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financial markets institutions

Questions and Answers of Financial Markets Institutions

Respond to parts a through d.a. What are the incremental cash flows associated with Small Corp.’s undertaking project X? Are these inflows or outflows, costs or revenue?b. What is the PV of project
Describe the equivalent tracking portfolio for project X, giving long and short positions and amounts, under a flat term structure of 8 percent, compounded annually. Conceptually, why are we
Let Bt price per $100 of face value of a zerocoupon bond maturing at year t. Then, if B1 $94.00, B2 $88.20, B3 $81.50, B4 $76.00, and B5 $73.00, implying that the term structure of interest
Consider the cash flows associated with undertaking project X.a. Is this an early or later cash flow stream?b. Based on the term structure of interest rates in exercise 10.5, what is the hurdle rate?
As a regional managing director of Finco, a U.S.-based investment company, your mandate is to scour the Midwest in search of promising investment opportunities and to recommend one project to
ABC Metalworks wants to determine which model sheetcutter to purchase. Three choices are available,(1) machine 1 costs the least but must be replaced the most frequently, (2) machine 2 has average
Investco, a West Coast research company, must decide on the level of computer technology it will buy for its analysis department. Package A, a midlevel technology, would cost $2.5 million for
Estimate the cost of capital with the CAPM, APT, and dividend discount models.AppendixLO1
Understand how to implement the comparison approach with the risk-adjusted discount rate method and know its shortcomings.AppendixLO1
Understand when to use comparison firms and when to use scenarios to obtain present values.AppendixLO1
Discount expected future cash flows at a risk-adjusted rate and know when to discount the certainty equivalent at a risk-free rate.AppendixLO1
Identify the certainty equivalent of a risky cash flow, using equilibrium models, risk-free scenarios, and forward prices.AppendixLO1
A project has an expected cash flow of $1 million one year from now. The standard deviation of this cash flow is $250,000. If the expected return of the market portfolio is 10 percent, the risk-free
Compute the expected year 1 restaurant cash flow for Marriott.Assume that Marriott’s restaurant division has the following joint distribution with the market return:AppendixLO1 Market Scenario
Find the covariance of the cash flow with the market return and its cash flow beta.Assume that Marriott’s restaurant division has the following joint distribution with the market return:AppendixLO1
Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, find the certainty equivalent of the year 1 cash
Discount your answer in exercise 11.4 at a riskfree rate of 4 percent per year to obtain the present value.Assume that Marriott’s restaurant division has the following joint distribution with the
Explain why the answer to exercise 11.5 differs from the answer in Example 11.2.Assume that Marriott’s restaurant division has the following joint distribution with the market return:AppendixLO1
Start with the risk-adjusted discount rate formula.Derive the certainty equivalent formula by rearranging terms and noting that b PV.AppendixLO1
In Section 11.3’s illustration, asset values increased 10 percent from 2001 to 2002, from $100 million to $110 million.a. Compute the percentage increase in the value of equity if the firm is
Explain intuitively why the certainty equivalent of a cash flow with a negative beta exceeds the cash flow’s expected value.AppendixLO1
Analyze the Hughes acquisition (which took place) by first computing the betas of the comparison firms, Lockheed and Northrop, as if they were all equity financed. Assume no taxes.In 1989, General
Compute the beta of the assets of the Hughes acquisition, assuming no taxes, by taking the average of the asset betas of Lockheed and Northrop.In 1989, General Motors (GM) was evaluating the
Compute the cost of capital for the Hughes acquisition, assuming no taxes.In 1989, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation.Recognizing that the appropriate
Compute the value of Hughes with the cost of capital estimated in exercise 11.12.In 1989, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation.Recognizing that the
Compute the value of Hughes if GM’s cost of capital is used as a discount rate instead of the cost of capital computed from the comparison firms.In 1989, General Motors (GM) was evaluating the
Risk-free rates at horizons of one year, two years, and three years are 6.00 percent per year, 6.25 percent per year, and 6.75 percent per year, respectively. The manager of the space shuttle at
Explain why, in the absence of personal taxes, there is an equivalence between dividends and share repurchases and why tax-paying investors prefer a share repurchase to a dividend payment.AppendixLO1
Provide reasons for why firms pay taxed dividends instead of repurchasing shares.AppendixLO1
Understand the difference between the classical tax system, which exists in the United States, and the imputation system, which exists in a number of other countries, and how these differences affect
Understand empirical evidence about how expected stock returns relate to dividend yields.AppendixLO1
Describe how personal taxes on dividend distributions can lead to distortions in both investment and financing decisions.AppendixLO1
Explain why the proportion of earnings distributed in the form of a share repurchase has increased substantially over the past 25 years.AppendixLO1
You are considering buying IBM stock which is trading today at $98 a share. IBM is going exdividend tomorrow, paying out $2.00 per share. If you believe the stock will drop to $96.50 following the
