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fundamentals of corporate finance

Questions and Answers of Fundamentals Of Corporate Finance

Cost of Capital. A financial analyst at Dawn Chemical notes that the firm’s total interest payments this year were $10 million while total debt outstanding was $80 million, and he concludes that
Cost of Equity. Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30 percent, and the
Cost of Debt. Olympic Sports has two issues of debt outstanding. One is a 9 percent coupon bond with a face value of $20 million, a maturity of 10 years, and a yield to maturity of 10 percent. The
Capital Structure. Examine the following book-value balance sheet for University Products, Inc. What is the capital structure of the firm based on market values? The preferred stock currently sells
Calculating WACC. Turn back to University Products’s balance sheet from the previous problem. If the preferred stock pays a dividend of $2 per share, the beta of the stock is .8, the market risk
Project Discount Rate. University Products is evaluating a new venture into home computer systems (see problems 15 and 16). The internal rate of return on the new venture is estimated at 13.4
Cost of Capital. The total market value of Okefenokee Real Estate Company is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock currently is
Changes in Capital Structure. Look again at our calculation of Big Oil’s WACC. Suppose Big Oil is excused from paying taxes. How would its WACC change? Now suppose Big Oil makes a large stock issue
Changes in Capital Structure. Refer again to problem 19. Suppose Big Oil starts from the financing mix in Table 4.13, and then borrows an additional $200 million from the bank. It then pays out a
WACC and Taxes. “The after-tax cost of debt is lower when the firm’s tax rate is higher;therefore, the WACC falls when the tax rate rises. Thus, with a lower discount rate, the firm must be worth
Cost of Capital. An analyst at Dawn Chemical notes that its cost of debt is far below that of equity. He concludes that it is important for the firm to maintain the ability to increase its borrowing
Fixed and Variable Costs. In a slow year, Wimpy’s Burgers will produce 1 million hamburgers at a total cost of $1.75 million. In a good year, it can produce 2 million hamburgers at a total cost of
Average Cost. Reconsider Wimpy’s Burgers from problem 1.a. What is the average cost per burger when the firm produces 1 million hamburgers?b. What is average cost when the firm produces 2 million
Sensitivity Analysis. A project currently generates sales of $10 million, variable costs equal to 50 percent of sales, and fixed costs of $2 million. The firm’s tax rate is 35 percent. What are the
Sensitivity Analysis. The project in the preceding problem will last for 10 years. The discount rate is 12 percent.a. What is the effect on project NPV of each of the changes considered in the
Sensitivity Analysis. Emperor’s Clothes Fashions can invest $5 million in a new plant for producing invisible makeup. The plant has an expected life of 5 years, and expected sales are 6 million
Scenario Analysis. The most likely outcomes for a particular project are estimated as follows:However, you recognize that some of these estimates are subject to error. Suppose that each variable may
Scenario Analysis. Reconsider the best- and worst-case scenarios in the previous problem.Do the best- and worst-case outcomes when each variable is treated independently seem to be reasonable
Break-Even. The following estimates have been prepared for a project under consideration:What must be the variable cost per unit? Fixed costs: Depreciation: Price: Accounting break-even: $20,000
Break-Even. Dime a Dozen Diamonds makes synthetic diamonds by treating carbon. Each diamond can be sold for $100. The materials cost for a standard diamond is $30. The fixed costs incurred each year
Break-Even. Turn back to problem 9.a. Would the accounting break-even point in the first year of operation increase or decrease if the machinery were depreciated over a 5-year period?b. Would the NPV
Break-Even. You are evaluating a project that will require an investment of $10 million that will be depreciated over a period of 7 years. You are concerned that the corporate tax rate will increase
Break-Even. Define the cash-flow break-even point as the sales volume (in dollars) at which cash flow equals zero. Is the cash-flow break-even level of sales higher or lower than the zero-profit
Break-Even and NPV. If a project operates at cash-flow break-even (see problem 12) for its entire life, what must be true of the project’s NPV?
