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# University of Mount Olive Financial Markets and Corporate Strategy Worksheet: Algebra Answers 2021

University of Mount Olive Financial Markets and Corporate Strategy Worksheet: Algebra Answers 2021

## University of Mount Olive Financial Markets and Corporate Strategy Worksheet: Algebra Answers 2021

**Question Title:**

University of Mount Olive Financial Markets and Corporate Strategy Worksheet

**Full Question:**

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Assignment 4b: Financial Markets and Corporate Strategy (assignment template) – 1 of 2

Insights/Instructions: Use this template to complete the assignment. Please do not delete these

insights/instructions or inquiries provided herein; rather, save the template, type your response

below then, after saving your work, upload the document to the assignment’s drop-box provided

in Moodle.

1. Time Value of Money. Access the online Corporate Finance resource and read the section on

Time Value of Money (pages 33 thru 69). (File is located in your Moodle Shell)

1. The “Time Value of Money” chapter offered several concepts and practical examples.

Which concept and example did you find most interesting? Explain/elaborate.

Response:

2. Manhattan Island (an example offered within the chapter):

a. Explain how $24 invested in a savings account offering a compound interest rate,

r, of 8% in 1626, would have been worth $75.979 trillion in the year 2000 (374

years).

Response:

b. Explain how $24 invested in a savings account offering a compound interest rate,

r, of 3.5% in 1626, would have been worth $9,287,569 (or approximately 9.3

million) in the year 2000.

Response:

c. What accounts for the significant difference in the value of the account in the year

2000?

Response:

3. * Present Values. Compute the present value of a $100 cash flow for the following

combinations of discount rates and times. Include the formula used to make the

calculations. Note: See page 50 and 51 of the online resource; the general formula is:

Present Value = Future Value after t periods / (1 + r)t

Show your work:

a. r = 12%; t = 10 years

b. r = 12%; t = 20 years

c. r = 7 percent; t = 10 years

d. r = 7 percent; t = 20 years

4. * Present Values. Would you rather receive $1,000 a year for 10 years or $800 a year for

15 years if:

Show your work:

a. The interest rate is 7 percent?

Response and rationale:

b. The interest rate is 22 percent?

Response and rationale:

c. Provide a rational as to why do your answers to “(a)” and “(b”) differ?

Response:

5. * Future Values. Compute the future value of a $100 cash flow for the following

combinations of discount rates and times. Include the formula used to make the

calculations. The general formula is:

Future Value = Present Value * (1 + r)t

Show your work:

a. r = 12%; t = 10 years

b. r = 12%; t = 20 years

c. r = 7 percent; t = 10 years

d. r = 7 percent; t = 20 years

6. * Calculating Interest Rate. Showing/explaining all of your work, find the interest rate

implied by the following combinations of present and future values:

Scenario

A

B

C

Years

10

3

6

Present Value

$400

$187

$260

Future Value

$684

$249

$300

Show your work:

A. For scenario A, the interest rate is:

Re: show/explain your work

B. For scenario B, the interest rate is:

Re: show/explain your work

C. For scenario C, the interest rate is:

Re: show/explain your work

Selected material from

Fundamentals of Corporate Finance

Third Edition

Richard A. Brealey

Bank of England and London Business School

Stewart C. Myers

Sloan School of Management

Massachusetts Institute of Technology

Alan J. Marcus

Wallace E. Carroll School of Management

Boston College

with additional material from

Fundamentals of Corporate Finance, Alternate Fifth Edition

Essentials of Corporate Finance, Second Edition

Stephen A. Ross, Massachusetts Institute of Technology

Randolph W. Westerfield, University of Southern California

Bradford D. Jordan, University of Kentucky

UNIVERSITY OF PHOENIX

Boston Burr Ridge, IL Dubuque, IA Madison, WI New York San Francisco St. Louis

Bangkok Bogotá Caracas Lisbon London Madrid

Mexico City Milan New Delhi Seoul Singapore Sydney Taipei Toronto

Selected material from

FUNDAMENTALS OF CORPORATE FINANCE, Third Edition

with additional material from

FUNDAMENTALS OF CORPORATE FINANCE, Alternate Fifth Edition

ESSENTIALS OF CORPORATE FINANCE, Second Edition

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved. Printed in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a data base retrieval system, without prior written permission of the publisher.

