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Questions and Answers of Corporate Finance

You have been asked to value Alcoa and have come up with the following inputs. • The stock has a beta of 0.90, estimated over the last five years. During this period, the firm had an average
You are analyzing a valuation done on a stable firm by a well-known analyst. Based on the expected FCFF next year of $30 million, and an expected growth rate of 5%, the analyst has estimated a value
You have been asked to value Office Help, a private firm providing Office support services in the New York area. The firm reported pretax operating income of $10 million in its most recent financial
National City, a bank holding company, reported earnings per share of $2.40 and paid dividends per share of $1.06.The earnings had grown 7.5% a year over the prior five years, and were expected to
The following were the P/E ratios of firms in the aerospace/defense industry with additional data on expected growth and risk:a. Estimate the average and median P/E ratios. What, if anything, would
NCH, which markets cleaning chemicals, insecticides, and other products, paid dividends of $2.00 per share on earnings of $4.00 per share. The book value of equity per share was $40.00, and earnings
You are trying to estimate a price per share on an IPO of a company involved in environmental waste disposal.The company has a book value per share of $20 and earned $3.50 per share in the most
Longs Drug, a large U.S. drugstore chain operating primarily in northern California, had sales per share of $122 on which it reported earnings per share of $2.45 and paid a dividend per share of
You have been asked to assess whether Walgreen, a drugstore chain, is correctly priced relative to its competitors in the drugstore industry. The following are the price/sales ratios, profit margins,
Assume in the previous question with Vernon Enterprises that the firm will earn a return on capital of 15% in perpetuity.a. Assume that the firm is instable growth, growing 5% a year forever;
Time Warner is considering a sale of its publishing division. The division had earnings EBITDA of $550 million in the most recent year (depreciation was $150 million), growing at an estimated 5% a
Cello is a manufacturer of pianos. It earned an aftertax return on capital of 10% last year and expects to maintain this return next year. If the current year’s aftertax operating income is $100
Cell Phone is a cellular firm that reported net income of $50 million in the most recent financial year. The firm had $1 billion in debt, on which it reported interest expenses of $100 million in the
Netsoft is a company that manufactures networking software. In the current year, the firm reported operating earnings before interest and taxes of $200 million (operating earnings does not include
Gemco Jewelers earned $5 million in aftertax operating income in the most recent year. The firm also had capital expenditures of $4 million and depreciation of $2 million during the year, and the
Now assume that Gemco Jewelers has $10 million in cash and nonoperating assets and that the firm has $15 million in outstanding debt. a. Estimate the value of equity in the firm. b. If the firm has 5
Union Pacific Railroad reported net income of $770 million after interest expenses of $320 million in a recent financial year. (The corporate tax rate was 36%.) It reported depreciation of $960
Lockheed, one of the largest defense contractors in the United States, reported EBITDA of $1,290 million in a recent financial year, prior to interest expenses of $215 million and depreciation
There is a conflict of interest between stockholders and managers. In theory, stockholders are expected to exercise control over managers through the annual meeting or the board of directors. In
In Germany, large banks are often large lenders and large equity investors in the same firm. For instance, Deutsche Bank is the largest stockholder in Daimler Chrysler, as well as its largest lender.
It is often argued that managers, when asked to maximize stock price, have to choose between being socially responsible and carrying out their fiduciary duty. Do you agree? Can you provide an example
Assume that you are advising a Turkish firm on corporate financial questions and that you do not believe that the Turkish stock market is efficient. Would you recommend stock price maximization as
It has been argued by some that convertible bonds (i.e., bonds that are convertible into stock at the option of the bondholders) provide one form of protection against expropriation by stockholders.
Societies attempt to keep private interests in line by legislating against behavior that might create social costs (such as polluting the water). If the legislation is comprehensive enough, does the
One of the arguments made for having legislation restricting hostile takeovers is that unscrupulous speculators may take over well-run firms and destroy them for personal gain. Allowing for the
Stockholders can transfer wealth from bondholders through a variety of actions. How would the following actions by stockholders transfer wealth from bondholders? a. An increase in dividends b. A
Stock prices are much too volatile for financial markets to be efficient. Comment.
Maximizing stock prices does not make sense because investors focus on short-term results and not on the long-term consequences. Comment.
There are some corporate strategists who have suggested that firms focus on maximizing market share rather than market prices. When might this strategy work, and when might it fail?
Antitakeover amendments can be in the best interests of stockholders. Under what conditions is this likely to be true?
