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Questions and Answers of
Corporate Finance
In the past, a fast-growing mobile telecommunications company has always capitalized its customer acquisition costs. For the next few years, management expects growth in its customer base to slow
Under what conditions might the stock market fail to reflect economic fundamentals?
In which of the following markets would you expect market mispricing to be more likely or less likely to occur: the market for equity stocks, fine arts, foreign currency, securitized debt
Over the past five years, the highest share price for Google was around $700 and its lowest price was around $175. Exxon’s highest and lowest share prices over the same period were $94 and $32. Do
Discuss the possible factors underlying differences in price for the same stock on two different markets, such as the spread between the London and New York prices for a share of Shell’s common
Why is it much more risky to take a short position in a stock than a long position? What does that mean for the likelihood of over- versus undervaluation of a company’s share price?
Discuss the key differences between the stock market downturn in 2001 and the one in 2008.
Discuss the pros and cons of introducing regulatory restrictions on short selling in an equity market.
What are the key strategic and tactical opportunities for an industrial company in case of general stock market overvaluation (and undervaluation)? What is typically preventing companies from
Why do executives spend so much time and effort on communicating with noise traders if intrinsic investors ultimately drive a company’s share price?
Would a company’s share price benefit from having fewer traders and more fundamental investors among the company’s shareholders?
Following the investor model presented in this chapter, what returns do noise traders make on their investments in the long term: negative returns, returns around zero, or positive returns? What
Why do noise traders have limited impact on a company’s share price even when they make the largest volume of trades in the company’s stock over a given time period?
Consider two companies that are identical except for their shareholder base. One company’s shareholders comprise mostly noise traders, with mechanical investors making up the remainder. The
Why could it be important for executives to understand the composition of their company’s shareholder base?
Do you think it is possible for a company to shape its shareholder base to maximize its share price? What would a company have to do?
Assuming that fundamental investors ultimately set a company’s share price, name two reasons why you could still expect the price to show significant volatility.
Explain why the value of a business may differ under different owners.
What are the potential sources of value that the best owner brings to a business? Share examples.
What are some impediments to matching the best potential owner to a business?
Provide examples of how the best owner of a business has changed over time. Give reasons for these changes.
Explain how and why the best owner of a business might change over time.
What are the steps involved in constructing a portfolio? Discuss potential hurdles in executing the analytic approach.
Should a company operate a diversified portfolio of businesses? What are the arguments for and against?
What are the benefits to society when a business is owned by its best owner?
Compare and contrast the value driver approach to performance measurement with the balanced scorecard approach.
What is the goal of setting performance targets? What are some of the pitfalls inherent in the way companies sometimes set targets?
Provide some examples of potential short-term operating metrics for a company that you are familiar with.
Provide some examples of potential medium-term value drivers for a company that you are familiar with.
Construct three different value driver trees for a company, using different branches.
How can an acquisition create value for the combined entity’s shareholders but not for the acquirer’s shareholders?
What are the pros and cons of measuring the success or failure of an acquisition by immediate stock price reactions to its announcement? When is this approach most likely to provide insights?
Describe the five acquisition archetypes that often create value for both the acquirer and the seller. Based on situations with which you are familiar, rank these archetypal strategies from easiest
What would it take for an acquisition to increase the acquirer’s value by 10 percent? Give your answer in terms of size of deal, value of improvements, and premium paid.
Describe the circumstances under which the acquirer is better off paying in stock rather than cash. What are the implications for the acquirers’ shareholders of paying in stock?
Why is it hard for acquirers simply to buy cheap?
Describe some important techniques for estimating potential operating improvements on the basis of only published information.
Explain under what conditions a divestiture will lead to EPS dilution or accretion if the proceeds from the divestiture are used: (1) to repay debt; (2) to repurchase shares. How do your answers
Describe the key reasons why divesting a business can create value for shareholders, even when the business is still in the early stages of its life cycle.
Identify and explain the significance of four factors that complicate a manager’s decision to divest a business unit.
