Questions and Answers of Corporate Finance 5th Edition

What is meant by hierarchies in long-term financing and why are bonds higher in priority than shares?
Explain what is meant by Islamic financing. What are the different types of securities that are used in this sector? In this context, explain what is meant by a ‘sukuk’.Construct a practical
The yields on non-convertible preference shares are lower than the yields on corporate bonds. Why is there a difference? Which investors are the primary holders of preference shares? Why?
What are the main differences between corporate debt and equity?Why do some firms try to issue equity in the guise of debt? How would you categorize preference shares?
International Energy plc was formed in 1912 with 100,000 shares of equity with a £1 par value. Today, the company’s share price is £9 and retained earnings are £213,000. International Energy has
The Cable Company has £1 million of positive NPV projects it would like to accept. If Cable’s managers follow the historical pattern of long-term financing for UK industrial firms, what will their
Do you think preference shares are more like debt or equity? Why?
Explain why leasing is consistent with Islamic financing principles.[Challenge: Explain what is meant by a ‘musharaka’ transaction in Islamic finance. Give an Example to illustrate your answer.]
New equity issues are generally only a small portion of all new issues. At the same time, companies continue to issue new debt. Why do companies tend to issue little new equity but continue to issue
What is the difference between internal financing and external financing? What factors influence a firm’s choices of external versus internal equity financing?
A company has €25 million in equity, €18 million in preference shares, €15 million in secured bonds, and €34 million in unsecured bonds. Assume, because of financial distress, that the
You plan to raise funds through following Islamic principles. You require funding today of 3 billion Bahrain dinars and would like to pay it back in equal amounts over 10 years in monthly
Following are the equity accounts for Dawn Technologies:(a) What are the retained earnings of Dawn Technologies?(b) How many shares are outstanding?(c) At what average price were the shares sold?(d)
The equity accounts for ABC plc are as follows:a) What are the ordinary share and total equity values for the equity account?(b) The company has decided to issue 5,000 shares of equity at a price of
Ulrich plc’s articles of incorporation authorize the firm to issue 500,000 shares of £5 par value ordinary equity, of which 410,000 shares have been issued. Those shares were sold at an average of
The shareholders of Unicorn plc need to elect seven new directors.There are 500,000 shares outstanding currently trading at £34 per share. You would like to serve on the board of directors;
You manage an Islamic financing division and have been approached by a company for funding of 6 billion Bahrain dinars. The company wish to pay the funding back in equal instalments over 10 years
You run an Islamic financing division and have been approached by a customer for a 40,000 Bahrain dinar ijarah thumma al bai’ financing deal. The customer wishes to pay a maximum of 1,000 Bahrain
You run an Islamic financing bank and have been approached by a company to construct a sale and buyback financing deal. The firm requires financing of £8 billion and wishes to pay back the financing
The Akva Group ASA equity accounts for 2008–2010 are given below.Explain what each item is and how it changed over time. EQUITY Paid-in capital Share capital Share premium reserve Other paid-in
In 2012, Rangers Football Club had a majority shareholder, Craig Whyte, who owned 83.5 per cent of the firm. The same individual also owned secured debt worth£18 million and was Rangers’ largest
An election is being held to fill three seats on the Board of Directors of a firm in which you are a shareholder. The company has 2,500 shares outstanding. If the election is conducted under
Assume that you are the manager of a family firm and the company wishes to expand its operations into a new unrelated business sector. The expansion requires funding. What type of financing (debt or
Your company plans to expand into a new business sector that requires higher levels of capital investment and fixed costs. Holding all else equal, what type of financing (debt or equity) would you
If you are the manager of a young research-intensive firm, which type of financing would you prefer and why? Carry out research on research-intensive firms in your country. What is the preferred
1. Your company, Living Planet plc, was formed in 1985 to develop technologies that combat climate change. You started the firm with £80,000 financing which consisted of 3,000 shares of equity
The Islamic Bank of Britain (IBB) released a new product in 2012 called a Home Purchase Plan (HPP). This product allows individuals to invest over the long term in a mortgage equivalent financing
Use a pizza analogy to explain why capital structure should not influence firm value in a world with no taxes, transaction costs or financial distress costs. List three assumptions that lie behind
Explain why, in a world with no taxes, transaction costs or financial distress costs, maximizing firm value is the same as maximizing share value. Are business risk and financial risk the same thing?
In a world with no taxes, no transaction costs, and no costs of financial distress, does moderate borrowing increase the required return on a firm’s equity? Does it necessarily follow that
How do corporate taxes affect the Modigliani–Miller theory of capital structure? Illustrate your answer with a practical example.