Companies outside the United States often have two classes of stock outstanding. One class of shares is voting and is held by the incumbent managers of the firm. The other class is nonvoting and
In recent years, top managers have been given large packages of options, giving them the right to buy stock in the firm at a fixed price. Will these compensation schemes make managers more responsive
Reader's Digest has voting and nonvoting shares. About 70% of the voting shares are held by charitable institutions, which are headed by the CEO of Reader's Digest. Assume that you are a large holder
The following table lists the stock prices for Microsoft from 1989 to 1998. The company did not pay any dividends during the periodYear Price (dollars)1989 .......... 1.201990
Assume you have all your wealth (a million dollars) invested in the Vanguard 500 index fund, and that you expect to earn an annual return of 12%, with a standard deviation in returns of 25%. Since
Every investor in the capital asset pricing model owns a combination of the market portfolio and a riskless asset. Assume that the standard deviation of the market portfolio is 30% and that the
The following table lists returns on the market portfolio and on Microsoft, each year from 1989 to 1998.a. Estimate the covariance in returns between Microsoft and the market portfolio. b. Estimate
United Airlines has a beta of 1.50. The standard deviation in the market portfolio is 22% and United Airlines has a standard deviation of 66%. a. Estimate the correlation between United Airlines and
You are using the arbitrage pricing model to estimate the expected return on Bethlehem Steel and have derived the following estimates for the factor betas and risk premia:a. Which risk factor is
The following equation is reproduced from the study by Fama and French of returns between 1963 and 1990.Rt = 0.0177 − 0.11 ln (MV) + 0.35 ln (BV∕MV)where MV is the market value of equity in
Unicom is a regulated utility serving Northern Illinois. The following table lists the stock prices and dividends on Unicom from 1989 to 1998.a. Estimate the average annual return you would have made
The following table summarizes the annual returns you would have made on two companies—Scientific Atlanta, a satellite and data equipment manufacturer, and AT&T, the telecomm giant, from 1988 to
You are in a world where there are only two assets, gold and stocks. You are interested in investing your money in one, the other, or both assets. Consequently, you collect the following data on the
You are interested in creating a portfolio of two stocks—Coca Cola and Texas Utilities. Over the last decade, an investment in Coca Cola stock would have earned an average annual return of 25%,
Assume that you have half of your money invested in Times Mirror, the media company, and the other half invested in Unilever, the consumer product giant. The expected returns and standard deviations
Assume that the average variance of return for an individual security is 50% and that the average covariance is 10%. What is the expected variance of a portfolio of 5, 10, 20, 50, and 100 securities.
In December 1995, Boise Cascade's stock had a beta of 0.95. The Treasury bill rate at the time was 5.8%, and the Treasury bond rate was 6.4%. The firm had debt outstanding of $1.7 billion and a
A prominent beta estimation service reports the beta of Comcast Corporation, a major cable TV operator, to be 1.45. The service claims to use weekly returns on the stock over the prior five years and
You have collected returns on AnaDone, a large diversified manufacturing firm, and the NYSE index for five years:a. Estimate the intercept (alpha) and slope (beta) of the regression.b. If you bought
You run a regression of monthly returns of Mapco, an oil-and gas-producing firm, on the S&P 500 Index and come up with the following output for the period 1991–1995. Intercept of the regression =
You have just run a regression of monthly returns of American Airlines (AMR) against the S&P 500 over the past five years. You have misplaced some of the output and are trying to derive it from what
You have run a regression of monthly returns on Amgen, a large biotechnology firm, against monthly returns on the S&P 500 Index, and come up with the following output: Rstock = 3.28% + 1.65 RMarket
You have just run a regression of monthly returns on MAD, a newspaper and magazine publisher, against returns on the S&P 500, and arrived at the following result: RMAD = −0.05% + 1.20 RS&P The
Time Warner, the entertainment conglomerate, has a beta of 1.61. Part of the reason for the high beta is the debt left over from the leveraged buyout of Time by Warner in 1989, which amounted to $10
Chrysler, the automotive manufacturer, had a beta of 1.05 in 1995. It had $13 billion in debt outstanding in that year and 355 million shares trading at $50 per share. The firm had a cash balance of
You are trying to estimate the beta of a private firm that manufactures home appliances. You have managed to obtain betas for publicly traded firms that also manufacture home appliances.The private
Boise Cascade also had debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate marginal tax rate was 36%.a. Assuming that the current beta of 0.95 for the stock
As the result of stockholder pressure, RJR Nabisco is considering spinning off its food division. You have been asked to estimate the beta for the division and decide to do so by obtaining the beta
Southwestern Bell, a phone company, is considering expanding its operations into the media business. The beta for the company at the end of 1995 was 0.90, and the debt to equity ratio was 1. The
The chief financial officer of Adobe Systems, a software manufacturing firm, has approached you for some advice regarding the beta of his company. He subscribes to a service that estimates Adobe
You are analyzing Tiffany’s, an upscale retailer, and find that the regression estimate of the firm’s beta is 0.75; the standard error for the beta estimate is 0.50. You also note that the
Biogen, a biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at the end of that year.a. Estimate the cost of equity for Biogen, if the Treasury bond rate is 6.4%.b. What
Genting Berhad is a Malaysian conglomerate with holdings in plantations and tourist resorts. The beta estimated for the firm, relative to the Malaysian stock exchange, is 1.15, and the longterm local
You have just done a regression of monthly stock returns of HeavyTech, a manufacturer of heavy machinery, on monthly market returns over the past five years and come up with the following
Safecorp, which owns and operates grocery stores across the United States, currently has $50 million in debt and $100 million in equity outstanding. Its stock has a beta of 1.2. It is planning a
Novell, which had a market value of equity of $2 billion and a beta of 1.50, announced that it was acquiring WordPerfect, which had a market value of equity of $1 billion and a beta of 1.30. Neither
You are analyzing the beta for Hewlett Packard and have broken down the company into four broad business groups, with market values and betas for each group.a. Estimate the beta for Hewlett Packard
The following table summarizes the percentage changes in operating income, percentage changes in revenue, and betas for four pharmaceutical firms.a. Calculate the degree of operating leverage for
A small manufacturing, which has limited access to capital, has a capital rationing constraint of $150 million and is faced with the following investment projects (numbers in millions):a. Which of
You are a small business owner considering two alternatives for your phone system.The discount rate is 8%. Which alternative would you pick?
