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Corporate Finance
A commodity bond links interest and principal payments to the price of a commodity. Differentiate a commodity bond from a straight bond and then from equity. How would you factor these differences
WestingHome is a manufacturing company that has accumulated a net operating loss of $2 billion over time. It is considering borrowing $5 billion to acquire another company. a. Based on the corporate
Answer true or false to the following questions relating to the free cash flow hypothesis (as developed by Jensen). a. Companies with high operating earnings have high free cash flows. b. Companies
Assess the likelihood that the following firms will be taken over, based on your understanding of the free cash flow hypothesis. You can assume that earnings and free cash flows are highly
Nadir, an unlevered firm, has expected earnings before interest and taxes of $2 million per year. Nadir’s tax rate is 40%, and the market value is V = E = $12 million. The stock has a beta of 1,
A firm that has no debt has a market value of $100 million and a cost of equity of 11%. In the Miller–Modigliani world. a. what happens to the value of the firm as the leverage is
Assume that personal investors pay a 40% tax rate on interest income and only a 20% tax rate on equity income.If the corporate tax rate is 30%, estimate whether debt has a tax benefit, relative to
In the illustration in Problem 25, what would the tax rate on equity income need to be for debt to not have an effect on value?
XYZ Pharma is a pharmaceutical company that traditionally has not used debt to finance its projects. Over the past 10 years, it has also reported high returns on its projects and growth and made
Unitrode, which makes analog/linear integrated circuits for power management, is a firm that has not used debt in the financing of its projects. The managers of the firm contend that they do not
Consolidated Power is a regulated electric utility that has equity with a market value of $1.5 billion anddebt outstanding of $3 billion. A consultant notes that this is a high debt ratio relative to
You are analyzing a new security that has been promoted as equity, with the following features: • The dividend on the security is fixed in dollar terms for the life of the security, which is 20
You are analyzing a convertible preferred stock with the following characteristics for the security: • There are 50,000 preferred shares outstanding, with a face value of $100 and a 6% preferred
You have been asked to calculate the debt ratio for a firm that has the following components to its financing mix: • The firm has 1 million shares outstanding, trading at $50 per share. • The
You have been asked to estimate the debt ratio for a firm with the following financing details: • The firm has two classes of shares outstanding: 50,000 shares of class A stock, with 2 voting
Zycor Corporation obtains most of its funding internally. Assume that the stock has a beta of 1.2, the riskless rate is 6.5%, and the market risk premium is 6%. a. Estimate the cost of internal
Office Helpers is a private firm that manufactures and sells Office supplies. The firm has limited capital and is estimated to have a value of $80 million with the capital constraints. A venture
Assume now that Office Helpers decides to go public and would like to offer its shares at a target price of $10 per share. If the IPO is likely to be underpriced by 20%, how many shares should the
Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions):In addition, you are provided the following
Terck, a leading pharmaceutical company, currently has a balance sheet that is as follows:The firms income statement looks as follows: Revenues.............. $1,000 Cost of goods sold
You have been asked to analyze the capital structure of DASA, an environmental waste disposal firm, and make recommendations on a future course of action. DASA has 40 million shares outstanding,
You have been asked by JJ Corporation, a California based firm that manufacturers and services digital satellite TV systems, to evaluate its capital structure. They currently have 70 million shares
Pfizer, one of the largest pharmaceutical companies in the United States, is considering what its debt capacity is. In March 1995, Pfizer had an outstanding market value of equity of $24.27 billion,
Upjohn, another major pharmaceutical company, is also considering whether it should borrow more. It has $664 million in book value of debt outstanding and 173 million shares outstanding at $30.75 per
Bethlehem Steel, one of the oldest and largest steel companies in the United States, is considering the question of whether it has any excess debt capacity. The firm has $527 million in market value
Kansas City Southern, a railroad company, had debt outstanding of $985 million and 40 million shares trading at $46.25 per share in March 1995. It earned $203 million in EBIT, and faced a marginal
In 1995, an analysis of the capital structure of Reebok provided the following results on the cost of capital and firm value.This analysis was based on the 1995 EBIT of $420 million and a tax rate
You are trying to evaluate whether United Airlines (UAL) has any excess debt capacity. In 1995, UAL had 12.2 million shares outstanding at $210 per share and debt outstanding of approximately $3
Intel has an EBIT of $3.4 billion and faces a marginal tax rate of 36.50%. It currently has $1.5 billion in debt outstanding, and a market value of equity of $51 billion. The beta for the stock is
Now assume that Plastico is considering a project that requires an initial investment of $100 million and has the following projected income statement (depreciation for the project is expected to be
NYNEX, the phone utility for the New York City area, has approached you for advice on its capital structure. In 1995, NYNEX had debt outstanding of $12.14 billion and equity outstanding of $20.55
A small, private firm has approached you for advice on its capital structure decision. It is in the specialty retailing business, and it had an EBIT last year of $500,000. • The book value of
XCV, Inc., which manufactures automobile parts for assembly, is considering the costs and the benefits of leverage. The CFO notes that the return on equity of the firm, which is only 12.75% now based
Plastico is considering a major change in its capital structure. It has three options:• Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it an
Plastico is interested in how it compares with its competitors in the same industry.a. Taking each of these variables, explain at an intuitive level whether you would expect Plastico to have more or
As CEO of a major corporation, you have to make a decision on how much you can afford to borrow. You currently have 10 million shares outstanding, and the market price per share is $50. You also
You have been hired as a management consultant by AD Corporation to evaluate whether it has an appropriate amount of debt (the company is worried about a lever aged buyout). You have collected the
UB is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.5. The riskless interest rate is 9%.Your research indicates
GenCorp, an automotive parts manufacturer, currently has $25 million in outstanding debt and has 10 million shares outstanding. The book value per share is $10, and the market price per share is $25.
