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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

Comment on the following statements17 :(a)Wilmott (2007, p. 77): Assume: “(1) two stocks A and B; (2) both have the same value, same volatility and are denominated in the same currency; (3) both
With zero interest rate, do the arbitrage for the following two assets: Asset I S = 9 (good time) S = 2 (bad time) 48. = S270 (good time) Asset 2 S = 32 (bad time)
Explain under what conditions an American put option will not be early exercised. How to use these conditions to determine the best time to liquidate a firm?
Explain how to use the p-index to invest in stocks. What are the limitations of the p-index?
Explain why the Black–Scholes-Merton option pricing model has:and the binomial option pricing model has:
Suppose you’re on a game show, and you’re given the choice of three doors: Behind one door is $1,000,000; behind the others, $0. You choose a door, say No. 1, and the host, who knows what’s
(1)How many choices do you have in this game?(2)If the host opens two other doors, how many choices do you have in this game?(3)If the host opens no door and asks you to choose again, how many
Suppose that an individual is offered a bet: ($100,000, 0.50; $50,000, 0.50). Mankiw and Zeldes (1991) argue that a person with a coefficient of relative risk aversion of 30 would be indifferent
Some researchers claim that most common errors among individuals are: under-diversification, holding onto losers, chasing winners, buying stocks that catch their attention, systematically ignoring
Explain why firms in the same industry usually have similar capital structure.
In both government and business, they usually intend to expand their sizes. Why?
What are the assumptions of the pecking order theory and the trade-off theory?
List the possible conflicts between shareholders and managers. Some sharehold-ers complain that the high-ranking officials get too much compensations. Is this complaint reasonable?
Explain why a firm has a lot of cash in hand but still issues corporate bonds to borrow from the markets.
Comment on the following statement. When a firm announces cash dividends, it is equivalent to the case that the firm changes part of its equity into a senior debt, and the original debt becomes
Some people argue that cash dividend can reduce free cash flow so that it will not only lessen the management team’s shirking problem but also may reduce the chance to invest in positive NPV
What are the assumptions of the bird-in-the-hand hypothesis?
When a firm announces share repurchases, does it mean that the firm’s stock price is over-or undervalued?
Explain why firms usually provide constant cash dividends.
After mergers and acquisitions, firms on average do not perform well. Explain why?
Mergers and acquisitions usually do not benefit the acquiring firm’s equityholders. Why will mergers and acquisitions still exist?
What are the benefits and costs of a regulated monopoly and an unregulated monopoly?
Some researchers suggest more rules and regulations, more frequent revelations of firms’ financial status, and independent directors. What are the benefits and costs of these suggestions?
The entrenchment effect, tunnelling, and perquisite consumptions may happen to both major shareholders and management. Are these transaction costs reasonable?
Is it true that higher inflation rate in a country leads to its currency depreciation.
Multinational corporations are claimed to be stateless. What kind of protections can these firms have?
Some argues that overseas investments will decrease domestic investments. Is this claim reasonable?
What additional factors does a multinational corporation need to consider when making investment decision?
What are the benefits and costs of a multinational company?
