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principles corporate finance

Questions and Answers of Principles Corporate Finance

19. The Web site www.mhhe.com/bma contains an Excel program for calculating the profitability of the Nodhead project. Now suppose that the cash flows from Nodhead’s new supermarket are as
21. Consider an asset with the following cash flows:Year 0 1 2 3 Cash flows ($ millions) ⫺12 ⫹5.20 ⫹4.80 ⫹4.40 The firm uses straight-line depreciation. Thus, for this project, it writes off
22. In our Nodhead example, true depreciation was decelerated. That is not always the case.For instance, Table 12.6 shows how on average the market value of a Boeing 737 has varied with its age 27
13. Here are alphas and betas for Intel and Conagra for the 60 months ending April 2009.Alpha is expressed as a percent per month.Alpha Beta Intel ⫺.57 1.08 Conagra ⫺.46 .65 Explain how these
16. What does the efficient-market hypothesis have to say about these two statements?a. “I notice that short-term interest rates are about 1% below long-term rates. We should borrow
20. Explain how incentive and agency problems can contribute to mispricing of securities or to bubbles. Give examples.
21. Many commentators have blamed the subprime crisis on “irrational exuberance.” What is your view? Explain briefly.
22. “The strong-form of the efficient-market hypothesis is nonsense. Look at mutual fund X; it has had superior performance for each of the last 10 years.” Does the speaker have a point?Suppose
7. Inbox Software was founded in 2007. Its founder put up $2 million for 500,000 shares of common stock. Each share had a par value of $.10.a. Construct an equity account (like the one in Table 14.2
8. Look back at Table 14.2 .a. Suppose that Honeywell issued an additional 50 million shares at $30 a share. Rework Table 14.2 to show the company’s equity after the issue.b. Suppose that Honeywell
11. Look up the financial statements for a U.S. corporation on the Internet and construct a table like Table 14.3 showing the types of debt that the company has issued. What arrangements has it made
1. Use data from the Standard & Poor’s market insight database at www.mhhe.com/ed umarketinsight to work out the financing proportions given in Figure 14.1 for a particular industrial company for
1. After each of the following issue methods we have listed two types of issue. Choose the one more likely to employ that method.a. Rights issue ( initial public offer/further sale of an already
2. Each of the following terms is associated with one of the events beneath. Can you match them up?a. Best effortsb. Bookbuildingc. Shelf registrationd. Rule 144A Events:A. Investors indicate to the
11. Why are the costs of debt issues less than those of equity issues? List the possible reasons.
16. Suppose that instead of having a rights issue of new stock at €4 (see Problem 15), Pandora decided to make a general cash offer at €4. Would existing shareholders still be just as well off?
18. Find the prospectus for a recent IPO. How do the issue costs compare with (a) those of the Marvin issue and (b) those shown in Table 15.3 ? Can you suggest reasons for the differences?
21. Here is recent financial data on Pisa Construction, Inc.Stock price $40 Market value of firm $400,000 Number of shares 10,000 Earnings per share $4 Book net worth $500,000 Return on investment
4. Patriot Games has 5 million shares outstanding. The president has proposed that, given the firm’s large cash holdings, the annual dividend should be increased from $6.00 a share to$8.00. If you
7. Answer the following question twice, once assuming current tax law and once assuming zero tax on capital gains.Suppose all investments offered the same expected return before tax. Consider two
8. Look in a recent issue of The Wall Street Journal at “Dividend News” and choose a company reporting a regular dividend.a. How frequently does the company pay a regular dividend?b. What is the
10. Little Oil has outstanding 1 million shares with a total market value of $20 million. The firm is expected to pay $1 million of dividends next year, and thereafter the amount paid out is expected
11. We stated in Section 16-5 that MM’s proof of dividend irrelevance assumes that new shares are sold at a fair price. Look back at problem 10. Assume that new shares are issued in year 1 at $10 a
14. “Many companies use stock repurchases to increase earnings per share. For example, suppose that a company is in the following position:Net profit $10 million Number of shares before repurchase
