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Questions and Answers of
Corporate Finance
Look back at Section 13.4. Suppose Big Oil is excused from paying taxes. It starts from the financing mix in Table 13.3, and then borrows an additional $200 million from the bank. It then pays out a
Look at our calculation of Big Oil's WACC in Section 13.4.a. Suppose Big Oil is excused from paying taxes. What would be its WACC?b. Now suppose that, after the tax rate has fallen to zero, Big Oil
An analyst at Dawn Chemical notes that its cost of debt is far below that of equity. He concludes that it is important for the firm to maintain the ability to increase its borrowing because if it
"The after-tax cost of debt is lower when the firm's tax rate is higher; therefore, the WACC falls when the tax rate rises. Thus, with a lower discount rate, the firm must be worth more if its tax
Olympic Sports has two issues of debt outstanding. One is a 9% coupon bond with a face value of $20 million, a maturity of 10 years, and a yield to maturity of 10%. The coupons are paid annually.
Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30%, and the current dividend yield is 2%.
Micro Spinoffs Inc. issued 20-year debt a year ago at par value with a coupon rate of 8%, paid annually. Today, the debt is selling at $1,050. If the firm's tax bracket is 35%, what is its
Reliable Electric is a regulated public utility, and it is expected to provide steady dividend growth of 5% per year for the indefinite future. Its last dividend was $5 per share; the stock sold for
Here is some information about Stoke church Inc.: Beta of common stock = 1.2Treasury bill rate = 4%Market risk premium = 7.5%Yield to maturity on long-term debt = 6%Book value of equity = $440
Reactive Industries has the following capital structure. Its corporate tax rate is 35%. What is its WACC?
True or false? a. Smart financial managers know that good financing decisions create as much value for the firm as good investment decisions. b. Competition between investors means that companies can
Look at the terms of the Apple bond issue in Section 14.5. a. Does the company have a call option? b. How much interest is paid on each Apple bond in a year? c. What was the total amount that the
Preferred stock of financially strong firms sometimes sells at lower yields than the bonds of those firms. For weaker firms, the preferred stock has a higher yield. What might explain this pattern?
Other things equal, will the following provisions increase or decrease the yield to maturity at which a firm can issue a bond? a. The borrower has the option to repay the loan before maturity. b. The
Fill in the blanks by choosing the appropriate term from the following list lease, funded, floating-rate, euro-bond, convertible, subordinated, call, sinking fund, prime rate, private placement,
Fill in the blanks in the following passage by choosing the most appropriate term from the following list: debt issues, higher, internally generated cash, lower, risen, financial deficit, fallen,
Common Products has just made its first issue of stock. It raised $2 million by selling 200,000 shares of stock to the public. These are the only shares outstanding. The par value of each share was
a. Rework Table 14.1, supposing that Dow Chemical now issues 10 million shares at $30 a share. Which of the figures would change?b. What would happen to Table 14.1 if instead Dow bought back 10
True or false? a. A company's equity includes both common and preferred stock. b. The sum of common equity and preferred stock is known as net worth. c. As its name implies, preferred stock is a more
a. Venture capital companies know that managers are more likely to work hard if they can be assured of a good steady salary. b. Venture capital companies generally advance the money in stages. c.
a. Is a private placement more likely to be used for issues of seasoned stock or seasoned bonds by an industrial company? b. Is a rights issue more likely to be used for an initial public offering or
Each of the terms listed below on the left is associated with one of the events on the right. Can you match them up? a. Shelf registration b. Firm commitment c. Rights issue A. The underwriter
Complete the passage using the following terms: limited partners, venture capital, private, underwriters, general partners, private equity, corporate ventures, partnerships, private, and angel
Pandora Box Company Inc. makes a rights issue at a subscription price of $5 a share. One new share can be purchased for every five shares held. Before the issue there were 10 million shares
Moonscape has just completed an initial public offering. The firm sold 3 million shares at an offer price of $8 per share. The underwriting spread was $.50 a share. The price of the stock closed at
When Microsoft went public, the company sold 2 million new shares (the primary issue). In addition, existing shareholders sold .8 million shares (the secondary issue) and kept 21.1 million shares.
