Principles of Corporate Finance_ 12th Edition

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bre44380_app_A1-A10 1 10/09/15 08:14 PM

Appendix

Answers to Select Basic Problems

CHAPTER 1

1. (a) Real; (b) executive airplanes; (c) brand names; (d)
   financial; (e) bonds; (f) investment; (g) capital budget-
   ing; (h) financing.


2. a. Financial assets, such as stocks or bank loans, are
   claims held by investors. Corporations sell finan-
   cial assets to raise the cash to invest in real assets
   such as plant and equipment. Some real assets are
   intangible.
   b. Capital budgeting means investment in real assets.
   Financing means raising the cash for this investment.
   c. The shares of public corporations are traded on stock
   exchanges and can be purchased by a wide range of
   investors. The shares of closely held corporations
   are not traded and are not generally available to
   investors.
   d. Unlimited liability: investors are responsible for all
   the firm’s debts. A sole proprietor has unlimited lia-
   bility. Investors in corporations have limited liability.
   They can lose their investment, but no more.

CHAPTER 2

1. 100 × (1.15)^8  = $305.90.


2. 374/(1.09)^9  = $172.20.


3. a. False; b. True; c. True; d. False.


4. PV = 4/(.14 − .04) = $40.


5. a. $90.53; b. $29.46; c. $3.52; d. $240.18.


6. (a) $12.625 million; (b) $12.705 million; (c) $12.712
   million.

CHAPTER 3

1. (a) Does not change; (b) Price falls; (c) Yield rises.


2. The yield over 6 months is 2.7/2 = 1.35%, with 52
   6-month periods to maturity. PV = $1,381.20.


3. a. Fall (e.g., 1-year 10% bond is worth 110/1.1 = 100 if
   r = 10% and is worth 110/1.15 = 95.65 if r = 15%).
   b. Less (e.g., see 5a).
   c. Less (e.g., with r = 5%, 1-year 10% bond is worth
   110/1.05 = 104.76).

d. Higher (e.g., if r = 10%, 1-year 10% bond is worth

110/1.1 = 100, while 1-year 8% bond is worth

108/1.1 = 98.18).

e. No, low-coupon bonds have longer durations (unless

there is only one period to maturity) and are there-

fore more volatile (e.g., if r falls from 10% to 5%, the

value of a 2-year 10% bond rises from 100 to 109.3

(a rise of 9.3%). The value of a 2-year 5% bond rises

from 91.3 to 100 (a rise of 9.5%).

7. (a) 4%; (b) PV = $1,075.44.


8. a. r 2  = (100/99.523).5 − 1 = 0.24%; r 3  = (100/98.937).33
   − 1 = 0.35%; r 4  = (100/97.904).25 − 1 = 0.53%; 
   r 5  = (100/96.034).2 − 1 = 0.81%.
   b. Upward-sloping.
   c. Higher. (The yield on the bond is a complicated aver-
   age of the separate spot rates.)


9. a. False. Duration depends on the coupon as well as the
   maturity.
   b. False. Given the yield to maturity, volatility is pro-
   portional to duration.
   c. True. A lower coupon rate means longer duration and
   therefore higher volatility.
   d. False. A higher interest rate reduces the relative pres-
   ent value of (distant) principal repayments.


10. 7.01%. (The extra return that you earn for investing for
    2 years rather than 1 is 1.06^2 /1.05 − 1 = .0701.)

CHAPTER 4

1. (a) True; (b) True.


2. P 0  = (5 + 110)/1.08 = $106.48


3. P 0  = 10/(.08 − .05) = $333.33.


4. 15/.08 + PVGO = 333.33; therefore PVGO = $145.83.


5. (a) False; (b) True.


6. Free cash flow is the amount of cash left over and avail-
   able to pay out to investors after all investments neces-
   sary for growth. In our simple examples, free cash flow
   equals operating cash flow minus capital expenditure.
   Free cash flow can be negative if investments are large.


7. If PVGO = 0 at the horizon date H, horizon
   value = earnings forecasted for H + 1 divided by r.