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corporate finance

Questions and Answers of Corporate Finance

When Collingwood Corp. issued its 60-day commercial paper the promised yield was 9 percent, whereas the 60-day T-bill yield was 6 percent. There is a 2-percent chance that Collingwood will default on
Collingwood Corp.’s bank is willing to provide it with a 10-year term loan for $50 million. The annual payments on this loan will be $5.25 million, and there is a “bullet” payment of $50
List and briefly describe the six basic factors used to determine a DBRS rating.
Rather than take a term loan from the bank, Collingwood Corp. has decided to issue $50 million of 10-year bonds. DBRS has assigned a rating of “BB” to this bond issue.a. Determine the probability
Sometimes, bonds are completely worthless when a company defaults on payments. However, in practice, bonds typically have some market value (recovery rate) even after a default. Collingwoodâ€™s
Determine the selling price of a Government of Canada treasury bill that has a quoted annual interest rate of 2.1 percent and will mature in 180 days. Assume a par value of $1,000.
On a one-year loan of $5,000, a bank charges interest at 10 percent. The bank also charges an application fee of $50 to cover processing expenses. What is the effective interest cost (annual rate)
As the newly appointed treasurer for Collingwood Corp., you have to decide how to raise $50 million in short-term financing. You believe you could issue commercial paper with a promised yield of 9
Calculate the value of the one-month CP given the following: PAR = $500,000; r (promised yield) = 5%; probability of not defaulting = 95%; RECOVER = 0; k = 15%. Round to nearest dollar.
In your job as treasurer of Collingwood Corp., you have to arrange a line of credit for the firm. The following is taken from the company€™s balance sheet.The bank will provide credit up
Collingwood Corp. has a revolving line of credit on which it owes $50 million. One of the restrictions imposed with this financing arrangement is that the company must maintain a minimum interest
Why do corporations issue long-term bonds, knowing that interest rate risk is higher for longer-term bonds?
1. Which of the following does not appear in the share structure of a firm?a. Preferred sharesb. Common sharesc. Restricted sharesd. None of the above2. Which of the following statements about
Discuss three reasons why firms issue preferred shares.
A firm has just filed for bankruptcy and is likely to be liquidated. The creditors, such as equipment suppliers and employees, are owed $1.5 million.a. How much will the equity holders receive if,
With the savings from your summer job you were able to buy 500 shares of a hot new Internet company last year. A few months after your purchase, the company was low on cash and needed to raise more
When a firm needed to raise capital to expand, the founder was concerned about losing control of the firm if he sold too many shares. The solution devised by his investment banker was to create two
A firm has 50 million common shares outstanding, on which it pays a quarterly dividend of $0.20 per share. The firm’s capital structure also includes two million cumulative preferred shares with a
The common shares of a firm are currently trading at $10.00, while its preferred shares trade at par. Calculate the convertible premium on the preferred shares. What does this premium mean?
In December 2009, Collingwood Corp. decided to issue 100,000 convertible bonds, maturing in December 2017. The bonds have a face value of $1,000 and promise an annual coupon payment of 5.75 percent.
Calculate the payoff of fully exercising warrants given the following: 900,000 existing shares are outstanding (n); 100,000 warrants (m) are outstanding and are exercisable at $10 (X). The firm is
Orion’s Belt Mining Co. has 12 million common shares outstanding, which are currently trading for $4.75 apiece. In addition, the company has issued three million share purchase warrants with a
A firm’s common shares currently trade at $20 per share. The firm has warrants outstanding that entitle the holder to purchase two shares at an exercise price of $18 per share. The expiry date is
Straight preferred shares issued by a firm have a discount rate of 8 percent per year, whereas these shares are yielding 6 percent on the $50 par value. The conversion value of these shares is
Jack and Jill Inc. very nearly tumbled into bankruptcy last year. To refinance the firm, the firm issued $25 million worth of 30-year income bonds. These bonds have an 8-percent coupon that is
Collingwood Corp. has decided to invest some of its excess cash in straight preferred shares issued by other companies. It will earn a yield of 6.5 percent on the $10-million investment. How much net
A firm has just issued convertible preferred shares with a $50 par value. The conversion price for these shares is $12.50 (per common share). What is the conversion ratio?
A firm has just issued convertible preferred shares. These shares have a call feature that permits the firm to repurchase the shares at par value (or, in effect, force the conversion into common
What are the differences between call options and warrants?
Calculate the conversion price and conversion value of the convertible bonds given the following: selling price $95; each bond is convertible into four common shares; current common share price $40.
1. Which of the following statements is false?a. Financing total assets is called the financial structure decision.b. Capital structure is how invested capital is financed.c. The financial structure
What is the market price and market-to-book ratio, assuming the firmâ€™s stock is a perpetuity and all earnings are paid out as cash dividends (i.e., the retention ratio iszero)?
Calculate invested capital and before-taxROI.
A firm's market values of equity and debt are $750,000 and $250,000, respectively. The before tax cost of debt = 6%; RF = 4%; beta (β) = 0.8; the market risk premium = 10%; and the tax rate = 20%.
