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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

Financial distress. Bob from accounting just barged into your office and screams “We’re about to go bankrupt! Do something!” Why is Bob so upset?Why is financial distress such a concern for a
Source of funds. Evaluate the statement “the cost of funds depends upon the use of the funds.” What does that mean? Assume you are talking to your supervisor in relation to a project you are
Cost of equity. Kelly’s Tiki Hut has experienced growth of 11% per year over the past 15 years and expects this to continue indefinitely. Three years ago, they began paying dividends. The first
Cost of equity. Suppose ABC Company has stock currently selling at$21.00 per share that just paid dividends of $1.75. They have a required rate of return of 12%. We have the following data for their
Cost of equity. You have just taken a position as chief financial officer of a large, multinational firm. Your first task is to find an appropriate cost of capital to apply to capital budgeting.
Cost of equity. Harry’s Toupee Shop, Inc., has publicly stated they are going to pay dividends next year of $1.24 and then increase this amount by 4% for the following five years. Following that,
Cost of debt. Suppose Bob’s Golf Cart Shop has 4,000 30-year bonds outstanding, each currently selling at $897.64. The bonds have 18 years left until maturity and have a coupon rate of 7.5%. What
Cost of debt. A firm has two types of debt in their capital structure. They have 200 coupon bonds selling at $986.68 each. They also have $200,000 worth of bank debt, which has an interest rate of
Taxes and costs. You need $530,000 and have decided to get it either from bank debt or from issuing equity. The beta on your firm is 0.35, the riskfree rate is 1.75%, and the market risk premium is
Cost of preferred stock. Your firm has 250,000 shares of $50 preferred stock currently selling at $23.56 per share. If these stocks pay a 3.5% dividend, what is the cost of these preferred shares?
Cost of zero-coupon bonds Consider a zero-coupon bond that has a face value of $100 and 13 years left until maturity. If the current price is $54.86, what is the current YTM of this bond?
Capital structure weights. Firm X has a WACC of 9.43%. They only have one type of debt and one type of equity. The cost of their debt is 8.4% and the cost of equity is 11.3%. What is the weight of
Capital structure weights. If the debt-to-equity ratio for a firm is 0.38, what is the weight of debt in the firm’s capital structure?
Capital structure weights. Your firm has an odd capital structure made up of only coupon bonds and preferred stock. The coupon bonds have a YTM of 5.61%. The preferred stock pays a dividend of $1.12
Weighted average cost of capital. Your firm has two types of bonds. First, there are 3,000 bonds outstanding with a 7% coupon rate and a yield to maturity of 6.5%. These bonds are selling at
Weighted average cost of capital. Suppose your firm has five sources of funding. They are as follows:55 400,000 shares of stock currently selling at $12.33 per share. The firm has experienced an
Optimal capital structure. Suppose a firm has four pieces of capital structure.They are as follows:55 Common stock that has a beta of 1.21. In addition, the market risk premium is 9.1% and the
Optimal capital structure. You are in charge of the finance department at Johnny’s Kawasaki, Inc. The firm is considering expanding to Europe and will build a plant in London. The plant will cost
Optimal capital structure. Bobby’s Beer Barn just paid a dividend of $1.06 and has seen their stock price rise to $27.48. However, they are attempting to purchase a new plant that needs capital of
Capital budgeting and capital structure. Discuss the relationship between the capital budgeting and capital structure decisions. Are they made independently or simultaneously? Why? How?
Payback period. What are the strengths and weaknesses of the payback period method of capital budgeting?
Discounted payback period. What differs between the discounted payback period and just the original? Is this difference a big deal?
Average accounting return. What are the strengths and weaknesses of the average accounting return method of capital budgeting?
Net present value. Your brilliant finance instructor just made the following comment: “The NPV incorporates everything we have done all semester long.”Is she/he crazy? Why would she/he make such
Net present value. Discuss the decision rule of the NPV. Where does the motivation come from? Why is this such a critical element in determining the importance of the model?
Profitability index. You have the NPV of a project. In order to get the PI, what other piece of information do you need? What does this tell you about the two methods?
Profitability index. What are the strengths and weaknesses of the profitability index method of capital budgeting?
Internal rate of return. You have calculated an IRR of 8.5% on a project. What does this mean? If the WACC is 7.5%, what is your decision based upon the IRR?
Internal rate of return. What are the strengths and weaknesses of the internal rate of return method of capital budgeting?
Capital budgeting tools. Your boss, Mad Man Mike, just said that you screwed up because the NPV calculation that you provided turned out to be wrong.How do you respond to this?
Capital budgeting tools. You just did a capital budgeting analysis and the payback period and NPV disagree. What do you do now? Why?
Capital budgeting tools. Susan just looked over your shoulder to see you calculating the NPV and IRR of a project and says, “Why do you waste your time doing both of them? They tell you the same
Payback period. Suppose you have a project that has a NINV of $825,000.The project is expected to generate net cash flows of $76,000 each year for 20 years. What is the payback period?