If you buy a new condo for $200,000, financing the entire purchase price plus $10,000 in closing costs via a 360-month mortgage with an APR of 8 percent, how much total interest (to the nearest
Suppose you have a $20,000 portfolio, which is equally invested in 10 different stocks and that the portfolio beta is 1.3. If you sell all your holdings in one of the stocks (which has a beta of 0.9)
You are evaluating a project which will cost $3,000 and has an expected future cash flow of $700 per year, forever, if we start it immediately. If we wait one year to start the project, the cost will
Imagine that you see an advertisement for Manic Wesley's Used Car Emporium that reads something like this: "\($10,000\) Instant Credit! Seven Years to Pay! Low, Low Monthly Payments: Only \($231.99\)
Black Eyed Peas, Inc., has an issue of preferred stock outstanding that pays a dividend of $2.50 per quarter in perpetuity. If a dividend was just paid and the preferred stock is currently selling
Assume that you buy a new car for $24,000, and that you finance $20,000 of the purchase price with a five-year (i.e., 60 monthly payments) loan, for which you are quoted an APR of 7.52 percent. What
You are looking at Jack's Shoes' accounting statements. Jack's Shoes has net income of $16,900 in 2003 and owes $8,650 in taxes for the year. The company repaid $4,200 in loan principal and $650 in
The SCFE Co. wants to add an additional production line. To do this, the company must spend $200,000 to expand its current building, and purchase$1.0 million in new equipment. The company anticipates
The SCFE Co. wants to add an additional production line. To do this, the company must spend $200,000 to expand its current building, and purchase$1.0 million in new equipment. The company anticipates
The SCFE Co. wants to add an additional production line. To do this, the company must spend $200,000 to expand its current building, and purchase$1.0 million in new equipment. The company anticipates
You are trying to pick the least-expensive car for your new delivery service.You have two choices: the Scion xA, which will cost $14,000 to purchase and which will have OCF of -$1,200 annually
An account was opened with $1,000 ten years ago. Today, the account balance is $1,700. If the account paid interest compounded monthly, how much interest on interest was earned?a. $155.04b. $168.20c.
On January 31st, 1985, Pontiac was running a series of ads urging consumers to "Buy a Grand Am for Under 10 Grand!" More specifically, they were selling such cars with an asking price of $9,995.
Cyclic, Inc., has announced that they intend to pay future dividends in a way so as to let them deal with seasonal fluctuations in the need for funds. They intend to pay dividends of $1, $2, $1, and
A company wishes to raise $20,000,000 through the sale of a zero-coupon bond issue, in which the bonds will have a maturity of 10 years and a face value of $20,000 per bond. If the yield on these
Suppose you want to buy a house five years from today. You currently have$25,000 saved toward this purchase, but don't think you'll be able to save any more money, other than the interest that the
Suppose your company has just issued a $30 million bond with a sinking fund provision that calls for retiring a proportionate percentage of the bonds during each year of the issue's 20-year life, so
You want to buy a new Dodge Fandango SUV for $28,000 and plan on putting $2,000 down. If you finance the remainder for 72 months at an APR of 9 percent, what will your payments be?a. $307.98b.
Your bank has agreed to loan your firm $300,000. You will repay the loan in three years with one lump sum of $500,000 (covering both principal and interest). What is the implied interest rate on the
Assume that you are buying a share of preferred stock that pays an annual dividend of $7 per share for $87. What will Rp be?a. 7.00%b. 8.05%c. 9.10%d. 9.85%
Your company is considering selling a newly developed portable video product, the j View. You have developed some forecasts for unit sales and selling price per unit, shown below. You also anticipate
The payoff diagram in Figure 17-13 represents what combination of positions?a. Long put at $45 and long put at $50b. Long put at $45 and short call at $50c. Short put at $45 and long put at $50d.
If someone had paid $5 for a call with E = $37, and the stock was selling for $40 at termination of the call, what would be this person's profit on the call?a. -$5b. -$2c. $2d. $3
Suppose that we are trying to value a three-period call option on a stock that will either go up by 7 percent or down by 4 percent per period, that the exercise price of the option is $35, that the
Suppose that we are trying to value a three-period call option on a stock that will either go up by 7 percent or down by 4 percent per period, that the exercise price of the option is $35, that the
Suppose that we are trying to value a three-period call option on a stock that will either go up by 7 percent or down by 4 percent per period, that the exercise price of the option is $35, that the
Suppose that we wish to value a call with a strike price of $32.50 on a stock that is currently selling for $35, when the call has nine months until expiration, the current nominal annual
Suppose that we wish to value a call with a strike price of $32.50 on a stock that is currently selling for $35, when the call has nine months until expiration, the current nominal annual
Suppose that we wish to value a call with a strike price of $32.50 on a stock that is currently selling for $35, when the call has nine months until expiration, the current nominal annual
Continuing the previous problem, what is the present value of this perpetuity if the first payment of $10 per year will not be received until five years from now, assuming that subsequent $10
An elderly woman is considering a "reverse mortgage," in which her bank will pay her $1,500 per month for the rest of her life. In exchange for this, the bank gets ownership of her home on her death,
Suppose you're considering buying a stock that is expected to pay a dividend of $1.25 per share, per year. If the stock is selling for $8.68, what is the appropriate rate of return on this stock?a.
