Hooper printing inc has bonds outstanding

Chapter 1

KEY TERMS Define each of the following terms:

a. Sarbanes-Oxley Act

b. Proprietorship; partnership; corporation

c. S corporations; limited liability companies (LLCs); limited liability partnerships (LLPs)

d. Stockholder wealth maximization

e. Intrinsic value; market price

f. Equilibrium; marginal investor

Questıons

1- If you bought a share of stock, what would you expect to receive, when would you expect

to receive it, and would you be certain that your expectations would be met?

2- If most investors expect the same cash flows from Companies A and B but are more confident

that A’s cash flows will be closer to their expected value, which company should

have the higher stock price? Explain.

3- What is a firm’s intrinsic value? its current stock price? Is the stock’s “true long-run value”

more closely related to its intrinsic value or to its current price?

4- When is a stock said to be in equilibrium? At any given time, would you guess that most

stocks are in equilibrium as you defined it? Explain.

Suppose three honest individuals gave you their estimates of Stock X’s intrinsic value.

5- One person is your current roommate, the second person is a professional security analyst

with an excellent reputation on Wall Street, and the third person is Company X’s CFO. If

the three estimates differed, in which one would you have the most confidence? Why?

Chapter 2

KEY TERMS Define each of the following terms:

a. Spot markets; futures markets

b. Money markets; capital markets

c. Primary markets; secondary markets

d. Private markets; public markets

e. Derivatives

Questıons

1- How does a cost-efficient capital market help reduce the prices of goods and services?

2- Describe the different ways in which capital can be transferred from suppliers of capital to

those who are demanding capital.

3- Is an initial public offering an example of a primary or a secondary market transaction?

Explain.

4- 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

5- What would happen to the U.S. standard of living if people lost faith in the safety of the

financial institutions? Explain

Chapter 3

KEY TERMS Define each of the following terms:

a. Annual report; balance sheet; income statement; statement of cash flows; statement of

stockholders’ equity

b. Stockholders’ equity; retained earnings; working capital; net working capital

c. Depreciation; amortization; operating income; EBITDA; free cash flow

d. Progressive tax; marginal tax rate; average tax rate

e. Tax loss carry-back; carry-forward; AMT

f. Capital gain (loss)

g. S corporation

Questıons

1- What four financial statements are contained in most annual reports?

2- Who are some of the basic users of financial statements, and how do they use them?

3- 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.

4- Explain the following statement: While the balance sheet can be thought of as a snapshot

of a firm’s financial position at a point in time, the income statement reports on operations

over a period of time.

5- Financial statements are based on generally accepted accounting principles (GAAP) and

are audited by CPA firms. Therefore, do investors need to worry about the validity of

those statements? Explain your answer.

Easy Problem

1- 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 the interest expense. Use this same procedure to complete

similar problems.]

2- 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 charge for depreciation and amortization?

3- STATEMENT OF STOCKHOLDERS’ EQUITY In its most recent financial statements,

Newhouse 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.

Intermedıate Problem

1- BALANCE SHEET Which of the following actions are most likely to directly increase cash

as shown on a firm’s balance sheet? Explain and state the assumptions that underlie your

answer.

a. It issues $2 million of new common stock.

b. It buys new plant and equipment at a cost of $3 million.

c. It reports a large loss for the year.

d. It increases the dividends paid on its common stock.

2- STATEMENT OF STOCKHOLDERS’ EQUITY Computer World Inc. paid out $22.5 million in

total common dividends and reported $278.9 million of retained earnings at year-end. The

prior year’s retained earnings were $212.3 million. What was the net income? Assume that

all dividends declared were actually paid.

4- STATEMENT OF CASH FLOWS W.C. Cycling had $55,000 in cash at year-end 2007 and

$25,000 in cash at year-end 2008. Cash flow from long-term investing activities totaled

–$250,000, and 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 firm’s net

income?

5- FREE CASH FLOW Bailey Corporation’s financial statements (dollars and shares are in

millions) are provided here.