A company intends to sell one if its larger business units to a strategic buyer. The company’s controller is concerned because the sale would result in overcapacity of 25 percent in the company’s
An executive is reluctant to sell a high-performing business unit, arguing that the sale would dilute the company’s ROIC to a level below the WACC and make the company value-destroying. Discuss.
Identify and describe two private transaction approaches to corporate divestiture and two public transaction approaches. When are private transactions likely to create more value than public
An oil company wants to divest its low-growth chemicals division, which has an estimated stand-alone value of around $5 billion and represents around 40 percent of the entire oil company’s value.
Define optimal capital structure. What is the relationship between optimal capital structure, corporate value, and cost of capital? How does the concept of effective capital structure differ from
Some companies carry essentially no long-term debt and only a minimal amount of short-term debt in their capital structure. Review the balance sheets of Google and Novartis. Provide an explanation
The degree of company financial risk is measured and reported by independent rating agencies such as Standard & Poor’s and Moody’s. What factors do these rating agencies evaluate when determining
Explain why companies with the same credit rating can have very different capital structures.
Describe a process a manager should employ to establish an effective capital structure target.
Start-up companies typically have little or no debt. Discuss if and how this fits with value maximization given the cost-benefit trade-offs between different levels of debt and tax savings,
Discuss the importance of the “pecking order” theory for managing the capital structure of a company, in terms of both short-term, tactical financing decisions and long-term, strategic decisions.
For which company would you think the issuance of a convertible bond makes more sense: BMW or Tesla? Explain why.
What is the purpose of investor communications? What do managers often believe the purpose is?
Why does a gap between a company’s intrinsic value and its market value raise issues for the company’s executives?
Do companies typically have a substantial gap between their market value and their intrinsic value? Give reasons for your answer.
What are the three main areas where a company can focus its attention in order to improve its investor communications?
Company shares are often categorized as growth stocks or value stocks by certain agencies. Why are these labels misleading? What is the difference between growth and value stocks?
Why is it beneficial for a company to provide more information to the investors than is required by regulators and GAAP?
What do executives believe are the benefits of issuing EPS guidance? Are these benefits actually realized by companies?
1. Exhibit 25.9 presents the tax reconciliation table for ToyCo, a $5 billion designer and distributor of children's toys. Convert the tax table from percent to $ millions. Separate the converted tax
Exhibit 25.5 presents two approaches for estimating operating taxes. Use both methods to determine the operating taxes for ToyCo in year 3. What are ToyCo's statutory rate, effective tax rate, and
When a company incorporated in a country with a high tax rate does business in countries with lower tax rates, it will report an effective tax rate below its statutory rate. Is the difference
Exhibit 25.10 presents deferred tax assets and liabilities for ToyCo. Using Exhibit 25.7 as a guide, reorganize the deferred tax table into three categories: net operating deferred tax liabilities
ToyCo has working capital of $400 million, fixed assets equal to $800 million, and debt equal to $600 million. Use this data and the reorganized deferredtaxes in Question 4 to create invested capital
One of the most common deferred tax liabilities occurs because of accelerated depreciation. When is the difference between reported taxes and cash taxes likely to be greatest? When will it be
Using an Internet search tool, locate Procter & Gamble's investor relations web site. Under "Financial Reporting," you will find the company's 2009 annual report. Procter & Gamble has a very
ValueCo generates $10 million in after-tax operating profit on $100 million in assets. The company has $20 million in accounts payable, $15 million in product warranty reserves, $5 million in
In year 0, SmoothCo has $50 million in cash and $50 million in inventory, financed by $100 million in equity. In year 1, the company records $100 million in revenue, $80 million in operating costs,
Companies in highly competitive industries often see a number of consecutive restructuring charges. In these cases, should restructuring be treated as operating or nonoperating? From a valuation
Casher Industries leases a significant portion of its assets, expecting $25 million in rental expense next year. Casher Industries can borrowat 7 percent and the average life of leased assets is
