QUESTIONS AND PROBLEMS

CHAPTER 1. CORPORATE FINANCE OVERVIEW

QUESTIONS
Q1.1. Differentiate the decisions of corporate finance? What is the purpose of
implementing these decisions?
Q1.2. What is tax shield? What costs can create a tax shield?
Q1.3. Differentiate criteria: EBIT, EBT, EAT, EPS, ROA, ROE.
Q1.4. What is agency cost? Why does this cost exist?
Q1.5. 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?
Q1.6 Goal of the Firm: Managers should not focus on the current stock value because
doing so will lead to an overemphasis on short-term profits at the expense of long-term
profits. What is your opinion?
Q1.7 Differentiate between equity and debt capital.
PROBLEMS
P1.1. (Tax shield)
a. Fixed assets cost 4 billion VND; amortized over 4 years using the straight-line method,
the tax rate be 20%. What is the tax shield value from annual depreciation?
b. Fixed assets cost 4 billion VND; depreciated over 4 years at the rate of 40% in turn;
30%; 20% and 10%, the TAX rate be 20%. What is the value of the tax shield over the
years?
c. In the first year, does the amortization method in (b) save taxes on the tax shield from
depreciation compared to a? What is the answer?
d. According to the time value of money, the manager should choose the depreciation
plan to get more profit? Why?
P1.2. (Financial indicators)
In 2019, Enterprise A has an average asset of VND 2000 billion. Revenue in the year
1000 billion. Operating costs 500 billion VND. The company has 30% debt, the rest is
equity. The outstanding share price is 10,000 VND. The corporate income tax rate is
20%, the loan interest rate is 8%. Calculate: EBIT, EBT, EAT, ROE, EPS of this business in
2019.
P1.3. (Financial indicators)
Ho Du enterprise has the following financial information in 2018:
- Revenue reached 8000 billion VND, total operating expenses 4800 billion VND.
 - In the year, enterprises borrow VND 2000 billion, lending interest rate is 12%; and
preferential dividends: 1500 million
- Number of common shares outstanding At the beginning of the year: 100 million
shares, at the end of the year 80 million shares.
- Corporate income tax rate: 20%
Calculate the company's EBIT, EBT, EAT and EPS.
P 1.4. (Calculating financial indicators)
Winry Company has the following financial information for 2019:
- Revenue reached 1000 billion dong, fixed cost was 100 billion, variable cost
accounted for 50% of revenue.
- In the year, enterprises(doanh nghiệp) borrow 200 billion, the loan interest rate is
12%; and preferred dividends: 10 billion dong
- Number of common shares outstanding at the beginning of 2019: 85 million
shares, and this year the company has purchased (mua thêm) 5 million treasury
shares(cổ phiếu quỹ).
- Corporate income tax rate: 20%
Calculate the company's EBIT, EBT, EAT and EPS.
P1.5. (Challenging Problem)
Enterprise A has an average asset of VND 2000 billion. Revenue in the year 1000 billion.
Operating costs 500 billion VND. The corporate income tax rate is 20%.
Suppose there are 4 cases of capital structure of company A:
(1) 100% capital is equity capital (VỐN CSH)
(2) 60% equity, 40% debt (VAY) (loan interest rate 8%)
(3) 50% equity, 50% debt (loan interest rate 10%)
(4) 50% equity, 50% debt (loan interest rate 8%)
Assume the share price is constant and equal to the par value of 10,000 VND. Complete
the following table:

(1) (2) (3) (4)

Revenue

Operating costs

EBIT

Interest expense (I)

EBT
Tax

EAT

Tax shield from interest

ROE: return (EAT) on equity

EPS
CHAPTER 2. TIME VALUE OF MONEY
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; perpetuity
g. Uneven (nonconstant) cash flow; payment (PMT); cash flow (CFt)
h. Annual compounding; semiannual compounding
i. Nominal (quoted) interest rate; annual percentage rate (APR); effective (equivalent)
annual rate (EAR or EFF%)
j. Amortized loan; amortization schedule
QUESTIONS
Q2.1.
a. In most matters of corporate finance, will people use simple interest or compound
interest? Why?
b. “With the same published interest rate, the shorter the compounding time (in other
words, the more compounding times); effective interest rate will be ____”. Fill in the
blanks and explain.
c. Differentiate interest rate pairs: Annual announced interest rate (APR) and effective
annual interest rate (EAR); Equivalent interest rate and proportional interest rate.
Q2.2. Draw and show how to draw any cash flow.
Q2.3. Draw cash flows and show how to calculate the future value and present value of a
cash flow.
Q2.4. Present and demonstrate formulas for calculating the future value of a steady
stream of cash flows.
Q2.5. Present and demonstrate formulas for the present value of a steady stream of
cash.
Q2.6. Present the meaning of the indicators: NPV, IRR, MIRR and DPP. Show the
difference between IRR and MIRR.
Q2.7. Differentiate the types of bonds: coupon, discount and compound.
Q2.8. Analyze the relationship between bond price and par value according to changes in
discount rate (average required rate of return of investors in the market).
Q2.9. Show how the price of the bond will move as the maturity date gets closer.
Q2.10. Explain the difference between bonds and stocks. Principles of valuation of bonds
and stocks.
PROBLEMS
P2.1. (Interest rates)
There is information about announced interest rate (LSCB) of banks (NH):
Bank 1: LSCB 12.68% annually, compounded annually
Bank 2: LSCB 11% annually, compounded monthly
Bank 3: LSCB 20.5%/2 years, compounding quarterly
Bank 4: LSCB 3%/quarter, compounded monthly
Bank 5: LSCB 1%/month, compounding quarterly
Bank 6: LSCB 2.99%/quarter, 6 months compound interest
Bank 7: LSCB 1%/month, compounded monthly
Calculate the effective interest rate of the above banks knowing the time to find is:
a. Monthly
b. Yearly
c. Quarterly
d. by 6 months
Finally, ưhich bank should Mr. Dam choose to borrow from? Know the other terms of the
banks are the same.
P2.2. (Interest rates)
Tri Viet Company has a loan with Dai Tin bank of VND 20 billion with a term of 5 years,
interest rate of 9% annually, monthly capital gain.
Request:
a. Calculate the effective annual interest rate (EAR) of the loan.
b. Instead of calculating interest on a monthly basis, the bank calculates interest on a
quarterly basis. How much interest a quarter must be, so that the amount the bank
receives does not change?
P2.3. Solving the following easy problems:
a. (Future value) If you deposit $2,000 in a bank account that pays 6% interest
annually, how much will be in your account after 5 years?
b. (Present value) What is the present value of a security that will pay $29,000 in
20 years if securities of equal risk pay 5% annually?
c. (Finding the required interest rate) Your parents will retire in 19 years. They
currently have $350,000 saved, and they think they will need $800,000 at
 retirement. What annual interest rate must they earn to reach their goal,
assuming they don’t save any additional funds?
d. (Time for a lump sum to double) If you deposit money today in an account that
pays 4% annual interest, how long will it take to double your money?
e. (Time to reach a financial goal) You have $33,556.25 in a brokerage account,
and you plan to deposit an additional $5,000 at the end of every future year until
your account totals $220,000. You expect to earn 12% annually on the account.
How many years will it take to reach your goal?
f. (Future value: annuity versus annuity due) What’s the future value of a 5%,
5-year ordinary annuity that pays $800 each year? If this was an annuity due,
what would its future value be?
g. (present and future values of a cash flow stream) An investment will pay
$150 at the end of each of the next 3 years, $250 at the end of Year 4, $300 at
the end of Year 5, and $500 at the end of Year 6. If other investments of equal risk
earn 11% annually, what is its present value? Its future value?
h. (Effective annual interest rate) Today, you borrow 100 million VND from Asia
Commercial Joint Stock Bank, 5 years after the loan matures, you have to pay both
principal and interest of 219.11 million VND. Calculate the effective annual
interest rate (EAR) of the loan.
i. (Effective annual interest rate) ThangLong Company borrows VND 400 million
from Dong A Bank, 12 months term, interest rate is 10% annually, the interest is
paid once upon receipt of loan, principal is paid at maturity. What is the effective
annual interest rate (EAR) on the loan?
j. (Annual percentage rate) You deposit 10 million into ACB bank. A year later,
you receive an amount (including principal and interest) of 11 million. What is the
annual percentage rate (APR), knowing the bank calculates interest on a monthly
basis.