This book contains select material from:

Fundamentals of Corporate Finance, Third Edition by Richard A. Brealey, Stewart C. Myers, and Alan J. Marcus. Copyright

© 2001, 1999, 1995, by The McGraw-Hill Companies, Inc.

Fundamentals of Corporate Finance, Alternate Fifth Edition by Stephen A. Ross, Randolph W. Westerfield, and Bradford D.

Jordan. Copyright © 2000, 1998, 1995, 1993, 1991 by The McGraw-Hill Companies, Inc.

Essentials of Corporate Finance, Second Edition by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan.

Copyright © 1999 by The McGraw-Hill Companies, Inc. Previous edition © 1996 by Richard D. Irwin, a Times Mirror

Higher Education Group, Inc. company.

All reprinted with permission of the publisher.

ISBN 0-07-553109-7

Sponsoring Editor: Christian Perlee

Production Editor: Nina Meyer

Contents

1

SECTION 1

How to Value Perpetuities 50

How to Value Annuities 51

Annuities Due 54

Future Value of an Annuity 57

The Firm and the Financial

Manager 3

Organizing a Business 4

Sole Proprietorships 4

Partnerships 5

Corporations 5

Hybrid Forms of Business Organization

6

The Role of the Financial Manager

7

The Capital Budgeting Decision

The Financing Decision 9

Inflation and the Time Value of Money

8

Effective Annual Interest Rates

Financial Institutions and Markets

Summary

10

Careers in Finance

13

15

Goals of the Corporation

Financial Planning

17

Shareholders Want Managers to Maximize

Market Value 17

Ethics and Management Objectives 19

Do Managers Really Maximize Firm Value?

Snippets of History 25

Summary

21

Financial Planning Models

Planners Beware

87

93

Pitfalls in Model Design 93

The Assumption in Percentage of Sales Models

The Role of Financial Planning Models 95

33

34

External Financing and Growth

38

Multiple Cash Flows

86

Components of a Financial Planning Model

An Example of a Planning Model 88

An Improved Model 89

Future Values and Compound Interest

Finding the Interest Rate

82

Financial Planning Focuses on the Big Picture 83

Financial Planning Is Not Just Forecasting 84

Three Requirements for Effective Planning 84

Related Web Links

28

Key Terms 28

Quiz

28

Practice Problems

29

Solutions to Self-Test Questions 31

Present Values

77

81

What Is Financial Planning?

25

The Time Value of Money

67

69

Related Web Links 69

Key Terms 70

Quiz 70

Practice Problems 72

Challenge Problems 75

Solutions to Self-Test Questions

Minicase 79

Financial Institutions 10

Financial Markets 11

Other Functions of Financial Markets and

Institutions 12

Who Is the Financial Manager?