Chapter 4

KEY TERMS Define each of the following terms:

a. Liquidity ratios: current ratio; acid test ratio

b. Asset management ratios: inventory turnover ratio; days sales outstanding (DSO);

fixed assets turnover ratio; total assets turnover ratio

c. Debt management ratios: debt ratio; times-interest-earned (TIE) ratio

d. Profitability ratios: operating margin; profit margin; basic earning power (BEP) ratio;

return on total assets (ROA); return on common equity (ROE)

e. Market value ratios: price/earnings (P/E) ratio; market/book (M/B) ratio

f. Trend analysis

g. DuPont equation

h. Benchmarking

i. “Window dressing” techniques

Questıons

1- 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 they focus on?

2- Why would the inventory turnover ratio be more important for someone analyzing a grocery

store chain than an insurance company?

3- 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 company’s sales, cash and equivalents,

DSO, and fixed assets turnover ratio remained constant. What balance sheet accounts

must have changed to produce the indicated changes?

4- 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?

5- 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?

Easy Problems

1- 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.

2- DEBT RATIO Bartley Barstools has an equity multiplier of 2.4, and its assets are financed

with some combination of long-term debt and common equity. What is its debt ratio?

3- 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?

4- 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 Jaster’s market/book ratio?

5- PRICE/EARNINGS RATIO A company has an EPS of $2.00, a cash flow per share of $3.00,

and a price/cash flow ratio of 8.0#. What is its P/E ratio?

Intermedıate Problems

1- DUPONT AND NET INCOME Ebersoll Mining has $6 million in sales, its ROE is 12%, and its

total assets turnover is 3.2#. The company is 50% equity financed. What is its net income?

2- BASIC EARNING POWER Duval Manufacturing recently reported the following information:

Net income $600,000

ROA 8%

Interest expense $225,000

Duval’s tax rate is 35%. What is its basic earning power (BEP)?

3- M/B AND SHARE PRICE You are given the following information: Stockholders’ equity !

$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 company’s common stock.

4- RATIO CALCULATIONS Assume the following relationships for the Brauer Corp.:

Sales/total assets 1.5#

Return on assets (ROA) 3%

Return on equity (ROE) 5%

Calculate Brauer’s profit margin and debt ratio.

5- TIE RATIO The H.R. Pickett Corp. has $500,000 of debt outstanding, and it pays an

annual interest rate of 10%. Its annual sales are $2 million, its average tax rate is 30%, and

its net profit margin is 5%. What is its TIE ratio?

Chapter 5

KEY TERMS Define each of the following terms:

a. Time line

b. FVN ; PV; I; INT; N; FVAN ; PMT; PVAN

c. Compounding; discounting

d. Simple interest; compound interest

e. Opportunity cost

f. Annuity; ordinary (deferred) annuity; annuity due

g. Consol; perpetuity

h. Uneven cash flow; payment; cash flow (CFt)

i. Annual compounding; semiannual compounding

j. Nominal (quoted) interest rate; annual percentage rate (APR); effective (equivalent)

annual rate (EAR or EFF%)

Questıons

1- What is an opportunity cost? How is this concept used in TVM analysis, and where is it

shown on a time line? Is a single number used in all situations? Explain.

2- Explain whether the following statement is true or false: $100 a year for 10 years is an annuity;

but $100 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.

3- If a firm’s 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 aren’t sure, plug in some numbers and check it out.)

4- Would you rather have a savings account that pays 5% interest compounded semiannually

or one that pays 5% interest compounded daily? Explain.

5- To find the present value of an uneven series of cash flows, you must find the PVs of the

individual cash flows and then sum them. Annuity procedures can never be of use, even

when some of the cash flows constitute an annuity because the entire series is not an

annuity. True or false? Explain.

Easy Problems

1- FUTURE VALUE If you deposit $10,000 in a bank account that pays 10% interest annually,

how much will be in your account after 5 years?