You have been called in as a consultant for Herberts a sporting goods retail firm, which is examining its debt policy. The firm currently has a balance sheet as follows:The
BMD is a firm with no debt on its books currently and a market value of equity of $2 billion. On the basis of its EBITDA of $200 million, it can afford to have a debt ratio of 50%, at which level the
Pfizer, a major pharmaceutical company, has a debt ratio of 10.30% and is considering increasing its debt ratio to 30%. Its cost of capital is expected to drop from 14.51% to 13.45%. Pfizer had an
Upjohn, also a major pharmaceutical company, is considering increasing its debt ratio from 11% to 40%, which is its optimal debt ratio. Its beta is 1.17, and the current Treasury bond rate is 6.50%.
You are trying to decide whether the debt structure that Bethlehem Steel has currently is appropriate, given its assets. You regress the changes in firm value against changes in interest rates and
Railroad companies in the United States tend to have long-term, fixed rate, dollar denominated debt. Explain why.
The following table summarizes the results of regressing changes in firm value against changes in interest rates for six major footwear companies:Change in Firm Value = a + b(Change in Long − Term
You have run a series of regressions of firm value changes at Motorola, the semiconductor company, against changes in a number of macroeconomic variables. The results are summarized here: Change in
MiniSink is a manufacturing company that has $100 million in debt outstanding and 9 million shares trading at $100 per share. The current beta is 1.10, and the interest rate on the debt is 8%. In the
IOU has $5 billion in debt outstanding (carrying an interest rate of 9%) and 10 million shares trading at $50 per share. Based on its current EBIT of $200 million, its optimal debt ratio is only 30%.
DGF Corporation has come to you for some advice on how best to increase their leverage over time. In the most recent year, DGF had an EBITDA of $300 million, owed $1 billion in both book value and
STL has asked you for advice on putting together the details of the new debt issues it is planning to make. What information would you need to obtain to provide this advice?
Assume now that you have uncovered the following facts about the types of projects STL takes: • The projects are primarily infrastructure projects, requiring large initial investments and long
You are attempting to structure a debt issue for Eaton Corporation, a manufacturer of automotive components. You have collected the following information on the market values of debt and equity for
Repeat the analysis in Problem 7 for a private firm that has provided you with the following estimates of operating income for the 10 years, for which you have the macroeconomic data:Operating Income
Assuming that you do the analysis in Problem 8 with both firm value and operating income, what are the reasons for the differences you might find in the results, using each? When would you use one
If a potential investment’s internal rate of return is above the company’s hurdle rate, should the investment be made?
Why does the use of the accelerated depreciation method (instead of straight-line) for income tax reporting increase an investment’s value?
Assume that Samsung manufactures and sells 60,000 units of a product at $11,000 per unit in domestic markets. It costs $6,000 per unit to manufacture ($4,000 variable cost per unit, $2,000 fixed cost
Park Co. is considering an investment that requires immediate payment of $27,000 and provides expected cash inflows of $9,000 annually for four years. If Park Co. requires a 10% return on its
Park Co. is considering an investment that requires immediate payment of $27,000 and provides expected cash inflows of $9,000 annually for four years. Assume Park Co. requires a 10% return on its
Howard Co. is considering two alternative investments. The payback period is 3.5 years for Investment A and 4 years for Investment B. (1) If management relies on the payback period, which
Project A requires a $280,000 initial investment for new machinery with a five-year life and a salvage value of $30,000. The company uses straight-line depreciation. Project A is expected to yield
Project A requires a $280,000 initial investment for new machinery with a five-year life and a salvage value of $30,000. The company uses straight-line depreciation. Project A is expected to yield
Following is information on an investment considered by Hudson Co. The investment has zero salvage value. The company requires a 12% return from its investments. Compute this investment’s net
Refer to the information in QS and instead assume the investment has a salvage value of $20,000. Compute the investment’s net present value. In QS Following is information on an investment
Xia Co. currently buys a component part for $5 per unit. Xia believes that making the part would require $2.25 per unit of direct materials and $1.00 per unit of direct labor. Xia allocates overhead
Signal mistakenly produced 1,000 defective cell phones. The phones cost $60 each to produce. A salvage company will buy the defective phones as they are for $30 each. It would cost Signal $80 per
A company has already incurred $5,000 of costs in producing 6,000 units of Product XY. Product XY can be sold as is for $15 per unit. Instead, the company could incur further processing costs of $8
A division of a large company reports the information shown below for a recent year. Variable costs and direct fixed costs are avoidable, and 40% of the indirect fixed costs are avoidable. Based on
Rory Company has a machine with a book value of $75,000 and a remaining five-year useful life. A new machine is available at a cost of $112,500, and Rory can also receive $60,000 for trading in its
Refer to the information in Exercise and assume that Beyer requires a 10% return on its investments. Compute the net present value of this investment. (Round to the nearest dollar.) Should Beyer
Refer to the information in Exercise and assume instead that double-declining depreciation is applied. Compute the machine's payback period (ignore taxes). (Round the payback period to three
Refer to the information in Exercise. Assume the company requires a 10% rate of return on its investments. Compute the net present value of each potential investment. (Round to the nearest dollar.)In
After evaluating the risk of the investment described in Exercise, B2B Co. concludes that it must earn at least an 8% return on this investment. Compute the net present value of this investment.