19. Refer back to Problem 18. Assume no taxes and a stock price immediately after the dividend announcement of $100.a. If you own 100 shares, what is the value of your investment? How does the
20. The shares of A and B both sell for $100 and offer a pretax return of 10%. However, in the case of company A the return is entirely in the form of dividend yield (the company pays a regular
21.a. The Horner Pie Company pays a quarterly dividend of $1. Suppose that the stock price is expected to fall on the ex-dividend date by $.90. Would you prefer to buy on the with-dividend date or
22. The middle-of-the-road party holds that dividend policy doesn’t matter because the supply of high-, medium-, and low-payout stocks has already adjusted to satisfy investors’demands. Investors
23. Consider the following two statements: “Dividend policy is irrelevant,” and “Stock price is the present value of expected future dividends.” (See Chapter 4.) They sound contradictory.This
24. “If a company pays a dividend, the investor is liable for tax on the total value of the dividend.If instead the company distributes the cash by stock repurchase, the investor is liable for tax
26. Suppose that there are just three types of investors with the following tax rates:Individuals Corporations Institutions Dividends 50% 5% 0%Capital gains 15 35 0 Individuals invest a total of $80
8. Gaucho Services starts life with all-equity financing and a cost of equity of 14%. Suppose it refinances to the following market-value capital structure:Debt (D) 45% at rD ⫽ 9.5%Equity (E)
9. Companies A and B differ only in their capital structure. A is financed 30% debt and 70%equity; B is financed 10% debt and 90% equity. The debt of both companies is risk-free.a. Rosencrantz owns
11. Executive Chalk is financed solely by common stock and has outstanding 25 million shares with a market price of $10 a share. It now announces that it intends to issue $160 million of debt and to
13. Hubbard’s Pet Foods is financed 80% by common stock and 20% by bonds. The expected return on the common stock is 12% and the rate of interest on the bonds is 6%. Assuming that the bonds are
16. Each of the following statements is false or at least misleading. Explain why in each case.a. “A capital investment opportunity offering a 10% DCF rate of return is an attractive project if it
17. Can you invent any new kinds of debt that might be attractive to investors? Why do you think they have not been issued?
19. Archimedes Levers is financed by a mixture of debt and equity. You have the following information about its cost of capital:rE ⫽ rD ⫽ 12% rA ⫽␤E ⫽ 1.5 ␤D ⫽ ␤A ⫽rf ⫽ 10% rm ⫽
21. Omega Corporation has 10 million shares outstanding, now trading at $55 per share.The firm has estimated the expected rate of return to shareholders at about 12%. It has also issued long-term
2. Here are book and market value balance sheets of the United Frypan Company (UF):Market Net working capital $ 20 $ 40 Debt Long-term assets 140 120 Equity$160 $160 Book Net working capital $ 20 $
5. This question tests your understanding of financial distress.a. What are the costs of going bankrupt? Define these costs carefully.b. “A company can incur costs of financial distress without
14. “The trouble with MM’s argument is that it ignores the fact that individuals can deduct interest for personal income tax.” Show why this is not an objection if personal tax rates on
18. Let us go back to Circular File’s market value balance sheet:Net working capital $20 $25 Bonds outstanding Fixed assets 10 5 Common stock Total assets $30 $30 Total value Who gains and who
19. The Salad Oil Storage (SOS) Company has financed a large part of its facilities with longterm debt. There is a significant risk of default, but the company is not on the ropes yet.Explain:a. Why
23. The possible payoffs from Ms. Ketchup’s projects (see Example 18.1, pages 455 & 456 )have not changed but there is now a 40% chance that Project 2 will pay off $24 and a 60%chance that it will
1. Look up Merck on the Market Insight database.a. Recalculate book- and market-value balance sheets using the most recent available financial information. Use the same format as for Table 18.3 .b.
2. Select three or four companies from the Market Insight database. Estimate how much more these companies could borrow before they would exhaust taxable profits.