61

Real versus Nominal Cash Flows 61

Inflation and Interest Rates 63

Valuing Real Cash Payments 65

Real or Nominal? 67

Summary

44

46

Future Value of Multiple Cash Flows 46

Present Value of Multiple Cash Flows 49

Level Cash Flows: Perpetuities and Annuities

50

94

96

100

Related Web Links 101

Key Terms 101

Quiz 101

Practice Problems 102

Challenge Problems 106

Solutions to Self-Test Questions

106

iii

IV

CONTENTS

109

APPENDIX A

Accounting and Finance

The Balance Sheet

Financial Ratios

The Income Statement

117

Profits versus Cash Flow

118

115

The Statement of Cash Flows

Accounting for Differences

119

121

134

The Du Pont System

145

Other Financial Ratios

146

Using Financial Ratios

147

Choosing a Benchmark 147

123

Corporate Tax 123

Personal Tax 125

Summary

133

Leverage Ratios 138

Liquidity Ratios 139

Efficiency Ratios 141

Profitability Ratios 143

112

Book Values and Market Values

Taxes

Financial Statement Analysis

111

Measuring Company Performance

The Role of Financial Ratios

126

Related Web Links 127

Key Terms 127

Quiz 127

Practice Problems 128

Challenge Problem 131

Solutions to Self-Test Questions

Summary

Bank Loans 185

Commercial Paper 186

Secured Loans 186

Working Capital Management and

Short-Term Planning 165

167

The Components of Working Capital 167

Working Capital and the Cash Conversion Cycle

The Working Capital Trade-Off 171

The Cost of Bank Loans

168

Links between Long-Term and Short-Term

Financing 172

Tracing Changes in Cash and Working Capital 175

Cash Budgeting

159

163

SECTION 2

Working Capital

151

153

Related Web Links 155

Key Terms 155

Quiz 155

Practice Problems 157

Challenge Problem 158

Solutions to Self-Test Questions

Minicase 160

131

150

177

Forecast Sources of Cash 177

Forecast Uses of Cash 179

The Cash Balance 179

A Short-Term Financing Plan

180

Options for Short-Term Financing

Evaluating the Plan 184

180

Sources of Short-Term Financing

187

Simple Interest 187

Discount Interest 188

Interest with Compensating Balances

Summary

189

190

Related Web Links 191

Key Terms 191

Quiz 191

Practice Problems 192

Challenge Problem 194

Solutions to Self-Test Questions

Minicase 197

195

Cash and Inventory Management

Cash Collection, Disbursement, and Float

185

Float 203

Valuing Float

204

201

202

CONTENTS

Managing Float

205

Credit Analysis

Speeding Up Collections 206

Controlling Disbursements 209

Electronic Funds Transfer 210

Inventories and Cash Balances

211

Managing Inventories 212

Managing Inventories of Cash 215

Uncertain Cash Flows 216

Cash Management in the Largest Corporations

Investing Idle Cash: The Money Market 218

Summary

The Credit Decision

217

Bankruptcy

224

231

SECTION 3

Valuing Bonds

240

227

244

Related Web Links 245

Key Terms 245

Quiz 245

Practice Problems 246

Challenge Problems 248

Solutions to Self-Test Questions 249

Minicase 250

Book Values, Liquidation Values, and Market

Values 283

256

Reading the Financial Pages

Valuing Common Stocks

257

Bond Prices and Yields 259

How Bond Prices Vary with Interest Rates 260

Yield to Maturity versus Current Yield 261

Rate of Return 265

Interest Rate Risk 267

The Yield Curve 268

Nominal and Real Rates of Interest 268

Default Risk 270

Valuations in Corporate Bonds 273

Summary 273

Related Web Links 274

Key Terms 274

Quiz 274

Practice Problems 275

Challenge Problems 277

Solutions to Self-Test Questions

Valuing Stocks

239

253

255

Bond Characteristics

Collection Policy

Summary

229

Credit Agreements

236

Bankruptcy Procedures 241

The Choice between Liquidation and

Reorganization 242

Credit Management and Collection

Terms of Sale

234

Credit Decisions with Repeat Orders 237

Some General Principles 238

219

Related Web Links 220

Key Terms 220

Quiz 220

Practice Problems 221

Challenge Problem 224

Solutions to Self-Test Questions

232

Financial Ratio Analysis 233

Numerical Credit Scoring 233

When to Stop Looking for Clues

Simplifying the Dividend Discount Model

279

Stocks and the Stock Market

Reading the Stock Market Listings

280

281

291

The Dividend Discount Model with No Growth 291

The Constant-Growth Dividend Discount Model 292

Estimating Expected Rates of Return 293

Nonconstant Growth 295

Growth Stocks and Income Stocks

The Price-Earnings Ratio 298

What Do Earnings Mean? 298

Valuing Entire Businesses 301

Summary

277

287

