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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

22.15a. If the risk of a stock increases, what is likely to happen to the prices of call options on the stock? Why?b. If the risk of a stock increases, what is likely to happen to the price of put
22.14 List the factors that determine the value of an American put option. State how a change in each factor alters the option’s value.
22.13 List the factors that determine the value of an American call option. State how a change in each factor alters the option’s value.
22.12 Suppose you observe the following market prices:American call (Strike $50) $8 Stock $60a. What should you do?b. What is your profit or loss?c. What do opportunities such as this imply about
22.3 Mr. Goodie holds American put options on Delta Triangle stock. The exercise price of the put is $40 and Delta stock is selling for $35 per share. If the put sells for $41⁄2, what is the best
22.2 What is the difference between American options and European options?
22.1 Define the following terms associated with options:a. Optionb. Exercisec. Strike priced. Expiration datee. Call optionf. Put option
• Why are the hidden options in projects valuable?
• How does put-call parity relate these two expressions?
• How can the value of the firm be expressed in terms of put options?
• How can the value of the firm be expressed in terms of call options?
• What is the formula for the Black-Scholes option-pricing model?
• How does the two-state option model work?
• Why does a stock’s variability affect the value of options written on it?
• List the factors that determine the value of options.
• How is a put option’s price related to the underlying stock price at expiration date?What is put-call parity?
• How is a call option’s price related to the underlying stock price at the expiration date?
• Summarize the good and bad arguments for leasing.
• How should one discount a riskless cash flow?
• What are the IRS guidelines for treating a lease contract as a lease for tax purposes?
• Define operating lease.
• Define capital lease.
• What are the differences between an operating lease and a financial lease?
• What are some reasons that assets like automobiles would be leased with operating leases, whereas machines or real estate would be leased with financial leases?
20.16a. In an efficient market callable and noncallable bonds will be priced in such a way that there will be no advantage or disadvantage to the call provision. Comment.b. If interest rates fall,
20.15 Which of the following are characteristics of public issues, and which are characteristics of direct financing?a. SEC registration requiredb. Higher interest costc. Higher fixed costd. Quicker
20.14 Describe the following types of bonds:a. Floating rateb. Deep discountc. Income
20.13 What is a “junk bond”? What are some of the controversies created by junk-bond financing?
20.12 Margret Kimberly, CFO of Charles River Associates, is considering whether or not to refinance the two currently outstanding corporate bonds of the firm. The first one is an 8-percent perpetual
20.11 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 pay an annual coupon of $80 for
20.10 Hudson River Electronics has $500 million of 9-percent perpetual bonds outstanding. These bonds can be called at a price of $1,090 for each $1,000 of face value. Under present market
20.9 New Business Ventures, Inc., has an outstanding perpetual bond with a face value equal to $1,000 and a 9-percent coupon rate. The bond cannot be called for one year. The call premium is set at
20.8 Illinois Industries has decided to borrow money by issuing perpetual bonds. The face value of the bonds will be $1,000. The coupon will be 8 percent, payable annually. The one-year interest rate
20.7 Bowdeen Manufacturing intends to issue callable, perpetual bonds. The bonds are callable at $1,250. One-year interest rates are 12 percent. There is a 60-percent probability that long-term
20.6 KIC, Inc., plans to issue $5 million of perpetual bonds. The face value of each bond is$1,000. The annual coupon on the bonds is 12 percent. Market interest rates on one-year bonds are 11
20.5 What is call premium? During what period of time is a bond said to be call-protected?
20.4 Which is riskier to a prospective creditor, an open-end mortgage or closed-end mortgage? Why?
20.3 Sinking funds have both positive and negative characteristics to the bondholders. Why?
20.2 Define the following terms:a. Protective covenantb. Negative covenantc. Positive covenantd. Sinking fund
20.1 Raeo Corp. bonds trade at 100 today. The bonds pay semiannual interest that is paid on January 1 and July 1. The coupon on the bonds is 10 percent. How much will you pay for a Raeo bond if today
• A private placement is more likely to have restrictive covenants than is a public issue. Why?
• What are the differences between private and public bond issues?
• Create an idea of an unusual bond and analyze its features
• Are the costs of bond issues related to their ratings?
• Why don’t bond prices change when bond ratings change?
• List and describe the different bond-rating classes.
• What are the disadvantages to bondholders of having a call provision?
• What are the advantages to a firm of having a call provision?
1. Suppose Kraus Intercable Company intends to issue perpetual bonds of $1,000 face value at a 10-percent interest rate.6 Annual coupons have been set at $100.There is an equal chance that by the end
• What is a call provision? What is the difference between the call price and the stated price?
• What advantages and what disadvantages do bondholders derive from provisions of sinking funds?
• Do bearer bonds have any advantage? Why might Mr. “I Like to Keep My Affairs Private”prefer to hold bearer bonds?
12.6 The following table lists possible rates of return on two risky assets, M and J. The table also lists their joint probabilities, that is, the probabilities that they will occur simultaneouslya.
1. Suppose Vermont Electronics Company is thinking about relocating its plant to Mexico where labor costs are lower. In the hope that it can stay in Vermont, the company has submitted an application
• List three ways financing decisions can create value
• Can you define an efficient market?
• Can you describe the three forms of the efficient-market hypothesis?
• What kinds of things could make markets inefficient?
• Does market efficiency mean you can throw darts at The Wall Street Journal listing of New York Stock Exchange stocks to pick a portfolio?