Break-Even. Modern Artifacts can produce keepsakes that will be sold for $80 each. Nondepreciation fixed costs are $1,000 per year and variable costs are $60 per unit.a. If the project requires an
Break-Even. A financial analyst has computed both accounting and NPV break-even sales levels for a project under consideration using straight-line depreciation over a 6-year period.The project
Break-Even. Reconsider Finefodder’s new superstore. Suppose that by investing an additional$600,000 initially in more efficient checkout equipment, Finefodder could reduce variable costs to 80
Break-Even and NPV. If the superstore project (see the previous problem) operates at accounting break-even, will net present value be positive or negative?
Operating Leverage. You estimate that your cattle farm will generate $1 million of profits on sales of $4 million under normal economic conditions, and that the degree of operating leverage is 7.5.
Operating Leverage.a. What is the degree of operating leverage of Modern Artifacts (in problem 14) when sales are $8,000?b. What is the degree of operating leverage when sales are $10,000?c. Why is
Operating Leverage. What is the lowest possible value for the degree of operating leverage for a profitable firm? Show with a numerical example that if Modern Artifacts (see problem 14a) has zero
Operating Leverage. A project has fixed costs of $1,000 per year, depreciation charges of$500 a year, revenue of $6,000 a year, and variable costs equal to two-thirds of revenues.a. If sales increase
Project Options. Your midrange guess as to the amount of oil in a prospective field is 10 million barrels, but in fact there is a 50 percent chance that the amount of oil is 15 million barrels, and a
Project Options. A silver mine can yield 10,000 ounces of copper at a variable cost of $8 per ounce. The fixed costs of operating the mine are $10,000 per year. In half the years, silver can be sold
Project Options. An auto plant that costs $100 million to build can produce a new line of cars that will produce cash flows with a present value of $140 million if the line is successful, but only
Production Options. Explain why options to expand or contract production are most valuable when forecasts about future business conditions are most uncertain.
Abandonment Option. Hit or Miss Sports is introducing a new product this year. If its seeat-night soccer balls are a hit, the firm expects to be able to sell 50,000 units a year at a price of $60
Expansion Option. Now suppose that Hit or Miss Sports from the previous problem can expand production if the project is successful. By paying its workers overtime, it can increase production by
Equity Accounts. The authorized share capital of the Alfred Cake Company is 100,000 shares. The equity is currently shown in the company’s books as follows:a. How many shares are issued?b. How many
Equity Accounts.a. Look back at problem 1. Suppose that the company issues 10,000 shares at $5 a share.Which of the above figures would change?b. What would happen to the company’s books if instead
Financing Terms. Fill in the blanks by choosing the appropriate term from the following list: lease, funded, floating-rate, eurobond, convertible, subordinated, call, sinking fund, prime rate,
Financing Trends. True or false? Explain.a. In several recent years, nonfinancial corporations in the United States have repurchased more stock than they have issued.b. A corporation pays tax on only
Preferred Stock. In what ways is preferred stock like long-term debt? In what ways is it like common stock?
Voting for Directors. If there are 10 directors to be elected and a shareholder owns 90 shares, indicate the maximum number of votes that he or she can cast for a favorite candidate undera. majority
Voting for Directors. The shareholders of the Pickwick Paper Company need to elect five directors. There are 400,000 shares outstanding. How many shares do you need to own to ensure that you can
Equity Accounts. Look back at Table 5.8.a. Suppose that Heinz issues 10 million shares at $55 a share. Rework Table 5.8 to show the company’s equity after the issue.b. Suppose that Heinz
Equity Accounts. Common Products has just made its first issue of stock. It raised $2 million by selling 200,000 shares of stock to the public. These are the only shares outstanding.The par value of
Protective Covenants. Why might a bond agreement limit the amount of assets that the firm can lease?
