Solutions to Lectures on Corporate Finance, Second Edition

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Solutions to Lectures on Corporate Finance, Second Edition
Peter Bossaerts and Bernt Arne Ødegaard 2006

LECTURES ON CORPORATE FINANCE - (Second Edition) © World Scientific Publishing Co. Pte. Ltd. http://www.worldscibooks.com/economics/6188.html

Contents
1 Finance 2 Axioms of modern corporate finance 3 On Value Additivity 4 On the Efficient Markets Hypothesis 5 Present Value 6 Capital Budgeting 7 Valuation Under Uncertainty: The CAPM 8 Valuing Risky Cash Flows 9 Introduction to derivatives. 10 Pricing Derivatives 11 Pricing of Multiperiod, Risky Investments 12 Where To Get State Price Probabilities? 13 Warrants 14 The Dynamic Hedge Argument 15 Multiple Periods in the Binomial Option Pricing Model 16 An Application: Pricing Corporate Bonds 17 Are capital structure decisions relevant? 18 Maybe capital structure affects firm value after all? 19 Valuation Of Projects Financed Partly With Debt 20 And What About Dividends? 21 Risk And Incentive Management 1 2 3 4 6 14 21 25 28 34 36 39 40 42 49 55 60 64 68 70 73

LECTURES ON CORPORATE FINANCE - (Second Edition) © World Scientific Publishing Co. Pte. Ltd. http://www.worldscibooks.com/economics/6188.html

Finance

1

Chapter 1

Finance

LECTURES ON CORPORATE FINANCE - (Second Edition) © World Scientific Publishing Co. Pte. Ltd. http://www.worldscibooks.com/economics/6188.html

2

Axioms of modern corporate finance

Chapter 2

Axioms of modern corporate finance

LECTURES ON CORPORATE FINANCE - (Second Edition) © World Scientific Publishing Co. Pte. Ltd. http://www.worldscibooks.com/economics/6188.html

On Value Additivity

3

Chapter 3

On Value Additivity
Problems
3.1 Ketchup [2] As an empirical investigation, check your local supermarket. Does 2 ketchup bottles of 0.5 litres cost the same as one ketchup bottle of 1 liter? What does this tell you about value additivity in financial markets? 3.2 Milk [2] Why is skimmed milk always cheaper than regular milk even if it is healthier?

Solutions
3.1 Ketchup [2] 3.2 Milk [2]

LECTURES ON CORPORATE FINANCE - (Second Edition) © World Scientific Publishing Co. Pte. Ltd. http://www.worldscibooks.com/economics/6188.html

4

On the Efficient Markets Hypothesis

Chapter 4

On the Efficient Markets Hypothesis
Problems
4.1 Interest Rates [2] Consider the following statement. Long term interest rates are at record highs. Most companies therefore find it cheaper to finance with common stock or relatively inexpensive short-term bank loans. What does the Efficient Market Hypothesis have to say about the correctness of this? 4.2 Semistrong [3] Can you expect to earn excess returns if you make trades based on your broker’s information about record earnings for a stock, rumors about a merger of a firm, or yesterday’s announcement of a successful test of a new product, if the market is semi-strong form efficient? 4.3 UPS [3] On 1/10/85, the following announcement was made: “Early today the Justice Department reached a decision in the UPC case. UPC has been found guilty of discriminatory practices in hiring. For the next five years, UPC must pay $2 million each year to a fund representing victims of UPC policies.” Should investors not buy UPC stock after the announcement because the litigation will cause an abnormally low rate of return over the next five years? 4.4 Management [3] Your broker claims that well–managed firms are not necessarily more profitable investment opportunities than firms with an average management. She cites an empirical study where 17 well–managed firms and a control group of 17 average firms were followed for 8 years after the former were reported in the press to be “excelling” as far as management is concerned. Is this evidence that the stock market does not recognize good management? 4.5 TTC [3] TTC has released this quarter’s earning report. It states that it changed how it accounts for inventory. The change does not change taxes, but the resulting earnings are 20% higher than what it would...
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