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corporate finance

Questions and Answers of Corporate Finance

Use the language of real options to explain why riskier firms must pay higher interest rates when they borrow money.
Why must manager intuition be part of the investment- decision process regardless of a project NPV or IRR? Why is it helpful to think about real options when making an investment decision?
Two firms in the same industry have very different equity betas. Offer two reasons why this could occur.
For a firm considering expansion of its existing line of business, why is the WACC, rather than the cost of equity, the preferred discount rate if the firm has both debt and equity in its capital
The cost of debt, rd, is generally less than the cost of equity, re, because debt is a less risky security. A naive application of the WACC formula may suggest that a firm could lower its cost of
Why would a project that reaches the breakeven point (BEP) in terms of net income be potentially bad for shareholders?
Which variable do you think would be more valuable to examine in a project sensitivity analysis the growth rate of sales or the allowable depreciation deductions each year? Explain.
You work for an airline that is considering a proposal to offer a new, nonstop flight between Atlanta and Tokyo. Senior management asks a team of analysts to run a Monte Carlo simulation of the
Why might the discount rate vary as you move through a decision tree?
Give a real- world example of an expansion option and an abandonment option.
Assuming that there are no corporate income taxes, how can the costs of preferred stock and debt be estimated without finding a preferred stock and a bond beta?
Krispy Kreme Doughnuts (KKD) has a capital structure consisting almost entirely of equity.a. If the beta of KKD stock equals 1.6, the risk-free rate equals 6 percent, and the expected return on the
What are financial intermediaries, and what role do these firms play in providing long- term capital to publicly traded U. S. nonfinancial corporations?
How does under-pricing add to the cost of going public?
What happens to a company’s stock price when the firm announces plans for a seasoned equity offering? What are the long- term returns to investors, following an SEO?
Why do you think that rights offerings have largely disappeared in the United States?
What are the relative advantages and disadvantages of private placements, compared to those of public offerings of stock and bond issues?
In what ways are non-U. S. (private- sector) initial public offerings similar to U. S. IPOs and in what ways are they different?
What are American Depositary Receipts (ADRs), and how are these created? Why do you think ADRs have proven to be so popular with U. S. investors?
In what key ways do share issue privatizations (SIPs) differ from private- sector share offerings? Why do you think governments deliberately under-price SIPs?
What patterns are observed in U. S. security issues each year? How do these patterns compare to those in international security issues?
What does the phrase bulge bracket mean?
What is the guiding principle behind most of the important U. S. securities legislation? What role does the security registration process play in implementing this philosophy?
What is shelf registration? Why do you think this has proven to be so popular among issuing firms?
What patterns have been observed in the types of firms going public in the United States? Why do you think that certain industries become popular with investors at different times?
What are the principal benefits of going public? What are the key drawbacks?
Distinguish between an equity carve-out and a spin-off. How might a spin-off create value for share-holders?
What does the term under-pricing refer to? If the average IPO is underpriced by about 15 percent, how could an unsophisticated investor, who regularly invests in IPOs, earn an average return less
How should a corporation estimate the amount of financing it must raise externally during a given year? Once that amount is known, what other decision must be made?
Differentiate between a U.S. commercial bank and the merchant banks found in other developed countries. How have these differences affected the securities markets in the United States versus those in
Assume that the Rome Electricity Company (REC) wants to create a sponsored ADR program worth $300 million to trade its shares on the New York Stock Exchange. Assume that REC is currently selling on
Nippon Computer Manufacturing Company (NCM) wants to create a sponsored ADR program, worth $250 million, to trade its shares on NASDAQ. Assume that NCM is currently selling on the Tokyo Stock
Suppose that you purchase shares of a company that recently executed an IPO at the post-offering market price of $32 per share, and you hold the shares for one year. You then sell your shares for $35
The Norman Company needs to raise $50 million of new equity capital. Its common stock is currently selling for $50 per share. The investment bankers require an underwriting spread of 3 percent of
What is a recapitalization? Why is this considered a pure capital structure change?
