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Questions and Answers of Corporate Finance

Conceptually, how do we determine the fair forward price for an asset? What are the necessary assumptions to arrive at a fair forward price?
Conceptually, what are the differences between Equations 23.1, 23.2, and 23.3? Which equation would you use to determine the fair forward price for an asset that does not earn any income but is
Explain the features of a futures contract that make it have less credit risk than a forward contract.
Why is fungibility an important feature of futures contracts?
Describe the delivery process for futures contracts. Why does delivery rarely take place in futures contracts?
Why is a call option on an interest rate called an interest rate cap and a put option called an interest rate floor?
Explain how a fixed-for-floating swap can be considered a portfolio of forward contracts on 6-month discount bonds.
Go to the CBOT website (www.cmegroup.com/company/cbot.html), and determine the contract specifications for soybean meal futures and 10-year U.S. Treasury note futures. Apart from the difference in
Go to the CME Group website (www.cmegroup.com/company/cbot.html), and determine the minimum initial margin requirements for speculators in the contracts traded on that exchange. Which contracts have
Suppose that an investor has agreed to pay $94,339.62 for a one-year discount bond in one year. Two years from now, the investor will receive the bond’s face value of $100,000. The current
Company A’s stock will pay a dividend of $5 in three months and $6 in six months. The current stock price is $200, and the risk-free rate of interest is 7% per year with monthly compounding for all
The current price of gold is $288 per troy ounce. The cost of storing gold is $0.03/oz per month. Assuming an annual risk-free rate of interest of 12% compounded monthly, what is the approximate
Following is the current yield to maturity on Treasury bills of various maturities: Time to Maturity Yield Months % 1 .......... 5.0 3 .......... 5.2 6 .......... 5.4 9
Using the information in Table, determine whether the three-month forward rate on euros is fair if the annualized yield for risk-free borrowing over the next three months is 8% in Europe and 5% in
A U.S. automobile importer is expecting a shipment of custom-made cars from Britain in six months. Upon delivery, the importer will pay for the cars in pounds. Using the information in Table 23.2,
Suppose that KF Exports enters into a FRA with Interfirst Bank with a notional principal of $50 million and the following terms: In six months, if LIBOR is above 6%, KF will pay Interfirst according
An investor purchases one gold futures contract for delivery in August 2011. Using the information in Table 23.3, determine the settle price for the contract on July 15, 2011. What is the total
Consider the following scenarios, determine how to hedge each scenario using bond futures, and comment on whether it would be appropriate to hedge the exposure. a. A bond portfolio manager will be
Chipman Products Company will suffer an increase in borrowing costs if the 13-week Treasury bill rate increases in the next six months. Chipman Products is willing to accept the risk of small changes
Company A, based in Switzerland, would like to borrow $10 million at a fixed rate of interest. Because the company is not well known, however, it has not been able to find a willing U.S. lender.
Citibank and ABM Company enter into a five-year interest rate swap with a notional principal of $100 million and the following terms: Every year for the next five years, ABM agrees to pay Citibank 6%
1. What are the types of risk factors that a company faces? 2. If risk aversion cannot explain why firms choose to hedge, then what are the motivations? 3. Explain how a firm's management can limit
List some common cash inflows from capital investments.
List some common cash outflows from capital investments.
What is the payback method of analyzing capital investments?
How is payback calculated with equal net cash inflows?
What is the decision rule for payback?
What are some criticisms of the payback method?
How is ARR calculated?
What is an annuity? How does it differ from a lump sum payment?
How is the present value of a lump sum determined?
How is the present value of an annuity determined?
What is net present value?
What is the decision rule for NPV?
What is the decision rule for IRR?
Cortes Company is considering three investment opportunities with the following payback periods:Use the decision rule for payback to rank the projects from most desirable to least desirable, all else
Discuss the relative volatility of short- and long-term interest rates.
What does the term structure of interest rates indicate?
How have new banking laws influenced competition?
What is the prime interest rate? How does the average bank customer fare in regard to the prime interest rate?
What does LIBOR mean? Is LIBOR normally higher or lower than the U.S. prime interest rate?
What is the difference between pledging accounts receivable and factoring accounts receivable?
What is an asset-backed public offering?
How is valuation of any financial asset related to future cash flows?
Why might investors demand a lower rate of return for an investment in Microsoft as compared to United Airlines?
What are the three factors that influence the required rate of return by investors?
If inflationary expectations increase, what is likely to happen to yield to maturity on bonds in the marketplace? What is also likely to happen to the price of bonds?
What are the three adjustments that have to be made in going from annual to semiannual bond analysis?
Why is a change in required yield for preferred stock likely to have a greater impact on price than a change in required yield for bonds?
What type of dividend pattern for common stock is similar to the dividend payment for preferred stock?
What two components make up the required rate of return on common stock?
The preferred stock of Denver Savings and Loan pays an annual dividend of $5.70. It has a required rate of return of 6 percent. Compute the price of the preferred stock.
