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Questions and Answers of
Corporate Finance
There is an old saying that nature abhors a vacuum. The financial equivalent is markets abhor arbitrage opportunities. Explain the central role this principle plays in the binomial model.
How are employee stock options different from the options that trade on the exchanges and in the over-the-counter market?
What is the most important reason why firms should be required to show an expense on their income statement for employee stock options?
Explain the difference between a long position and a short position. Considering call options, what is the maximum gain and loss possible for an investor who holds the long position? What is the
What would happen if an investor who owned a share of a particular stock also bought a put option, with a strike price of $ 50, and sold a call option, with a strike price of $ 50? Try to draw the
Is selling a call the same thing as buying a put? Explain why or why not.
Throughout most of this book, we have shown that if an assets risk increases its price declines. Why is the opposite true for options?
Put options increase in value as stock prices fall, and call options increase in value as stock prices rise. How can the same movement in an underlying variable (e. g., an increase either in time
Look at the Opti-tech call option prices in Table. Call prices increase as the strike price decreases, holding the expiration month constant. The strike prices decrease in increments of $2.50. Do
Refer to the data in the following table.Strike Price Put Price$30 ………………. $1.00$35 ………………. $3.50$40
Suppose that Lisa Emerson owns a share of Zytex Chemical stock which is worth $100 per share. Lisa purchases a put option on this stock with a strike price of $95 and she sells a call option with a
Why are acquired resources integrated into a company in so many different forms? What transaction-specific circumstances might lead to a preference of one integrative form over another?
What characteristics surrounding a merger would lead you to conclude that it is motivated by value-maximizing managers rather than non-value-maximizing managers? What actions could directors or
If you wanted to expand your operations into a foreign country with nebulous laws and an unstable political climate, would you favor internal or external expansion? Why?
What is the free cash flow theory of mergers? Why do you think that managers might be tempted to pursue size-increasing mergers even when these do not maximize value?
Which industries do you anticipate will experience industry shocks that will spur merger activity in the near future?
How does the dynamic interpretation of antitrust laws affect managers acquisition strategies? What impact does the involvement of individual states have on the acquisition decision?
How does a tender offer differ from a proxy fight? Why might these two corporate control actions be considered different ways to achieve the same objective?
What is the purpose of classifying mergers by degree of business concentration? Why do you think these classifications have changed over time?
As conglomerate mergers and corporate diversification have proven to be failures in general, why would any manager pursue these objectives? Can you think of any cases where corporate diversification
What is a Herfindahl Index, and what is it meant to measure?
What are the two most important methods of paying for corporate acquisitions?
What is goodwill in the context of merger accounting? What must an acquiring company do if the value of an acquired company is revealed to have declined after a merger?
Who wins and who loses in corporate takeovers? Why does acquiring firm shareholders generally lose in stock- swap mergers but either benefit or at least break even in acquisitions paid for with cash?
What is the purpose of the Williams Act? What are the specific provisions of the act? Discuss.
Elaborate on the significance of the mode of payment for the stockholders of the target firm and their continued interest in the surviving firm. Specifically, which form of payment retains the
Relate the industry shock theory of mergers to the history of merger waves. What were the motivating factors for increased merger activity in each of the five major merger waves?
Under what conditions would external expansion be preferable to internal expansion? What is the ultimate decision criterion for determining the acceptability of any expansion strategy?
Delineate the value-maximizing motives for mergers. How are these motives interrelated?
What is the meaning of risk management?
Explain the objectives of risk management both before and after a loss occurs.
What conditions should be fulfilled before retention is used in a risk management program?
A group of investors are discussing the formation of a new property and liability insurer. The proposed company would market a new homeowner’s policy that combines traditional homeowner coverages
Explain the legal distinction between an agent and a broker.
Who owns the policy expirations or the renewal rights to the business under the independent agency system?
Based on the following information, determine the policyholders’ surplus for XYZ Insurance Company:Total invested assets ....... $50,000,000Loss reserves ............ 40,000,000Total
What are the major categories of expenses for a life insurance company?
Explain the principal methods for regulating insurance companies.
