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Questions and Answers of Finance

The Locke Corporation has just leased a metal-bending machine that calls for annual lease payments of $30,000 payable in advance. The lease period is six years, and the lease is classified as a
Define the conversion price of a convertible debenture, the conversion ratio, the conversion value, the premium over conversion value, and the premium over straight bond value.
If the desire of a company in selling convertible securities is delayed equity financing, would it be wise to establish at the time the security is initially sold a step-up in conver¬sion price
Why would an investor want to invest in warrants as opposed to common stock?
As a lender, how attractive are warrants to you as a "sweetener"? Will you give terms more favorable than you otherwise would? Explain.
Why is unlimited upside potential and a lower (price) boundary of zero attractive to investors in a warrant? If the common stock were highly volatile, would this be a good or a bad thing?
With option financing, such as convertible securities and debt issues with warrants attached, does the company get something (a lower interest cost) for nothing?
How does an exchangeable bond differ from a convertible bond? How is the bond the same?
With respect to valuation, is the investor better off with an exchangeable bond or with a convertible bond?
This chapter argues that convertible securities are a form of delayed equity financing allowing the sale of equity at a 10 to 20 percent premium over current market price. Yet most convertibles are
If convertible securities can be issued at a lower effective interest rate than long-term bonds, why would a company ever issue straight debt?
Some warrants have a current theoretical value of zero and yet sell for positive prices. Explain why.
Suppose that you are the financial manager of a closely held (owned by few shareholders) small electronics firm. You have a favorable investment opportunity and are considering raising funds to
What reasons can you offer for the use of warrants by small, rapidly growing companies?
Why does the market price of an option such as a warrant usually exceed its value as common stock?
The common stock of the Blue Sky Corporation earns $3 per share, has a 60 percent dividend payout, and sells at a P/E ratio of 8.333. Blue Sky wishes to offer $10 million of 9 percent, 20-year
Suppose you have just bought a warrant that entitles you to purchase two shares of common stock for $45. The market price of the common stock is $26 per share, whereas the market price of the
Assume that the Blue Sky Corporation (in Problem 1) could sell $10 million in straight debt at 12 percent as an alternative to the convertible issue. Compute the earnings per share and earnings
Faversham Fish Farm has outstanding a 7.75 percent, 20-year convertible debenture issue. Each $1,000 debenture is convertible into 25 shares of common stock. The company also has a straight debt
The following year, Faversham Fish Farm (see Problem 3) flounders. Its stock price drops to $10 per share and the market price of the convertible debentures to $440 per debenture. The straight bond
The Rambutan Fruit Company needs to raise $10 million by means of a debt issue. It has the following two alternatives: a 20-year, 8 percent convertible debenture issue with a $50 conversion price and
Singapore Enterprise is considering an exchangeable bond issue where each bond can be exchanged for 162A shares of Malaysian Palm Oil Company. The latter company's stock is currently selling for $50
Using Eq. (22.3), compute the theoretical value of each of the following warrants:
Alexander Zinc Company called its 7 percent convertible subordinated debentures for redemption at the end of last month. The call price was 106 ($1,060 per $1,000 face value). A holder of a $1,000
Jenni Shover, Inc., has warrants outstanding that allow the holder to purchase three shares of common stock for a total $60 for each warrant that is held. Currently, the market price per share of
How does the "current" purchase method of accounting treat an acquisition? How does this differ from the "old" purchase method?
Why does it matter whether an acquisition is made with cash or with common stock?
As a shareholder in a company, would you like it to have antitakeover amendments? What are some of these devices?
In your opinion, does the threat of a tender offer lead to better management of corporations?
In corporate restructuring (broadly defined), what are the principal sources of value creation?
How does a partial sell-off differ from a spin-off? How does an equity carve-out differ from a partial sell-off and a spin-off?
What are the motivations for going private? Do the shareholders who are bought out gain anything?
Much has been written about leveraged buyouts (LBOs). Are they a good thing?
Illustrate and explain how the ratio of P/E multiples for two merged firms affects the earnings per share of the surviving firm.
What is the incentive for senior lenders and junior subordinated lenders to finance a leveraged buyout? Are there risks to them?
With a common-stock-for-common-stock acquisition, is it better to analyze the situation on a cash-flow basis or to look more to the acquisition's effect on the surviving firm's earnings per share?
It has been noted that the number of mergers tends to vary directly with the level of relative business activity. Why would this be?
