Eastern Illinois University
Critical Thinking Questions
1) An article in the December 5, 2011 edition of the Wall Street Journal discussed the decision by the band
Metallica to tour Europe in 2012 instead of a planned tour in 2013. What does this indicate the band believes is
going to happen to the value of the euro versus the U.S. dollar?
2) An article in the December 1, 2011 edition of the Wall Street Journal indicated the major topic of discussion at
the Tokyo Motor Show was the value of the Japanese yen calling it “the biggest headache for the Japanese
auto industry today”. Would the Japanese auto executives prefer to see the yen increase or decrease in
3) “Advisers Worry Younger Clients Are Playing It Too Safe” was the headline in the June 20, 2011 edition of the
Wall Street Journal . The article discussed many young investors were “opting for safe investments, such as
certificates of deposit and savings accounts”. Where will these younger clients spend their retirement years?
4) Why would firms desiring to grow choose the corporate form of organization?
5) On December 5, 2002, bonds issued by Lucent Technologies that mature in 2028 had a yield to maturity of
13.9% while bonds issued by Bausch & Lomb that also mature in 2028 had a yield to maturity of 8.3%. What
does this information tell you about the required rate of return for the stocks of these two companies?
6) Should bright finance students invest in efficient or inefficient markets? Explain why.
7) Should bright music students invest in efficient or inefficient markets? Explain why.
8) Vanguard is one of the largest managers of mutual funds in the United States. During the first nine months of
2002, individuals invested over $34 billion in Vanguard’s mutual funds, more than any other mutual fund. In
the November 25, 2002 edition of Business Week, Vanguard indicated the company’s mutual fund shareholders
had invested over two-thirds of their funds into bonds during 2002. In the same article, Vanguard indicated
they had surveyed their investors and over 70% of them did not know what would happen to the price of
bonds if interest rates increase. Your observations on the asset allocation strategy of these investors.
9) No See Lite, age 64, has an investment portfolio composed of the following assets:
Stock Percent of portfolio Beta Yield to Maturity
Southwest Airlines 50% 1.4
American Airlines 45% 1.7
Continental Airlines bonds 2% 9.5%
Treasury bills 3% 1.2%
What are the two most important observations you have regarding his investment portfolio?
10) No C. Picture, age 24, has an investment portfolio composed of the following assets:
Stock Beta Expected Return
Southwest Airlines 1.5 20.0%
Treasury bills 2.0%
If Mr. Picture wanted to construct a $50,000 portfolio with a beta of .9 and an expected return of 12.8%, how much
should he invest in each of the assets?
11) Which of the following sources of capital would have the highest cost to the firm: issuing new bonds, retained
earnings, issuing preferred stock, issuing common stock? Explain why.
12) Chucktown Chops has the following capital structure with these required rates of return. Calculate the WACC
for Chucktown Chops assuming the company has a 30% tax rate.
Percent Before-tax cost
Common stock 65% 20.0%
Preferred stock 15% 14.0%
Debt 20% 10.0%
13) Explain what would happen to the value of the firm if the firm’s WACC (weighted average cost of capital) is
decreased from 11.3% to 10.5%.
14) Should a firm borrow money to maintain its dividend when earnings decrease temporarily? Explain why or why
15) Chucktown Chops is evaluating the acquisition of a pickle factory. The factory has a cost of $500,000. I.B.
Dense, the company’s chief financial officer, has calculated the project has an IRR of 3%, an NPV of $974,500
and a payback period of 22.64 years. Discuss two observations you have regarding Mr. Dense’s calculations.
16) Chucktown Chops is evaluating the issuance of additional common stock. I.B. Dense, the company’s chief
financial officer, has calculated cost of preferred stock to be 8.9%, the cost of retained earnings to be 14.2%,
the after-tax cost of debt to be 16.3% and the cost of issuing additional stock to be 7.9%. Discuss two
observations you have regarding Mr. Dense’s calculations.
17) If inflation increases from a 2% annual rate to a 4% annual rate, what will be the impact on the price of
18) If inflation increases from a 2% annual rate to a 4% annual rate, what will be the impact on the price of
19) On November 15, 2004, the stock of Microsoft went ex-dividend for the payment of a one-time dividend of
$3.08 per share. On November 15, the price of the stock was approximately $30 per share. Explain what most
likely happened to the price of the stock on November 16th.
20) From a shareholder’s perspective, what are the advantages of a company repurchasing shares of its own stock
instead of using the cash to pay an additional dividend?
21) What are the advantages of a stable dividend policy versus a residual dividend policy?
