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essentials corporate finance

Questions and Answers of Essentials Corporate Finance

Cost of Capital Suppose Tom O’Bedlam, president of Bedlam Products, Inc., has hired you to determine the firm’s cost of debt and cost of equity capital.a. The stock currently sells for $50 per
Company Risk versus Project Risk Both Dow Chemical Company, a large natural gas user, and Superior Oil, a major natural gas producer, are thinking of investing in natural gas wells near Houston. Both
Divisional Cost of Capital Under what circumstances would it be appropriate for a firm to use different costs of capital for its different operating divisions? If the overall firm WACC was used as
Leverage Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market
Beta What factors determine the beta of a stock? Define and describe each.
Calculating Cost of Equity The Dybvig Corporation’s common stock has a beta of 1.21. If the risk-free rate is 3.5 percent and the expected return on the market is 11 percent, what is Dybvig’s
Calculating Cost of Debt Advance, Inc., is trying to determine its cost of debt.The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue
Calculating Cost of Debt Shanken Corp. issued a 30-year, 6.2 percent semiannual bond 7 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35 percent.a.
Calculating Cost of Debt For the firm in the previous problem, suppose the book value of the debt issue is $70 million. In addition, the company has a second debt issue on the market, a zero coupon
Calculating WACC Mullineaux Corporation has a target capital structure of 70 percent common stock and 30 percent debt. Its cost of equity is 13 percent, and the cost of debt is 6 percent. The
Taxes and WACC Miller Manufacturing has a target debt–equity ratio of .55. Its cost of equity is 14 percent, and its cost of debt is 7 percent. If the tax rate is 35 percent, what is Miller’s
Finding the Capital Structure Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 13 percent, and its cost of debt is 6.5 percent. The tax rate is
Book Value versus Market Value Filer Manufacturing has 8.3 million shares of common stock outstanding. The current share price is $53, and the book value per share is $4. Filer Manufacturing also has
Calculating the WACC In the previous problem, suppose the company’s stock has a beta of 1.2. The risk-free rate is 3.1 percent, and the market risk premium is 7 percent. Assume that the overall
Finding the WACC Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent.Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par
Finding the WACC Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual bonds outstanding, par value$1,000 each. The common stock currently
SML and WACC An all-equity firm is considering the following projects:Project Beta IRR W .80 9.4%X .95 10.9 Y 1.15 13.0 Z 1.45 14.2 The T-bill rate is 3.5 percent, and the expected return on the
Calculating Flotation Costs Suppose your company needs $20 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 7 percent, but the
Calculating Flotation Costs Southern Alliance Company needs to raise $55 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for
WACC and NPV Och, Inc., is considering a project that will result in initial aftertax cash savings of $3.5 million at the end of the first year, and these savings will grow at a rate of 4 percent per
Preferred Stock and WAC C The Saunders Investment Bank has the following financing outstanding. What is the WACC for the company?Debt: 60,000 bonds with a coupon rate of 6 percent and a current price
Flotation Costs Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $19 million, and the company paid $1,150,000 in flotation costs. In addition, the equity
Calculating the Cost of Equity Floyd Industries stock has a beta of 1.3. The company just paid a dividend of $.95, and the dividends are expected to grow at 4.5 percent per year. The expected return
Firm Valuation Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material
Flotation Costs and NPV Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .55.It’s considering building a new
Flotation Costs Trower Corp. has a debt–equity ratio of .85. The company is considering a new plant that will cost $145 million to build. When the company issues new equity, it incurs a flotation
1 We mentioned in the last chapter that, according to theory, firms should create all-debt capital structures under corporate taxation. Because firms generally employ moderate amounts of debt in the
2 Because financial distress costs are substantial and the shareholders ultimately bear them, firms have an incentive to reduce costs. Protective covenants and debt consolidation are two common cost
3 Because costs of financial distress can be reduced but not eliminated, firms will not finance entirely with debt. Figure 19.1 illustrates the relationship between firm value and debt. In the
4 Signalling theory argues that profitable firms are likely to increase their leverage because the extra interest payments will offset some of the pre-tax profits. Rational shareholders will infer
5 Managers owning a small proportion of a firm’s equity can be expected to work less, maintain more lavish expense accounts and accept more pet projects with negative NPVs than managers owning a
6 The pecking order theory implies that managers prefer internal to external financing. If external financing is required, managers tend to choose the safest securities, such as debt. Firms may
7 The market timing theory suggests that there is no pecking order or trade-off of capital structure choices. Observed debt ratios are simply a function of past market to book valuations and the
8 Berens and Cuny (1995) argue that significant equity financing can be explained by real growth and inflation, even in a world of low bankruptcy costs.