Nicholas owns a laptop computer that was stolen. The laptop cost $1000 when it was purchased five years ago. A similar laptop computer today can be purchased for $500. Assuming that the laptop was 50
Megan owns an antique table that has a current market value of $12,000. The table is specifically insured for $12,000 under a valued policy. The table is totally destroyed when a tornado touches down
Megan, age 32, is married and has a son, age 1. She recently purchased a cash-value life insurance policy that has the following characteristics: • The frequency and amount of premium payments are
Todd, age 28, would like to save money for a comfortable retirement. He is considering Purchasing a cash-value life insurance policy that has the following characteristics:• The premiums are
How does an annuity differ from life insurance?
Identify the annuity settlement options that are typically found in a fixed annuity.
Explain the eligibility requirements for a traditional IRA.
Jennifer, age 28, is divorced and has a son, age one. Six months ago, Jennifer purchased an individual medical insurance policy covering the entire family. Her son was recently diagnosed with
Brandon, age 23, recently graduated from college. He is insured as a dependent under his father’s group health insurance policy, which provided coverage for him as a student until he graduated.
Describe briefly the major health-care problems in the United States
Identify the optional benefits that can be added to a disability-income policy.
Doug, age 40, is the owner of a small firm that sells window blinds and cleans carpets. The company provides health insurance for seven employees. The wife of one employee has breast cancer and has
Ken, age 52, works only part-time and has no health insurance. The cartilage in both his knees is severely eroded from osteoarthritis, which causes severe pain during his daily activities. As a
Explain the definition of disability used in the OASDI program.
The Social Security Administration has several benefit calculators available on its Web site. The “Quick Calculator” will give you a rough estimate of your retirement benefits. Benefit estimates
Explain the meaning of imputed negligence.
Explain the meaning of res ipsa loquitur.
The PAP provides coverage for your covered auto. Identify the four classes of vehicles that are considered to be covered autos.
Does the PAP cover you if you are driving a vehicle in a foreign country? Explain your answer.
James, age 18, lives at home and occasionally drives the car of his friend, Mary. Mary carries $300,000 of liability insurance on her car under a PAP. James is also insured under his mother’s PAP,
Explain how personal liability insurance can be added to a dwelling policy.
Identify the coverage found in a typical boat owner’s package policy.
What is the purpose of a FAIR plan?
Delivery Service purchased a commercial umbrella policy with a $10 million liability limit and a $100,000 self-insured retention. The umbrella insurer required Delivery Service to carry a $1 million
Richard owns several retail stores. The employees are insured for employee theft under a commercial crime coverage form (loss-sustained form) with an insurance limit of $10,000. Richard discovered
Identify the major risks faced by business firms.
Can our goal of maximizing the value of the shareholders’ wealth conflict with other goals, such as avoiding unethical or illegal behaviour? In particular, do you think that topics such as customer
What are the major types of financial institutions and financial markets in Canada?
What are some major trends in Canadian financial markets? Explain how these trends affect the practice of financial management in Canada.
How does tax treatment of investment income differ among interest, dividends, and capital gains?
Explain how carryback/carryforward provisions and investment tax credits reduce corporate taxes.
Corporation X has $100,000 in taxable income, and Corporation Y, a manufacturer, has $1 million in taxable income.a. What is the tax bill for each firm in Ontario?b. Suppose both firms have
Mary Song, a Toronto investor, receives $10,000 in dividends from B.C. Forest Products shares, $10,000 in interest from a deposit in a chartered bank, and a $10,000 capital gain from selling Central
In Problem 3.9, suppose the firm wishes to keep its debt-to-equity ratio constant. What is EFN now?
Redo Problem 3.10 using sales growth rates of 30 percent and 35 percent in addition to 20 percent. Illustrate graphically the relationship between EFN and the growth rate, and use this graph to
Using the definitions below, show that EFN can be written asEFN = – PM(S)b + [A – PM(S )b] × gAsset needs will equal A × g. The addition to retained earnings will equal PM(S)b × (1 + g).S =
The most recent financial statements for Fontenot Co. are shown here:Assets and costs are proportional to sales. The company maintains a constant 30 percent dividend payout ratio and a constant
If the Layla Corp. has a 15 percent return on equity and a 10 percent dividend payout ratio, what is its sustainable growth rate?