22) What tends to happen to the price of a company’s stock when it announces it will issue additional shares in a
23) Why would a company declare a 2-for-1 stock split?
a. What will be the impact on the price of the company’s stock?
b. What will be the impact on the wealth of a shareholder who currently owns 100 shares?
c. What signal does the declaration of a 2-for-1 stock split send to stock market investors?
24) Why is underpricing not a great concern with bond offerings?
25) Why does IPO underpricing tend to occur?
26) Is the balance of cash per the books generally larger or smaller than the available balance per the bank?
27) On December 7, 2011, Chucktown Chops sold 1,000 pounds of chops at $1.20 per pound to the Taylorville IGA,
terms 5/10; n/60.
a. When must the Taylorville IGA pay for the chops to receive a discount?
b. How much will the Taylorville IGA pay Chucktown chops if the payment is made during the discount
c. What is the implicit rate of return earned by Taylorville IGA if they pay during the discount period?
EOQ (2xTxF ) / H
28) Olney Ostriches sells ostrich cookers for $40 per unit. It costs the company $60 to place an order and holding
costs per unit average $4. The company produces and sells 100,000 curlers every 365 days. The company
currently orders lots of 10,000 units at a price of $15 per unit. Calculate the EOQ.
a. Calculate EOQ.
b. Based on the EOQ, how many orders should be placed during a year?
c. If Olney Olives places orders based on the EOQ, what will be the average inventory?
d. Calculate the difference in inventory costs between the EOQ and the current order quantity of 10,000
29) If you have $100 U.S., how many Chinese Yuan can you get?
30) If you have 1 million South Korean wons, how many U.S. dollars do you have?
31) How many Brazilian reals would you receive for a Norway krone?
32) If the Brazilian real increases in value versus the Norwegian krone would exports of Brazilian soybeans to
Norway increase or decrease? Would the number of Norwegians vacationing in Brazil increase or decrease?
33) If a cheeseburger kids meal at McDonalds in Charleston costs $3.49, how much should a cheeseburger kids
meal cost in yen in Tokyo, Japan?
34) You buy 100 shares of Nestle for 9,000 Swiss francs today. One year from now you sell the 100 shares for
10,000 Swiss francs. Assume a Swiss franc is worth $.98 in U.S. dollars at the time of the stock sale. What is
your gain or loss in U.S. dollars?
35) Chucktown Chops had sales of $20 million in 2011. The average collection period is 40 days. What is the
company’s average investment in accounts receivable on the balance sheet?
36) Discuss three factors impacting your credit score.
37) Explain the concept of a lockup period with respect to IPOs. What generally might happen to the price of a
company’s stock the day after the lockup period expires? Explain why.
38) Charleston Chalk had revenue of $600,000 and expenses of $450,000 in 2010. During the year the company
paid dividends of $50,000. As of December 31, 2010, the company had assets of $2,000,000 and liabilities of
$600,000. Similar companies have a beta of 1.2 and a P/E ratio of 19. If the company plans to offer 500,000
shares in an IPO, what price would you set for the stock as an Italian suit person?
39) What is the market capitalization of Charleston Chalk after the IPO?
40) An increase in interest rates in New Zealand would lead to a(n) ___ increase ___ decrease in the value of the
U.S. dollar versus the New Zealand dollar.
41) An increase in inflation in Mexico would lead to a(n) ___ increase ___ decrease in the value of the U.S. dollar
versus the Mexican peso.
42) A decrease in the value of the U.S. dollar would cause a(n) ___ increase ___ decrease in the value of foreign
investments held by U.S. investors.
43) During 2011, the value of the U.S. dollar has ___ increased ___decreased versus most other currencies.
44) Martians have landed in Chicago and announced next Wednesday they will be blowing up the Earth as they
want to end the misery of fans of the Chicago Scrubs. Which of the following statement(s) are true?
The would be an example of systematic risk
The correlation of asset classes would increase
45) Your Aunt Edna informs you at Thanksgiving dinner her company, Edna’s Eggs, has decided to build a new free
range alligator egg farm in northern Montana. The Chief Financial Officer of Edna’s Eggs, No C. Light, a recent
Illinois State graduate, has calculated the farm will have an initial cost of $500,000, a required rate of return of
2.1%, an NPV of $42, and an IRR of 16.4% over the 20 year life of the farm. Aunt Edna asks if you have any
thoughts on this project as a bright finance student. Discuss the two most important observations you have
regarding Mr. Light’s analysis of this project.
46) On November 15, 2011, Wal-Mart announced same store sales had increased 1.3% for the most recent quarter
reversing a trend of declining same store sales. Would the most likely explanation for the increase in same
store sales be the opening of a number of Wal-Mart stores in emerging markets such as India and China in
recent months or an expanded selection of locally produced goods in existing stores?
47) What are the two most important concepts you have learned in this course? Explain why they are the most
important concepts to you.