P2.4. (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 $600 compounded for 1 year at 6%
b. An initial $600 compounded for 2 years at 6%
c. The present value of $600 due in 1 year at a discount rate of 6%
d. The present value of $600 due in 2 years at a discount rate of 6%
P2.5. (Present and future values for different interest rates)
Find the following values. Compounding/discounting occurs annually.
a. An initial $200 compounded for 10 years at 4%
b. An initial $200 compounded for 10 years at 8%
c. The present value of $200 due in 10 years at 4%
d. The present value of $1,870 due in 10 years at 8% and at 4%
e. Define present value and illustrate it using a time line with data from part d. How are
present values affected by interest rates?
P2.5. (Future value of an annuity)
a. Truc Nhan has incomes at the end of each year, continuously for 5 years with the
amount of 10 billion annually, if every year he deposits those money in the bank with an
interest rate of 8% annually, capital gains quarterly, what will be the total amount you
get from the bank at the end of year 5?
b. With the data in question a, instead of receiving money at the end of year 5, he
withdraws money at the end of year 10, asking how much money Truc Nhan can
withdraw?
c. With the data in question a, the next 5 years, singer Truc Nhan continues to send 15
billion at the end of each year. Calculate the amount he received at the end of year 10.
P2.6. (Future value of a complicated cash flow)
At the end of each year, Mai Hong Ngoc invests money, the money is made as follows:
- First year investment of $1.5 million,
- Year 2 - 8 each year invest $1 million,
- 9th year, invest $1.2 million.
The investment gives her an average return of 10%.
Request:
a. Calculate the total amount she received from the investment at the end of year 9.
b. If she won't receive all the money and interest until the end of year 12, calculate the
amount that Dong Nhi has.
c. If the funds are invested at the beginning of each year, how does the amount she has
at the end of year 9 compare with the outcome in a.
P2.7. (Present value of money)
Hari Won won the lottery with an amount of VND 1500 million. The lottery company
announced that there are 2 methods of receiving money as follows: (1) She will receive
the entire amount mentioned above after 5 years; or (2) today you only get 1300 million.
Which method should she choose, knowing that she can deposit at the Bank with a
constant interest rate over the years, 8% annually, capital gain once a quarter.
P2.8. (Present value of an annuity)
At the moment, you borrow from a bank with an amount of 500 million (PV), the loan
interest rate is 9.5% annually, monthly installments, the loan term is 8 years, the
monthly amount (CF) you have to pay. Pay to the bank is the same. Calculate CF.
If the installment is made annually, recalculate the amount you have to pay the bank
periodically (recalculate the CF).
P2.9. PV AND LOAN ELIGIBILITY
You have saved $4,000 for a down payment on a new car. The largest monthly payment
you can afford is $350. The loan will have a 12% APR based on end-of-month payments.
What is the most expensive car you can afford if you finance it for 48 months? For 60
months?
P2.10. (Present value of a cash flow) A 2.11
Enterprise A borrows from bank VCB at a constant interest rate every year, 10%
annually. Installments made over 20 years are as follows:
At the end of the first year pay 30 million,
End of year 2-12: 35 million annually
At the end of the 13th year onwards: 10 million annually
Request:
a. Calculate the amount of business A has borrowed at present.
b. If loan repayments are made at the beginning of the year, calculate the loan amount.
Thereby explaining the formula showing the relationship between PV of cash flow at the
beginning of the period and cash flow at the end of the period.
P2.11. (Present value of a cash flow)  2.11 B
Company B is expected(dự kiến) to pay for its annual expenses(chi phí) in the future
(forever). Last year, this expenditure was worth 300 million (CF0), and is expected to
change with annual inflation by 5%. Company B needs to prepare how much money at
present, knowing the discount rate is 10%. (Hint: use the formula to calculate the
Present Value of an infinitely growing cash flow)/ Giá trị hiện tại của dòng tiền tăng
trưởng đều vô hạn
P2.12. (Challenging Problems)
Your client just turned 40 this year, he wants to save money before retirement, by
depositing money in the bank once a year with the amount of VND 100 million, the first
deposit one year from today. Currently, the last period thời hạn cuối là is at the time of
retirement. Deposit interest rate is 9% annually, monthly capital gain. Ask:
a. How much money will he have at 60?
b. If he retires at 60 and withdraws rút tiền for 15 years, how much will he withdraw each
month? Know the first draw kỳ rút đầu tiên is 1 month after retirement. Sau 1 tháng nghỉ
hưu
c. If the announced interest rate (lãi suất hiệu dụng) is reduced to 6% annually,
compounded monthly, how much is the withdrawal amount per month?
d. If in the first 20 years the announced interest rate remains unchanged, but in the
following years, the announced interest rate decreases to 6% annually. Recalculate the
amount you withdraw every month.
P2.13. (Challenging Problems)
Currently, enterprise B borrows from VCB at the same interest rate every year, 10%
annually. Installments [Các khoản trả góp] (interest and principal; lãi và gốc) expected to
be made in 30 years (from the time of borrowing) are as follows:
From the end of years 2-12: 95 million annually
From the end of the 13th-20th year: 70 million annually
The years after that, each year pay 50 million.
Request:
a. Calculate the amount of loan of enterprise B knowing that VCB disbursed once (the
entire loan is received at present).
b. In case VCB disburses the loan in 4 installments, with equal amounts and 6 months
apart, the first installment is at present. Calculate the amount of each installment DN B
receives.
P2.14. (Challenging Problems)
Minh Chau Company uses its own capital (vốn tự có) and loans from the bank to finance
a project to [manufacture a new product] (sản xuất một san phầm mới), the economic
life (tuổi thọ dự án) of the project is 20 years, excluding the 4 year construction period.
year.
The total loan amount is 150 billion VND, disbursed 4 times according to the construction
progress, one year apart each time, the first time one year after the start of
construction, with the amount of: 30; 50; 50 and 20 billion. Loan interest rate is 10%
annually. The repayment (trả nợ) of capital and interest is made for 10 years, once a
year, in equal amounts (số tiền bằng nhau), the first payment one year after the end of
the construction period. (1 năm sau khi kết thúc thời gian xây dựng)
Request:
a) Calculate the amount Minh Chau has to pay the bank each year.
b) If the annual payment is 30 billion VND, how long will it take, from the time of
commencement(khởi công), before Minh Chau pays all the capital and interest to the
bank?
d) If the amount to be paid each year, during 20 years is 22 billion VND, what is the
interest rate on the loan % annually?
P2.15. (Challenging Problems)
Phong Phu Textile Company intends to invest in a new MMTB, with three suppliers
offering the following payment methods:
- Supplier A: Installment continuously for 4 years, paying 220 million VND each year, the
first payment period is 1 year after receiving the device.
- Supplier B: 4 years after receiving the machine, will make a one-time payment of 900
million VND.
- Provider C: Installment continuously for 4 years with the amount of: 100 respectively;
100; 130 and 550 million dong, the first payment period is 1 year after receiving the
device.
a. Please indicate the published price of the supplier.
b. Which supplier should the company choose, knowing the company can deposit money
in the bank with the interest rate: 10% annually, compounding quarterly
P2.16. (Challenging Problems)
Mr. A buys a car at a Winwin store for an instant sale price of 1500 million. If Mr. A pays
in installments, the method is as follows: prepayment of 500 million, and monthly
payment of 100 million within 18 months.
Outside, Mr. A has a loan with a limit (available) at bank B of 2000 million, with an
interest rate of 12% annually, paying interest quarterly.
Which method do you think Mr. A should choose?
Hint: Mr. A has 2 options: (1) installment payment to Winwin store; (2) Borrow from a
bank to pay principal and interest in installments.
P2.17. (Loan Amortization Schedule)
Make a Loan Amortization Schedule:
- The annual payment amount is 50 million VND,
- 10% loan interest rate
- The loan period is 5 years
Does the interest rate over the years tend to increase, decrease or remain constant?
Why?
P2.18 (Loan amortization)
Jan sold her house on December 31 and took a (nhận) $10,000 mortgage as part of the
payment. The 10-year mortgage has a 10% nominal interest rate, but it calls for semi-
annual payments beginning next June 30. Next year Jan must report on Schedule B of
her IRS Form 1040 the amount of interest that was included in the two payments she
received during the year.
a. What is the dollar amount of each payment Jan receives?
b. How much interest was included in the first payment? How much repayment of
principal was included? How do these values change for the second payment?
c. How much interest must Jan report on Schedule B for the first year? Will her interest
income be the same next year?
d. If the payments are constant, why does the amount of interest income change over
time?
P2.19. (Interest rate and duration)
a. You deposit a sum of money in the bank with an interest rate of 8% annually, capital
gain per year. After how many years will you receive double the original deposit?
b. After 8 years, the amount you received from a deposit has doubled the original
deposit. What is the deposit interest rate % annually? Know the bank charges interest to
enter your capital once a year.
c. Right now, you borrow 100 million VND from Asia Commercial Joint Stock Bank, 5
years after the loan matures, you have to pay both principal and interest of 219.11
million VND. Calculate the effective annual interest rate (EAR) of the loan.
d. Thang Long Company borrows VND 400 million from Dong A Bank, 12 months term,
interest rate is 10% annually, interest is paid once (lãi suất trả 1 lần) upon receipt of
loan(khi nhận được khoản vay), principal is paid at maturity(tiền gốc trả khi đáo hạn).
What is the effective annual interest rate (EAR) on the loan?
e. You deposit 10 million into ACB bank. A year later, you receive an amount (including
principal and interest) of 11 million. Ask what the annual announced interest rate (APR)
is, knowing the bank calculates interest on a monthly basis (tính lãi hằng tháng).
P2.20. (Effective rate of interest)
Find the interest rates earned on each of the following:
a. You borrow $720 and promise to pay back $792 at the end of 1 year.
b. You lend $720 and the borrower promises to pay you $792 at the end of 1 year.
c. You borrow $65,000 and promise to pay back $98,319 at the end of 14 years.
d. You borrow $15,000 and promise to make payments of $4,058.60 at the end of each
year for 5 years.
P2.21. (Reaching a financial goal)
Allison and Leslie, who are twins, just received $10,000 each for their 25th birthday.
They both have aspirations to become millionaires. Each plans to make a $5,000 annual
contribution to her “early retirement fund” on her birthday, beginning a year from today.
Allison opened an account with the Safety First Bond Fund, a mutual fund that invests in
high-quality bonds whose investors have earned 8% per year in the past. Leslie invested
in the New Issue Bio-Tech Fund, which invests in small, newly issued bio-tech stocks and
whose investors have earned an average of 13% per year in the fund’s relatively short
history.
a. If the two women’s funds earn the same returns in the future as in the past, how old
will each be when she becomes a millionaire?
b. How large would Allison’s annual contributions have to be for her to become a
millionaire at the same age as Leslie, assuming their expected returns are realized?
c. Is it rational or irrational for Allison to invest in the bond fund rather than in stocks?
P2.22. (Amortization schedule with a balloon payment)
You want to buy a house that costs $140,000. You have $14,000 for a down payment,
but your credit is such that mortgage companies will not lend you the required $126,000.
However, the realtor persuades the seller to take a $126,000 mortgage (called a seller
take-back mortgage) at a rate of 5%, provided the loan is paid off in full in 3 years. You
expect to inherit $140,000 in 3 years, but right now all you have is $14,000, and you can
afford to make payments of no more than $22,000 per year given your salary. (The loan
would call for monthly payments, but assume end-of-year annual payments to simplify
things.)
a. If the loan was amortized over 3 years, how large would each annual payment be?
Could you afford those payments?
b. If the loan was amortized over 30 years, what would each payment be? Could you
afford those payments?
c. To satisfy the seller, the 30-year mortgage loan would be written as a balloon note,
which means that at the end of the third year, you would have to make the regular
payment plus the remaining balance on the loan. What would the loan balance be at the
end of Year 3, and what would the balloon payment be?
P2.23. (Capital budgeting)
There are two projects with the following net cash flows: (Unit: VND million)