Casher Industries expects to earn $25 million in operating profit next year.The company pays an operating tax rate of 30 percent and a marginal tax rate of 35 percent. Using the lease data provided
Many financial analysts estimate the value of operating leases by discounting rental payments provided in the annual report at the cost of debt. Is this method likely to overestimate or underestimate
Many companies securitize their accounts receivable. Name two ways the cost for securitizing receivables is recognized. If you decide to capitalize securitized receivables, when is an expense
Using an Internet search tool, locate Procter & Gamble's investor relations web site. Under "Financial Reporting," you will find the company's 2009 annual report. In Note 8 of the annual report
Using an Internet search tool, locate Procter & Gamble's investor relations web site. Under "Financial Reporting," you will find the company's 2009 annual report. In the balance sheet, there is
ResearchCo is a medical devices company, producing equipment for diagnosing and treating heart disease. The company currently generates$100 million in revenues and is expected to grow 10 percent per
Your colleague argues that R&D for ResearchCo should be capitalized and amortized. If R&D is capitalized, what is the starting R&D asset, investment in R&D, amortization of R&D,
Use the R&D capitalization table developed in Question 2 to modify NOPLAT and invested capital from Question 1. What is the ROIC on yearend capital by year? How does this compare to the ROIC computed
Compute the annual free cash flow for ResearchCo with and without the capitalization of R&D.Howdo the two sets of free cash flows differ? Assume no depreciation of physical assets.
Why does high inflation typically destroy value for companies?
Which company’s ROIC would you expect to go up more in times of inflation: a company with long-lived assets or one with short-lived assets, everything else being equal?
Describe the impact of high inflation on the financial statements of a company. What unique challenges does inflation present for analysis of historical performance?
Explain how an increase in inflation affects a company’s tax shields from depreciation and the resulting impact on the company’s value.
Describe the five-step approach to combining nominal and real forecasts.
Assume that inflation unexpectedly increases by 10 percent. Explain why a company’s ROIC then needs to increase by more than 10 percent to preserve its shareholder value.
Assume a high-inflation scenario in which a manufacturing company does not grow in real terms, and maintains its inventory of raw materials constant relative to sales. Does the company need to invest
In conditions of high inflation, nonmonetary assets tend to be stated on the balance sheet at values far below their replacement costs. Inventory accounting can further complicate historical analysis
Many companies use economists’ forecasts of foreign exchange rates to translate cash flow projections denominated in foreign currency. What are the possible drawbacks of using such forecasts?
Why do local market risk premiums differ across national stock markets? Do the differences mean that some markets are more attractive to invest in than others?
Are there conditions under which you should consider using a local market risk premium and a local beta estimate for a valuation rather than a global risk premium and beta?
What impact does the globalization of capital markets have on a manager’s judgment of the appropriate cost of capital to employ when estimating the value of a subsidiary headquartered in a foreign
U.S. GAAP and IFRS accounting standards are converging. Since this is the case, why would a manager need to understand the historical differences between these standards?
Discuss the differences between the current, temporal, and inflationadjusted current methods for translating the financial statements of acquisitions or divisions located in moderately inflationary
Define contingent net present value (NPV). Outline and explain the differences between standard and contingent NPV.
Identify the value drivers embedded in a “real” option and how they might interact.
Assume a company runs a plant for which the value one year from now is either $1,000 if market growth is positive or $250 if market growth is negative. The probability of positive market growth is
Under what circumstances should a manager apply a standard NPV approach, a DTA approach, or an ROV approach to valuation?
It is often argued that the two most important real options available to a manager evaluating investment decisions are the option to defer an investment decision and the option to abandon an
The option to defer an investment reduces risk for a company because it does not need to commit the full investment outlay until there is more certainty about the true value of the underlying asset.
When estimating the value of an option on a traded stock, the expected return on the stock is irrelevant—as proven in option pricing theory. For the valuation of an option on an asset that is not
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