3. The Market Insight database gives access to dozens of industry surveys. Check out the financial tables at the end of these surveys for several different industries. We suggest that you start with
10. Suppose KCS Corp. buys out Patagonia Trucking, a privately owned business, for $50 million.KCS has only $5 million cash in hand, so it arranges a $45 million bank loan. A normal debt-to-value
11. Table 19.3 shows a book balance sheet for the Wishing Well Motel chain. The company’s long-term debt is secured by its real estate assets, but it also uses short-term bank financing.It pays 10%
12. Suppose Wishing Well is evaluating a new motel and resort on a romantic site in Madison County, Wisconsin. Explain how you would forecast the after-tax cash flows for this project.( Hints: How
13. To finance the Madison County project, Wishing Well will have to arrange an additional$80 million of long-term debt and make a $20 million equity issue. Underwriting fees, spreads, and other
14. Table 19.4 shows a simplified balance sheet for Rensselaer Felt. Calculate this company’s weighted-average cost of capital. The debt has just been refinanced at an interest rate of 6%(short
16. Digital Organics (DO) has the opportunity to invest $1 million now ( t ⫽ 0) and expects after-tax returns of $600,000 in t ⫽ 1 and $700,000 in t ⫽ 2. The project will last for two years
18. Suppose the project described in Problem 17 is to be undertaken by a university. Funds for the project will be withdrawn from the university’s endowment, which is invested in a widely
20. Take another look at the valuations of Rio in Tables 19.1 and 19.2 . Now use the live spreadsheets on this book’s Web site ( www.mhhe.com/bma) to show how the valuations depend on:a. The
22. Nevada Hydro is 40% debt-financed and has a weighted-average cost of capital of 9.7%:WACC ⫽ 1 1 ⫺ Tc 2 rD DV⫹ rE EV⫽ 1 1 ⫺ .35 2 1 .085 2 1 .40 2 ⫹ .125 1 .60 2 ⫽ .097 Goldensacks
23. Chiara Company’s management has made the projections shown in Table 19.5 . Use this Excel spreadsheet as a starting point to value the company as a whole. The WACC for Visit us at
26. Modify Table 19.1 on the assumption that competition eliminates any opportunities to earn more than WACC on new investment after year 7 (PVGO ⫽ 0). How does the valuation of Rio change?
27. Table 19.6 is a simplified book balance sheet for Apache Corp. at year-end 2008. Here is some further information:Number of outstanding shares (N ) 335.75 million Price per share (P) $74.0 Beta
2. Note Figure 20.13 on the next page. Match each diagram, ( a ) and ( b ), with one of the following positions:• Call buyer• Call seller• Put buyer• Put seller
5. There is another strategy involving calls and borrowing or lending that gives the same payoffs as the strategy described in Problem 3. What is the alternative strategy?
8. Look again at Figure 20.13 . It appears that the investor in panel ( b ) can’t lose and the investor in panel ( a ) can’t win. Is that correct? Explain. ( Hint: Draw a profit diagram for each
11. Respond to the following statements.a. “I’m a conservative investor. I’d much rather hold a call option on a safe stock like Exxon Mobil than a volatile stock like Google.”b. “I bought
15. It is possible to buy three-month call options and three-month puts on stock Q. Both options have an exercise price of $60 and both are worth $10. If the interest rate is 5% a year, what is the
16. In January 2009, a one-year call on the stock of Amazon.com, with an exercise price of$45.00, sold for $19.55. The stock price was $55. The risk-free interest rate was 2.5%. How much would you be
17. FX Bank has succeeded in hiring ace foreign exchange trader Lucinda Cable. Her remuneration package reportedly includes an annual bonus of 20% of the profits that she generates in excess of $100
20. Test the formula linking put and call prices by using it to explain the relative prices of actual traded puts and calls. ( Note: The formula is exact only for European options. Most traded puts
21.a. If you can’t sell a share short, you can achieve exactly the same final payoff by a combination of options and borrowing or lending. What is this combination?b. Now work out the mixture of
22. The common stock of Triangular File Company is selling at $90. A 26-week call option written on Triangular File’s stock is selling for $8. The call’s exercise price is $100. The riskfree
23. Ms. Higden has been offered yet another incentive scheme (see Section 20-2 ). She will receive a bonus of $500,000 if the stock price at the end of the year is $120 or more;otherwise she will
24. Option traders often refer to “straddles” and “butterflies.” Here is an example of each:• Straddle: Buy call with exercise price of $100 and simultaneously buy put with exercise price
27. Table 20.4 lists some prices of options on common stocks (prices are quoted to the nearest dollar). The interest rate is 10% a year. Can you spot any mispricing? What would you do to take
28. You’ve just completed a month-long study of energy markets and conclude that energy prices will be much more volatile in the next year than historically. Assuming you’re right, what types of
29. Figure 20.14 below shows some complicated position diagrams. Work out the combination of stocks, bonds, and options that produces each of these positions. (b) FIGURE 20.14 Some complicated
31. Three six-month call options are traded on Hogswill stock:Exercise Price Call Option Price$ 90 $ 5 100 11 110 15 How would you make money by trading in Hogswill options? ( Hint: Draw a graph with
4. Imagine that Google’s stock price will either rise by 25% or fall by 20% over the next six months (see Section 21-1). Recalculate the value of the call option (exercise price $430)using ( a )
7. “An option is always riskier than the stock it is written on.” True or false? How does the risk of an option change when the stock price changes?