Projects Net cash flows

0 1 2 3 4 5 6

X -1000 - 300 900 500 400 300 100

Y -1000 - 300 100 300 400 500 900

Both projects have the same risk. Calculate:

a. The NPV of two projects, given the main discount rate equal to the project's cost of
capital (WACC) is 12%.
b. IRR of 2 projects. And whether to invest in this project or not?
c. MIRR of 2 projects in 2 cases of reinvestment interest rate:
• Correct WACC
• Equal to 15%
d. DPP and PP of 2 projects
P2.24. (Capital budgeting)
A project has the following information (VND): Investment cost is 1500 million; project
duration 5 years, annual net cash flow at the end of the year in the amount of 400
million, at the end of year 5, the project has an additional liquidation of 500 million.
a. What is the NPV of the project, is it acceptable to invest or not? Assume that the
discount rate is 10% per year.
b. What is the internal rate of return (IRR) % annually?
c. If residuals (positive NCF) are deposited in the bank with an APR of 8% annually,
compounded annually, what is the rate of return on the investment opportunity adjusted
for reinvestment opportunity (MIRR)? % annually?
d. Does the IRR in question b take into account the opportunity to reinvest the surplus
cash flow (positive NCF), indicating what is the reinvestment interest rate (if any)?
P2.25. (NPV profiles: scale differences)
A company is considering two mutually exclusive expansion (loại trừ lẫn nhau) plans.
Plan A requires a $40 million expenditure on a large-scale integrated plant that would
provide expected cash flows of $6.4 million per year for 20 years. Plan B requires a $12
million expenditure to build a somewhat less efficient, more labor-intensive plant with
expected cash flows of $2.72 million per year for 20 years. The firm’s WACC is 10%.
a. Calculate each project’s NPV and IRR.
b. Graph the NPV profiles for Plan A and Plan B and approximate the crossover rate.
c. Calculate the crossover rate where the two projects’ NPVs are equal.
d. Why is NPV better than IRR for making capital budgeting decisions that add to
shareholder value?
P2.26. (NPV and IRR)
A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month, 60
payments remain, and the next payment is due in 1 month. The mall’s owner plans to
sell the property in a year and wants rent at that time to be high so that the property will
appear more valuable. Therefore, the store has been offered a “great deal” (owner’s
words) on a new 5-year lease. The new lease calls for no rent for 9 months, then
payments of $2,600 per month for the next 51 months. The lease cannot be broken, and
the store’s WACC is 12% (or 1% per month).
a. Should the new lease be accepted? (Hint: Make sure you use 1% per month.)
b. If the store owner decided to bargain with the mall’s owner over the new lease
payment, what new lease payment would make the store owner indifferent between the
new and old leases? (Hint: Find FV of the old lease’s original cost at t 59; then treat this
as the PV of a 51-period annuity whose payments represent the rent during months 10
to 60.)
c. The store owner is not sure of the 12% WACC—it could be higher or lower. At what
nominal WACC would the store owner be indifferent between the two leases? (Hint:
Calculate the differences between the two payment streams; then find its IRR.)
P2.22. (Multiple IRRS and MIRR)
A mining company is deciding whether to open a strip mine, which costs $2 million. Cash
inflows of $13 million would occur at the end of Year 1. The land must be returned to its
natural state at a cost of $12 million, payable at the end of
Year 2.
a. Plot the project’s NPV profile.
b. Should the project be accepted if WACC 5 10%? If WACC 5 20%? Explain your
reasoning.
c. Think of some other capital budgeting situations in which negative cash flows during
or at the end of the project’s life might lead to multiple IRRs.
d. What is the project’s MIRR at WACC 5 10%? At WACC 5 20%? Does MIRR lead to the
same accept/reject decision for this project as the NPV method? Does the MIRR method
always lead to the same accept/reject decision as NPV? (Hint: Consider mutually
exclusive projects that differ in size.)
P2.27. (Bond valuation)
Currently, a newly issued bond has a par value of 1 million dong. Ten-year term, the
interest rate stated on the bond is 10% annually. Interest is paid annually and capital is
paid at maturity. Valuing this bond, in the following cases:
a. The time of valuation is at present, the rate of return of investors is 14% annually.
b. The valuation time is 2 years later than the present time, the investor's rate of return
is 12% annually.
c. The time of valuation is in the 6th year of the bond, the investor's rate of return is 8%
annually.
P2.28. (Bond valuation)
A bond with a par value of VND 100,000, term of 10 years, the interest rate stated on the
bond is 8% annually. Interest and capital are paid at maturity. Know the required rate of
return is 12% annually.
Pricing this bond:
a. At year 0 of the bond
b. In year 4 of the bond
P2.29. (Bond valuation)
Company B's coupon bond has a par value of 100,000 VND, refunded after 10 years
(from today), coupon interest is 8,000 VND.
a) What is the coupon rate of the bond?
b) Determine the market price of the bond, in the cases where the average interest rate
of return of investors in the market of the corresponding bond: 6%; 8%; ten%.
c) Suppose you buy this bond for 80,000 VND; If you hold the bond to maturity and the
company pays the interest and principal in full, what is your return on investment (YTM)?
(hint: find the discount rate in the pricing formula)
d) If the proceeds from the bond in question c are reinvested by you and recovered at
the time of redemption, what is the rate of return on your investment per year? Know the
reinvestment interest rate is 10% (initial purchase price is 80,000 VND). (Hint: find the
same compound interest as MIRR)
e) In your opinion, what should be the reinvested interest rate, so that the rate of return
on new investment (adjusted YTM) is equal to YTM?
P2.30. (Bond valuation)
a. A bond with par value of VND 10 million, maturing after 10 years, coupon rate: 0%.
How much would you buy the bond, if your required rate of return was 15%?
b. Government issues perpetual bonds, par value 1 million dong, coupon rate 14%,
interest is paid once a year. How much would you buy this bond, if your required rate of
return was 12%?
P2.31. (Bond valuation)
There are 2 types of bonds in your portfolio. Both have a face value of 100,000 VND, with
an annual coupon of 10,000 VND. Bond A matures in 10 years, and B will mature in 1
year. Said:
a) What is the price of each bond if the market demand for both bonds is 5%?
b) If the market interest rate rises to 10%, by what % will the price of each bond
decrease? Which bond is more sensitive to interest rate movements?
P2.32. (Bond valuation)
Hong Ha Company issues a bond with the par value of 100,000 VND; period of 10 years;
Coupon interest rate is 8%, interest is paid annually. The market price is 92,000 VND.
a. If an investor buys this bond now and holds it until maturity, what rate of return will
the investor get? >> YTM
b. If an investor buys this bond now and plans to sell it for VND98,000 in year 6, what
rate of return will the investor get? >>> YTC
c. If an investor buys this bond now and plans to sell it for VND 92000 in year 5, what
rate of return will the investor get? >>>> YTC (5 years)
P2.33. (Bond valuation)
Clifford Clark is a recent retiree who is interested in investing some of his savings in