A firm has common shares outstanding with a discount rate of 12 percent. The current market price is $22.75, and dividend payments for this year are expected to be $0.60. What is the per share
A firm’s earnings and dividends are expected to grow at a constant rate indefinitely, and it is expected to pay a dividend of $8.75 per share next year. Expected EPS and BVPS next year are $12 and
Calculate the cost of equity using the constant growth DDM given the following: current dividend = $3; payout ratio = 0.5 (assume it is not changing); ROE = 12%; and the current market price of the
Calculate PVGO and PVEO given the following information: ROE1 = 20%; ROE2 = 25%; further investment (Inv) = $100; BVPS = $10; and Ke = 10%. Is this firm a star? If not, what is it according to Boston
A firm is going to finance a new project 100 percent with debt, through a new bond issue. Since the firm is using only debt to finance the project, the NPV of the project should be calculated using
Montreal Brokers, a small brokerage firm and PEI tronics, a software development company, are both separately considering developing and marketing a new software package. Neither party is aware that
Suppose a firm uses a constant WACC to calculate the NPV of all of its capital budgeting projects, rather than adjusting for the risk of the individual projects. What errors will the firm make in
A firm has the following capital structure based on market values: equity 65 percent and debt 35 percent. The current yield on government T-bills is 2 percent, the expected return on the market
A firm has the following balance sheet items:The before-tax interest cost on new 15-year debt would be 7.5 percent, and each $1,000 bond would net the firm $975 after issuing costs. Common shares
A company can issue new 20-year bonds at par that pay 5 percent annual coupons. The net proceeds to the firm (after taxes) will be 98 percent of par value. They estimate that new preferred shares
a. Kitchener Consumer Products plans to issue 25-year bonds with an 11.5 percent coupon rate, with coupons paid semi-annually and a par value of $1,000. After-tax flotation costs (issuing and
A firm wishes to raise funds in the following proportions: 20 percent debt, 20 percent P/S, and 60 percent CE (common equity). Assume the cost of internally generated funds is 15 percent. Annual
What is the cost of equity (Ke) given RF = 2%, beta (Î²) = 1.5, expected market return(ERM) =12%?
Provide two reasons why the cost of a security to a company differs from its required return in capital markets.
What is VFed given the expected earnings per share on the S&P 500 is $23.50 and the long-term U.S. bond rate is 4.75 percent?
Rocky Mountain Depot just announced its EPS of $4.50. Retention ratio (b) = 0.6. The earnings are expected to grow at 10 percent for one year and then at 5 percent indefinitely. Given that Ke = 17%,
Calculate the cost of issuing new equity for a firm, assuming issue costs are 3 percent of the share price after taxes; market price per share = $40; current dividend = $2.75; and the constant growth
1. What is the invested capital given the following? Accounts receivable = $50,000; current assets = $200,000; total assets = $700,000; shareholders’ equity = $440,000; accounts payable =
Calculate ROE if ROI = 12%, RD = 10%, B = $200,000, SE = $300,000, and T = 0.35. Identify the business risk and financial risk.
What is the intercept and slope of the financial leverage (ROE-ROI) line in Practice Problem 13? Explain the meaning of the slope. What is the pecking order according to Myers’ argument?
What is the ROE indifference point of the two strategies of Arctic Inc. as follows? TC = 30%, Strategy 1: debt-equity ratio = 0.7. Strategy 2: debt-equity ratio = 1.0. Arctic Inc.’s after-tax cost
Use two different methods to calculate ROI given the following information for Brandon Corp. Sales = $500,000; Cost of goods sold = $100,000; Interest cost $22,500; TC = 40%. The firm’s debt (B =
Calculate the fixed burden coverage and cash-flow-to-debt ratio given the following: EBIT = $700,000; depreciation and amortization = $60,000; preferred dividend $50,000; sinking fund payments =
Calculate Altmanâ€™s Z score for Home Depot in fiscal year 2011 (as of January 29, 2012) and then compare it with Moodyâ€™s rating chart. Is this company an IG or non-IG? All numbers are
Explain the elements of Altman€™s Z score as used in Practice Problem18.
Calculate the EPS indifference EBIT* level given the following information. The corporate tax rate is 20 percent. Under a 75-percent D/E ratio, the number of common shares outstanding is 30,000;
In order for the M&M irrelevance theorem to hold, what key assumptions must be met?