The Tax Reform Act of 1986 removed the tax preference for capital gains. Does this eliminate the tax preference for share repurchases over dividends?AppendixLO1
Hot Shot Uranium Mines is issuing stock for the first time and needs to determine an initial proportion of debt and equity. In its first years, the firm will have substantial tax write-offs as it
Suppose you are a manager who wants to retain as much as possible of the firm’s earnings in order to increase the size of the firm. How would you react to proposals to repurchase shares that would
Hunter Industries has generated $1 million in excess of its investment needs. The firm can invest the excess cash in Treasury bonds at 8 percent or distribute the cash to shareholders as a
Suppose that the capital gains tax rate is expected to increase in three years. How would this affect Bill Gates’s decision on whether Microsoft should use some of the company’s excess cash to
The XYZ Corporation has an expected dividend of$4 one period from now. This dividend is expected to grow by 2 percent per period.a. What is the value of a share of stock, assuming that the
Alpha Corporation earned $150 million in beforetax profits in 1996. Its corporate tax rate is 35 percent. Daniel Reptella, who owns 20 percent of the firm’s shares, has a personal marginal tax rate
You are engineering an LBO of Acme Industries, an industrial bottle maker. After the LBO, the firm will be financed 90 percent with debt and 10 percent with equity. Fred Farber, the CEO, will own 30
Understand the effect of direct bankruptcy costs on borrowing rates and capital structure choices.AppendixLO1
Describe the factors contributing to the conflicts of interest between debt holders and equity holders.AppendixLO1
Explain how debt can cause equity holders to take on projects that are too risky and to pass up positive NPV projects.AppendixLO1
Identify various situations in which debt holders and equity holders may disagree on the liquidation decision.AppendixLO1
Understand how bond covenants, bank loans, privately placed debt, project finance, and convertible bonds can mitigate some of these debt holder–equity holder conflicts.AppendixLO1
Describe how conflicts between debt holders and equity holders affect capital structure choices.AppendixLO1
A firm has $100 million in cash on hand and a debt obligation of $100 million due in the next period. With this cash, it can take on one of two projects—A or B—which cost $100 million each.Assume
Nigel decides he can make zippers at night for one period and will have cash flows next period of$210 if the economy is favorable, and $66 if the economy is unfavorable. One-third of these proceeds
A firm has a senior bond obligation of $20 due this period and $100 next period. It also has a subordinated loan of $40 owed to Jack and Jill and due next period. It has no projects to provide cash
Hiroko Fashion Corporation (HFC) can pursue either project Dress or project Cosmetic, with possible payoffs at year-end as follows:Each project costs $6 million at the beginning of the year. Assume
Sigma Design, a computer interface start-up firm with no tangible assets, has invested $50,000 in R&D. The success of the R&D effort as well as the state of the economy will be observed in one year.
Describe the relation between the zero-beta expected return on common stock and the zerobeta expected return on corporate bonds in an economy where stock returns are taxed more favorably than bond
ABC Corp., which currently has no assets, is considering two projects that each cost $100.Project A pays off $120 next year in the good state of the economy and $90 in the bad state of the economy.
Suppose you are hired as a consultant for Tailways, Inc., just after a recapitalization that increased the firm’s debt-to-assets ratio to 80 percent. The firm has the opportunity to take on a
In the event of bankruptcy, the control of a firm passes from the equity holders to the debt holders.Describe differences in the preferences of the equity holders and debt holders and how decisions
Why are debt holder–equity holder incentive problems less severe for firms that borrow short term rather than long term?AppendixLO1
Consider the case of Ajax Manufacturing which just completed an R&D project on widgets that required a $70 million bond obligation. The R&D effort resulted in an investment opportunity that will cost
Assume now that if Ajax Manufacturing (see exercise 16.12) uses a more capital-intensive manufacturing process, it can produce a greater number of widgets at a lower variable cost. Given the greater
With debtor in possession (DIP) financing, bankrupt firms are able to obtain additional amounts of debt that is senior to the firm’s existing debt. Explain how the firm’s existing debt holders
You have been hired as a bond analyst for Bull Sterns. A highly leveraged firm, Emax Industries, has switched to a more flexible management process that enables it to change its investment strategy
Atways Industries is involved in two similar mining projects. The Wyoming project was financed through the firm’s internal cash flows and appears as an asset on its balance sheet. The Montana
Describe how a firm’s financial situation is likely to affect its sales and its ability to attract employees and suppliers.AppendixLO1
Understand how financial distress can benefit some firms by inducing employees, suppliers, and governments to make financial concessions to the firm.AppendixLO1
Explain how a firm’s financial condition affects the way its competitors price their products.AppendixLO1
Describe how the past profitability of a firm affects its current capital structure.AppendixLO1
