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theory of corporate finance

Questions and Answers of Theory Of Corporate Finance

Firms with large tax obligations may not have high debt ratios, because these are often the same kinds of firms that were highly profitable—which would have increased the value of their equity.
Our knowledge about the deeper determinants is not very good. We can only explain a small part of the variation of capital structure with proxies for deeper causes such as financial distress or
No. For example, in the context of M&A activity, although it is correct that many equity shares appear, generally even more debt offerings appear. This can increase or decrease the debt ratio.
On average, seasoned equity issuing activity outside M&A is trivial.
Yes, long-term debt net issuing activity is important. It can explain over 30% of the variation in 5-year changes.
No, dividend activity is typically fairly unimportant from a larger capital structure perspective. Table 22.6 suggests that dividends explain only about 69% − 66% = 3% of capital structure changes.
Over 5-year horizons, the most important financial mechanisms were (a) debt net issuing and (b) the direct influence of stock returns. Both accounted for about 40% of the variation in debt/equity
In 1991, U.S. firms were slightly more indebted than their British counterparts.
High debt ratios: Utilities and banks had high financial debt ratios, though not necessarily high broader total indebtedness measures. Steel and automobiles are more indebted on broader measures. Low
Profitable firms tended to have higher indebtedness ratios.
Measured in market values, small firms had median financial debt ratios of about 10–15%; large firms of about 25–35%. Small firms had median total liability ratios of about 30%; large firms of
A drawback to using an interest coverage ratio is that the operating profit of a firm can vary greatly from one year to the next. The interest coverage ratio therefore moves around a lot. In some
Yes, virtually all firms are partly financed by at least some nonfinancial liabilities, too. However, the nonfinancial liabilities may not allow arbitrary use on the margin. Thus, the financial debt
as $155,459, so the financial capital is $155,459 + $22,927 = $178,386 in market value.This means that its book financial-debt-to-capital was $22,927/$54,615 ≈ 42%; its market
You must use the information from Q 22.1. First note that the book value of equity is the difference between total assets and total liablities, that is, BVE = $111,003 − $79,315 = $31,688.
IBM’s market value of assets in 2004 was $79,315 + $155,459 = $234,774. This means that its book liabilities-to-assets ratio was $79,315/$111,003 ≈ 71%; its market liabilities-to-assets ratio was
Managers frequently state that they like sound finances with plenty of financial flexibility. Is financial flexibility also always good for shareholders?
If firms fail to readjust their capital structure, does this mean that learning about capital structure theories is a waste of your time?
Why do our theories of capital structure explain relatively little of firms’capital structures?
What deeper characteristics help explain corporate debt/equity ratios?
Firms with large tax obligations are known to be more inclined to issue debt and retire equity. Does this mean that firms with high tax obligations usually have high debt ratios?
How good is our knowledge about what deeper determinants create the empirically observed capital structure patterns?
If many equity shares appear in the context of M&A activity, does this imply that the firm’s debt/equity ratio is likely to go down?
How important is seasoned equity issuing activity that does not occur in the context of M&A activity, at least for S&P 100 firms?
Is long-term net debt issuing a major factor in determining the capital structure changes ofU.S. firms—explaining why some firms are increasing their debt ratios and other firms are lowering their
Is dividend activity a major factor in determining capital structure changes in U.S. firms—explaining why some firms have high debt ratios and other firms have low debt ratios?
What are the most important financial mechanisms influencing capital structure changes over 5-year horizons?
In 1991, were U.S. firms more or less indebted than their British counterparts?
What industries were characterized by very high debt ratios? Which were characterized by very low debt ratios?
Did profitable firms have higher or lower indebtedness ratios than unprofitable firms?
Roughly and on average, what were the liabilities ratios of firms—large and small—on various measures?
What are the drawbacks to using the interest coverage ratio as a measure of indebtedness?
Are firms partly financed by their nonfinancial liabilities? If so, how do you incorporate this into the firm’sWACC?
(Continued from Q 22.1) In 2004, IBM’s financials reported financial debt of $22,927. What was its financial-debt-to-capital ratio, in book value and market value?
In 2004, IBM’s financials reported total assets of $111,003 and total liabilities of $79,315. Its market value of equity was $155,459.What was its liabilities-to-assets ratio, in book and market
How would you measure the whole cost of issuing, including deadweight costs that capital structure changes create, direct fees, and everything else? Should you add the dilution costs and the
Can a firm raise financing through its management of accounts payable?
What is the typical underwriting commission for IPOs?
What is an “open IPO window”?
What typically happens to the IPO share price when the lock-up period expires?
Evaluate: Everyone knows that analysts are conflicted and not trustworthy when evaluating IPOs that their own firm issues. Therefore, because no investor would pay serious attention, analysts do not
What is the empirical evidence on the long-run performance of IPOs?
What are the possible reasons for IPO underpricing?
Explain the winner’s curse. Does it apply only to IPO shares, or could it also apply to an auction for a one-of-a-kind painting?
Your firm has $200 million of debt outstanding(held by 600 creditors) and $300 million of equity outstanding (held by 300,000 shareholders).Construct a coercive rights offering to raise $100 million
How does a rights offering differ from a shelf offering?
Give an illustration of a coercive bond offer.
Do corporate bonds trade very actively? If so, where do they trade? If not, why not?
What are the components in a typical corporate bond issue?
Evaluate the following statement: If a firmfaces an efficient bond market, then this firm can issue any bond it likes—it does not matter as far as firm value is concerned.
From a firm value perspective, should managers always strive to make financial flexibility a main goal, as they claim in surveys?
How can a firm manage its cash to avoid running into financial distress? What are the drawbacks?
Is it a good idea to follow the same capital structure as other firms in your industry?
