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essentials corporate finance

Questions and Answers of Essentials Corporate Finance

Cumulative Voting An election is being held to fill three seats on the board of directors of a firm in which you hold stock. The company has 7,600 shares outstanding. If the election is conducted
Cumulative Voting The shareholders of Motive Power Corp. need to elect three new directors to the board. There are 13,000,000 shares of common stock outstanding, and the current share price is
Corporate Voting Candle box Inc. is going to elect six board members next month.Betty Brown owns 17.4 percent of the total shares outstanding. How confident can she be of having one of her candidate
Valuing Callable Bonds KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent and 30 years to maturity. The current market interest rates on these bonds are 7 percent. In one
Valuing Callable Bonds New Business Ventures, Inc., has an outstanding perpetual bond with a 10 percent coupon rate that can be called in one year. The bond makes annual coupon payments. The call
Valuing Callable Bonds Bowdeen Manufacturing intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at $1,175. One-year interest rates are 9 percent. There is
Valuing Callable Bonds Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 7 percent, payable annually. The one-year interest rate is 7 percent. Next
Bond Refunding An outstanding issue of Public Express Airlines debentures has a call provision attached. The total principal value of the bonds is $250 million, and the bonds have an annual coupon
Bond Refunding Charles River Associates is considering whether to call either of the two perpetual bond issues the company currently has outstanding. If the bond is called, it will be refunded, that
Valuing the Call Feature Consider the prices of the following three Treasury issues as of February 24, 2012:6.500 May 16 106.31250 106.37500 −13 5.28 8.250 May 16 103.43750 103.5000 −3 5.24
Treasury Bonds The following Treasury bond quote appeared in The Wall Street Journal on May 11, 2004:9.125 May 09 100.09375 100.12500 . . . −2.15 Why would anyone buy this Treasury bond with a
Diversifiable and Nondiversifiable Risks In broad terms, why is some risk diversifiable?Why are some risks nondiversifiable? Does it follow that an investor can control the level of unsystematic risk
Covariance Briefly explain why the covariance of a security with the rest of a welldiversified portfolio is a more appropriate measure of the risk of the security than the security’s variance.
Risk A broker has advised you not to invest in oil industry stocks because they have high standard deviations. Is the broker’s advice sound for a risk-averse investor like yourself? Why or why not?
Security Selection Is the following statement true or false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to
Determining Portfolio Weights What are the portfolio weights for a portfolio that has 135 shares of Stock A that sell for $47 per share and 105 shares of Stock B that sell for $41 per share?
Portfolio Expected Return You own a portfolio that has $2,100 invested in Stock A and $3,200 invested in Stock B . If the expected returns on these stocks are 11 percent and 14 percent, respectively,
Portfolio Expected Return You own a portfolio that is 25 percent invested in Stock X , 40 percent in Stock Y , and 35 percent in Stock Z . The expected returns on these three stocks are 11 percent,
Portfolio Expected Return You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14 percent and Stock Y with an expected return of 9 percent. If your
Calculating Returns and Standard Deviations Based on the following information, calculate the expected return and standard deviation for the two stocks:State of Economy Probability of State of
Calculating Returns and Standard Deviations Based on the following information, calculate the expected return and standard deviation:State of Economy Probability of State of Economy Rate of Return if
Calculating Expected Returns A portfolio is invested 10 percent in Stock G , 65 percent in Stock J , and 25 percent in Stock K . The expected returns on these stocks are 9 percent, 11 percent, and 14
Returns and Standard Deviations Consider the following information:State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom .65 .07 .15 .33 Bust
Returns and Standard Deviation s Consider the following information:State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom .20 .24 .45 .33 Good
Calculating Portfolio Betas You own a stock portfolio invested 10 percent in Stock Q , 35 percent in Stock R , 20 percent in Stock S , and 35 percent in Stock T .The betas for these four stocks are
Using CAPM A stock has a beta of 1.15, the expected return on the market is 11 percent, and the risk-free rate is 5 percent. What must the expected return on this stock be?
Using CAPM A stock has an expected return of 10.2 percent, the risk-free rate is 4 percent, and the market risk premium is 7 percent. What must the beta of this stock be?
Using CAPM A stock has an expected return of 13.4 percent, its beta is 1.60, and the risk-free rate is 5.5 percent. What must the expected return on the market be?
Using CAPM A stock has an expected return of 13.1 percent, a beta of 1.28, and the expected return on the market is 11 percent. What must the risk-free rate be?
Using CAPM A stock has a beta of 1.13 and an expected return of 12.1 percent.A risk-free asset currently earns 5 percent.a. What is the expected return on a portfolio that is equally invested in the
Using the SML Asset W has an expected return of 12.3 percent and a beta of 1.3.If the risk-free rate is 4 percent, complete the following table for portfolios of Asset W and a risk-free asset.
