There is no Test bank for Chapter 1

Chapter 1 There is no Test bank for Chapter 1

Corporate Finance Theory and Practice 2e Aswath Damodaran (For Complete File, Download Link at the end of this File) (Test Bank) 1 / 4

Chapter 2

• One of the requirements of a good objective function is that it be observable and

timely. What do we mean by “observable” and “timely” and why are these characteristics important?

• Why is the annual meeting not a very effective device for investors to keep control

over managers? What would you change about the way annual meetings are structured and run to make them more effective?

• Why is the board of directors not very effective at giving stockholders oversight

over managers? What would you change about the way they are structured to make them more effective?

• What is the source of the conflict between stockholders and bondholders? What are

some of the ways in which stockholders can enrich themselves at bondholder expense and how do bondholders protect themselves against such actions?

• When we talk about “efficient markets” as a necessary condition for stock price

maximization to work as the sole objective, what do we mean by “efficiency”?Why does it matter?

• What is a social cost? Give an example of a social cost and explain how this social

cost can ultimately affect firm value?

• Consider the objective of maximizing market share. Examine the potential for

agency problems (between managers and stockholders, stockholders and bondholders, the firm with financial markets and society) with this objective.

• Why might manager-based corporate governance systems (like the German and

Japanese system) be more effective than market-based system at dealing with firm- specific problems but less effective at dealing with systematic problems?

• “A key advantage of a market-based system that focuses on stock price

maximization is that it is self-correcting”. Explain what we mean by “self- correcting” and give an example.

• Under what conditions would maximizing stock prices be congruent with

maximizing societal welfare?

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Chapter 3

• You are comparing two cash flows - $ 10 million at the end of 5 years and $ 22

million at the end of 10 years.

• With an 8% interest rate, which cash flow would you prefer to receive?
• At approximately what discount rate would you be indifferent between the two

cashflows?You have a $ 50,000 automobile loan that you took on when you bought your new Porsche. The loan has to be paid off in equal monthly installments over the next 36 months, with each installment including both interest and principal.

• Estimate the monthly payment assuming a 1% monthly interest rate.
• If you pay 1% a month, what is the annualized interest rate on the loan?
• At the end of 1 year, how much would you still owe in principal on the loan?

You have just won the New York State lottery and you are promised $ 1 million at the end of each year for the rest of your life. You are 35 years old, and the actuarial tables suggest that you will live to be 75. A company has approached you with an offer to give you a lump sum now, in return for your turning over your annual payments to them.

• If you could earn 6% on your investments, how much would you demand as the

lump sum?

• Under what conditions would you settle for less?

You are trying to estimate the value of a building, based upon the rental cash flows. The total rental revenue on the building last year was $ 7 million and it is expected to grow 5% a year for the next 12 years; the operating expenses were $ 2 million and they can be expected to grow 5% a year for the next 12 years, as well. At the end of 12 years, the building has to be sold to the owner of the land (on which the building is built) for $ 100 million. The discount rate on the cash flows, based upon the uncertainty, is estimated to be 10%. (You can ignore taxes)

• Estimate the value of the building. 3 / 4

• Now assume that at the end of year 12, the building would not be sold for $ 100

million. Instead, the cash flows are expected to grow at 3% a year forever after that.Estimate the value of the building based upon this assumption.You are planning for your retirement. You estimate that your income, which was $ 100,000 in the last year, will grow at 8% a year for the next 30 years (which is your estimate of how long you plan to continue working), and that your expenses, which were $ 80,000 in the last year, will grow 6% a year for the next 30 years. (You can invest at 7%)

• Estimate how much you will save by the end of the 30

th year.

• If you expect to live for 20 years after you retire, how much can you afford to

withdraw each year from these savings?Central Graphics Inc. has a pension plan that has expected obligations of $ 25 million, growing 5% a year for the next 30 years. The fund’s assets currently (market value of existing investments) are worth $ 300 million. The firm expects to earn 10% on these assets annually. The firm plans to make an additional contribution to make the fund fully funded (value of the assets = value of expected obligations).

• How much will the additional contribution have to be, if the firm plans to make it

immediately?

• How much will the annual contribution have to be, if the firm plans to make it in

three equal installments at the end of each of the next 3 years?You can expect to pay $ 8,000 a year, growing at 5% a year, to send a child to private school for 12 years. Beyond that period, you can expect to pay college tuition for 4 years; the annual cost currently of going to college is $ 15,000 but you can expect this to grow 4% a year over time. Your investments are expected to earn 6% a year.

• Estimate the total cost, in present value terms, of educating a child in a private

school and university.

• What difference would it make if tuition (in both the private school and college)

were tax deductible, and your tax rate was 40%?

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