Having heard about IPO under pricing, I put in an order to my broker for 1,000 shares of every IPO he can get for me. After 3 months, my investment record is as follows:a. What is the average under
Look at the illustrative new-issue prospectus in the appendix.a. Is this issue a primary offering, a secondary offering, or both?b. What are the direct costs of the issue as a percentage of the total
a. The value of the firm does not depend on the fraction of debt versus equity financing. b. As financial leverage increases, the value of the firm increases by just enough to offset the additional
A firm currently has a debt-equity ratio of 1/2. The debt, which is virtually riskless, pays an interest rate of 6%. The expected rate of return on the equity is 12%. What would happen to the
River Cruises (Section 16.1) is all-equity-financed with 100,000 shares. It now proposes to issue $250,000 of debt at an interest rate of 10% and to use the proceeds to repurchase 25,000 shares.
Establishment Industries borrows $800 million at an interest rate of 7.6%. Establishment will pay tax at an effective rate of 35%. What is the present value of interest tax shields if:a. It expects
What is an interest tax shield? How does it increase the size of the "pie" for after tax income stockholders? Explain.
Dusit is financed 30% by debt yielding 8%. Investors require a return of 15% on Dusit's equity.a. What is the company's weighted-average cost of capital if the corporate tax rate is 35%?b. What
a. Financial slack means having cash in the bank or ready access to the debt markets. b. Financial slack is most valuable to firms with few investment opportunities. c. Managers with excessive
Here is Establishment Industries' market-value balance sheet (figures in $ millions):The debt is yielding 7%, and the cost of equity is 14%. The tax rate is 35%. Investors expect this level of
Here are book- and market-value balance sheets of the United Frypan Company:Assume that MM's theory holds except for taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume
a. If the probability of default is high, managers and stockholders will be tempted to take on excessively risky projects. b. If the probability of default is high, stockholders may refuse to
Fill in the missing entries by choosing from the following terms: safe tangible assets, less, pecking order theory, capital, taxable income to shield, interest tax shields, financial distress,
What are the drawbacks of operating a firm that is close to bankruptcy? Give some examples.
For which of the following firms would you expect the costs of financial distress to be highest? Explain briefly. a. A computer software company that depends on skilled programmers to produce new
Alpha Coip, and Beta Corp. both produce turbo encabulators. Both companies' assets and operations are growing at the same rate, and their annual capital expenditures are about the same. However,
Scan the Beyond the Page icon in the margin on page 483 to read about Sealed Air's restructuring. What was the value of financial slack to Sealed Air before its restructuring? What does the success
MM's proposition 1 suggests that in the absence of taxes it makes no difference whether the firm borrows on behalf of its shareholders or whether they borrow directly. However, if there are corporate
River Cruises (see Section 16.1) is all-equity-financed. Suppose it now issues $250,000 of debt at an interest rate of 10% and uses the proceeds to repurchase 25,000 shares. Assume that the firm pays
MM's proposition I, when modified to recognize corporate taxes, suggests that there is a tax advantage to firm borrowing. If there is a tax advantage to firm borrowing, there is also a tax
River Cruises' management now understands that the trade-off theory of optimal capital structure implies managers will increase debt as long as the value of additional interest tax shields exceeds
Let's go back to the Double-R Nutting Company. Suppose that Double-R's bonds have a face value of $50. Its current market-value balance sheet is:Who would gain or lose from the following
When companies announce an issue of common stock, the share price typically falls. When they announce an issue of debt, there is typically only a negligible change in the stock price. Can you explain
River Cruises (see Section 16.1) is all-equity-financed with 100,000 shares. It now proposes to issue $250,000 of debt at an interest rate of 10% and use the proceeds to repurchase 25,000 shares.
