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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

What are the two risks for a shareholder of an indebted company?
Of the following decisions, which is the most important: An investment decision? A financing decision? Why?
Explain what impact an increase in debt will have on the β of shares.
What are Modigliani and Miller’s theories based on?
The fact that shareholders’ expected returns rise with the level of debt does not run contrary to the approach taken by Modigliani and Miller. Why?
Is the cost of capital an accounting or financial concept?
Why can it be dangerous to use a spreadsheet to create simulations of the cost of capital?
Can a company create value by going into debt?
What is the cost of net debt of a company that has no more shareholders’ equity equal to? And the cost of capital?
What are we forgetting when we say that by increasing return on equity, the leverage effect of debt cannot increase value?
True or false? “By reducing financial leverage, we reduce the cost of debt and the cost of equity, and accordingly, the weighted average cost of capital?” Why?
True or false? “The more debt we incur, the higher the interest rate we are charged.Our shareholders also require a higher return. Additionally, if we want a low cost of capital, we have to have a
According to the new approach by Modigliani and Miller (1963), how does the value of a levered company differ from the value of an unlevered company?
What are the two drawbacks to Modigliani and Miller’s 1963 theory?
What is Modigliani and Miller’s 1977 theory based on and what conclusions do they draw?
Describe the tax breaks for debt financing and for equity financing.
What are the latest tax trends with regard to sources of financing?
Why are holding companies keen to have stakes that are larger than 5%?
What is the value of a levered company when there is a strong likelihood that it will file for bankruptcy?
What is your view of the following statement: “X went bankrupt because its financial expenses amounted to 13% of its sales”?
Why do managers tend to be wary of debt?
Why is it a good thing for a highly profitable company that has reached maturity to carry a lot of debt?
During the 1990s, interest rates in Europe were generally revised downwards. If Modigliani and Miller’s 1963 theory was right, should debt levels of companies have increased or decreased? Debt
According to signal theory, should undervalued companies carry more or less debt than other companies? Why?
If Modigliani and Miller’s 1963 theory had been right, how much corporate income tax would the state have collected every year?
In your view, after a failed takeover bid, will the debt-to-equity ratio of the target tend to rise or fall? Why?
In your view, can the theories of capital structure described in this chapter be proven with as much certainty as, say, the put/call parity described in Chapter 28 that deals with options? Why?
Is it better to calculate book value or the value of leverage (debt-to-equity ratio) in order to assess the level of risk taken by a company?
Does the pecking order theory imply that the company has an optimal capital structure? What are the criteria for determining capital structure according to this approach?
If there was an optimal debt-to-equity ratio, should it be stable over time? Why?
An LBO fund is prepared to pay 3000 for operating assets if the financing is split equally between debt and equity, and 35,000 if the split is 75% debt and 25% equity.State your views.
70% of company A’s needs are equity-financed at a cost of 10% and 30% debt-financed at 6%. What is the weighted average cost of capital of this company if the tax rate is 20%, 50% and 80%?
A company is totally financed by equity capital for a market value of 200m. The only tax it has to pay is corporate income tax at a rate of 40%. Calculate the value of this company if it borrows 50m
Company C is financed by equity for a market value of 40 and by debt for a market value of 30. This debt is perpetual and its interest rate is 6%. The corporate income tax rate is 40%(a) How much of
Redo the table on p. 700 for Spain and Tunisia assuming two situations: no debt and 500 of debt at 7%. Assume Tunisian tax rate on interest is 35%. State your views. The net return of Enterprise
When making a comparison with options, what does shareholders’ equity correspond to?
When making a comparison with options, what does a credit risk correspond to?
For what type of company can we apply the options theory for the valuation of shareholders’ equity?
According to this theory, can the value of a company’s equity be nil?
Why is the application of this theory more advantageous for companies in difficulty?
Is this view of the company opposed to the theory of markets in equilibrium?
Give an example of a decision where creditors are “expropriated” by shareholders, without the debt agreement being renegotiated. Explain.
Is the effect of expropriation a result of market inefficiency?
A company is in trouble as a result of low profits and excessive debts.(a) Do you think that the creditors and the shareholders have the same concerns?More specifically, in the event of the
What is a covenant? Provide a theoretical example of the usefulness of covenants.