Reward-to-Risk Ratios Stock Y has a beta of 1.35 and an expected return of 14 percent. Stock Z has a beta of .80 and an expected return of 11.5 percent. If the risk-free rate is 4.5 percent and the
Reward-to-Risk Ratios In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?
Portfolio Returns and Deviation s Consider the following information about three stocks:State of Economy Probability of State of Economy Rate of Return if State Occurs Stock A Stock B Stock C Boom
Analyzing a Portfoli o You want to create a portfolio equally as risky as the market, and you have $1,000,000 to invest. Given this information, fill in the rest of the following table:Asset
Analyzing a Portfolio You have $100,000 to invest in a portfolio containing Stock X , Stock Y , and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has
Covariance and Correlatio n Based on the following information, calculate the expected return and standard deviation of each of the following stocks. Assume each state of the economy is equally
Covariance and Correlatio n Based on the following information, calculate the expected return and standard deviation for each of the following stocks. What are the covariance and correlation between
Portfolio Standard Deviation Security F has an expected return of 10 percent and a standard deviation of 43 percent per year. Security G has an expected return of 15 percent and a standard deviation
Portfolio Standard Deviation Suppose the expected returns and standard deviations of Stocks A and B are E( R A ) 5 .09, E( R B ) 5 .15, s A 5 .36, and s B 5 .62.a. Calculate the expected return and
Correlation and Bet a You have been provided the following data about the securities of three firms, the market portfolio, and the risk-free asset:Security Expected Return Standard Deviation
Beta and CAPM A portfolio that combines the risk-free asset and the market portfolio has an expected return of 7 percent and a standard deviation of 10 percent.The risk-free rate is 4 percent, and
Beta and CAPM Suppose the risk-free rate is 4.2 percent and the market portfolio has an expected return of 10.9 percent. The market portfolio has a variance of .0382.Portfolio Z has a correlation
Systematic versus Unsystematic Ris k Consider the following information about Stocks I and II:State of Economy Probability of State of Economy Rate of Return if State Occurs Stock I Stock II
SML Suppose you observe the following situation:Security Beta Expected Return Pete Corp. 1.35 12.28%Repete Co. .80 8.54 Assume these securities are correctly priced. Based on the CAPM, what is the
Covariance and Portfolio Standard Deviatio n There are three securities in the market. The following chart shows their possible payoffs:State Probability of Outcome Return on Security 1 Return on
SML Suppose you observe the following situation:State of Economy Probability of State Return if State Occurs Stock A Stock B Bust .15 −.10 −.08 Normal .60 .09 .08 Boom .25 .32 .26a. Calculate the
Standard Deviation and Beta There are two stocks in the market, Stock A and Stock B . The price of Stock A today is $75. The price of Stock A next year will be$64 if the economy is in a recession,
Minimum Variance Portfoli o Assume Stocks A and B have the following characteristics:Stock Expected Return (%) Standard Deviation (%)A 9 33 B 15 62 The covariance between the returns on the two
Bankruptcy Costs What are the direct and indirect costs of bankruptcy? Briefly explain each.
Stockholder Incentives Do you agree or disagree with the following statement? A firm’s stockholders will never want the firm to invest in projects with negative net present values.
Firm Value Janetta Corp. has an EBIT rate of $975,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35
Agency Costs Tom Scott is the owner, president, 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
Capital Structure Decisions Due to large losses incurred in the past several years, a firm has $2 billion in tax loss carryforwards. This means that the next $2 billion of the firm’s income will be
Cost of Debt What steps can stockholders take to reduce the costs of debt?
M&M and Bankruptcy Costs How does the existence of financial distress costs and agency costs affect Modigliani and Miller’s theory in a world where corporations pay taxes?
Agency Costs of Equity What are the sources of agency costs of equity?