2- PRESENT VALUE What is the present value of a security that will pay $5,000 in 20 years if

securities of equal risk pay 7% annually?

3- FINDING THE REQUIRED INTEREST RATE Your parents will retire in 18 years. They currently

have $250,000, and they think they will need $1,000,000 at retirement. What annual

interest rate must they earn to reach their goal, assuming they don’t save any additional

funds?

4-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?

5-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?

Intermediate Problems

1- PRESENT AND FUTURE VALUES FOR DIFFERENT PERIODS Find the following values using

the equations and then a financial calculator. Compounding/discounting occurs annually.

a. An initial $500 compounded for 1 year at 6%

b. An initial $500 compounded for 2 years at 6%

c. The present value of $500 due in 1 year at a discount rate of 6%

d. The present value of $500 due in 2 years at a discount rate of 6%

2- PRESENT AND FUTURE VALUES FOR DIFFERENT INTEREST RATES Find the following values.

Compounding/discounting occurs annually.

a. An initial $500 compounded for 10 years at 6%

b. An initial $500 compounded for 10 years at 12%

c. The present value of $500 due in 10 years at 6%

d. The present value of $1,552.90 due in 10 years at 12% and at 6%

e. Define present value and illustrate it using a time line with data from Part d. How are

present values affected by interest rates?

3 -GROWTH RATES Shalit Corporation’s 2008 sales were $12 million. Its 2003 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 that statement correct?

4- 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.

5-TIME FOR A LUMP SUM TO DOUBLE How long will it take $200 to double if it earns the

following rates? Compounding occurs once a year.

a. 7%

b. 10%

c. 18%

d. 100%

Chapter 6

KEY TERMS Define each of the following terms:

a. Production opportunities; time preferences for consumption; risk; inflation

b. Real risk-free rate of interest, r*; nominal (quoted) risk-free rate of interest, rRF

c. Inflation premium (IP)

d. Default risk premium (DRP)

e. Liquidity premium (LP); maturity risk premium (MRP)

f. Interest rate risk; reinvestment rate risk

g. Term structure of interest rates; yield curve

h. “Normal” yield curve; inverted (“abnormal”) yield curve; humped yield curve

i. Pure expectations theory

Questıons

1- Suppose interest rates on residential mortgages of equal risk are 5.5% in California and

7.0% in New York. Could this differential persist? What forces might tend to equalize

rates? Would differentials in borrowing costs for businesses of equal risk located in

California and New York be more or less likely to exist than differentials in residential

mortgage rates? Would differentials in the cost of money for New York and California

firms be more likely to exist if the firms being compared were very large or if they were

very small? What are the implications of all of this with respect to nationwide branching?

2- Which fluctuate more—long-term or short-term interest rates? Why?

3- 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 shortterm

basis? Why?

4- Suppose the population of Area Y is relatively young and the population of Area O is relatively

old but everything else about the two areas is the same.

a. Would interest rates likely be the same or different in the two areas? Explain.

b. Would a trend toward nationwide branching by banks and the development of nationwide

diversified financial corporations affect your answer to part a? Explain.

5- 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?

Easy Problems

1- 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 premium " 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 rate of return?

2- EXPECTED INTEREST RATE The real risk-free rate 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?

3- 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?

4- MATURITY RISK PREMIUM The real risk-free rate is 3%, and inflation is expected to be

3% for the next 2 years. A 2-year Treasury security yields 6.2%. What is the maturity risk

premium for the 2-year security?

5- 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?

Intermediate Problems

1- EXPECTATIONS THEORY Interest rates on 4-year Treasury securities are currently 7%,

while 6-year Treasury securities yield 7.5%. If the pure expectations theory is correct, what

does the market believe that 2-year securities will be yielding 4 years from now?

2- EXPECTED INTEREST RATE The real risk-free rate is 3%. Inflation is expected to be 3% this

year, 4% next year, and 3.5% thereafter. The maturity risk premium is estimated to be 0.05 $

(t ! 1)%, where t " number of years to maturity. What is the yield on a 7-year Treasury note?