9 Debt–equity ratios vary across industries. We present three factors determining the target debt–equity ratio:(a) Taxes: Firms with high taxable income should rely more on debt than firms with
1 Costs of Financial Distress What are the direct and indirect costs of bankruptcy? Briefly explain each and provide a practical example of these costs.
2 Description of Financial Distress Costs Are managers liable to act differently when their firm is in financial distress? Explain your answer using practical examples.
3 Rationale for the Tax Benefits of Debt Despite the significant costs of high leverage, tax systems around the world have a built-in debt bias. Why do you think this is?
4 Trade-off Theory 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
5 Signalling 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.
7 Pecking Order Theory 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
8 Growth and the Debt–equity Ratio 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
9 Market Timing Theory Is the market timing theory of financing choices consistent with the pecking order theory or trade-off theory? Explain your answer.
10 Observed Capital Structures 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,
11 Shareholder Incentives 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?
12 Debt and Risk 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
13 Capital Structure Decisions 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
14 Observed Capital Structures Refer to the observed capital structures given in Figure 19.4. What do you notice about the types of industries with respect to their average debt–asset ratios? Are
15 Costs of Bankruptcy What is the average cost of bankruptcy? Why do bankruptcy costs differ both within a country and between countries? What type of costs are incurred in financial distress? Use
16 Bankruptcy and Corporate Ethics 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
17 Firm Value 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
1 Financing Decisions and Firm Value What are the three ways a firm can create value from financing opportunities? Provide an example to illustrate each way.
3 Efficient Market Hypothesis Explain what is meant by the efficient market hypothesis. Define the three forms of market efficiency and explain each form with respect to how you can make a profit
7 Behavioural Biases in Corporate Finance Review two cognitive biases corporate managers may exhibit. Use an example to illustrate their impact on firm value.
8 Implications for Corporate Finance What does efficient market theory and behavioural finance imply for corporate decision-making? Provide three examples of how each theory may affect managerial
11 Investment Gurus In every market crash, some investors can earn significantly positive returns. How can you explain this using the efficient markets hypothesis and behavioural finance theory?
14 Investor Sentiment Some people believe that, following the European Consumer Confidence Index(see chart below), allows you to predict future market movements. The Index was consistently negative
15 Efficient Markets All publicly listed European companies follow International Accounting Standards.This means that financial statements are based largely on market values instead of historical
18 Efficient Markets Hypothesis When the 56-year-old founder of Turkish firm Gulf Oil and Minerals died of a heart attack, its share price immediately jumped from 18.00 Lira a share to 20.25 Lira, a
20 Efficient Markets Hypothesis TransTrust NV has changed how it accounts for inventory. Taxes are unaffected, although the resulting earnings report released is 20 per cent higher than it would have
22 Efficient Markets Hypothesis Your broker commented that well-managed firms are better investments than poorly managed firms. As evidence he cited a recent study examining 100 small manufacturing
26 Behavioural Finance A global publication has identified a fund manager as consistently outperforming the market over the past five years. An analyst argues that the identification of this manager
27 Efficient Markets Hypothesis Assume markets are efficient. During a trading day, British Golf plc announces it has lost a contract for a large golfing project that, prior to the news, it was
29 Stock Market Movements Some people argue that the efficient market hypothesis cannot explain the 2018 global stock market falls. Provide an explanation using the efficient market hypothesis and
33 Cumulative Abnormal Returns National Airlines Group, Air France-KLM and Lufthansa announced purchases of planes on 18 July (18/7), 12 February (12/2) and 7 October (7/10), respectively. Given the
1 Explain what is meant by efficient market theory and discuss some of its implications for corporate financial management. (25 marks)
2 ‘Even in an efficient market it is still valid to seek out a “favourable” rate of return from an equity investment.’Consider the argument that, in an efficient market ‘one security is as
3 Explain how behavioural finance can provide insights to corporate financial managers. (25 marks)