Both Company X and Company Y have considerable variability in their earnings, but they are in unrelated industries. Could a merger of the two companies reduce the risk for shareholders of both
Many a corporate merger is made with the motive of increasing "growth." What does this growth refer to? Can you increase growth without increasing the overall risk of the surviving company?
Why is it that so many acquisition opportunities look good before the merger but later prove to be "dogs"?
Is an acquisition-minded company consistently able to find bargains? If so, why is it that other companies do not discover these bargains?
When evaluating a potential acquisition's future, why penalize the prospect by deducting the capital expenditures that will need to be made when performing a cash-flow analysis? Are not future
The following data are pertinent for Companies A and B:a. If the two companies were to merge and the share exchange ratio were 1 share of Company A for each share of Company B, what would be the
Hogs Breath Inns, a chain of restaurants, is considering going private. The president, Clint Westwood, believes that with the elimination of shareholder servicing costs and other costs associated
Donatello Industries wishes to sell its sewer pipe division for $10 million. Management of the division wishes to buy it and has arranged a leveraged buyout. Management will put up $1 million in
Merry Land Company, an amusement park in Atlanta, has experienced increased difficulty in paying its bills. Although the park has been marginally profitable over the years, the current outlook is not
The Fias Company is in Chapter 11. The trustee has estimated that the company can earn $1.5 million before interest and taxes (40 percent tax rate) in the future. In the new capitalization, the
Facile Fastener Company had the following liabilities and equity position when it filed for bankruptcy under Chapter 11 (in thousands):After straightening out some operating problems, the company is
The Schoettler Company wishes to acquire the Stevens Company. If the merger were effected through an exchange of stock, Schoettler would be willing to pay a 25 percent premium for the Stevens shares.
Assume the exchange of Schoettler shares for Stevens shares as outlined in Problem 2. a. What is the share exchange ratio? b. Compare the earnings per Stevens share before and after the merger.
Copper Clapper Company currently has annual earnings of $10 million with 4 million shares of common stock outstanding and a market price per share of $30. In the absence of any mergers, Copper
The Byer Corporation, which has a 16 percent after-tax cost of capital, is considering the acquisition of the Cellar Company, which has about the same degree of systematic risk. If the merger were
Valdez Coffee Company is considering the cash acquisition of Mountain Creamery, Inc., for $750,000. The acquisition is expected to result in incremental cash flows of $100,000 in the first year, and
Bigge Stores, Inc. (BSI), has acquired the L. Grande Company (LGC) for $4 million in stock and the assumption of $2 million in LGC liabilities. The balance sheets of the two companies before the
Leonardo Company has three divisions, and the total market value (debt and equity) of the firm is $71 million. Its debt-to-market-value ratio is 0.40, and bond indentures provide the usual protective
Lorzo-Perez International has a subsidiary, the DelRay Sorter Company. The company believes the subsidiary on average will generate $1 million per year in annual net cash flows after necessary
Is the risk-reward trade-off the same with an international investment as it is with a domestic investment?
Should purchasing-power parity always hold in international markets? Explain.
What is meant by interest-rate parity? Does it work?
Why should a company manage its currency-risk exposure? Can the company "self-insure" at less cost?
Explain the function performed by the Eurodollar market.
What are the functions of the bill of lading?
What is the creditworthiness of a bankers' acceptance? How does it differ from that of the international trade draft? What determines the face value of the acceptance?
In general, how does financing foreign trade differ from financing domestic trade?
Why would a company want to establish a joint foreign venture when it loses partial control over its foreign operations?
Many countries require that nationals control more than 50 percent of the voting stock in any venture. Is this wise? Explain.
Do income taxes paid by a foreign branch work to the detriment of the US parent company?
What are the various types of exchange-rate risk exposure to the corporation with operations abroad?
What difference does it make whether the dollar or the local currency is the "functional currency" when it comes to the accounting treatment of currency translations gains or losses?
Natural hedges sometimes exist for a company with an operation abroad. What is meant by this term, and why are natural hedges important?
With respect to foreign currency, what is a forward discount? What is a forward premium7. Illustrate with an example. What is the purpose of forward exchange markets?
When it comes to currency hedges, how do forward contracts, futures contracts, options contracts, and currency swaps differ?