corporate bonds. His financial planner has suggested the following bonds:
● Bond A has a 7% annual coupon, matures in 12 years, and has a $1,000 face value.
● Bond B has a 9% annual coupon, matures in 12 years, and has a $1,000 face value.
● Bond C has an 11% annual coupon, matures in 12 years, and has a $1,000 face value.
Each bond has a yield to maturity of 9%.
a. Before calculating the prices of the bonds, indicate whether each bond is trading at a
premium, at a discount, or at par.
b. Calculate the price of each of the three bonds.
c. Calculate the current yield for each of the three bonds.
d. If the yield to maturity for each bond remains at 9%, what will be the price of each
bond 1 year from now?
e. Mr. Clark is considering another bond, Bond D. It has an 8% semiannual coupon and a
$1,000 face value (i.e., it pays a $40 coupon every 6 months). Bond D is scheduled to
mature in 9 years and has a price of $1,150. It is also callable in 5 years at a call price of
$1,040.
1. What is the bond’s nominal yield to maturity?
2. What is the bond’s nominal yield to call?
3. If Mr. Clark were to purchase this bond, would he be more likely to receive the yield to
maturity or yield to call? Explain your answer.
f. Explain briefly the difference between price risk and reinvestment risk. Which of the
following bonds has the most price risk? Which has the most reinvestment risk?
● A 1-year bond with a 9% annual coupon
● A 5-year bond with a 9% annual coupon
● A 5-year bond with a zero coupon
● A 10-year bond with a 9% annual coupon
● A 10-year bond with a zero coupon
g. Only do this part if you are using a spreadsheet. Calculate the price of each bond (A,
B, and C) at the end of each year until maturity, assuming interest rates remain
constant. Create a graph showing the time path of each bond’s value.
1. What is the expected interest yield for each bond in each year?
2. What is the expected capital gains yield for each bond in each year?
3. What is the total return for each bond in each year?
P2.34. (Stock valuation)
a. A stock(cổ phiếu) has an expected annual dividend of $5,000, what is the intrinsic
value of the stock if the stock's required rate of return is 15% per year?
b. Shares of FPT company(cổ phiếu công ty FPT) have a dividend rate of last year (D0)
of: 3200 VND/share, the expected dividend growth rate in the future is 5% annually,
until forever. What is the intrinsic value of the stock? if the required rate of return on
the stock is 15% per year.
c. A stock with an expected dividend payout at the end of this year (D1) is : 5000 VND,
dividend growth rate is 4% annually until forever. What will be the market price of the
stock after 4 years? if the required rate of return in the market for the stock at that time
was 12%.
P2.35. (Stock valuation)
Shares of Bach Dang company had a dividend payment last year of (D0) 1000 VND, the
dividend growth rate of the company is expected as follows: the first 3 years: 25%
annually, the remaining years until forever 4% annually, the required rate of return in
the market is now 12%. Ask :
a) When does the rapid growth phase end?
b) What is the market price of the stock at the end of the rapid growth phase (P3)?
c) What is the current market price?
P2.36. (Stock valuation)
The common stock of company ABC has the dividend rate of the past year (D0) of VND
2,500/share. The current market price is 45,000 VND, the required market return of the
stock is currently 16%, said:
a. If the future dividend growth rate is constant forever, what is the growth rate per
year?
b. If in the next 10 years the dividend is still 2,500 VND/share, then the new dividend
grows at a constant rate, then what is the growth rate of % annually?
P2.37. (Stock valuation)
a. CADIVI Company is expected to pay dividends for the next 2 years with equal
payments (trả hai năm với mức trả bằng nhau), then the dividend will grow at a
rate of 10% annually for the next 2 years, from the 5th year the growth rate will be
stable at 5% annually until forever. With a required rate of return of 14%, the intrinsic
value of the stock is VND35,000. What is the expected dividend for the next 2 years?
COI SÁCH TRANG 96
b. Last year and expected for many years to come, company A's ROE was 15%, retained
earnings ratio (TỶ LỆ LỢI NHUẬN GIỮ LẠI) was 40%, and the dividend is expected to be
distributed at the end of this year at 2,000 VND/share. What is the intrinsic value of a
company's common stock? Assume the stock's required rate of return is currently 12%.
CHAPTER 3. RISK AND RETURN
KEY TERMS Define each of the following terms using graphs or equations to illustrate
your answers whenever feasible:
a. Risk; stand-alone risk; probability distribution
b. Expected rate of return E(R)
c. Standard deviation, coefficient of variation (CV); Sharpe ratio.
d. Risk aversion; risk premium (RP); realized rate of return
e. Risk premium for Stock i, RPi; market risk premium, RPM
f. Expected return on a portfolio; market portfolio
g. Correlation; correlation coefficient
h. Market risk; diversifiable risk; relevant risk
i. Capital asset pricing model (CAPM)
j. Beta coefficient
QUESTIONS
3.1. Differentiate between a stock’s expected rate of return E(R), required rate of return,
and realized, after-the-fact historical return ( R ). Which would have to be larger to induce
you to buy the stock? At a given point in time, would the rates mentioned earlier
typically be the same or different? Explain.
3.2. Suppose you owned a portfolio consisting of $250,000 of long-term U.S. government
bonds.
a. Would your portfolio be riskless? Explain.
b. Now suppose the portfolio consists of $250,000 of 30-day Treasury bills. Every 30 days
your bills mature, and you will reinvest the principal ($250,000) in a new batch of bills.
You plan to live on the investment income from your portfolio, and you want to maintain
a constant standard of living. Is the T-bill portfolio truly riskless? Explain.
c. What is the least risky security you can think of? Explain.
3.3. What does correlation coefficient mean?
3.4. Is the following statement true or false? Explaining your choices.
a. The covariance ranges from -1 to 1.
b. Adding any security to a portfolio can reduce the risk of the entire portfolio.
c. The correlation coefficient ranges from -1 to 1.
3.5. You have 2 portfolios: Portfolio (A) consists of 2 securities with a correlation
coefficient close to 1; and portfolio (B) consists of 2 securities with negative correlation
coefficient (close to -1). How are the graphs (representing risk and return) of these two
portfolios different?
3.6. In the CAPM model:
a. What is the beta coefficient (β)? Give the formula for calculating this coefficient and its
meaning. If a company’s beta were to double, would its required return also double?
b. Showing the differences between market risk premium (RP m) and Risk premium for a
Stock.
c. When are the two risk premiums mentioned above (in question b) equal?
PROBLEMS
P3.1. (Return rate)
At time t0, t1, t2, t3 the price of stock A is 100; 140; 175; 100 USD). Ignoring dividends,
calculate:
a. The rate of return for each period of stock A
b. Average and average return on stock A.
P3.2. (Return rate)
An investor buys stock A for 2 years. The first year he lost 5%. What is the 2nd year rate
of return, so that:
a. Average rate of return per year is 12%
b. Overall rate of return for 2 years is 20%
c. This investor breaks even.
P3.3. (Return rate )
There are two investments with the following information:

Purchase Coefficient
Securities selling price dividend
price β

A 15000 15500 1000 1.5

B 40000 55000 4000 1.9

Risk-free rate of return: 4%

Rate of return on market portfolio: 12.5%
a. Determine expected return and practical return of stocks.
b. How will investors decide?

P3.4. (Return rate)

An investor has the following information:
 Expected rate of Current market price of a stock
Securities Beta return

X 1,25 13,88% 25.000 VND

Y 0,86 ? 20.000 VND

If the stocks are priced correctly and the CAPM is appropriate, help the CFO determine:
a. Market risk premium, Risk premium and expected return on stock Y; (the risk-free rate
is 7%).
b. The fair value of stock X if the dividend per share in year 1 is 2,200 dong, year 2 is
2,400 dong and then grows at a steady rate of 6% per year forever. Is this stock
overvalued or undervalued? Why?
c. The return on a portfolio consisting of 2 million shares of X and 5 million shares of Y.
P3.4. (Realized rates of return)
Stocks A and B have the following historical returns:

Year Stock A’s Returns Stock B’s Returns

RA RB

2016 (24.25%) 5.50%

2017 18.50 26.73

2018 38.67 48.25

2019 14.33 (4.50)

2020 39.13 43.86

a. Calculate the average rate of return for each stock during the period 2016 through
2020. Assume that someone held a portfolio consisting of 50% of Stock A and 50% of
Stock B. What would the realized rate of return on the portfolio have been in each year
from 2016 through 2020? What would the average return on the portfolio have been
during that period?
b. Calculate the standard deviation of returns for each stock and for the portfolio.
c. Assume the risk-free rate during this time was 3.5%. What are the Sharpe ratios for
Stocks A and B and the portfolio over this time period using their average returns?
d. Looking at the annual returns on the two stocks, would you guess that the correlation
coefficient between the two stocks is closer to 10.8 or to 20.8?
e. If more randomly selected stocks had been included in the portfolio, which of the
following is the most accurate statement of what would have happened to σ p?
1. σ p would have remained constant.
2. σ p would have been in the vicinity of 20%.
3. σ p would have declined to zero if enough stocks had been included.
P3.5. (Challenging Problem)
An investor is considering the following two securities: chứng khoán
Security A is a coupon bond (trái phiếu coupon) , par value is 100,000 VND, coupon
interest rate is 9% annually, remaining period of this bond is 5 years. At the moment,
this bond is trading(giá giao dịch) at VND 95,000.
Securities B is a company stock, has a cash dividend of 5,000 dong at the end of the
year and is expected to remain unchanged over the years until forever, the current
market price is 35,500 dong, the expected price sold after 5 years is 48000 VND.
a. Suppose the above two securities are issued by the same company; without
calculation, which securities to invest in will have lower risk and which security's risk
premium is higher?
b. If the investor decides to invest in a combination of these two securities at the
moment, what is the annual rate of return he can achieve? Given that the weights of two
securities A and B are 40% and 60% respectively.
c. If the investor requires a return of 16% annually, should the investor invest in the
above portfolio or not? If not, how should the weighting of each security in the portfolio
be adjusted?
Comprehensive/Spreadsheet Problem
P3.5. (Evaluating risk and return)
Bartman Industries’s and Reynolds Inc.’s stock prices and dividends, along with the
Winslow 5000 Index, are shown here for the period 2012– 2017. The Winslow 5000 data
are adjusted to include dividends.