Payback period. Joe’s Beef Barn is planning to purchase a new meat grinding machine. They have two options. Option A is expected to generate net cash flows of $35,000 for the next ten years and has
Discounted payback period. A firm is considering a 15-year project that is expected to return NCFs of $12,000 in each of the first seven years and then $8,000 in each of the remaining eight years. If
Discounted payback period. Netty’s Cow Barn, Inc. is considering a new milking system. They have calculated the NPV of this project to be $68,524.The project is an eight-year project where each
Average accounting return. Consider a project that is expected to generate$45,800 in net income for each of its ten years. In addition, it is going to cost $389,000 to get started. What is the
Average accounting return. The AAR of a project has been calculated to be 98.43%. The project is a five-year project and is expected to generate net income of $126,440 in each of those five years. If
Average accounting return. A firm is considering a three-year project. It is believed that the first year’s sales will be $21,000 and that this number will increase by $2,000 (over each previous
Net present value. What is the NPV of a project that is expected to generate NCFs of $450,500 each year for the next 32 years? The project has a NINV of $6 million and WACC of 7%.
Net present value. Suppose you are considering a three-year project that is expected to generate NCFs of $24,000 in each of the first two years and then $36,000 in the last year. If the IRR is 6.47%
Net present value. An investment project has an initial cost of $518,297.The cash flows over the four-year life of the investment are projected to be$287,636, $203,496, $103,802, and $92,556,
Net present value. Suppose you have a project with IRR of 11.3%. The project is expected to generate NCFs of $44,900 in each of its eight years.What is the firm’s NPV if their WACC is 10.4%?
Net present value. Hattie’s Hat Company, Inc. is considering a project that has a NCS of $256,000, an increase in NWC of $125,000, and NCF of$85,542 during each year of the project. Hattie has
Internal rate of return. Billy’s Bean Barn is thinking of purchasing a new shucking machine that costs $126,000. They expect to generate NCFs of$26,000 each year for the seven years of the project.
Internal rate of return. Suppose a project is expected to have a two-year life and is expected to generate net cash flows of $10,000 in year 1.In year 2, the cash flow decreases to $8,000. If the
Internal rate of return. Consider a project that is expected to generate NCFs of $75,000 in each of the four years of the project. In order to get the project up and running, the firm will have to
Breakeven analysis. Suppose you are evaluating a four-year project, where each year is projected to be identical. The NINV of the project is $897,000, and the company’s WACC is 7.6%.(a) What level
Net present value. You are considering a four-year project that has the following pro forma statement:In addition, you have estimated the project will require an increase in net capital spending of
Sensitivity analysis. In #17 above, suppose you wanted to conduct sensitivity analysis where actual sales can deviate by +/− 10% from those projected. The COGS will remain constant as a percentage
Capital budgeting tools. Scotty’s Pickle Factory is considering purchase of a new machine to supplement his operations. After a long, drawn-out process, his financial team has come up with
Corporations: Name at least two advantages associated with a corporation.What are the primary disadvantages?
Sole proprietorships and partnerships: What are the primary disadvantages to both the sole proprietorship and partnership forms of business organizations?What are potential benefits?
Agency problems: Bob Thomas is the manager of MLP, Inc., a publicly traded firm. Last year, he chose to forego a valuable project so he could give himself a larger bonus. What did Bob create? How do
Agency problems: Publicly traded companies are likely to have many different owners. Private companies, however, have relatively few owners. Does this mean that agency problems do not exist for
Sarbanes-Oxley: What is the motivation behind the legislation? What does its implementation mean to publicly held corporations?
Primary markets: What is the difference between primary and secondary markets?Give an example of each.
Initial public offerings: What are the primary “ingredients” in the IPO process?Describe each in detail.
Angel investors: Describe the role of angel investors in the development of an early stage firm. What are the benefits of weaknesses of being an angel investor?What are the good and bad of taking
Private equity: What is different between private and public equity? As an investor, what would be different about your relationship to the firm and the control you have in its activities?
Private capital markets: Take us through the evolution of a firm, from inception to going public, assuming the company remains highly successful at each stage. What happens to the ownership levels of
Venture capital and underwriters: Describe two financial intermediaries that often help the issuing firms in the going-public process. What roles do each play?
Initial public offerings: Discuss the paperwork that is involved in an IPO. What is included in each and what purpose does it serve?
Initial public offerings: What are the two primary purposes for a firm to go public?
Initial public offerings: Johnny Quickset sits three seats across from you in finance class. After class he approached you and asked the following question:“How do underwriters make money?” How
Lockup agreement: Scotty Blow’s lamp store went public on 14 July 2010.Three weeks later, Scotty sold 47% of his shares for a profit of $2 million. Why is this a bad thing? Discuss the mechanism
Goal of the firm: What is the only appropriate goal of the firm? Why?