Think of the gaudy corporate perks given to managers, such as a plush office, a company jet, or luxury box seats at professional sporting events. How can managers justify these as value-maximizing
In most countries, firms in high-tech industries are almost all intangible asset-rich rather than fixed asset- rich. What effect do you think the continued growth of these industries will have on
What happens to stock prices when corporate managers announce leverage-increasing transactions such as debt-for-equity exchange offers? What happens to stock prices, in response to
What is the fundamental principle of financial lever-age? How does it pertain to the reasons why managers may choose to substitute debt for equity in their firm’s capital structure?
Explain how Propositions I and II are different and how they are similar.
What is the difference between levered and unlevered equity? What effect does substituting debt for equity have on the required return on (levered) equity?
What effect does incorporating corporate income taxation have on the M& M capital structure irrelevance hypothesis? Why?
The Jobs and Growth Tax Relief Reconciliation Act of 2003 significantly reduced the effective personal tax rates on dividend income for most U. S. investors. What effect do you think this act has had
What are the important direct and indirect costs of bankruptcy? Which of these, do you think, are the most important for discouraging maximum debt use by corporate managers?
Suppose an individual borrows from a bank to buy a new car. Later on, the borrower realizes that in a few months, he will have to default on this loan and the bank will repossess the car. What kind
Suppose commercial bank experiences losses on some of its loans. As a result, it approaches bankruptcy. What kinds of asset-substitution problems may arise?
How do stock prices generally react to announcements of firms’ changes in leverage? Why is this result perplexing and seemingly contradictory given your answer to Question 12-2?
What factors should a manager consider when deciding on the amount and type of long- term debt to be used to finance a business?
What factors might influence the choice between a bond issue with a sinking fund requirement and a serial bond issue?
What factors, other than the current interest rate at which new debt could be sold, should a manager consider when deciding to refund a bond issue?
Why is it considered important whether a lease is classified as an operating lease or as a financial (or capital) lease?
What factors should be considered when deciding between leasing an asset and borrowing funds to purchase the asset?
What factors should a manager consider when negotiating the covenants in a long- term debt agreement?
How can managers estimate their firms cost of long-term debt prior to meeting with a lender?
Suppose that a specialty retail firm takes out a term loan from a bank. Which do you think the bank would prefer to receive as collateral, a claim on the firm’s inventory or its receivables?
A problem with collateral is that its value is positively correlated with the borrower’s ability to repay. Explain.
What aspect of syndicated lending is most attractive to the lenders?
Why are syndicated loans especially useful for financing takeovers?
How do project finance loans differ from other types of syndicated loans?
What factors should a manager consider when choosing between a term loan and a bond issue for funding long- term debt?
What elements must be included in a lease in order for it to be considered a financial (capital) lease?
Comment on the following statement: A key benefit of leasing is that it allows for the effective depreciation of land.
What are the key advantages of leasing as compared to borrowing to acquire an asset? What are the key disadvantages of leasing?
What is a debenture? Why do you think that this is the most common form of corporate bond in the United States, but is much less commonly used elsewhere? Discuss.
The initial proceeds per bond, the size of the issue, the initial maturity of the bond, and the years remaining to maturity are shown in the following table for a number of bonds. In each case, the
Web Tools Company is considering using the proceeds from a new $50 million bond issue to call and retire its outstanding $50 million bond issue. The details of both bond issues are outlined in what
For each of the loan amounts, interest rates, loan terms, and annual payments shown in the following table, calculate the annual interest paid each year over the term of the loan, assuming that the
Shredding Pines Company wishes to purchase an asset that costs $750,000. The full amount needed to finance the asset can be borrowed at 9 percent interest. The terms of the loan require equal
What policies and payments comprise a firm’s dividend policy? Why is determining dividend policy more difficult today than in decades past?
Managers of slow- growing, but profitable, firms (i. e., tobacco companies) should pay out these high earnings as dividends. What can they choose to do instead?