Year Bartman Industries Reynolds Inc. Winslow 5000

Stock Price Dividend Stock Price Dividend Includes

Dividends

2021 $17.25 $1.15 $48.75 $3.00 $11,663.98

2020 14.75 1.06 52.30 2.90 8,785.70

2019 16.50 1.00 48.75 2.75 8,679.98

2018 10.75 0.95 57.25 2.50 6,434.03

 2017 11.37 0.90 60.00 2.25 5,602.28

2016 7.62 0.85 55.75 2.00 4,705.97

a. Use the data to calculate annual rates of return for Bartman, Reynolds, and the
Winslow 5000 Index. Then calculate each entity’s average return over the 5-year period.
(Hint: Remember, returns are calculated by subtracting the beginning price from the
ending price to get the capital gain or loss, adding the dividend to the capital gain or
loss, and dividing the result by the beginning price. Assume that dividends are already
included in the index. Also, you cannot calculate the rate of return for 2016 because you
do not have 2015 data.)
b. Calculate the standard deviations of the returns for Bartman, Reynolds, and the
Winslow 5000. (Hint: Use the sample standard deviation formula)
c. Calculate the coefficients of variation for Bartman, Reynolds, and the Winslow 5000.
d. Assume the risk-free rate during this time was 3%. Calculate the Sharpe ratios for
Bartram, Reynolds, and the Index over this period using their average returns.
e. Construct a scatter diagram that shows Bartman’s and Reynolds’s returns on the
vertical axis and the Winslow 5000 Index’s returns on the horizontal axis.
f. Estimate Bartman’s and Reynolds’s betas by running regressions of their returns
against the index’s returns. Are these betas consistent with your graph?
g. Assume that the risk-free rate on long-term Treasury bonds is 4.5%. Assume also that
the average annual return on the Winslow 5000 is not a good estimate of the market’s
required return—it is too high. So use 10% as the expected return on the market. Use
the SML equation to calculate the two companies’ required returns.
h. If you formed a portfolio that consisted of 50% Bartman and 50% Reynolds, what
would the portfolio’s beta and required return be?
i. Suppose an investor wants to include Bartman Industries’s stock in his portfolio. Stocks
A, B, and C are currently in the portfolio, and their betas are 0.769, 0.985, and 1.423,
respectively. Calculate the new portfolio’s required return if it consists of 25% of
Bartman, 15% of Stock A, 40% of Stock B, and 20% of Stock C.
CHAPTER 4. COST OF USING CAPITAL
KEY TERMS - Define each of the following terms:
a. Target capital structure; capital components
b. Before-tax cost of debt, rd; after-tax cost of debt, rd (1 - t)
c. Cost of preferred stock, rp
d. Cost of retained earnings, rre; cost of new common stock, rne
e. Weighted average cost of capital, WACC
f. Flotation cost, F; flotation cost adjustment; retained earnings breakpoint
QUESTION
4.1. Explain why the statement “The cost of equity is often higher than the cost of debt”.
4.2. What is the after-tax cost of debt? Why consider this cost?
4.3. Is the cost of debt due to the bond issue higher or lower than the investor's required
rate of return on the Bonds?
4.4. What is the release cost? Why is there an issue cost when issuing a new bond or
stock? If the issuer incurs this cost, how will the cost of the acquired capital compare to
the investor's desired rate of return?
4.5. Explain the concept of the average cost of capital (WACC) and its meaning.
4.6. How would each of the following scenarios affect a firm’s cost of debt, r d(1 - t); its
cost of equity, re; and its WACC? Indicate with a plus (1), a minus (2), or a zero (0)
whether the factor would raise, lower, or have an indeterminate effect on the item in
question. Assume for each answer that other things are held constant, even though in
some instances this would probably not be true. Be prepared to justify your answer but
recognize that several of the parts have no single correct answer. These questions are
designed to stimulate thought and discussion.

Effect on

rd(1 - rs WACC
t)

a. The corporate tax rate is lowered.

b. The Federal Reserve tightens credit.

c. The firm uses more debt; that is, it increases its debt
ratio.

d. The dividend payout ratio is increased.

 e. The firm doubles the amount of capital it raises during
the year.

f. The firm expands into a risky new area.

g. The firm merges with another firm whose earnings are

countercyclical both to those of the first firm and to the
stock market.

h. The stock market falls drastically, and the firm’s stock

price falls along with the rest.

i. Investors become more risk-averse

j. The firm is an electric utility with a large investment in

nuclear plants. Several states are considering a ban on
nuclear power generation.

PROBLEMS
P4.1. (Cost of debt)
Company ABC issues a par value of 1 million VND, term of 5 years, coupon rate 10%
annually, annual interest payment. Issuing price 0.98 million VND/bond.
Calculating the cost of debt due to bond issuance in 2 cases:
P4.2. (Cost of debt)
Enterprise C needs to raise an additional VND 500 billion to invest in new projects, the
enterprise decides to issue bonds. Bonds have a par value of VND 100,000, tenor of 10
years, coupon rate of 10%, interest paid once a year. The company's CFO predicts the
average expected rate of return of investors in the bond market at the time of issue is 10
percent, the bond's pre-tax cost of debt is 10.5%, indicates that if the chief financial
officer's prediction is correct then:
a. What is the issue price of a bond?
b. What is the issue cost and net issue price of a bond?
c. How many bonds must the business issue to get the required amount of capital?
d. What is the after-tax cost of debt of the bond? The income tax rate is 20%.
P4.3. (Cost of equity )
a. Determine the cost of using preferred equity of company ABC; Knowing that ABC
issues 10 million shares at the price of 12000 VND/share and is expected to pay a
dividend of 2000 VND annually, the cost of stock issuance is 1%/issue price.
b. Determine the cost of common stock outstanding for ABC Company; know that ABC
plans to pay a dividend of 4000 VND/share; The annual dividend growth rate is about 3%
annually; The current market price of shares is 25000 VND.
c. Determine ABC's cost of common stock; know the following information: Treasury
bond interest rate is 10% annually; coefficient β = 1.5; market risk premium = 5%.
d. Determine the cost of common equity (newly issued) of company ABC; know that ABC
has just paid a dividend of 4500 VND/share, the annual dividend growth rate is about 4%
annually; the selling price of newly issued shares is 25000 VND; Issuing cost is 2%/share
selling price.
P4.4. (Cost of equity)
Company A's shares have the following information: last year's dividend of VND 4500,
outstanding price of VND 48,000. Calculate the usage cost of this funding in the following
scenarios:
a. The growth rate in the next year g1 = 10%, the following years will increase steadily
at a rate of g2 = 4%.
b. During 5 years (2011-2016), the company's dividend increased from 3500 VND to
4500 VND. It is expected that this growth rate will be maintained forever.
c. Return on equity (ROE) = 16%, retained earnings ratio 40%. Stable growth rate for
many years to come.
4.5. (WACC and cost of common equity)
Kahn Inc. has a target capital structure of 60% common equity and 40% debt (according
to book value) to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a
WACC of 13%, a before-tax cost of debt of 10%, and a tax rate of 40%. The company’s
retained earnings are adequate to provide the common equity portion of its capital
budget. Its expected dividend next year (D1) is $3, and the current stock price is $35.
a. What is the company’s expected growth rate?
b. If the firm’s net income is expected to be $1.1 billion, what portion of its net income is
the firm expected to pay out as dividends?
P4.6. (WACC) 4.5
In 2011, ABC company had the following financial structure:

Source Amount Cost of capital

(billion)

Bank loan 100 9%

Bonds 600 10%

Determine the Preferred shares 50 13% company's
average cost of capital, knowing
Common shares 850 15%
that the cost of debt is the pre-
tax, the corporate tax rate is 20%.
P4.7. (WMCC)4.6
A company has the following (unchanged) financial structure:

Source of funding Proportion Cost of component capital (after tax)

Long-term debt 40% 5.6%

Common shares 60% 13.0%

Total 100%

The company has a retained earnings of VND720 billion, rre=13%, beyond this the
company must use additional funding by newly issued common shares to be able to
maintain its capital structure at r. =16%.
In addition, the company can borrow a maximum of VND 400 billion with rD* of 5.6%
respectively, beyond this level, rD* will increase to 8.4%.
Request:
a. Determine the break points, from which, corresponding to each capital size, determine
the average cost of capital (WACC).
b. Graph and show the marginal cost of capital.
What opportunities should the company invest in?
P4.8. (WMCC)4.7
A company has the following (unchanged) financial structure:

Cost of component capital

Source of funding Proportion
(after tax)

Nợ vay dài hạn 40% 6%

Cổ phiếu ưu đãi 10% 10%

Cổ phần thường 50% 13.0%

Tổng cộng 100%

The company has a retained earnings of VND700 billion, rre=13%, beyond this the
company must use additional funding by newly issued common shares to be able to
maintain its capital structure at r. =16%.
In addition, the company can borrow up to 300 billion VND with rD* of 6% respectively,
beyond this level, rD* will increase to 8.4%.
Request:
a. Determine the break points, from which, corresponding to each capital size, determine
the average cost of capital (WACC).
b. Graph and show the marginal cost of capital.
c. The following investment opportunities are available:

Investment capital (billion

Opportunities IRR (%)
VND)

A 18.0 200

B 17.5 300

C 17.0 400

D 16.0 400

E 15.0 300

F 13.0 400

G 11.0 100

What opportunities should the company invest in?