Observed Capital Structures Refer to the observed capital structures given in Table 17.3 of the text. What do you notice about the types of industries with respect to their average debt–equity
Bankruptcy and Corporate Ethics Continental Airlines once filed for bankruptcy, at least in part, as a means of reducing labor costs. Whether this move was ethical or proper was hotly debated. Give
Unlevered Cost of Equity Beginning with the cost of capital equation—that is:RWACC = _ B_ _+S_ _S_ R S + _ B_ _+B_ _S_ R B show that the cost of equity capital for a levered firm can be written as
Firm Value Janetta Corp. has an EBIT rate of $975,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35
Nonmarketed Claims Dream, Inc., has debt outstanding with a face value of$6 million. The value of the firm if it were entirely financed by equity would be$17.85 million. The company also has 350,000
Capital Structure and Nonmarketed Claims Suppose the president of the company in the previous problem stated that the company should increase the amount of debt in its capital structure because of
Capital Structure and Growth Edwards Construction currently has debt outstanding with a market value of $85,000 and a cost of 9 percent. The company has EBIT of$7,650 that is expected to continue in
Costs of Financial Distress Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The
Agency Costs Fountain Corporation’s economists estimate that a good business environment and a bad business environment are equally likely for the coming year.The managers of Fountain must choose
Financial Distress Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a
Personal Taxes, Bankruptcy Costs, and Firm Value 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
Personal Taxes, Bankruptcy Costs, and Firm Value Overnight Publishing Company(OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to
What is the expected value of the company in one year, with and without expansion?Would the company’s stockholders be better off with or without expansion? Why?Sam McKenzie is the founder and CEO
What is the expected value of the company’s debt in one year, with and without the expansion?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering
One year from now, how much value creation is expected from the expansion? How much value is expected for stockholders? Bondholders?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc.,
If the company announces that it is not expanding, what do you think will happen to the price of its bonds? What will happen to the price of the bonds if the company does expand?Sam McKenzie is the
If the company opts not to expand, what are the implications for the company’s future borrowing needs? What are the implications if the company does expand?Sam McKenzie is the founder and CEO of
Because of the bond covenant, the expansion would have to be financed with equity.How would it affect your answer if the expansion were financed with cash on hand instead of new equity?Sam McKenzie
Dividend Policy It is sometimes suggested that firms should follow a “residual”dividend policy. With such a policy, the main idea is that a firm should focus on meeting its investment needs and
Dividends and Stock Price Last month, Central Virginia Power Company, which had been having trouble with cost overruns on a nuclear power plant that it had been building, announced that it was
Dividend Policy For initial public offerings of common stock, 2007 was a relatively slow year, with only about $35.6 billion raised by the process. Relatively few of the 159 firms involved paid cash
Investment and Dividends The Phew Charitable Trust pays no taxes on its capital gains or on its dividend income or interest income. Would it be irrational for it to have low-dividend, high-growth
Dividends and Stock Value The growing perpetuity model expresses the value of a share of stock as the present value of the expected dividends from that stock. How can you conclude that dividend
Bird-in-the-Hand Argument The bird-in-the-hand argument, which states that a dividend today is safer than the uncertain prospect of a capital gain tomorrow, is often used to justify high dividend
Dividends and Income Preference The desire for current income is not a valid explanation of preference for high current dividend policy because investors can always create homemade dividends by
Dividends and Clientele Cap Henderson owns Neotech stock because its price has been steadily rising over the past few years and he expects this performance to continue. Cap is trying to convince
Dividends and Taxes Your aunt is in a high tax bracket and would like to minimize the tax burden of her investment portfolio. She is willing to buy and sell to maximize her aftertax returns, and she
Dividends versus Capital Gains If the market places the same value on $1 of dividends as on $1 of capital gains, then firms with different payout ratios will appeal to different clienteles of
Dividend Irrelevancy In spite of the theoretical argument that dividend policy should be irrelevant, the fact remains that many investors like high dividends. If this preference exists, a firm can
Dividends and Stock Price Empirical research has found that there have been significant increases in stock price on the day an initial dividend (i.e., the first time a firm pays a cash dividend) is
Dividends and Taxes Lee Ann, Inc., has declared a $9.50 per-share dividend.Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be
Stock Dividends The owners’ equity accounts for Hexagon International are shown here:Common stock ($1 par value) $ 30,000 Capital surplus 185,000 Retained earnings 627,500 Total owners’ equity
Stock Splits and Stock Dividends Roll Corporation (RC) currently has 330,000 shares of stock outstanding that sell for $64 per share. Assuming no market imperfections or tax effects exist, what will
Regular Dividends The balance sheet for Levy Corp. is shown here in market value terms. There are 12,000 shares of stock outstanding.Market Value Balance Sheet Cash $ 55,000 Equity $465,000 Fixed
Share Repurchase In the previous problem, suppose Levy has announced it is going to repurchase $22,800 worth of stock. What effect will this transaction have on the equity of the firm? How many
Stock Dividends The market value balance sheet for Outbox Manufacturing is shown here. Outbox has declared a stock dividend of 25 percent. The stock goes exdividend tomorrow (the chronology for a
Stock Dividends The company with the common equity accounts shown here has declared a stock dividend of 15 percent when the market value of its stock is $45 per share. What effects on the equity
Stock Splits In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 45 cent per share cash dividend on the new(postsplit) shares represents an
Dividends and Stock Price The Mann Company belongs to a risk class for which the appropriate discount rate is 10 percent. Mann currently has 220,000 outstanding shares selling at $110 each. The firm
Homemade Dividends You own 1,000 shares of stock in Avondale Corporation.You will receive a dividend of $1.10 per share in one year. In two years, Avondale will pay a liquidating dividend of $56 per
Homemade Dividends In the previous problem, suppose you want only $500 total in dividends the first year. What will your homemade dividend be in two years?
Stock Repurchase Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $4,000 would be spent. Current earnings are$2.10 per share, and the stock currently
Dividends and Firm Value The net income of Novis Corporation is $85,000.The company has 25,000 outstanding shares and a 100 percent payout policy.The expected value of the firm one year from now is

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