How do Miller and Modigliani (M&M) arrive at their conclusion that dividend policy is irrelevant in a world of frictionless capital markets? Why is the assumption of fixed investment policy crucial
During the late 1960s, the top marginal personal income tax rate on dividends, received by British investors, reached 98 percent, yet dividend pay-outs actually increased. How can you justify this
In what way can managers use dividends to con-vey pertinent information about their firms in a world of informational asymmetry? Why would a manager choose to convey information via a dividend
Why is it difficult for a firm with weaker cash flows to mimic a dividend increase undertaken by a firm with stronger cash flows?
According to the residual theory of dividends, how does a firm set its dividend? With which dividend policy is this theory most compatible? Does it appear to be empirically validated?
What do you think the typical stock market reaction is to the announcement that a firm will increase its dividend payment? Why?
Assume you are the sole owner of a profitable, private U. S. corporation. What do you think would be the most tax- efficient method of receiving owner-ship income (via salary, perks, retained
Why should we expect a firm’s stock price to decline by approximately the amount of the dividend payment on the ex-dividend date? Why do U. S. stock prices generally fall by less than the amount of
How do average dividend payout ratios for companies headquartered in English common- law countries compare with those of companies head-quartered in civil law countries? What explains this difference?
If high- dividend stocks offer a higher expected (and required) return than low- dividend stocks, due to the higher personal taxes levied on the former, why don’t corporations simply reduce
Which U. S. industries are characterized by relatively high dividend payout ratios? Are these same industry patterns observed in other industrialized countries? What explains these industry patterns?
What is the basis of the argument that transactions costs provide a reason for firms to pay dividends, and how has the steep decline in transactions costs in recent years affected this argument?
What does it mean to say that dividends are irrelevant in a world without taxes or other market frictions?
How does the fraction of NASDAQ-listed companies that pay regular cash dividends compare to the fraction of NYSE-listed firms that regularly pay dividends? What accounts for this difference?
Compare and contrast the constant payout ratio dividend policy and the constant nominal dividend payment policy. Which policy do most public companies actually follow? Why?
How do the industrial patterns observed for dividend payouts compare to the patterns observed for capital structures? For example, are industries characterized by high dividend payouts also
On January 1, 20069, you examine two unlevered firms that operate in the same industry, have identical assets worth $80 million that yield a net profit of 12.5 percent per year, and have 10 million
A company decides to compete by making a major investment to modernize production facilities. Describe two ways in which meeting this objective might force a firm to sacrifice other objectives.
Firm A competes in a market in which the demand for its product and its selling price are highly un-predictable. Firm B competes in a market in which these factors are much more stable. Which firm
Describe and evaluate the use of return on investment (ROI) and economic value added (EVA) as growth targets in financial planning. Why do firms often use annual growth in sales or assets as a target
Explain the difference between a firm’s sustainable growth rate and its optimal growth rate. In what circumstances is a firm’s optimal growth rate likely to exceed its sustainable rate, and under
Current asset accounts, especially cash and inventory, usually increase at a rate slightly less than the growth rate in sales. Why? If true, what is the implication of this fact for the sustainable
Suppose that a firm follows the matching strategy. Does this imply that the firm’s current assets will equal its current liabilities?
Why do firms prepare cash budgets? How do (a) collection patterns and (b) payment patterns impact the cash budget?
What can be done to deal with uncertainty in the cash budgeting process? Why might an intra-month view of the firm’s cash flows cause a well-prepared cash budget to fail?
Why might pro forma statements and the equation for external funds required yield different projections for a firm’s financing needs?
In what ways can the sustainable growth model highlight conflicts between a firm’s competing objectives?
What is the logic of the percentage-of-sales method for constructing pro forma statements?
Explain the difference between the stock price, the exercise price, and the option premium. Which of these are market prices determined by the forces of supply and demand?
To value options, using the binomial method, is it necessary to know the expected return on the stock? Why or why not?

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