P4.9. (WACC ) 4.8
a. The project's cost of capital (WACC) is 16%. The after-tax cost of debt is 10% and
(D/V) = 45%. So what is the cost of equity?
b. The project's cost of capital (WACC) is 16%. The cost of equity is 20%. Know (E/V) =
60%. So how much can you borrow at a pre-tax price? The corporate income tax rate is
20%.
c. The project's cost of capital (WACC) is 16%. Know that the after-tax cost of debt is
10% and the cost of equity is 25%. What is the capital structure of the company?
P4.10. (Challenging Problem)4.9
Enterprise AD uses only debt and common equity.
The proportion of debt in the target capital structure is 45%, enterprises can borrow
unlimitedly at the interest rate of 10%.
Last year's dividend was 2,000 VND/share, expected dividend growth rate of 4%
annually, current market price of 20,000/share, income tax rate of 20%.
The enterprise is appraising 2 investment projects: project A has an IRR of 13%, project
B is 10%, and 2 projects have a level of risk equal to the risk of the enterprise's existing
assets.
Indicate:
a. What is the cost of common equity? Know that additional common equity is raised
from retained earnings.
b. What is the average cost of capital (WACC) for the business?
c. Should enterprises approve the investment in these two projects?
P4.11. (Challenging Problem)4.10
White Company uses retained earnings and bond issuance to invest 35 billion dong in a
project. Project with net cash flow (Unit: billion VND):

Time 1 2 3 4 5

NCF 12 10 25 15 10

The stock's risk-free rate is expected to be 8%, the stock's beta is 1.2, and the stock's
(system) risk premium is 8%.=(Rm-Rf)*b
- Bonds issued with par value of VND 10 million, tenor of 10 years, coupon rate of 8%,
annual interest payment, expected net issuance price of VND 8.5 million.
- The corporate and project income tax rate is 20%.
Define:
a. The pre-tax and after-tax cost of debt of the bond.
b. Market risk premium and cost of retained earnings.
c. The average cost of capital of the project (WACC), knowing the target capital structure
includes: long-term debt 40%, common stock 60%.
d. Calculate the project's NPV and IRR. Should the company implement the project or
not?
Comprehensive Problem
4.12. (Calculating the WACC)
Here is the condensed 2018 balance sheet for Skye Computer
Company (in thousands of dollars):
2018
Current assets $2,000
Net fixed assets 3,000
Total assets $5,000
Accounts payable and accruals $ 900
Short-term debt 100
Long-term debt 1,100
Preferred stock (10,000 shares) 250
Common stock (50,000 shares) 1,300
Retained earnings 1,350
Total common equity $2,650
Total liabilities and equity $5,000
Skye’s earnings per share last year were $3.20. The common stock sells for $55.00, last
year’s dividend (D0) was $2.10, and a flotation cost of 10% would be required to sell new
common stock. Security analysts are projecting that the common dividend will grow at
an annual rate of 9%. Skye’s preferred stock pays a dividend of $3.30 per share, and its
preferred stock sells for $30.00 per share. The firm’s before-tax cost of debt is 10%, and
its marginal tax rate is 35%. The firm’s currently outstanding 10% annual coupon rate,
long-term debt sells at par value. The market risk premium is 5%, the risk-free rate is
6%, and Skye’s beta is 1.516. The firm’s total debt, which is the sum of the company’s
short-term debt and long-term debt, equals $1.2 million.
a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the
cost of preferred stock, the cost of equity from retained earnings, and the cost of newly
issued common stock. Use the DCF method to find the cost of common equity.
b. Now calculate the cost of common equity from retained earnings, using the CAPM
method.
c. What is the cost of new common stock based on the CAPM?
d. If Skye continues to use the same market-value capital structure, what is the firm’s
WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so
rapidly that it must issue new common stock?
CHAPTER 5. FINANCIAL LEVERAGE
QUESTION
5.1. Why is the rate of change (increase/decrease) of EPS higher than that of EBIT when
the company uses debt and preferred equity?
What happens if the company uses only common stock?
5.2. Why is EBIT generally considered independent of financial leverage? Why might EBIT
actually be affected by financial leverage at high debt levels?
Is the debt level that maximizes a firm’s expected EPS the same as the debt level that
maximizes its stock price? Explain.
5.3. If a firm goes from zero debt to successively higher levels of debt, why would you
expect its stock price to rise first, then hit a peak, and then begin to decline?
5.4. Which of the following would likely encourage a firm to increase the debt in its
capital structure?
a. The corporate tax rate increases.
b. The personal tax rate increases.
c. Due to market changes, the firm’s assets become less liquid.
d. Changes in the bankruptcy code make bankruptcy less costly to the firm.
e. The firm’s sales and earnings become more volatile.
PROBLEMS
P5.1. (Financial leverage effects)
The Neal Company wants to estimate next year’s return on equity (ROE) under different
financial leverage ratios. Neal’s total capital is $14 million, it currently uses only common
equity, it has no future plans to use preferred stock in its capital structure, and its
federal-plus-state tax rate is 40%. The CFO has estimated next year’s EBIT for three
possible states of the world: $4.2 million with a 0.2 probability, $2.8 million with a 0.5
probability, and $700,000 with a 0.3 probability. Calculate Neal’s expected ROE,
standard deviation, and coefficient of variation for each of the following debt-to-capital
ratios; then evaluate the results:
Debt/Capital Ratio Interest Rate
0% —
10 9%
50 11
60 14
P5.3. (Financial leverage)
The company has the following criteria:

Options

Issuing common Borrowing (Issuing

stock Bonds)

EBIT 1000 1000

I 0 200

Tax 200 160

EAT 800 640

Number of Shares 100 75

EPS (earning per share) 8 8.53

If EBIT of each option increases by 10%, by how much does the EPS of each alternative
increase? Determine the growth rate of EPS. From there determine the financial leverage
of each option.
P5.4. (Financial leverage)
Two companies A and B are similar in all respects except for their use of leverage:
Company A. Total assets of 20,000 billion VND, fully financed by equity, outstanding
number of shares 200 million shares
Company B. Total assets of VND 20,000 billion, financed by debt (40%) with an interest
rate of 8%, by equity (60%), outstanding shares of 120 million shares.
The current EBIT of both companies is: 1,600 billion VND, income tax rate of 20%.
Assuming current levels, the EBITs of both companies are down 10%. How much %
decrease in EAT, ROE, and EPS of each company? How many times more is the EPS
reduction rate than the EBIT reduction rate?
P5.5. (Challenging Problem)
Company ABC, with business capital: 100 billion. Currently, all business capital is
obtained from the issuance of common shares, par value of 10,000 VND/share. TAX rate:
20%
To expand production and business activities, ABC company needs a new investment
capital of 20 billion. The company is considering 2 capital raising options: (1)Issuing
more common shares at the selling price of 10,000 VND/share or (2) Borrowing at 14%
interest rate (2).
a. If the company's current EBIT is 16 billion, calculate its current EPS.
b. If the business expansion plan is successful, EBIT is expected to reach 20 billion.
Calculate EPS for each capital raising plan.
c. Determine the EBIT at which the two EPSs of the two alternatives are equal.
P5.6. (Challenging Problem)
Company B specializes in the production and consumption of one type of product,
business results in 2019 are as follows (Unit: million VND)

Y 2019

Net Revenue 260.000

Total variable cost 104.000
Total fixed cost 120.000
Operating profit 36.000
Interest (I) 16.000
Profit before tax 20.000
Income tax payable 5.000
Profit after tax 15.000