Today’s Price and Tomorrow’s Price 287

The Dividend Discount Model 288

301

Related Web Links 302

Key Terms 302

Quiz 302

Practice Problems 303

Challenge Problems 306

Solutions to Self-Test Questions

307

296

V

VI

CONTENTS

Introduction to Risk, Return, and the

Opportunity Cost of Capital 311

Rates of Return: A Review 312

Market Indexes 314

The Historical Record 314

Using Historical Evidence to Estimate Today’s Cost of

Capital 317

318

Variance and Standard Deviation 318

A Note on Calculating Variance 322

Measuring the Variation in Stock Returns

322

Net Present Value and Other Investment

Criteria 341

343

A Comment on Risk and Present Value

Valuing Long-Lived Projects 345

Other Investment Criteria

344

349

Internal Rate of Return 349

A Closer Look at the Rate of Return Rule 350

Calculating the Rate of Return for Long-Lived

Projects 351

A Word of Caution 352

Payback 352

Book Rate of Return 355

Investment Criteria When Projects Interact

Mutually Exclusive Projects 356

Investment Timing 357

Long- versus Short-Lived Equipment 359

Replacing an Old Machine 361

Mutually Exclusive Projects and the IRR Rule

Other Pitfalls of the IRR Rule 363

Capital Rationing

365

Soft Rationing 365

Hard Rationing 366

Pitfalls of the Profitability Index

Summary

331

Message 1: Some Risks Look Big and Dangerous but

Really Are Diversifiable 331

Message 2: Market Risks Are Macro Risks 332

Message 3: Risk Can Be Measured 333

Summary

334

Related Web Links 334

Key Terms 334

Quiz 335

Practice Problems 336

Solutions to Self-Test Questions

338

Challenge Problems 373

Solutions to Self-Test Questions

373

339

SECTION 4

Net Present Value

324

Diversification 324

Asset versus Portfolio Risk 325

Market Risk versus Unique Risk 330

Thinking about Risk

Seventy-Three Years of Capital Market

History 313

Measuring Risk

Risk and Diversification

367

Related Web Links 368

Key Terms 368

Quiz 368

Practice Problems 369

3667

Using Discounted Cash-Flow Analysis to

Make Investment Decisions 377

Discount Cash Flows, Not Profits

379

Discount Incremental Cash Flows

381

Include All Indirect Effects 381

Forget Sunk Costs 382

Include Opportunity Costs 382

Recognize the Investment in Working Capital

Beware of Allocated Overhead Costs 384

356

383

Discount Nominal Cash Flows by the Nominal Cost

of Capital 385

Separate Investment and Financing Decisions

Calculating Cash Flow 387

361

Capital Investment 387

Investment in Working Capital 387

Cash Flow from Operations 388

Example: Blooper Industries

390

Calculating Blooper’s Project Cash Flows 391

Calculating the NPV of Blooper’s Project 392

Further Notes and Wrinkles Arising from Blooper’s

Project 393

Summary

397

Related Web Links

Key Terms 398

Quiz 398

398

386

CONTENTS

Practice Problems 200

Challenge Problems 402

Solutions to Spreadsheet Model Questions

Solutions to Self-Test Questions 404

Minicase 405

403

Risk, Return, and Capital Budgeting

Measuring Market Risk

408

Measuring Beta 409

Betas for MCI WorldCom and Exxon

Portfolio Betas 412

Risk and Return

Big Oil’s Weighted-Average Cost of Capital

420

The Cost of Capital

435

Geothermal’s Cost of Capital

436

450

When You Can and Can’t Use WACC 451

Some Common Mistakes 452

How Changing Capital Structure Affects Expected

Returns 452

What Happens When the Corporate Tax Rate Is Not

Zero 453

424

Flotation Costs and the Cost of Capital

Summary

454

Related Web Links 455

Key Terms 455

Quiz 455

Practice Problems 456

Challenge Problems 458

Solutions to Self-Test Questions

Minicase 459

Calculating the Weighted-Average Cost of

Capital 438

458

463

SECTION 5

Project Analysis

Real Oil Company WACCs

465

How Firms Organize the Investment Process

Stage 1: The Capital Budget 467

Stage 2: Project Authorizations 467

Problems and Some Solutions 468

Some “What-If ” Questions

469

Sensitivity Analysis 469

Scenario Analysis 472

Break-Even Analysis

473

Accounting Break-Even Analysis

474

450

Interpreting the Weighted-Average Cost of

Capital 451

425

432

447

The Expected Return on Bonds 448

The Expected Return on Common Stock 448

The Expected Return on Preferred Stock 449

422

Company versus Project Risk 422

Determinants of Project Risk 423

Don’t Add Fudge Factors to Discount Rates

Related Web Links 426

Key Terms 426

Quiz 426

Practice Problems 427

Challenge Problem 432

Solutions to Self-Test Questions

446

Calculating Required Rates of Return