The most recent financial statements for Bradley Inc. are shown here (assuming no income taxes):Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid. Next
The Steiben Company has a return on equity of 13.1 percent and a dividend payout ratio of 40 percent.a. What is the company’s sustainable growth rate?b. Can the company’s actual growth rate
The Optical Scan Company has forecast a 20 percent sales growth rate for next year. The current financial statements are shown here:a. Using the equation from the chapter, calculate the EFN for next
The most recent financial statements for Moose Tours Inc. appear below. Sales for 2016 are projected to grow by 20 percent. Interest expense will remain constant; the tax rate and the dividend payout
Currently, Jack Morris makes $85,000 per annum. Next year his income will be $108,000. Jack is a big spender and he wants to consume $135,000 a year. The equilibrium interest rate is 7 percent. What
Rachel Pettit is a miser. Her current income is $55,000; next year she will earn $38,000. She plans to consume only $20,000 this year. The current interest rate is 9 percent. What will
Ben earns $4,000 this year and zero income the next year. Ben also has an investment opportunity in which he can invest $2,000 and receive $3,000 next year. Suppose Ben consumes $1,000 this year,
What is the basic reason that financial markets develop?
Suppose that the equilibrium interest rate is 5.3 percent. What would happen in the market if a group of financial intermediaries attempted to control interest rates at 4 percent?
The following figure depicts the financial situation of Jane Fawn. In period 0, her labour income and current consumption are $50; later, in period 1, her labour income and consumption will be $44.
Enrique Rodrigues has $54,300 this year, as represented by point A. He has the opportunity to make an investment in productive assets represented by point B in the following figure. He wants to
To answer this question, refer to the figure below. The Badvest Corporation is an all-equity firm with BD in cash on hand. It has an investment opportunity at point C, and it plans to invest AD in
Assume that capital markets do not exist. Ryan has $70,000 today (t = 0) and will receive $90,000 in exactly one year (t = 1). The graph below illustrates point Y: having $70,000 now and receiving
Argos Corp. has 9 percent coupon bonds making annual payments with a YTM of 7.81 percent. The current yield on these bonds is 8.42 percent. How many years do these bonds have left until they mature?
You’ve just found a 10 percent coupon bond on the market that sells for par value. What is the maturity on this bond?
Bond P is a premium bond with a 9 percent coupon. Bond D is a 5 percent coupon bond currently selling at a discount. Both bonds make annual payments, have a YTM of 7 percent, and have 10 years to
The YTM on a bond is the interest rate you earn on your investment if interest rates don’t change. If you actually sell the bond before it matures, your realized return is known as the holding
Microhard has issued a bond with the following characteristics:Par: $1,000Time to maturity: 15 yearsCoupon rate: 7 percentSemiannual paymentsCalculate the price of this bond if the YTM isa. 7
For the company in Problem 6.19, what is the dividend yield? What is the expected capital gains yield?Problem 6.19The next dividend payment by ECY Inc. will be $3.20 per share. The dividends are
White Wedding Corporation will pay a $3.05 per share dividend next year. The company pledges to increase its dividend by 5.25 percent per year, indefinitely. If you require an 11 percent return on
Ayden Inc. has an issue of preferred stock outstanding that pays a $5.90 dividend every year, in perpetuity. If this issue currently sells for $87 per share, what is the required return?
Watters Umbrella Corp. issued 12-year bonds two years ago at a coupon rate of 7.8 percent. The bonds make semiannual payments. I these bonds currently sell for 105 percent of par value, what is
North Side Corporation is expected to pay the following dividends over the next four years: $10, $7, $6, and $2.75. Afterwards, the company pledges to maintain a constant 5 percent growth rate in
Janicek Corp. is experiencing rapid growth. Dividends are expected to grow at 30 percent per year during the next three years; 18 percent over the following year; and then 8 percent per year,
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