Bond Yields. Other things equal, will the following provisions increase or decrease the yield to maturity at which a firm can issue a bond?a. A call provisionb. A restriction on further borrowingc. A
Income Bonds. Income bonds are unusual. Interest payments on such bonds may be skipped or deferred if the firm’s income is insufficient to make the payment. In what way are these bonds like
Preferred Stock. Preferred stock of financially strong firms sometimes sells at lower yields than the bonds of those firms. For weaker firms, the preferred stock has a higher yield. What might
Underwriting.a. Is a rights issue more likely to be used for an initial public offering or for subsequent issues of stock?b. Is a private placement more likely to be used for issues of seasoned stock
Underwriting. Each of the following terms is associated with one of the events beneath.Can you match them up?a. Shelf registrationb. Firm commitmentc. Rights issue A. The underwriter agrees to buy
Underwriting Costs. State for each of the following pairs of issues which you would expect to involve the lower proportionate underwriting and administrative costs, other things equal:a. A large
IPO Costs. Why are the issue costs for debt issues generally less than those for equity issues?
Venture Capital. Why do venture capital companies prefer to advance money in stages?
IPOs. Your broker calls and says that you can get 500 shares of an imminent IPO at the offering price. Should you buy? Are you worried about the fact that your broker called you?
IPO Underpricing. Having heard about IPO underpricing, I put in an order to my broker for 1,000 shares of every IPO he can get for me. After 3 months, my investment record is as follows:a. What is
IPO Costs. Moonscape has just completed an initial public offering. The firm sold 3 million shares at an offer price of $8 per share. The underwriting spread was $.50 a share. The price of the stock
IPO Costs. Look at the illustrative new issue prospectus in the appendix.a. Is this issue a primary offering, a secondary offering, or both?b. What are the direct costs of the issue as a percentage
Flotation Costs. “For small issues of common stock, the costs of flotation amount to about 15 percent of the proceeds. This means that the opportunity cost of external equity capital is about 15
Flotation Costs. When Microsoft went public, the company sold 2 million new shares (the primary issue). In addition, existing shareholders sold .8 million shares (the secondary issue)and kept 21.1
Flotation Costs. The market value of the marketing research firm Fax Facts is $600 million.The firm issues an additional $100 million of stock, but as a result the stock price falls by 2 percent.
Flotation Costs. Young Corporation stock currently sells for $30 per share. There are 1 million shares currently outstanding. The company announces plans to raise $3 million by offering shares to the
Private Placements. You need to choose between the following types of issues:A public issue of $10 million face value of 10-year debt. The interest rate on the debt would be 8.5 percent and the debt
Rights. In 2001 Pandora, Inc., makes a rights issue at a subscription price of $5 a share. One new share can be purchased for every four shares held. Before the issue there were 10 million shares
Rights. Problem 15 contains details of a rights offering by Pandora. Suppose that the company had decided to issue the new stock at $4 instead of $5 a share. How many new shares would it have needed
Show that Pandora’s shareholders are just as well off if it issues the shares at $4 a share rather than the $5 assumed in problem 15.
Rights. Associated Breweries is planning to market unleaded beer. To finance the venture it proposes to make a rights issue with a subscription price of $10. One new share can be purchased for each
Merger Motives. Which of the following motives for mergers make economic sense?a. Merging to achieve economies of scale.b. Merging to reduce risk by diversification.c. Merging to redeploy cash
Merger Motives. Explain why it might make good sense for Northeast Heating and Northeast Air Conditioning to merge into one company.
Empirical Facts. True or false?a. Sellers almost always gain in mergers.b. Buyers almost always gain in mergers.c. Firms that do unusually well tend to be acquisition targets.d. Merger activity in
Merger Tactics. Connect each term to its correct definition or description: A. LBO B. Poison pill C. Tender offer D. Shark repellent E. Proxy contest 1. Attempt to gain control of a firm by winning
Empirical Facts. True or false?a. One of the first tasks of an LBO’s financial manager is to pay down debt.b. Shareholders of bidding companies earn higher abnormal returns when the merger is
Merger Gains. Acquiring Corp. is considering a takeover of Takeover Target Inc. Acquiring has 10 million shares outstanding, which sell for $40 each. Takeover Target has 5 million shares outstanding,
Mergers and P/E Ratios. If Acquiring Corp. from problem 6 has a price-earnings ratio of 12, and Takeover Target has a P/E ratio of 8, what should be the P/E ratio of the merged firm? Assume in this
Merger Gains and Costs. Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively.