Analogue Technology has preferred stock outstanding that pays a $9 annual dividend. It has a price of $76. What is the required rate of return (yield) on the preferred stock?
Stagnant Iron and Steel currently pays a $12.25 annual cash dividend (D0). They plan to maintain the dividend at this level for the foreseeable future as no future growth is anticipated. If the
BioScience Inc. will pay a common stock dividend of $3.20 at the end of the year (D1). The required return on common stock (Ke) is 14 percent. The firm has a constant growth rate (g) of 9 percent.
How does the cost of a source of capital relate to the valuation concepts presented previously in Chapter 10?
What are the two sources of equity (ownership) capital for the firm?
Explain why retained earnings have an associated opportunity cost?
Why is the cost of retained earnings the equivalent of the firm’s own required rate of return on common stock (Ke)?
How are the weights determined to arrive at the optimal weighted average cost of capital?
Wallace Container Company issued $100 par value preferred stock 12 years ago. The stock provided a 9 percent yield at the time of issue. The preferred stock is now selling for $72. What is the
What are the important administrative considerations in the capital budgeting process?
What are the weaknesses of the payback method?
What is normally used as the discount rate in the net present value method?
If corporate managers are risk-averse, does this mean they will not take risks? Explain.
Assume a company, correlated with the economy, is evaluating six projects, of which two are positively correlated with the economy, two are negatively correlated, and two are not correlated with it
Corporate debt has been expanding very dramatically in the last three decades. What has been the impact on interest coverage, particularly since 1977?
What are some specific features of bond agreements?
Discuss the relationship between the coupon rate (original interest rate at time of issue) on a bond and its security provisions.
What method of “bond repayment” reduces debt and increases the amount of common stock outstanding?
What is the purpose of serial repayments and sinking funds?
How does the bond rating affect the interest rate paid by a corporation on its bonds?
What is a Eurobond?
What do we mean by capitalizing lease payments?
Explain the close parallel between a capital lease and the borrow-purchase decision from the viewpoint of both the balance sheet and the income statement.
Floating rate bond (LO16-2) You buy an 8 percent, 25-year, $1,000-par-value floating rate bond in 1999. By the year 2004, rates on bonds of similar risk are up to 11 percent. What is your one best
What are the first three priority items under liquidation in bankruptcy?
Why has corporate management become increasingly sensitive to the desires of large institutional investors?
Why might a corporation use a special category such as founders’ stock in issuing common stock?
What is the purpose of cumulative voting? Are there any disadvantages to management?
How does the preemptive right protect stockholders from dilution?
What is an advantage of floating rate preferred stock for the risk-averse investor?
If you buy stock on the ex-dividend date, will you receive the upcoming quarterly dividend?
Name three industries in which mergers have been prominent.
What is the difference between a merger and a consolidation?
How goodwill is now treated in a merger?
Why do management and stockholders often have divergent viewpoints about the desirability of a takeover?
What is the purpose(s) of the two-step buyout from the viewpoint of the acquiring company?
If Consolidated Power is priced at $50.00 with dividend, and its price falls to $46.50 when a dividend of $5.00 is paid, what is the implied marginal rate of personal taxes for its stockholders?
RJR Nabisco, in response to stockholder pressure in 1996, announced a significant increase in dividends paid to stockholders financed by the sale of some of its assets. What would you expect the
When firms increase dividends, stock prices tend to increase. One reason given for this price reaction is that dividends operate as a positive signal. What is the increase in dividends signaling to
You are comparing the dividend policies of three dividend paying utilities. You have collected the following information on the ex-dividend behavior of these firms.If you were a tax-exempt
Southern Rail has just declared a dividend of $1. The average investor in Southern Rail faces an ordinary tax rate of 50%. Although the capital gains rate is also 50%, it is believed that the
LMN Corporation, a real estate company, is planning to pay a dividend of $0.50 per share. Most of the investors in LMN are other corporations that pay 40% of their ordinary income and 28% of their
Geotech Inc., which has had a history of high growth and pays no dividends, announces that it will start paying dividends next quarter. How would you expect its stock price to react to the
JC Automobiles is a small auto parts manufacturing firm that has paid $1.00 in annual dividends each year for the past five years. It announces that dividends will increase to $1.25 next year. What
Would your answer be different for the previous problem if JC Automobiles were a large firm followed by thirty-five analysts? Why or why not?
WeeMart, a retailer of children’s clothes, announces cut in dividends following a year in which both revenues and earnings dropped significantly. How would you expect its stock price to react?
Vernon Enterprises has current aftertax operating income of $100 million and a cost of capital of 10%. The firm earns a return on capital equal to its cost of capital. a. Assume that the firm is
In the face of disappointing earnings results and increasingly assertive institutional stockholders, Eastman Kodak was considering the sale of its health division, which earned $560 million in EBIT

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