How would you explain these data? Can you reconcile these data with the IFE?
- What factors might lead to persistent covered interest arbitrage opportunities among countries?
- In early 1989, Japanese interest rates were about 4 percentage points below U.S. rates. The wide difference between Japanese and U.S. interest rates prompted some U.S. real estate developers to borrow in yen to finance their projects. Comment on this strategy.
- In late December 1990, one‑year German Treasury bills yielded 9.1%, whereas one‑year U.S. Treasury bills yielded 6.9%. At the same time, the inflation rate during 1990 was 6.3% in the U.S., double the German rate of 3.1%.
12.a. Are these inflation and interest rates consistent with the Fisher Effect?
12.b. What might explain this difference in interest rates between the U.S. and Germany?
- The spot rate on the euro is $0.91 and the 180‑day forward rate is $0.93. What are possible reasons for the difference between the two rates?
- If the dollar is appreciating against the Polish zloty in nominal terms but depreciating against the zloty in real terms, what do we know about Polish and U.S. inflation rates?
- Suppose the nominal peso/dollar exchange rate is fixed. If the inflation rates in Mexico and the U.S. are constant (but not necessarily equal), will the real value of the peso/dollar exchange rate also be constant over time?
- If the average rate of inflation in the world rises from 5% to 7%, what will be the likely effect on the U.S. dollar’s forward premium or discount relative to foreign currencies?
- Comment on the following quote from the Wall Street Journal (August 27, 1984, p. 6) that discusses the improving outlook for Britain’s economy: “Recovery here will probably last longer than in the U.S. because there isn’t a huge budget deficit to pressure interest rates higher.”
- Comment on the following headline that appeared in the Wall Street Journal (December 19, 1990, p. C10): “Dollar Falls Across the Board as Fed Cuts Discount Rate to 6.5% From 7%.” (The discount rate is the interest rate the Fed charges member banks for loans.)
- In an integrated world capital market, will higher interest rates in, say Japan, mean higher interest rates in, say, the U.S.?
- From base price levels of 100 in 2000, Japanese and U.S. price levels in 2006 stood at 98 and 109, respectively.
1.a. If the 2000 $:¥ exchange rate was $0.00928, what should the exchange rate be in 2006?
1.b. In fact, the exchange rate in 2006 was ¥1 = $0.00860. What might account for the discrepancy? (Price levels were measured using the consumer price index.)
- Two countries, the U.S. and England, produce only one good, wheat. Suppose the price of wheat is $3.25 in the U.S. and is £1.35 in England.
2.a. According to the law of one price, what should the $:£ spot exchange rate be?
2.b. Suppose the price of wheat over the next year is expected to rise to $3.50 in the U.S and to £1.60 in England. What should the one‑year $:£ forward rate be?
- If expected inflation is 100% and the real required return is 5%, what will the nominal interest rate be according to the Fisher Effect? (exact and approximate!)
- Suppose the short-term interest rate in France was 3.7%, and forecast French inflation was 1.8%. At the same time, the short-term German interest rate was 2.6% and forecast German inflation was 1.6%.
4.a. Based on these figures, what were the real interest rates in France and Germany?
- In July, the one‑year interest rate is 12% on British pounds and 9% on U.S. dollars.
5.a. If the current exchange rate is $1.63:£1, what is the expected future exchange rate in one year?
5.b. Suppose a change in expectations regarding future U.S. inflation causes the expected future spot rate to decline to $1.52:£1. What should happen to the U.S. interest rate?
- Suppose that in Japan the interest rate is 8% and inflation is expected to be 3%. Meanwhile, the expected inflation rate in France is 12%, and the English interest rate is 14%. To the nearest whole number, what is the best estimate of the one‑year forward exchange premium (discount) at which the pound will be selling relative to the French franc?
- Suppose three‑year deposit rates on Eurodollars and Eurofrancs (Swiss) are 12% and 7%, respectively. If the current spot rate for the Swiss franc is $0.3985, what is the spot rate implied by these interest rates for the franc three years from now?
- Assume the interest rate is 16% on pounds sterling and 7% on euros. At the same time, inflation is running at an annual rate of 3% in Germany and 9% in England.
10.a. If the euro is selling at a one-year forward premium of 10% against the pound, is there an arbitrage opportunity? Explain.
10.b. What is the real interest rate in Germany? In England?
- Suppose that three-month interest rates (annualized) in Japan and the U.S. are 7% and 9%, respectively. If the spot rate is ¥142:$1 and the 90-day forward rate is ¥139:$1:
13.a. Where would you invest?
13.b. Where would you borrow?
13.c. What arbitrage opportunity do these figures present?
13.d. Assuming no transaction costs, what would be your arbitrage profit per dollar or dollar-equivalent borrowed?
- Suppose today’s exchange rate is $1.35/€. The six-month interest rates on dollars and euros are 6% and 3%, respectively. The six-month forward rate is $1.3672. A foreign exchange advisory service has predicted that the euro will appreciate to $1.375 within six months.
15.a. How would you use forward contracts to profit in the above situation?
15.b. How would you use money market instruments (borrowing and lending) to profit?
15.c. Which alternatives (forward contracts or money market instruments) would you prefer? Why?