Stock versus Cash Offers. Suppose that instead of making a cash offer as in problem 8, Velcro Saddles considers offering Pogo shareholders a 50 percent holding in Velcro Saddles.a. What is the value
Merger Gains. Immense Appetite, Inc., believes that it can acquire Sleepy Industries and improve efficiency to the extent that the market value of Sleepy will increase by $5 million.Sleepy currently
Mergers and P/E Ratios. Castles in the Sand currently sells at a price-earnings multiple of 10. The firm has 2 million shares outstanding, and sells at a price per share of $40. Firm Foundation has a
Stock versus Cash Offers. Sweet Cola Corp. (SCC) is bidding to take over Salty Dog Pretzels(SDP). SCC has 3,000 shares outstanding, selling at $50 per share. SDP has 2,000 shares outstanding, selling
Bootstrap Game. The Muck and Slurry merger has fallen through (see Section 6.3). But World Enterprises is determined to report earnings per share of $2.67. It therefore acquires the Wheelrim and Axle
Merger Gains and Costs. As treasurer of Leisure Products, Inc., you are investigating the possible acquisition of Plastitoys. You have the following basic data:You estimate that investors currently
Exchange Rates. Use Table 6.5 to answer these questions:a. How many euros can you buy for $100? How many dollars can you buy for 100 euros?b. How many Swiss francs can you buy for $100? How many
Exchange Rate Relationships. Look at Table 6.5.a. How many Japanese yen do you get for your dollar?b. What is the 1-year forward rate for the yen?c. Is the yen at a forward discount or premium on the
Exchange Rate Relationships. Define each of the following theories in a sentence or simple equation:a. Interest rate parity theory.b. Expectations theory of forward rates.c. Law of one price.d.
International Capital Budgeting. Which of the following items do you need if you do all your capital budgeting calculations in your own currency?Forecasts of future exchange rates Forecasts of the
Foreign Currency Management. Ms. Rosetta Stone, the treasurer of International Reprints, Inc., has noticed that the interest rate in Switzerland is below the rates in most other countries.She is
Hedging Exchange Rate Risk. An importer in the United States is due to take delivery of silk scarves from Europe in 6 months. The price is fixed in euros. Which of the following transactions could
Currency Risk. Sanyo produces audio and video consumer goods and exports a large fraction of its output to the United States under its own name and the Fisher brand name. It prices its products in
Managing Exchange Rate Risk. A firm in the United States is due to receive payment of 1 million Australian dollars in 8 years’ time. It would like to protect itself against a decline in the value
Interest Rate Parity. The following table shows interest rates and exchange rates for the U.S. dollar and Mexican peso. The spot exchange rate is 9.5 pesos per dollar. Complete the missing entries:
Exchange Rate Risk. An American investor buys 100 shares of London Enterprises at a price of £50 when the exchange rate is $1.60/£. A year later the shares are selling at £52. No dividends have
Interest Rate Parity. Look at Table 6.5. If the 3-month interest rate on dollars is 6.0 percent(annualized), what do you think is the 3-month sterling (U.K.) interest rate? Explain what would happen
Expectations Theory. Table 6.5 shows the 1-year forward rate on the Canadian dollar.a. Is the Canadian dollar at a forward discount or a premium on the U.S. dollar?b. What is the annualized
Interest Rate Parity. Suppose the interest rate on 1-year loans in the United States is 5 percent while in the United Kingdom the interest rate is 6 percent. The spot exchange rate is$1.55/£ and the
Purchasing Power Parity. Suppose that the inflation rate in the United States is 4 percent and in Canada it is 5 percent. What would you expect is happening to the exchange rate between the United
Cross Rates. Look at Table 6.5. How many Swiss francs can you buy for $1? How many yen can you buy? What rate do you think a Japanese bank would quote for buying or selling Swiss francs? Explain what
International Capital Budgeting. Suppose that you do use your own views about exchange rates when valuing an overseas investment proposal. Specifically, suppose that you believe that the leo will
Currency Risk. You have bid for a possible export order that would provide a cash inflow of ∼1 million in 6 months. The spot exchange rate is ∼1.06/$ and the 1-year forward rate is∼1.07/$.

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