3- INFLATION Due to a recession, expected inflation this year is only 3%. However, the inflation

rate in Year 2 and thereafter is expected to be constant at some level above 3%. Assume

that the expectations theory holds and the real risk-free rate is r* " 2%. If the yield

on 3-year Treasury bonds equals the 1-year yield plus 2%, what inflation rate is expected

after Year 1?

4- DEFAULT RISK PREMIUM A company’s 5-year bonds are yielding 7.75% per year. Treasury

bonds with the same maturity are yielding 5.2% per year, and the real risk-free rate

(r*) is 2.3%. The average inflation premium is 2.5%; and the maturity risk premium is estimated

to be 0.1 $ (t ! 1)%, where t " number of years to maturity. If the liquidity premium

is 1%, what is the default risk premium on the corporate bonds?

Chapter 7

KEY TERMS Define each of the following terms:

a. Bond; treasury bond; corporate bond; municipal bond; foreign bond

b. Par value; maturity date; original maturity

c. Coupon payment; coupon interest rate

d. Fixed-rate bond; floating-rate bond; zero coupon bond; original issue discount (OID)

bond

e. Call provision; sinking fund provision

f. Convertible bond; warrant; putable bond; income bond; indexed, or purchasing

power, bond

Questıons

1- Why is a call provision advantageous to a bond issuer? When would the issuer be likely to

initiate a refunding call?

2- Are securities that provide for a sinking fund more or less risky from the bondholder’s

perspective than those without this type of provision? Explain.

What’s the difference between a call for sinking fund purposes and a refunding call?

3- Why are convertibles and bonds with warrants typically offered with lower coupons than

similarly rated straight bonds?

4- Explain whether the following statement is true or false: Only weak companies issue

debentures.

5- Would the yield spread on a corporate bond over a Treasury bond with the same maturity

tend to become wider or narrower if the economy appeared to be heading toward a

recession? Would the change in the spread for a given company be affected by the firm’s

credit strength? Explain.

Easy Problems

1- BOND VALUATION Callaghan Motors’ bonds have 10 years remaining to maturity. Interest

is paid annually, they have a $1,000 par value, the coupon interest rate is 8%, and the

yield to maturity is 9%. What is the bond’s current market price?

2- 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?

3- 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?

4- YIELD TO MATURITY A firm’s bonds have a maturity of 10 years with a $1,000 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?

Intermediate Problems

1- 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.

2- YIELD TO MATURITY Heymann Company bonds have 4 years left to maturity. Interest is

paid annually, and the bonds have a $1,000 par value and a coupon rate of 9%.

a. What is the yield to maturity at a current market price of (1) $829 and (2) $1,104?

b. Would you pay $829 for each bond if you thought that a “fair” market interest rate for

such bonds was 12%—that is, if rd ! 12%? Explain your answer.

3- CURRENT YIELD, CAPITAL GAINS YIELD, AND YIELD TO MATURITY Hooper Printing Inc.

has bonds outstanding with 9 years left to maturity. The bonds have an 8% annual coupon

rate and were issued 1 year ago at their par value of $1,000. However, due to changes in

interest rates, the bond’s market price has fallen to $901.40. The capital gains yield last

year was $9.86%.

a. What is the yield to maturity?

b. For the coming year, what are the expected current and capital gains yields? (Hint:

Refer to Footnote 8 for the definition of the current yield and to Table 7-1.)

c. Will the actual realized yields be equal to the expected yields if interest rates change?

If not, how will they differ?

4- 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 are the bond’s 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 8 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?

5- YIELD TO CALL It is now January 1, 2009, and you are considering the purchase of an

outstanding bond that was issued on January 1, 2007. It has a 9.5% annual coupon and

had a 30-year original maturity. (It matures on December 31, 2036.) There is 5 years of call

protection (until December 31, 2011), after which time it can be called at 109—that 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?