You have been asked to compare three alternative investments and make a recommendation. • Project A has an initial investment of $5 million and after-tax cash flows of $2.5 million a year for the
You are the manager of a pharmaceutical company and are considering what type of laptop computers to buy for your salespeople to take with them on their calls. • You can buy fairly inexpensive
You are the supervisor of a town where the roads are in need of repair. You have a limited budget and are considering two options: • You can patch up the roads for $100,000, but you will have to
You are the manager of a specialty retailing firm that is considering two strategies for getting into the Malaysian retail market. Under the first strategy, the firm will make an initial investment
You work for a firm that has limited access to capital markets. As a consequence, it has only $20 million available for new investments this year. The firm does have a ready supply of good projects,
You are the owner of a small hard ware store, and you are considering opening a gardening store in a vacant area in the back of your present store. You estimate that it will cost you $50,000 to set
You are the manager of a grocery store, and you are considering offering babysitting services to your customers. You estimate that the licensing and set up costs will amount to $150,000 initially and
You run a financial service firm where you replace your employee’s computers every three years. You have 5,000 employees, and each computer costs $2,500 currently—the old computers can be sold
You are examining the viability of a capital investment in which your firm is interested. The project will require an initial investment of $500,000 and the projected revenues are $400,000 a year for
A closely held, publicly traded firm faces self-imposed capital rationing constraints of $100 million in this period and $75 million in the next period. It has to choose among the following projects
Your company is considering producing a new product. You have a production facility that is currently used to only 50% of capacity, and you plan to use some of the excess capacity for the new
You are an analyst for a sporting goods corporation that is considering a new project that will take advantage of excess capacity in an existing plant. The plant has a capacity to produce 50,000
You own a rental building in the city and are interested in replacing the heating system. You are faced with the following alternatives: a. A solar heating system, which will cost $12,000 to install
You are trying to choose a new siding for your house. A salesman offers you two choices: a. Wood siding, which will last 10 years and cost $5,000 to install and $1,000/year to maintain. b. Aluminum
You have just been approached by a magazine with an offer for renewing your subscription. You can renew for one year at $20, two years for $36, or three years at $45. Assuming that you have an
You have been hired as a capital budgeting analyst by a sporting goods firm that manufactures athletic shoes and has captured 10% of the overall shoe market (the total market is worth $100 million a
You are considering the possibility of replacing an existing machine that has a book value of $500,000, a remaining depreciable life of five years, and a salvage value of $300,000. The replacement
You are helping a bookstore decide whether it should open a coffee shop on the premises. The details of the investment are as follows: • The coffee shop will cost $50,000 to open; it will have a
The lining of a plating tank must be replaced every three years at the cost of approximately $2,000. A new lining material has been developed that is more resistant to the corrosive effects of the
An income bondholder receives interest payments only if the firm makes income. If the firm does not make interest payments in a year, the interest is cumulated and paid in the first year the firm
You are a venture capitalist and have been approached by Cirrus Electronics, a private firm. The firm has no debt outstanding and does not have earnings now but is expected to be earning $15 million
The unlevered beta of electronics firms, on average, is 1.1. The riskless rate is 6.5%, and the market risk premium is 6%.a. Estimate the expected return, using the CAPM.b. If you are a venture
Sunshine Media has just completed an IPO, where 50 million shares of the 125 million shares outstanding were issued to the public at an offering price of $22 per share. On the offering date, the
IPOs are difficult to value because firms going public tend to be small, and little information is available about them. Investment bankers have to underprice IPOs because they bear substantial
You are the owner of a small and successful firm with an estimated market value of $50 million. You are considering going public.a. What are the considerations you would have in choosing an
You have been asked for advice on a rights offering by a firm with 10 million shares outstanding trading at $50 per share. The firm needs to raise $100 million in new equity. Assuming that the rights
You are stockholder in a SmallTech, a company that is planning to raise new equity. The stock is trading at $15 per share, and there are 1 million shares outstanding. The firm issues 500,000 rights
Assume that SmallTech has net income of $1 million and that the earnings will increase in proportion with the additional capital raised.a. Estimate the earning per share that SmallTech will have
MVP, a manufacturing firm with no debt outstanding and a market value of $100 million, is considering borrowing $40 million and buying back stock. Assuming that the interest rate on the debt is 9%
A business in the 45% tax bracket is considering borrowing money at 10%.a. What is the after-tax interest rate on the debt?b. What is the after-tax interest rate if only half of the interest expense

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