What's wrong with the following arguments? a. As the firm borrows more and debt becomes risky, both stock- and bondholders demand higher rates of return. Thus by reducing the debt ratio we can reduce
Reliable gearing currently is all-equity-financed. It has 10,000 shares of equity outstanding, selling at $100 a share. The firm is considering a capital restructuring. The low-debt plan calls for a
"Increasing financial leverage increases both the cost of debt (rdebt) and the cost of equity (requity). So the overall cost of capital cannot stay constant." This problem is designed to show
Astromet is financed entirely by common stock and has a beta of 1.0. The firm pays no taxes. The stock has a price-earnings multiple of 10 and is priced to offer a 10% expected return. The company
Cash Cow International paid a regular quarterly dividend of $.075 a share. a. Match each of the following dates to the correct term: i. May 7 ii. June 6 ii. June 7 iv. June 11 v. July 2 A. Record
Mr. Milquetoast is enthusiastic about the prospects for Face book. He wants to invest $100,000 in the stock, but hesitates because Face book has never paid a dividend. He needs to generate $5,000 per
Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year's earnings are forecast at $56 million. There are 10 million outstanding shares. The company has
Consolidated Pasta is currently expected to pay annual dividends of $10 a share in perpetuity on the 1 million shares that are outstanding. Shareholders require a 10% rate of return from consolidated
Respond to the following two statements: a. "MM say that investors are equally happy with a dollar of dividends and a dollar of capital gains. That's crazy. Everyone knows that dividends are stable
You own 2,000 shares of Patriot Corporation, which is about to double its dividend from $.75 to $1.50 per share. You do not need the extra dividend income, but you don't want to sell out. What would
Go back to the first Hewlard Pocket balance sheet. Pocket needs to hold on to $50,000 of cash for a future investment. Nevertheless it decides to pay a cash dividend of $2 per share, and to replace
Go back again to the first Hewlard Pocket balance sheet. Now assume that Pocket wins a lawsuit and is paid $100,000 in cash. The market value of the equity rises by that amount, and Pocket decides to
a. A corporation cannot pay a dividend if its legal capital is impaired or if it is insolvent. b. The effective tax rate on capital gains can be less than the stated rate. c. Managers and investors
The expected pretax return on three stocks is divided between dividends and capital gains in the following way:a. If each stock is priced at $100, what are the expected net returns on each stock to
Good Values Inc. is all-equity-financed. The total market value of the firm currently is $100,000, and there are 2,000 shares outstanding. Ignore taxes. a. The firm has declared a $5 per share
Investors require an after-tax rate of return of 10% on their stock investments. Assume that the tax rate on dividends is 30% while capital gains escape taxation. A firm will pay a $2 per share
Prowler Corporation wants to increase its debt ratio without changing its operations or capital investment outlays. Obviously Prowler will have to increase borrowing, but how should it reduce equity?
MM show that in an idealized setting, firm value is not affected by payout policy. Yet we observe that more mature firms regularly pay higher dividends than do younger ones. Is this purely
In Section 17.2, we report results of a survey about corporate dividend policy. How might the tendencies documented in that survey result in more mature firms exhibiting systematically higher
Would you predict that mature or younger firms make greater use of repurchases relative to dividends? Why might one of these payout tools be better suited to younger firms?
Big Industries has the following market-value balance sheet. The stock currently sells for $20 a share, and there are 1,000 shares outstanding. The firm will either pay a $1 per share dividend or
Suppose that you own 1,000 shares of Nocash Corp. and the company is about to pay a 25% stock dividend. The stock currently sells at $100 per share.a. What will be the number of shares that you hold
a. A company can keep repurchased stock in its treasury and reissue it later. b. The most common method for repurchasing stock is by auction. c. A greenmail transaction is one in which the target of
Which of the following newspaper headlines would have the greatest positive impact on stock price? Explain a. "Growler Corporation announces a $ 1 increase in its regular dividend." b. "Growler
Why are dividend increases typically good news for investors and dividend cuts bad news? Explain briefly.