Suppose you estimate that the next three quarterly dividends paid to ILHS Corp. will be $2.00, $2.25, and $2.50, respectively, and you decide to assume that all subsequent dividends will grow at a
Take the example on p. 633 and give a probability of 50% to the two states of the world. Calculate the value of A, B and G. Calculate the value of C, D and E. What are your conclusions? State of the
You offer investors the opportunity to invest 100, financed solely with equity. Assuming that no taxes are payable, projected constant annual profits to perpetuity are 25 (we assume that necessary
What does it mean when a source of financing is cheap?
When is value created?◦ in the choice of investment;◦ in the choice of financing?
You are required to analyse a number of decisions and establish whether or not they will create value. You then have to decide whether value was in fact created or transferred on a general level, and
Analyse the following financial decisions. Do they send out positive, negative or neutral signals? Signal Sale of company by managing shareholder Sale of company by non-managing shareholder Failure
What is synergy?
Can we talk about financial synergy?
What is a conglomerate discount? How can it be avoided?
Show how the share price of a very profitable company which invests at a rate of return that is higher than the required rate of return can still drop.
Your new insight into investment policy, especially the link between P/E and PBR, and the rate of return on the investment.
Should an investment have a higher expected rate of return than required rate of return? Generally will value always be created?
Show how the conglomerate discount leads to an increase in the cost of equity.
Can a signal be sent if there is no cash flow?
What is an economic rent? What is it based on?
A company that is close to insolvency carries out a capital increase. Is this a signal?Why? What criteria can you identify as being necessary for a decision to be described as a signal?
An increasing number of large groups now ask their top managers to invest a large amount of their personal wealth (often more than 40%) in company shares. What is the theory behind this type of
Can you explain why the behaviour described in Question 17 could have the secondary effect of encouraging managers to diversify their groups’ activities?Question 17An increasing number of large
What is the most relevant cash flow when valuing a company using the discounted cash flow method?
What sort of a discount can a minority shareholder get compared with a financial value? Show how the situation differs between a listed company and an unlisted company.
What is a synergy?
Logically, should a foreign investor with little knowledge of the country pay more or less for a company? Explain why foreign investors often offer the highest price. What is the role of the
Can you multiply a P/E ratio by the EBIT to get the equity value?
Describe the type of company that has a financial value higher than its strategic value.
Which method in your view would be best suited for valuing: a property management company; a holding company; mutual fund; a company in the aeronautics sector; a bicycle factory; a portfolio of
Can an asset have several values? Why?
Is a valuation of a cinema theatre or a chemist shop in terms of a number of weeks’sales a result of the sum-of-the-parts or the cash flow method?
What are the two determining factors when valuing a wine estate?
Which method should be used for estimating the value of a company in decline?
When a company is bought, is there a control premium?
Name the types of companies for which cash flow value is much higher than net asset value.
Can the purchase of a company by venture capitalists create value? And by trade buyers?
Has a reduction in working capital of 1% the same impact on a DCF as a 1%improvement in the EBIT margin?
Why can we say that the mean or the median figure is the choice of an indecisive person?
What is the popular saying on which the cash flow fade method is founded?
Should the buyer’s costs be separated from the target company’s costs in the cost savings that come out of a merger of two companies?
Why is the cost of equity for a company with no debt equal to the average weighted cost of capital?
What is the cost of capital equal to?

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