Refer to the information in Exercise and instead assume the company requires a 12% return on its investments.In exerciseCompute each projects (a) Net present value (b) Profitability
Gilberto Company currently manufactures 65,000 units per year of one of its crucial parts. Variable costs are $1.95 per unit, fixed costs related to making this part are $75,000 per year, and
Assume Apple invested $2.12 billion to expand its manufacturing capacity. Assume that these assets have a 10-year life, and that Apple requires a 10% internal rate of return on these
Apple and Google sell a variety of products, including smartphones and tablet computers. Some products are more profitable than others. Teams of employees in each company make advertising,
Access Samsung’s 2013 Corporate Sustainability Report, from its website www.samsung.com. Identify and read the section “Social Responsibility: Making Contributions Around the
Explain what is meant by the return on an investment. Differentiate between the two components of return—income and capital gains (or losses).
Define and briefly discuss each of the following sources of risk. a. Business risk b. Financial risk c. Purchasing power risk d. Interest rate risk e. Liquidity risk f. Tax risk g Event risk h.
Briefly describe standard deviation as a measure of risk or variability.
Differentiate among the three basic risk preferences: risk-indifferent, risk-averse, and risk-seeking. Which of these attitudes toward risk best describes most investors?
Describe the steps involved in the investment decision process. Be sure to mention how returns and risks can be evaluated together to determine acceptable investments.
What role do historical performance data play in estimating an investment’s expected return? Discuss the key factors affecting investment returns—internal characteristics and external forces.
What is a satisfactory investment? When the present value of benefits exceeds the cost of an investment, what can you conclude about the rate of return earned by the investor relative to the discount
Define the following terms and explain how they are used to find the risk-free rate of return and the required rate of return for a given investment. a. Real rate of return b. Expected inflation
What is meant by the holding period, and why is it advisable to use holding periods of equal length when comparing alternative investments? Define the holding period return, and explain for what
Define yield (internal rate of return). When is it appropriate to use yield rather than the HPR to measure the return on an investment?
Explain why you must earn 10% on all income received from an investment during its holding period in order for its yield actually to equal the 10% value you’ve calculated.
Explain how either the present value (of benefits versus cost) or the yield measure can be used to find a satisfactory investment. Given the following data, indicate which, if any, of these
Define risk. Explain what we mean by the risk-return tradeoff. What happens to the required return as risk increases? Explain.
Two investments offer a series of cash payments over the next 4 years, as shown in the following table:a. What is the total amount of money paid by each investment over the 4 years? b. From a time
How much would an investor earn on a stock purchased 1 year ago for $45 if it paid an annual cash dividend of $2.25 and had just been sold for $52.50? Would the investor have experienced a capital
You are considering 2 investment alternatives. The first is a stock that pays quarterly dividends of $0.25 per share and is trading at $30 per share; you expect to sell the stock in 6 months for $34.
Assume you invest $5,000 today in an investment that promises to return $9,000 in exactly 10 years. a. Use the present value technique to estimate the yield on this investment. b. If a minimum return
You invest $7,000 in stock and receive $65, $70, $70, and $65 in dividends over the following 4 years. At the end of the 4 years, you sell the stock for $7,900. What was the yield on this investment?
Your friend asks you to invest $10,000 in a business venture. Based on your estimates, you would receive nothing for 4 years, at the end of year 5 you would receive $4,690, and at the end of year 6
Use a financial calculator or an Excel spreadsheet to estimate the yield each of the following investments.
Sara Holliday must earn a return of 10% on an investment that requires an initial outlay of $2,500 and promises to return $6,000 in 8 years. a. Use present value techniques to estimate the yield on
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