Show the impact of personal taxes on the firm value in an MM universe.When would a firm be indifferent between issuing debt or equity? Illustrate your answer with a practical example.
Explain, using an example, how a change in the capital structure of a firm can affect the company’s return on equity.
What is the basic goal of financial management with respect to capital structure? Is there an easily identifiable capital structure that will maximize the value of the firm? Why or why not?
Mayou plc currently has no debt in its capital structure but has decided to issue new debt to replace the equity so that the debt to equity ratio is 1:1. On the firm’s accounting statements, the
Penybont plc is planning to raise funds to finance a major new development, and its management is considering borrowing on a long-term basis for the first time. It has been established that it is
Fresenius SE & Co has no debt outstanding and a total market value of €12.68 billion. Earnings before interest and taxes (EBIT) are projected to be €2.56 billion if economic conditions are
Using the information in the question above on Fresenius SE & Co, suppose Fresenius has a book value of €12.68 billion.(a) Calculate return on equity, ROE, under each of the three economic
Hammerson plc is comparing two different capital structures: an allequity plan (Plan I) and a levered plan (Plan II). Under Plan I, Hammerson would have 712 million shares of equity outstanding.
In Problem 13, use MM Proposition I to find the share price under each of the two proposed plans. What is the value of the firm?Problem 13,Hammerson plc is comparing two different capital structures:
Taiyuan Coal Gasification Ltd is comparing two different capital structures. Plan I would result in 1.62 billion shares of equity and 798 million yuan in debt. Plan II would result in 1 billion
ABC plc is comparing two different capital structures. Plan I would result in 1,100 shares of stock and €16,500 in debt. Plan II would result in 900 shares of stock and €27,500 in debt, on which
Star plc, a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 40 per cent debt. Currently there are 2,000 shares outstanding and
ABC AG and XYZ AG are identical firms in all respects except for their capital structure. ABC is all equity financed with NKr600,000 in equity shares. XYZ uses both shares and perpetual debt; its
Nina plc uses no debt. The weighted average cost of capital is 13 per cent. If the current market value of the equity is £35 million and there are no taxes, what is EBIT?
Strade plc is an all equity financed company. The Finance Director suggested in a recent meeting with the Board of Directors a capital restructuring to introduce some debt in the company’s
Shadow plc has no debt but can borrow at 8 per cent. The firm’s WACC is currently 12 per cent, and the tax rate is 28 per cent.(a) What is Shadow’s cost of equity?(b) If the firm converts to 25
Bruce & Co. expects its EBIT to be £100,000 every year forever. The firm can borrow at 10 per cent. Bruce currently has no debt, and its cost of equity is 20 per cent. If the tax rate is 21 per
In Problem 23, what is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision?Problem 23,Bruce & Co. expects its EBIT to be
Levered plc and Unlevered plc are identical in every way except their capital structures. Each company expects to earn £96 million before interest per year in perpetuity, with each company
Tool Manufacturing has an expected EBIT of £35,000 in perpetuity and a tax rate of 28 per cent. The firm has £70,000 in outstanding debt at an interest rate of 9 per cent, and its unlevered cost of
Old School Corporation expects an EBIT of £9,000 every year forever. Old School currently has no debt, and its cost of equity is 17 per cent. The firm can borrow at 10 per cent. If the corporate tax
Bigelli SpA is financed entirely with equity. The company is considering a loan of €1 million. The loan will be repaid in equal instalments over the next 2 years, and it has an 8 per cent interest
Alpha NV and Beta NV are identical in every way except their capital structures. Alpha NV, an all-equity firm, has 5,000 shares of equity outstanding, currently worth €20 per share. Beta NV uses
Acetate SA has equity with a market value of €20 million and debt with a market value of €10 million. Treasury bills that mature in one year yield 8 per cent per year, and the expected return on
The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The market value of Knight Company’s 6 per cent bonds is SKr1 million. Financial
Locomotive plc is planning to repurchase part of its ordinary share equity by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 40 per cent to 50 per
Green Manufacturing plc plans to announce that it will issue £2 million of perpetual debt and use the proceeds to repurchase equity. The bonds will sell at par with a 6 per cent annual coupon rate.
Williamsen GmbH has a debt–equity ratio of 2.5. The firm’s weighted average cost of capital is 15 per cent, and its pre-tax cost of debt is 10 per cent. Williamsen is subject to a corporate tax
In a world of corporate taxes only, show that the RWACC can be written as RWACC = RA × [1 – tC (B/V)].36 Cost of Equity and Leverage Assuming a world of corporate taxes only, show that the cost of
Assume a firm’s debt is risk-free, so that the cost of debt equals the risk-free rate, Rf. Define βA as the firm’s asset beta – that is, the systematic risk of the firm’s assets. Define βS
What does this tell you about the relationship between capital structure and shareholder risk? How is the shareholders’ required return on equity affected? Explain.