Does a covenant represent a prevention against issuing new debt or does it ensure that shareholders/management will enter into discussions with creditors?
Can you give an example of a group where shareholders’ equity is made up of pure time value?
What is the role of debt in the management/shareholder relationship?
Can a good financing plan make up for a mediocre investment?
What disorder afflicts the investor who mistakes the coupon rate on a convertible bond for its financial cost?
A 17% rate of return is required on a certain asset. The acquisition of that asset is financed entirely by equity. What rate of return do shareholders require on it? If the asset were financed
What is the source of financing for which the difference between financial cost and apparent cost is greatest?
Would you advise a startup to seek debt financing? If yes, could it get it?
Is there an optimal capital structure?
Equity capital has two roles in a financing plan. What are they?
Free subscription warrants are distributed to all the shareholders on a one-for-one basis. The value of each warrant isb. What is the value of the share after the warrant is detached, other things
If a shareholder sells the warrant, what is he actually selling?
What difference is there between a big dividend payout and a share buyback of the same amount (a) for the company? (b) for the shareholders?
Which is the fundamental journal article on the subject of capital structure?
In the final analysis, isn’t the cheapest financial resource short-term borrowing?
How do you reconcile these two statements:◦ “You can’t make money without borrowing money.”◦ “Borrowing can’t create value.”
Will a company with ample growth opportunities tend to issue short-term, mediumterm or long-term debt? Why?
Give two examples of inflation profits. Under what conditions can they occur?
If you believe a finance director’s main concern is financial flexibility, would you expect a company ever to use up its borrowing capacity?
Is a company destined always to be financed with equity capital?
Why do startups go through several rounds of financing before they reach maturity?Couldn’t they do it with a single big round?
Can an entrepreneur with an industrial strategy be opportunistic in his financing choices over time?
Why did European companies rid themselves of so much debt in 1980–1998? Why did they stop doing it in 1998–2002?
Why does internal financing enjoy such a positive image?
Why is a policy of sticking strictly to internal financing unsound?
What determines the rate of growth of capital employed?
What should a company do if its rate of return on reinvested earnings is below the weighted average cost of capital?
By what criterion should a policy of reinvesting cash flow be judged?
In your opinion, which theory best explains the interest of internal financing from an overall standpoint?
Show with an example why reinvestment of earnings by the company has no cost for a holder of options on the company’s shares.
What is the market’s sanction for over-reliance on internal financing?
What kind of companies rely heavily on internal financing? What kind do not?
Can internal financing lower the cost of capital?
What are the advantages and drawbacks of 100% internal financing for family shareholders?
Why is internal financing the financial resource with the lowest implementation cost?
Under what condition is the dividend growth rate at least equal to the growth rate of free cash flow?
What are the two criteria by which a dividend policy should be judged?
Does an increase in the dividend result in an increase in the value of the share?
Given tax neutrality, would you prefer to receive dividends or realise capital gains?Same question given the French tax system.
According to signalling theory, what is indicated by maintaining the per-share dividend following a capital increase by incorporation of reserves?
Is there a cost to the company of issuing bonus shares? Does such an issue change shareholder wealth? What purpose does it serve?
Does a high dividend provide assurance of a stable share price? Why?
Can a company have a target dividend yield for its shareholders? Why or why not?
On the record date of the dividend, the value of the share decreases instantly by the amount of the dividend. Is the shareholder worse off?
What is the natural temptation of a company that is required to pay out 100% of its earnings, in terms of how much earnings it records?
On what condition would you invest in a company that pays no dividend?
A company that has not been paying dividends announces that it will pay one. How would you interpret this news according to (a) equilibrium market theory, (b) agency theory and (c) signalling theory?
Is a manager who holds stock options in favour of a high-dividend policy? Why or why not?
Do tobacco companies in western countries have high payout ratios? Why or why not?
What signal is sent by paying a dividend in shares?
Explain why a sharp increase in dividend often results in a decrease in the value of the company’s borrowings.
What is the impact of a debt-heavy capital structure on the payout ratio?
In what circumstances does a company have good reason to have a capital decrease?
Forgetting tax considerations, can a capital decrease enhance the value of the company’s operating assets? the value of its shares?
What difference do you see between payment of dividends and capital reduction?

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