8. For which of the following options might it be rational to exercise before maturity? Explain briefly why or why not.a. American put on a non-dividend-paying stock.b. American call—the dividend
9. Johnny Jones’s high school derivatives homework asks for a binomial valuation of a 12-month call option on the common stock of the Overland Railroad. The stock is now selling for $45 per share
10. Suppose a stock price can go up by 15% or down by 13% over the next year. You own a one-year put on the stock. The interest rate is 10%, and the current stock price is $60.a. What exercise price
12. Buffelhead’s stock price is $220 and could halve or double in each six-month period(equivalent to a standard deviation of 98%). A one-year call option on Buffelhead has an exercise price of
13. Suppose that you own an American put option on Buffelhead stock (see Problem 12) with an exercise price of $220.a. Would you ever want to exercise the put early?b. Calculate the value of the
14. Recalculate the value of the Buffelhead call option (see Problem 12), assuming that the option is American and that at the end of the first six months the company pays a dividend of $25. (Thus
15. Suppose that you have an option that allows you to sell Buffelhead stock (see Problem 12)in month 6 for $165 or to buy it in month 12 for $165. What is the value of this unusual option?
16. The current price of the stock of Mont Tremblant Air is C$100. During each six-month period it will either rise by 11.1% or fall by 10% (equivalent to an annual standard deviation of 14.9%). The
17. The current price of United Carbon (UC) stock is $200. The standard deviation is 22.3% a year, and the interest rate is 21% a year. A one-year call option on UC has an exercise price of $180.a.
20. Other things equal, which of these American options are you most likely to want to exercise early?a. A put option on a stock with a large dividend or a call on the same stock.b. A put option on a
21. Is it better to exercise a call option on the with-dividend date or on the ex-dividend date?How about a put option? Explain.
24. Use the formula that relates the value of the call and the put (see Section 20-2) and the one-period binomial model to show that the option delta for a put option is equal to the option delta for
26. Your company has just awarded you a generous stock option scheme. You suspect that the board will either decide to increase the dividend or announce a stock repurchase program.Which do you
28. Some corporations have issued perpetual warrants. Warrants are call options issued by a firm, allowing the warrant holder to buy the firm’s stock.a. What does the Black–Scholes formula
3. Flip back to Tables 6.2 and 6.6, where we assumed an economic life of seven years for IM&C’s guano plant. What’s wrong with that assumption? How would you undertake a more complete analysis?
10. Look again at Table 22.2 . How does the value in 1982 of the option to invest in the Mark II change if:a. The investment required for the Mark II is $800 million (vs. $900 million)?b. The present
11. You own a one-year call option on one acre of Los Angeles real estate. The exercise price is$2 million, and the current, appraised market value of the land is $1.7 million. The land is currently
12. A variation on Problem 11: Suppose the land is occupied by a warehouse generating rents of $150,000 after real estate taxes and all other out-of-pocket costs. The present value of the land plus
13. You have an option to purchase all of the assets of the Overland Railroad for $2.5 billion.The option expires in nine months. You estimate Overland’s current (month 0) present value (PV) as
14. In Section 10-4 we considered two production technologies for a new Wankel-engined outboard motor. Technology A was the most efficient but had no salvage value if the new outboards failed to
18. Go to this book’s Web site ( www.mhhe.com/bma ) and find the “live” spreadsheet for the Subductor project. Show how the value of the option to abandon changes as you change different input
19. In binomial trees, risk-neutral probabilities are set to generate an expected rate of return equal to the risk-free interest rate in each branch of the tree. What do you think of the following

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