Beginning with the cost of capital equation – that is:show that the cost of equity capital for a levered firm can be written as follows: RWACC E D+E Rg+ D R D+E
Sapphire is an all-equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15 per cent. The company has decided to modify its capital
Stephenson Real Estate was founded 25 years ago by the current CEO, Robert Stephenson.The company purchases real estate, including land and buildings, and rents the property to tenants. The company
What are the direct and indirect costs of bankruptcy? Briefly explain each and provide a practical example of these costs.
Are managers liable to act differently when their firm is in financial distress? Explain your answer using practical examples.
Despite the significant costs of high leverage, tax systems around the world have a built-in debt bias. Why do you think this is?
Explain what is meant by the trade-off theory of capital structure choice. Your answer should discuss the main costs and benefits of debt within this model and its empirical limitations.
Explain how managers can signal to the market the value of their firm through their capital structure decisions. Do you think this is an effective strategy? Explain.
Explain what is meant by the pecking order theory and how it relates to observed capital structures of companies. Where does a deeply discounted equity rights issue fit into the pecking order of
How does growth affect the desired debt to equity ratio of a company? Explain the impact of growth opportunities in the context of the static trade-off theory and pecking order theory of capital
Is the market timing theory of financing choices consistent with the pecking order theory or trade-off theory? Explain your answer.
In all countries, it appears that some firms have a target debt ratio while others do not have one. What does this say about the validity of the trade-off theory, pecking order theory, and market
Do you agree or disagree with the following statement? ‘A firm’s shareholders will never want the firm to invest in projects with negative net present values.’ Why? What steps can shareholders
You have been asked the following questions: ‘If debt can reduce the weighted average cost of capital for project appraisal, why does it then increase the risk of a company? Is it possible for a
During the last few years, many companies have suffered major trading losses because of the poor economic climate. Assume your firm has found itself in this situation and is considering a major
What is the average cost of bankruptcy for a firm in the United States? How does this compare to other countries? Why do bankruptcy costs differ both within a country and between countries?
Explain the ethical considerations of the following:(a) Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such cases the firm is
Hoy plc has a profit before interest and taxes of £900,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 17 per cent, and the corporate tax
Tom Scott is the owner, chairman and primary salesperson for Scott Manufacturing. Because of this, the company’s profits are driven by the amount of work Tom does. If he works 40 hours each week,
Transvaal Ltd currently has debt outstanding with a market value of R980,000 and a cost of 10 per cent. The company has an EBIT of R98,000 that is expected to continue in perpetuity. Assume there are
Costs of Financial Distress Steinberg plc and Dietrich plc are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies’
Kašna Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of Kašna must choose between two
Good Time plc is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 per cent and the probability of a recession is 40 per cent. It
When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero
Overnight Publishing SA (OP) has€2 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm’s debt is held by one
Islamic financing forbids the use of interest in any financial security, and this will clearly have an impact on the capital structure decisions of firms that follow Shariah principles. At the same
Many firms have pension plans for their employees that are heavily in deficit (i.e. the asset value of the fund is less than the present value of its future pension payments). How does this affect
Many companies in emerging markets use AAA rated firms in the West to guarantee any debt issue that is made by the firm. A good example is the Bakrie family in Indonesia, who used Bumi plc in the UK
In the aftermath of the global financial crisis in the late 2000s, many companies sought to bring their leverage ratios down to much lower levels. In 2012, Lloyds Banking Group began to repurchase
Look again at Table 16.3. Can you provide a market timing interpretation to the distribution of gearing ratios in the table? Can you provide a more plausible or intuitive interpretation of the
Biller Industries plc is a global haulage equipment and scaffolding manufacturer. The company has never borrowed before but feels that in order to maximize growth and increase value, a debt issue is
How is the APV of a project calculated? What about the FTE?What is the main difference between the APV, FTE and WACC?
What assumptions are commonly made in a capital budgeting analysis?
Is WACC consistent with a target debt–equity ratio?Explain.
Compare and contrast the three methods of capital budgeting. What are their strengths and weaknesses? When and why should you use each method instead of the other two? Are the three methods
Review the steps required in calculating the correct discount rate for capital budgeting when a firm has a high level of debt in its capital structure.
You are determining whether your company should undertake a new project and have calculated the NPV of the project using the WACC method when the CFO, a former accountant, notices that you did not
Zoso is a rental car company that is considering whether to add 25 cars to its fleet. The company depreciates all its rental cars using 20 per cent reducing balance, and at the end of 5 years assumes

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