4 What strategies can financial managers follow if they believe behavioural finance is a valid hypothesis?(25 marks)
1 What implications do you draw from the graph for mutual fund investors?You have been at your job for West Coast Yachts for a week now and have decided you need to sign up for the company’s
2 Is the graph consistent or inconsistent with market efficiency? Explain carefully.You have been at your job for West Coast Yachts for a week now and have decided you need to sign up for the
3 What investment decision would you make for the equity portion of your retirement account? Why?You have been at your job for West Coast Yachts for a week now and have decided you need to sign up
1 Visit Yahoo! Finance and download the share prices of five British banks for the dates 1 August 2008 to 31 January 2009. Also download the FTSE 100 index for the same period.In many countries,
2 Track each bank’s share price before the ban, during the ban and after the ban. Do the share price movements support the view that the market was irrationally depressed because of speculative
3 Carry out your own investigation of short-selling in Europe. How did other European governments deal with the short-selling controversy?In many countries, regulators have moved to ban an activity
4 Write a report about the short-selling controversy in the context of the efficient markets hypothesis and behavioural finance. What does it say about the validity (if at all) of either theory?In
5 If there is one area where International Financial Reporting Standards have faced a lot of criticism, it is with respect to their effect on market prices. Because financial assets and liabilities
1 Ordinary Shares What is a proxy? What is the difference between voting rights and cash flow rights? Do you think this will have an impact on share values?
2 Corporate Long-term Debt Why do you think companies have issued bonds in different currencies, maturities and coupon rates? Shouldn’t the coupon be the same on every bond? Explain.
3 Preference Shares Preference shares do not offer a corporate tax shield on the dividends paid. Why do we still observe some firms issuing preference shares?
4 Patterns of Financing Why do you think companies in certain countries prefer different forms of financing?Carry out your own research and comment on capital structure choice among firms in the G7
5 Hierarchies What is meant by hierarchies in long-term financing and why are bonds higher in priority than shares?
6 Debt versus Equity Financing Review the differences between debt and equity financing. Explain in detail how debt differs from equity. Are preference shares better than debt and equity because they
7 Preference Shares and Bond Yields 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
8 Corporate Financing 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?
9 Par Values 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.
10 Corporate Financing 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
11 Preference Shares Do you think preference shares are more like debt or equity? Why?
12 Book Value per Share Consider the shareholder equity statement for Toosoon plc. What is the book value per share?Shareholders’ Equity £Ordinary equity, 6,000,000 at £2 par value 12,000,000
14 Internal versus External Financing What is the difference between internal financing and external financing? What factors influence a firm’s choices of external versus internal equity financing?
15 Security Priority A company has €25 million in equity, €18 million in preference shares, €15 million in secured bonds and €34 million in unsecured bonds. Assume that, because of financial
16 Shareholder Loans In what situations would you consider using shareholder loans? What are the benefits from using shareholder loans and what are the drawbacks?CHALLENGE
17 Equity Accounts Following are the equity accounts for Dawn Technologies:Ordinary shares, £0.12 par value 120,000 Additional paid-in capital 4,526,123 Retained earnings ?Total 6,421,830(a) What
18 Equity Accounts The equity accounts for ABC plc are as follows:Ordinary shares, £2 par value 500 shares outstanding ?Capital surplus 250,000 Retained earnings 750,000 Total ?(a) What are the
19 Equity Accounts 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
20 Corporate Voting 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
21 Multiple Share Classes Facebook founder Mark Zuckerberg owns 18 per cent of Facebook’s shares, with the other 82 per cent of shares owned by outside investors like financial institutions.
22 Multiple Share Classes What are the strengths of a dual-class share structure like that encountered in Facebook? Answer from the perspective of an institutional investor and Mark Zuckerberg.
23 Hybrid Securities Your company is considering the issue of a security that pays a fixed dividend for 20 years, at which point the security will cease to exist. If your firm can’t afford to pay
24 Share Capital The Akva Group ASA equity accounts for 2008–2010 are given below. Explain what each item is and how it changed over time.Note 2010 2009 2008 Equity Paid-in capital Share capital 15

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