• What does it mean to say the price you pay for a stock is fair?
• What are three implications of the efficient-market hypothesis for corporate finance?
13.1a. What rule should a firm follow when making financing decisions?b. How can firms create valuable financing opportunities?
13.2 Define the three forms of market efficiency.
13.4 Aerotech, an aerospace-technology research firm, announced this morning that it has hired the world’s most knowledgeable and prolific space researchers. Before today, Aerotech’s stock had
13.5 When the 56-year-old founder of Gulf & Western, Inc., died of a heart attack, the stock price jumped from $18.00 a share to $20.25, a 12.5-percent increase. This is evidence of market
13.6 On January 10, 1985, the following announcement was made: “Early today the Justice Department reached a decision in the Universal Product Care (UPC) case. UPC has been found guilty of
13.7 Newtech Corp. is going to adopt a new chip testing device that can greatly improve its production efficiency. Do you think the lead engineer of this device can profit from purchasing the
13.8 Trans Trust Corp. has changed how it accounts for inventory. The change does not change tax, but the resulting earnings report released this quarter is 20 percent higher than what it would have
13.10 Sooners Investing Agency has been the hottest stock picker for the past two years.Before the rise to fame occurred, subscribers to the Sooners newsletter totaled only 200.Those subscribers beat
13.11 In a recent discussion with you, your broker commented that well-managed firms are not necessarily more profitable than firms with average management. To convince you of this, she presented you
13.12 A famous economist just announced his findings that the recession is over and the economy is entering the expansion stage once again. Can you profit from investing in the stock market after you
13.14 Some people argue that the EMH can’t explain the 1987 market crash or the high priceto-earnings ratio of the Japanese stock market. What alternative hypothesis is currently used for these two
13.21 Suppose the market is semistrong-form efficient. Can you expect to earn excess returns if you make trades based on:a. Your broker’s information about record earnings for a stock?b. Rumors
13.22 Consider an efficient capital market in which a particular macroeconomic variable that influences your firm’s net earnings is positively serially correlated. Would you expect price changes in
1. Suppose 100 shares of common stock have a par value of $2 each and are sold to shareholders for $10 per share. The capital surplus would be ($10 - $2) * 100= $8 * 100 = $800, and the total
• What is a company’s book value?
• What is corporate debt? Describe its general features.
• Why is it sometimes difficult to tell whether a particular security is debt or equity?
• Do you think it is more like debt or equity?
• What are three reasons why preferred stock is issued?
• What are the major sources of corporate financing?
• What pecking order can be observed in the historical patterns of long-term financing?
14.1 Following are the equity accounts for Kerch Manufacturing.a. How many shares are outstanding?b. At what average price were the shares sold?c. What is the book value of Kerch stock? Common stock,
14.2 The Eastern Spruce equity accounts for last year are as followsa. Fill in the missing numbers.b. Eastern decided to issue 1,000 shares of new stock. The current price is $30 per share.Show the
14.3 Ulrich Inc.’s articles of incorporation authorize the firm to issue 500,000 shares of $5 parvalue common stock, of which 325,000 shares have been issued. Those shares were sold at an average
14.4 The shareholders of the Unicorn Company need to elect seven new directors. There are 2 million shares outstanding. How many shares do you need to be certain that you can elect at least one
14.5 Power Inc. is going to elect six board members next month. Betty Brown owns 17.3 percent of the total shares outstanding. How confident can she be to have one of her candidate friends be elected
14.6a. An election is being held to fill two seats on the board of directors of a firm in which you hold stock. There is a total of 420 shares outstanding. If the election is conducted under
14.7 What are the differences between preferred stock and debt?
14.8 Preferred stock doesn’t offer corporate tax shield on the dividends paid. Why do we still observe some firms issuing preferred stock?
14.9 The yields on nonconvertible preferred stock are lower than the yields on corporate bonds.a. Why is there a difference?b. Which investors are the primary holders of preferred stock? Why?
14.10 What are the main differences between corporate debt and equity? Why do some firms try to issue equity in the guise of debt?
14.11 The Cable Company has $1 million of positive NPV projects it would like to take advantage of. If Cable’s managers follow the historical pattern of long-term financing for U.S. industrial
15.5 The Veblen Company and the Knight Company are identical in every respect except that Veblen Company is not levered. The market value of Knight Company’s 6-percent bonds is$1 million. The
16.4 Chrysler’s financial structure in August 1983 was as follows:Due to large losses incurred during 1978–1981, Chrysler had $2 billion in tax-loss carryforwards; therefore, the next $2 billion
16.5 Fountain Corporation economists estimate that the probability of a good business environment next year is equal to the probability of a bad environment. Knowing that, the managers of Fountain
16.11 Fortune Enterprises (FE) is an all-equity firm that is considering issuing $13,500,000 in 10-percent debt. The firm will use the proceeds of the bond sale to repurchase equity. FE has a
16.12 The general expression for the value of a leveraged firm in a world in which TS = 0 iswhere VU = Value of an unlevered firm TC = Effective corporate tax rate for the firm TB = Personal tax
16.18 The management of New England Textile Corporation (NETC) has decided to relocate the firm to North Carolina after four more years of operating its factory in Cotton Mather, Massachusetts.
16.20 Assume that there are three groups of investors with the following tax rates and investable funds:Each group requires a minimum after-tax return of 8.1 percent on any security. The only types

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