The following tables contain financial statements for Dynastatics Corporation. Although the company has not been growing, it now plans to expand and will increase and fixed assets (that is, assets
Eagle Sports Supply has the following financial statements. Assume that Eagle's assets are proportional to its sales.INCOME STATEMENT, 2015Sales .................. $950Costs ..................
Find the sustainable and internal growth rates for a firm with the following ratios: Asset turnover = 1.40; Profit margin = 5%; Payout ratio = 25%; Equity/assets = .60.
If Planner's Peanuts dividend payout ratio in Problem 9 is fixed at 50%, calculate the required total external financing for growth rates in 2016 of 15%, 20%, and 25%.
What is the maximum possible growth rate for Planner's Peanuts if the payout ratio remains at 50% and:a. No external debt or equity is to be issued?b. The firm maintains a fixed debt ratio but issues
Executive Fruit's financial manager believes that sales in 2015 could rise by as much as 20% or by as little as 5%.a. Recalculate the first-stage pro forma financial statements (Table 18.5) under
Plank's Plants had net income of $2,000 on sales of $50,000 last year. The firm paid a dividend of $500. Total assets were $100,000, of which $40,000 was financed by debt.a. What is the firm's
A firm has decided that its optimal capital structure is 100% equity-financed. It perceives its optimal dividend policy to be a 40% payout ratio. Asset turnover is sales/assets = .8, the profit
Go-Go Industries is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 25%. Its plowback ratio is 40%.a. What is the internal growth
An all-equity-financed firm plans to grow at an annual rate of at least 10%. Its return on equity is 18%. What is the maximum possible dividend payout rate the firm an maintain without resorting to
Suppose the firm in the previous question has a debt-equity ratio of 1/3. What is the maximum dividend payout ratio it can maintain without resorting to any external financing?
A firm has an asset turnover ratio of 2.0. Its plowback ratio is 50%, and ii is all-equity-financed. What must its profit margin be if it wishes to finance 10% growth using only internally generated
Use Spreadsheet 18.1 to answer the following questions about Executive Fruit. a. What would be the required external financing if the growth rate is 15% and the dividend payout ratio is 60%? b. Given
The 2015 financial statements for Growth Industries are presented below. Sales and costs in 2016 are projected to be 20% higher than in 2015. Both current assets and accounts payable are projected
Now suppose that the fixed assets of Growth Industries (from the previous problem) are operating at only 75% of capacity. What is the required external financing over the next year?
If Growth Industries from Problem 27 is operating at only 75% of capacity, how much can sales grow before the firm will need to raise any external funds? Assume that once fixed assets are operating
Managers sometimes state a target growth rate for sales or earnings per share. Do you think that either makes sense as a corporate goal? If not, why do you think that managers focus on them?
Percentage of sales models usually assume that costs, fixed assets, and working capital all increase at the same rate as sales. When do you think that these assumptions do not make sense? Would you
What are the possible choices of balancing items when using a financial planning model? Discuss whether some are generally preferable to others.
How would Executive Fruit's financial model change if the dividend payout ratio were cut to 1/3? Use the revised model to generate a new financial plan for 2015 assuming that debt is the balancing
Here are the abbreviated financial statements for Planner's Peanuts:If sales increase by 20% in 2016 and the company uses a strict percentage of sales planning model (meaning that all items on the
The corporate form of organization is superior to other forms when it comes to raising money and transferring ownership interest, but it has the significant disadvantage of double taxation.
Ritter Corporaton's accountants prepared the following financial statements for year-end 2010:a. Explain the change in cash during 2010.b. Determine the change in net working capital in 2010.c.
Ramey, Inc., has sales of $14,900, costs of $5,800, depreciation expense of $1,300, and interest expense of $780. If the tax rate is 40 percent, what is the operating cash flow, or OCF?
Referring back to the D.R. Horton example at the beginning of the chapter, note that we suggest that D.R. Horton's stockholders probably didn't suffer as a result of the reported loss. What do you
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