The following spot rates are observed in the foreign currency markets:On the basis of this information, compute to the nearest second decimal the number of a. Britland ounces that can be acquired for
The US Imports Company purchased 100,000 Freedonian marks' worth of machinery from a firm in Zeppo, Freedonia. The value of the dollar in terms of the mark has been decreasing. The firm in Zeppo
Fuel-Guzzler Vehicles, Inc., is considering a new plant in Lolland. The plant will cost 26 million guildnotes. Incremental cash flows are expected to be 3 million guildnotes per year for the first 3
Fleur du Lac, a Trance company, has shipped goods to an American importer under a letter of credit arrangement, which calls for payment at the end of 90 days. The invoice is for $124,000. At present
Wheat sells for $4 a bushel in the United States. The price in Canada for a bushel of wheat is 4.56 Canadian dollars. The exchange rate is 1.2 Canadian dollars to $1 US. Does purchasing-power parity
At present, the US dollar is worth 140 yen in the spot market. The nominal Japanese interbank Euromarket interest rate, expressed in terms of the 90-day return, is 4 percent, and for the United
Cordova Leather Company is in a 38 percent US tax bracket. It has sales branches in Algeria and in Switzerland, each of which generates earnings of $200,000 before taxes. If the effective income tax
McDonnoughs Hamburger Company wishes to lend $500,000 to its Japanese subsidiary. At the same time, Tsunami Heavy Industries is interested in making a medium-term loan of approximately the same
The government of Zwill presently encourages investment in the country. Comstock International Mining Corporation, a US company, is planning to open a new copper mine in Zwill. The front-end
What is a firm’s intrinsic value? its current stock price? Is the stock’s “true long-run value” more closely related to its intrinsic value or to its current price?
Assume that you recently graduated with a degree in finance and have just reported to work as an investment adviser at the brokerage firm of Smyth Barry & Co. Your first assignment is to explain the
Donna Jamison, a 2003 graduate of the University of Florida with 4 years of banking experience, was recently brought in as assistant to the chairperson of the board of D€™Leon Inc., a small food
Part I of this case, presented in Chapter 3, discussed the situation of D’Leon Inc., a regional snack foods producer, after an expansion program. D’Leon had increased plant capacity and
Answer the following questions:a. Assuming a rate of 10% annually, find the FV of $1,000 after 5 years.b. What is the investment€™s FV at rates of 0%, 5%, and 20% after 0, 1, 2, 3, 4, and 5
a. Draw time lines for (1) a $100 lump sum cash flow at the end of Year 2, (2) an ordinary annuity of $100 per year for 3 years, and (3) an uneven cash flow stream of -$50, $100, $75, and $50 at the
Suppose 2-year Treasury bonds yield 4.5%, while 1-year bonds yield 3%. r* is 1%, and the maturity risk premium is zero.a. Using the expectations theory, what is the yield on a 1-year bond 1 year from
a. What are the four most fundamental factors that affect the cost of money, or the general level of interest rates, in the economy?b. What is the real risk-free rate of interest (r*) and the nominal
The real risk-free rate is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium is zero. What is the yield on 2-year Treasury securities?
You are considering a 10-year, $1,000 par value bond. Its coupon rate is 9%, and interest is paid semiannually. If you require an “effective” annual interest rate (not a nominal rate) of 8.16%,
A bond has a $1,000 par value, 10 years to maturity, and a 7% annual coupon and sells for $985. a. What is its yield to maturity (YTM)? b. Assume that the yield to maturity remains constant for the
Robert Black and Carol Alvarez are vice presidents of Western Money Management and codirectors of the company’s pension fund management division. A major new client, the California League of
Assume that the risk-free rate is 6% and the expected return on the market is 13%. What is the required rate of return on a stock with a beta of 0.7?
Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the expected return for the overall stock market? What is the required rate of return on a stock with a beta of 1.2?
A stock is expected to pay a dividend of $0.50 at the end of the year (that is, D1 ¼ 0.50), and it should continue to grow at a constant rate of 7% a year. If its required return is 12%, what is the
Robert Balik and Carol Kiefer are senior vice presidents of the Mutual of Chicago Insurance Company. They are codirectors of the company’s pension fund management division, with Balik having
How should the capital structure weights used to calculate the WACC be determined?
Coleman Technologies is considering a major expansion program that has been proposed by the company’s information technology group. Before proceeding with the expansion, the company must estimate
You recently went to work for Allied Components Company, a supplier of auto repair parts used in the after-market with products from Daimler, Chrysler, Ford, and other automakers. Your boss, the

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