Request:
a. Determine break-even revenue. Indicate what percentage (%) of the decrease in sales
and the rate of decrease (%) will the new company lose (EBIT < 0).
b. Determine the leverage of the levers and state their economic significance.
c. Assuming that next year (2020), sales revenue increases by 15% compared to current
sales, what will be the company's profit after tax?
d. To achieve a profit after tax of 16,992 million, what should be the next year's sales
revenue?
P5.7. (Challenging Problem)
There are figures on output and profit at an enterprise given in the following table:

EBIT (VND million) EAT (VND million)

Q

10000 4000 1440

12000 6000 2880
14000 8000 4320

Request:
a. Determine the inclination of the balance bars at the output level of 12000 pieces
(DOL, DFL, DTL)
b. At a production level of 12,000 units, if production increases by 12%, what will be the
operating profit and after-tax profit?
c. Determine fixed costs and interest payable
d. Determine the breakeven output
e. To achieve operating profit of 7200 million enterprises, how many products must be
produced and sold?
f. Determine the level of output at which net profit is zero
CHAPTER 6. THE THEORY OF CAPITAL STRUCTURE
QUESTION
6.1. Explain the principle of valuing a company using the discounted cash flow method.
From there, build a pricing formula.
6.2. “Company value does not depend on capital structure”. What theory is this about?
6.3. Present the content of the firm value of the M&M theory of taxed environment
(referred to as M&M with tax). From this, show how the cost of capital of the leveraged
firm (company L) is related to the cost of equity of the unlevered firm (U company).
6.4. Does pecking order theory make the claim of “negative or affirming the existence of
an optimal capital structure” like other theories?
6.5. According to pecking order theory, what sources of external capital include? Explain
the prioritization of funds according to this theory.
6.6. Is the following statement true or false, explain?
a. M&M assumes a perfect financial environment and no corporate taxes.
b. M&M has taxes, clause I says that the company with debt will have a higher EPS.
c. M&M has taxes, clause II says that the cost of equity will increase with increasing debt
and the debt ratio (D/V) will increase accordingly.
d. The trade-off theory holds that increased borrowing will not increase the risks and
costs of financial distress.
e. The pecking order theory does not make any statements about the "negative or
positive existence of an optimal capital structure".
d. Tax-free M&M uses arbitrage to explain that the value of the company does not
change when the capital structure changes.
6.7. Bankruptcy and Corporate Ethics
a. As mentioned in the text, some firms have filed for bankruptcy because of actual or
likely litigation-related losses. Is this a proper use of the bankruptcy process?
b. Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate
terms. Critics argue that in such cases, the firm is using bankruptcy laws “as a sword
rather than a shield.” Is this an ethical tactic?
c. As mentioned in the text, Continental Airlines filed for bankruptcy, at least in part, as a
means of reducing labor costs. Whether this move was ethical, or proper, was hotly
debated. Give both sides of the argument.
PROBLEMS
P6.1. (WACC and optimal capital structure)
Elliott Athletics is trying to determine its optimal capital structure, which now consists of
only debt and common equity. The firm does not currently use preferred stock in its
capital structure, and it does not plan to do so in the future. Its treasury staff has
consulted with investment bankers. On the basis of those discussions, the staff has
created the following table showing the firm’s debt cost at different debt levels:
Debt-to-Capital Equity-to Capital Debt-to-Equity Bond Rating Before-Tax
Ratio (wd) Ratio (wc) Ratio (D/E) Cost of Debt (rd)
0.0 1.0 0.00 A 7.0%
0.2 0.8 0.25 BBB 8.0
0.4 0.6 0.67 BB 10.0
0.6 0.4 1.50 C 12.0
0.8 0.2 4.00 D 15.0

Elliott uses the CAPM to estimate its cost of common equity, r e, and estimates that the
risk-free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott
estimates that if it had no debt, its “unlevered” beta, b U, would be 1.2.
a. What is the firm’s optimal capital structure, and what would be its WACC at the
optimal capital structure?
b. If Elliott’s managers anticipate that the company’s business risk will increase in the
future, what effect would this likely have on the firm’s target capital structure?
c. If Congress were to dramatically increase the corporate tax rate, what effect would
this likely have on Elliott’s target capital structure?
d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1)
the debt/capital ratio and (2) the debt/equity ratio.
P6.2. (M&M with tax)6.1
The two companies are similar in every way except for the level of debt usage. Expected
EBIT is 220 billion VND annually until forever, TAX rate: 20%. Company U does not use
financial leverage, the cost of equity r0 = 16%. Company L uses 600 billion VND of debt,
with interest rate rD = 10%.
Request:
a/ Determine the value of 2 companies.
b) Determine company L's cost of equity and from there determine company L's WACC.
c/ Determine the value of equity and value of company L in another way and check it
against a.
P6.3. (M&M without tax)6.2
Company XYZ currently does not use debt, EBIT is expected to remain at VND 620 billion
annually, the number of common shares outstanding is 200 million shares, the
company's cost of capital is 15%.
Company XYZ is studying to invest in upgrading machinery and equipment with an initial
investment of VND 500 billion, which contributes to an annual increase of EBIT of VND
130 billion. Assuming the investment project to upgrade machinery and equipment has
the same risk as the company's current risk level, the company is exempt from tax and
has no bankruptcy costs.
a. Determine the value of company XYZ, the value of equity, the value of each share
before investing in upgrading machinery and equipment.
b. To finance the investment project to upgrade the above mentioned machinery and
equipment, the company is considering two funding options as follows:
Option 1: Issuing common shares
Option 2: Issue bonds with coupon rate of 13%
Determine the company value and the value per share after implementing the above
project.
c. Determine the company's cost of equity in the case of the bond issue mentioned
in b in two different ways.
P6.4. (M&M with tax)6.3
Currently, XNX company has 3 million common shares outstanding, with a market price
of 38,000/share and 30 billion in debt (company L). The company has achieved ROE of
20%, the rate of retained earnings is 30%, the company has just paid a dividend of
4,000/share with the TAX rate of 20%.
a. What is the market value of this company?
b. Under M&M with taxes, if the company has no debt, what is the value of the company?
What is the cost of equity then (company U)? know that the company borrows at a cost
of 10% per year.
c. If this company wants to borrow another 10 billion dong of debt to buy back shares,
how much will the value of the company increase compared to the present? What is the
current cost of equity and average cost of capital (using taxed M&M theory)
d. Assuming the company can only borrow up to a certain level (Optimal debt ratio),
beyond this level the value of the business will decrease because the cost of financial
stress increases. Given that at that level, the present value of the cost of financial stress
is 8.6 billion. Applying the Trade-off theory to determine the capital structure of the
business at this point.
P6.4. (M&M without tax)
Firms X and Y are similar in all respects except capital structure. X does not use debt, Y
uses VND 500 billion of debt (market value) with a cost of debt of 10%.
Both have EBIT of VND 200 billion annually, company X's cost of equity is 15%. Define:
a. The value of company X and Y.
b. Company Y's cost of equity comes in two different ways.
c. WACC of 2 companies
d. Redefine the value of company Y and compare with the results in a.
e. If the value of Y is higher than X, what will happen under the tax-free M&M.
P6.5. (M&M with tax)
Company L has the following information:
- Debt at market value: VND 1750 billion, cost of debt is 8%
- Equity at market value is VND 2250 billion, required rate of return of owners is 16%.
Request:
a. Determine the company's WACC. What is the owner's required rate of return when the
firm does not use debt?
b. EBIT is determined in two ways: based on the WACC of company L and based on the
cost of equity when the company does not use debt.
c. The company plans to adjust its capital structure: borrow another 500 billion and use
this money to reduce equity by buying back outstanding shares. Redefine the value of
the company, debt ratio, WACC, cost of equity.
d. The company plans to adjust its capital structure: using equity to reduce debt by 500
billion. Redefine the value of the company, debt ratio, WACC, cost of equity.