In the M&M no-tax world, calculate the value of the levered firm (VL). Cost of unlevered equity (KU) = 15%; cost of debt (KD) = 7%; debt (D) = $400,000; and NI = $520,000. What is the cost of
In the M&M no-tax world, an unlevered firm has a cost of equity of 10 percent and expected EBIT of $375,000. The firm decided to issue $2 million of debt at a cost of 6 percent to finance a
In the M&M tax world, what is the value of levered firm (VL) in Practice Problem 22 if the tax rate is 30 percent? What is the cost of levered equity? What is the market risk premium (MRP) given βU
In the M&M tax world, calculate the value of the unlevered firm (U) and the identical risk-levered firm (L). Corporate tax rate = 20%; perpetual EBIT for U and L = $2 million; cost of capital of U
Susan and Celia are twins but have very different attitudes toward debt. Susan believes that firms should have a D/E ratio of 0.2 while Celia believes that the D/E ratio should be 1.1. Both sisters
The Saskatchewan Botanicals Company expects a free cash flow of $1.2 million every year forever. Saskatchewan Botanicals currently has no debt, and its cost of equity is 20 percent.The corporate tax
Athabascan Drilling is currently unlevered and is valued at $10 million. The company is considering including debt in its capital structure and would like to know the likely impact on its value and
Straightforward Theatre Company has an EBIT of $1 million per year. The WACC of the firm is 10 percent and the before-tax cost of debt is 4 percent. The debt is risk free and all cash flows are
Explain how the static trade-off model can be used to find an optimal capital structure.
Describe the factors that can affect a firm’s capital structure in practice.
State the two possible ways bankruptcy can occur. What is the role of a monitor appointed by the court under the Companies’ Creditors Arrangement Act (CCAA)? Compare the difference of recognizing
Describe the relationship between the debt ratio and firm value when we consider the existence of bankruptcy costs. How do you view the agency costs when bankruptcy occurs?
Summarize the main factors you need to consider if the CFO of your firm asks you to evaluate your firm’s capital structure.
Gus Fitzgerald, a local shipping tycoon, is very confused. He has issued stock to finance a positive NPV investment. He expected the stock price to rise, as positive NPV projects are supposed to
Your cousin has just started his MBA and is confused. He understands that without taxes, capital structure is irrelevant. He also understands that with taxes, firms should use 100 per-cent debts.
State the two rules of financial leverage.
With reference to the M&M irrelevance theorem, calculate the market value of an unlevered firm (U) and an identical risk-levered firm (L). The expected EBIT of the unlevered firm (U) = $1.5 million,
What important issues does the static trade-off model ignore?
What is the pecking order according to Myers’ argument?
1. Dividend-payout ratio is defined as:a. The dividend yield plus the capital gains yield.b. Dividends per share divided by earnings per share.c. Dividends per share divided by income per share.d.
A firm has a dividend yield of 3.14 percent and a payout ratio of 35.84 percent. If its earnings are $25 million and there are 7 million shares outstanding, what is the price per share?
CGC Company is considering its dividend policy. Currently CGC pays no dividends, has cash flows from operations of $10 million per year (perpetual), and needs $8 million for capital expenditures. The
Explain the implications of M&M’s homemade dividend argument.
Currently a firm has an operating cash flow of $350 million and there is a promising project available, which costs $200 million. There are 100 million shares outstanding with a current price of $40
A firm has one million shares outstanding. After-tax earnings have been constant at $10 per share. The firm pays out all earnings in dividends at the end of each year. The shareholders’ required
Assume that the shareholders of a firm pay a net tax of 30 percent on cash dividends received. After-tax earnings have been constant at $10 per share. The firm pays out all earnings in dividends at
A firm's next-period market value of equity is $2.5 million and there are 100,000 shares outstanding, with K = 15%.a. What is the current stock price if the firm pays $500,000 in cash dividends?b.
MCC Corporation currently has cash flow from operations of $10 million, capital expenditures of $8 million, and pays a dividend of $2 million (all are perpetuities). The firm has no growth prospects
A dividend-paying company has a current dividend yield of 8 percent and a stock price of $100. The company has paid the same dividend for the past 15 years and it is not expected to change. Alice
A firm follows a strict residual dividend policy. This firm will have profits of $500,000 this year. After screening all available investment projects, the firm has decided to take three out of the
Explain why firms do not simply pay out dividends as a fixed portion of their profits. What do most firms do in terms of dividend policy?
The current stock price of Abacus is $50. For the past 20 years, the firm has paid an annual dividend of $5. On July 26, it announced a dividend of $6 payable on September 10 to shareholders of
Investor A’s personal tax rate is 25 percent while Investor B’s is 29 percent. Investor A owns 100 shares of SNS Company and receives an annual dividend of $1.60 per share. Investor B owns 100
Kumar expected his firm to earn $1,000 per year forever, with no growth. Given a cost of capital of 10 percent, the value of the firm is $10,000. Kumar identified a new project, which costs $1,000
Describe possible reactions from the market of the following dividend payout changes: dividend initiation, dividend increase, and dividend decrease.a. Dividend initiationb. Dividend increasec.
A company has announced an increase in its quarterly dividend from $0.25 to $0.33 per share. If an investor who owns 700 shares is in the 20 percent tax bracket, calculate the amount by which the
List the main reasons why firms repurchase shares.
Describe the difference between a stock dividend and a cash dividend plus a DRIP.
According to equity market capitalization, what is the cost of capital for the stock of the following firm? Current market value of the equity is $1.2 million with 100,000 shares outstanding. The

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