Understand empirical research relating a firm’s characteristics to its capital structure choices.AppendixLO1
What are the differences between direct and indirect bankruptcy costs? Who bears these costs?Explain your answer by referring to a real situation from the recent past.AppendixLO1
As a potential employee, why might you be interested in the employer’s capital structure?AppendixLO1
Compare qualitatively the indirect bankruptcy costs of operating a franchised hotel to that of running a high-tech start-up computer firm.AppendixLO1
You are the manager of a company that produces automobiles. A union contract will come up for renegotiation in two months and you wish to increase your firm’s bargaining power prior to hearing the
BCD Manufacturing is considering repurchasing 40 percent of its common stock. Management estimates the tax savings from such a move to be$48 million, based on the addition of $1 billion of debt at a
Carcinogens-R-Us and Lung Decay, two cigarette producers of comparable size, are struggling for market share in a declining market. Carcinogens-R-Us has just undergone a leveraged buyout and is able
Comparing the indirect costs of bankruptcy, explain why Apple includes very little debt in its capital structure while Marriott International uses a fairly large amount of debt.AppendixLO1
Describe the trade-offs involved when firms decide how to price their products. What are the costs and benefits of raising prices? How do interest rates affect the decision? How do leverage ratios
Weston Tractor is a cyclical business that is forced to lay off workers during downturns. The CEO estimates that they saved $50 million during the last recession by laying off excess labor.However,
Compass Computers has suffered an unexpected loss and is currently having financial difficulties.Explain why Compass may choose not to issue equity to solve its financial problems. If Compass does
As the CEO of Mega Corp., which do you prefer:a competitor with high leverage or one with low leverage? Under what conditions will you act more or less aggressively if your competitor is highly
Compton Industries currently has 2 million shares outstanding at $3 per share. Because the company is having financial difficulties, it also has $50 million in face value of long-term outstanding
You have been hired by Dell Computer Corporation to advise it on its capital structure.This $75 billion company would like to raise an additional $25 billion to acquire the assets of one of its
In 1999 Chrysler had close to $10 billion in cash on its balance sheet invested in short-term securities. Kerkorian, Chrysler’s largest shareholder, wanted Chrysler to use the cash to buy back
Explain why grocery store prices tended to increase in markets where one or more of the main competitors initiated an LBO. (Hint: Think of market share as an investment.)AppendixLO1
Over the past 20 years, the transaction costs associated with issuing and repurchasing debt and equity securities have declined. What effect do you think this change has had on capital structure
Understand how financial decisions are affected by managers who are better informed than outside shareholders about firm values.AppendixLO1
Identify situations in which managers have an incentive to distort accounting information.AppendixLO1
Explain how financial decisions about the firm’s dividend choice, capital structure, and real investments affect stock prices.AppendixLO1
Interpret the empirical evidence about the reaction of stock prices to various financing and investing decisions.AppendixLO1
Describe how a firm’s investment decisions might be made differently if its management is highly concerned about the firm’s current stock price.AppendixLO1
Why might a firm choose to increase its debt level in response to favorable information about its future prospects?AppendixLO1
Exhibit 19.5 shows that stock prices of industrial firms react more negatively to stock issues than do utilities. Why do you think this is the case?AppendixLO1
Classical finance theory suggests that firms take projects with positive NPVs regardless of the amount of cash the firm has available. However, empirical evidence suggests that the amount that firms
Why might a manager close to retirement select a higher debt ratio than a manager far from retirement?AppendixLO1
ABC Industries is considering an investment that requires the firm to issue new equity. The project will cost $100, but will add $120 to the firm’s value. Although management believes the firm’s
As economies develop, disclosure laws generally get tougher and accounting information becomes more informative. Briefly describe how such changes in the quality of information affect the incentives
If it was known that management was selling shares at the same time as it was increasing leverage, how would this affect the credibility of the signal? Why? What other actions or motivations by
The following table describes management’s view of Abracadabra Corporation’s future cash flows along with the consensus view of outside analysts.Cash Flows State of the Economy: Low Average High
Analysts project that Infotech, an information services company, will have the following financial data for equally probable high and low states:Value State: Low High Cash $100 $100 Fixed asset value
Mr. Chan and Mr. Smith are the CEOs of similar textile manufacturing firms. Chan is 64 years old and plans to retire next year. Smith is 52 years old and expects to remain with the firm for some
Gordon Wu (the largest shareholder of Hopewell)has just announced that he is planning to issue outof-the-money covered warrants on 10 percent of Hopewell’s outstanding stock. Does this announcement

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