Goal of the firm: Name at least four other potential goals of the firm and discuss what those goals lack in relation to the true goal.
ESG: Describe what is meant by ESG. What are the three components and why should a firm care about them? Why should investors?
Goal of the firm and agency problems: Suppose the CEO of a Fortune 500 firm superficially inflates year-end earnings reports to increase his bonus.What is this an example of? How does this influence
Director voting: What is the primary difference between cumulative and straight voting? How does this affect minority shareholder participation?
Proxy voting: Discuss how proxy voting affects shareholder influence over the ownership structure. What potential benefits of proxy voting come to mind?Can you think of any potential disadvantages?
Governance: What is meant by a firm’s governance? How would this affect an investor in a publicly traded firm?
Capital budgeting: How important is capital budgeting in corporate finance?What types of issues have to be addressed in capital budgeting?
Capital structure: How important is capital structure in corporate finance?What types of issues have to be addressed in capital structure?
Capital structure: Suppose you are the CFO of a company that just built a$40 million dollar plant. What are your options for paying for this plant?
Capital structure and capital budgeting: Your friend is having trouble grasping the concepts of capital structure and capital budgeting, so you decide to explain it to her in terms of her personal
Working capital management: How does working capital management fit into the equation? What types of things need to be considered in working capital management?
Capital budgeting, capital structure, and working capital management: Suppose you are the CFO for a pencil-making firm that is in need of a new machine.Discuss the basic steps that you must go
PV of unequal cash flows Suppose you have an incentive deal worked out with your father. For every year you survive college with an acceptable GPA, you get compensated. Since the classes get harder,
Present value You and your husband (wife) just had a nasty divorce. You, being the bread winner in the family, have to pay support to him (her) for the next fifteen years. You haggle out a price of
Annuities You just signed a loan agreement on a boat. You will pay $867 each month for the next ten years. What was the purchase price of the boat if the APR is 8.5 %, compounded monthly?
FV of unequal cash flows You expect to receive cash flows of $12,000 at the end of year 1, $8,000 at the end of year 2, $4,500 at the end of year 3, and $7,800 at the end of year 4.What will this be
Annuities You plan to invest $15,000 at the end of each of the next twelve years into an account earning 6.4 % compounded annually. How much will it be worth at the end of those twelve years?
Annuities and time You want to quit your day job and become a day trader.However, knowing the risk of doing so, you want to have a nest egg first. Your goal is to have $100,000 in an investment
Annuities and rates Your grandpa is a great guy and is willing to give you$50,000 today to pay off some student loan. But he wants to be repaid $200 each month for the next thirty years. What APR is
Interest-only loans Suppose you buy a condo as an investment property. You buy it with a thirty-year interest-only loan with a rate of 5 %, compounded monthly. The condo costs $215,000, and you
Amortized loans You want to buy a house with a price tag of $277,777. You pay 10 % down and borrow the rest on an amortized loan at a rate of 6 %, compounded monthly, for thirty years. After 6 months
Loans types Suppose you want to buy a $200,000 home on a hybrid loan. For the first five years, the loan will be an interest-only loan, and then it will turn into an amortized loan. If the applicable
Future value Suppose you’ve just gotten a job that has an annual salary of$105,000. You are also promised a 3 % raise in each of the following three years. However, you were fortunate to be born
Present value Mary Lee Tucker has just turned 17.Her boyfriend, Scotty, decided to have a party for her. The party was thrown in Scotty’s parent’s basement with their full knowledge and consent.
Present value Susie bets you $1,000 that she can run a mile in 5 min. You obviously don’t believe her, so you agree to take on the bet. However, at the last minute, she informs you that she
Future value Following up on the previous question, suppose that you realize that you’re not exactly getting a fair deal. How much would you be willing to accept in 6 months in exchange for the
Annuity amount Suppose your goal is to have $200,000 at the end of ten years in order to buy a home. If you invest in an account that earns an interest rate of 6.7 %, compounded monthly, how much
Annuity amount You just bought a car that costs $19,000. You finance it over the next five years, at a rate of 5.5 %, compounded monthly. How much is your monthly payment?
Present value Suppose you were just hired at a prestigious sales company. You have two options for your salary. You can get paid either on a commission basis or on a straight salary basis. If you
Future value You have just started a side business making erasers for pencils. Your goal is to make enough to buy the house you desire on the lake. The house costs $200,000 and you want to buy it ten
Loans You want to buy a farm that costs $650,000. You plan to finance over the next thirty years. You are considering two options. Option A is that you use savings of $25,000 as a down payment on the
Public debt Discuss the similarities and differences between private and public debts. What are the advantages of public debt relative to private debt? What are the disadvantages?
Bond price What is the current price of a 25-year, 8 % coupon bond that has a required return of 8.26 %, 12 years left until maturity, and makes annual payments?

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