414

Capital Budgeting and Project Risk

Calculating Company Cost of Capital as a Weighted

Average 440

Market versus Book Weights 441

Taxes and the Weighted-Average Cost of Capital 442

What If There Are Three (or More) Sources of

Financing? 443

Wrapping Up Geothermal 444

Checking Our Logic 445

Measuring Capital Structure

411

Why the CAPM Works 416

The Security Market Line 417

How Well Does the CAPM Work? 419

Using the CAPM to Estimate Expected Returns

Summary

407

VII

466

NPV Break-Even Analysis 475

Operating Leverage 478

Flexibility in Capital Budgeting

Decision Trees 481

The Option to Expand 482

Abandonment Options 483

Flexible Production Facilities 484

Investment Timing Options 484

Summary 485

Related Web Links

Key Terms 485

485

481

454

VIII

CONTENTS

Quiz 512

Practice Problems 513

Solutions to Self-Test Questions

Quiz 485

Practice Problems 486

Challenge Problems 489

Solutions to Self-Test Questions

Minicase 491

489

How Corporations Issue Securities

Venture Capital

An Overview of Corporate

Financing 493

Common Stock

Arranging a Public Issue

The Underwriters

Book Value versus Market Value 496

Dividends 497

Stockholders’ Rights 497

Voting Procedures 497

Classes of Stock 498

Corporate Governance in the United States and

Elsewhere 498

499

Corporate Debt

500

General Cash Offers and Shelf Registration

Costs of the General Cash Offer 529

Market Reaction to Stock Issues 530

507

Patterns of Corporate Financing

508

Do Firms Rely Too Heavily on Internal Funds?

External Sources of Capital 510

526

General Cash Offers by Public Companies

Debt Comes in Many Forms 501

Innovation in the Debt Market 504

Summary

526

The Private Placement

Convertible Securities

508

Related Web Links

Key Terms 512

532

Related Web Links 533

Key Terms 533

Quiz 534

Practice Problems 534

Challenge Problem 536

Solutions to Self-Test Questions

Minicase 537

537

512

545

APPENDIX B

Leasing 547

Lease or Buy?

Leasing versus Buying

A Preliminary Analysis

555

555

548

555

Operating Leases

548

Three Potential Pitfalls

Financial Leases

549

NPV Analysis

Tax-Oriented Leases

Leveraged Leases

550

Sale and Leaseback Agreements

Accounting and Leasing

552

The Cash Flows from Leasing

The Incremental Cash Flows

554

550

556

Leverage and Capital Structure

559

The Capital Structure Question 560

550

Taxes, the IRS, and Leases

556

A Misconception

549

553

553

528

528

531

Appendix: Hotch Pot’s New Issue Prospectus

511

A Note on Taxes

520

521

Who Are the Underwriters?

Summary

517

519

The Initial Public Offering

494

Preferred Stock

514

The Effect of Financial Leverage 560

The Impact of Financial Leverage 560

Financial Leverage, EPS, and ROE:

An Example 561

EPS versus EBIT 561

539

CONTENTS

565

SECTION 6

Mergers, Acquisitions, and Corporate

Control 567

22.1 The Market for Corporate Control

569

Method 1: Proxy Contests 569

Method 2: Mergers and Acquisitions 570

Method 3: Leveraged Buyouts 571

Method 4: Divestitures and Spin-offs 571

22.2 Sensible Motives for Mergers

572

Economies of Scale 573

Economies of Vertical Integration 573

Combining Complementary Resources 574

Mergers as a Use for Surplus Funds 574

22.3 Dubious Reasons for Mergers

575

Diversification 575

The Bootstrap Game 575

22.4 Evaluating Mergers

577

22.6 Leveraged Buyouts

587

588

Merger Waves 588

Do Mergers Generate Net Benefits?

22.8 Summary

Glossary

589

590

APPENDIX C

635

23.2 Some Basic Relationships

598

602

Exchange Rates and Inflation 602

Inflation and Interest Rates 606

Interest Rates and Exchange Rates 608

The Forward Rate and the Expected Spot Rate

Some Implications 610

23.5 Summary

585

22.7 Mergers and the Economy

23.1 Foreign Exchange Markets

625

617

Related Web Links 618

Key Terms 618

Quiz 618

Practice Problems 619

Challenge Problem 621

Solutions to Self-Test Questions

Minicase 623

609

612

613

Net Present Value Analysis 613

The Cost of Capital for Foreign Investment

Avoiding Fudge Factors 616

584

Barbarians at the Gate?

International Financial

Management 597

23.4 International Capital Budgeting

582

Who Gets the Gains?

595

23.3 Hedging Exchange Rate Risk

Mergers Financed by Cash 577

Mergers Financed by Stock 579

A Warning 580

Another Warning 580

22.5 Merger Tactics

Related Web Links 592

Key Terms 592

Quiz 592

Practice Problems 5…

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