Empirically, do managers seem to act as if they believe that they can time the overall stock market (not just their own stock)? Are they doing so successfully?
Explain the difference between the financing pyramid and the pecking order.Which leads to which?
Would a firm that has followed only a pecking order after its IPO in its capital-issuing decision end up with more debt than equity in its capital structure?
Do all firms follow capital structures that were created through a pecking order?
What are the theories that can explain why firms may follow a pecking order when issuing securities?
If the pecking order holds perfectly, would managers ever issue equity?
If the world is not perfect, what is the likely effect of an equity issue on the firm’s value and on the firm’s debt ratio? How does it compare to the perfect-market scenario?
What is the effect of a repayment of debt on the firm’s value and on the firm’s debt ratio in a perfect market?
A $500 million firmis financed by $250 million in debt and $250 million in equity. It issues$150 million in debt and repurchases $50 million in equity. The market believes the$100 million increase in
Does the debt/equity ratio of a firm change only with the firm’s issuance and retirement of debt and equity?
A firm issues $50 in new debt and $200 in new equity. Does this mean that its debt/equity ratio decreases?
Name some examples of financial and nonfinancial liabilities.
Give an example of one financial mechanism each in a perfect market that (a) increases the debt ratio of the firm and decreases the firm size; (b) decreases the debt ratio of the firm and decreases
Is it possible that issuing new equity to take a positive-NPV project reduces the value of the firm?
What are the two important questions that a CFO acting on behalf of shareholders should ask?
From a firm value perspective: The answers are no and yes. The empirical evidence suggests that increases in funds and thus firm size are usually bad news for the firm. Increases in debt ratios are
The price reaction on the actual issue day should be about zero, because the share sale is an event that was announced earlier and thus should have been almost perfectly anticipated. If the market
Issuing such equity would not necessarily harm the firm—it could even rescue it. The negative reaction may come from your investors learning (possibly correctly) that something bad has recently
Recall from Section 11.7 on page 375 that any value drop must occur at the instant of the issue announcement.Otherwise, you could profitably trade on your advance knowledge of the already-announced
Trade credit is extended by a firm’s supplier in the form of delayed payment due dates. That is, the firm is not required to pay for the goods upon receipt. Therefore, the firm has some time to
The performance of an industry in the stock market is a good predictor for future IPO waves.
On average, IPO shares appreciate by 10–15% from the offer price to the first after-market price and then lose about 5% per annum over the following 3 to 5 years. (Other regularities are described
There are a number of explanations for IPO underpricing—such as the winner’s curse, payment to investors for revealing information, the intent to leave goodwill for future offerings, highly
The typical IPO sells off about one-third of the firm.
This is an example of the winner’s curse in the IPO context. An uninformed investor would expect to be rationed if the offering is underpriced. For every share requested, fair rationing means that
For the painting:(a) Yes, the average private value is equal to the expected painting value, because (20% + 10% + 0% −15% − 15%)/5 = 0%.(b) You should assume you are the one that had the 20%
False. The 10–15% IPO underpricing is not an annualized figure, unlike the stock market, which has a rate of return of about 10% per annum. IPO underpricing is a 1-day figure. Thus, the IPO 10%
A coercive seasoned equity rights offering could give existing shareholders the right to purchase more shares at a price below the market value of shares. Investors who do not participate are
Assume that the shares are $10 each. You can then purchase shares for the 1/5 price mentioned in the question, that is, $2 each. Of 50 million shares, 25 million will participate. You will raise an
A coercive bond exchange offer gives existing bondholders the right to exchange their bonds for more senior bonds with lower face values. Bondholders who do not participate are effectively
Managers can reduce the likelihood of running out of cash by matching cash inflows and outflows, paying for an irrevocable credit line, holding liquid investments, or reducing their liabilities
No, existing capital structures may not be optimal. The market pressures that force poorly financed companies to their optimal capital structures are too weak. In addition, other firms’ managers
No, the pecking order does not fully imply that firms have to follow a financing pyramid. Equity can change in value (and debt can accumulate during operations). Many firms follow a financing pecking
The “financing pyramid” states that companies are financed predominantly by safer securities. Equity would be the small part of the pyramid at the top. The traditional view of the financing
True: If a theory predicts that issuing equity is more expensive than issuing debt, then a pecking order would arise naturally.
The pecking order states that managers prefer issuing higher-priority (safer) securities first, before proceeding to lower-priority, less safe alternatives. Therefore, they prefer to finance first
A share repurchase decreases the firm size and increases the firm’s debt ratio.
To have a 5:1 debt/equity ratio with $600 million in overall value, the firm needs to have $500 million in debt and $100 million in equity. One way to accomplish this is to issue $250 million in debt
The answer to whether the level of corporate debt is under the complete control and at the discretion of management is ambiguous. Firms that operate may incur liabilities, so in this sense the answer
Firms usually experience their most drastic capital structure changes when they take over other firms.
Table 21.1 describes the financial mechanisms that can change capital structures and firm sizes:(a) Debt ratio increases, firm size decreases: Exogenous value drop, share repurchase, cash
From a value perspective, your two main questions when deciding on capital structure actions should be:(1) Can you invest your investors’ money better than they can? (2) Do your investors
Are activities that increase firm size through issuing usually good news from a firm value perspective? Are increases in debt ratios usually good news from a firm value perspective? What about from a
What do you expect the price reaction to be on the day that the new seasoned equity offering shares are sold into the market? (This is not the announcement day.)
If you know that offering more equity will reduce the value of your firm, does this mean that issuing such equity would be harmful to the firm?
In an efficient market, when would you expect the issue announcement price drop to occur—at the instant of the issue announcement or at the instant of the issue?
What is trade credit? Can trade credit be an important source of funding for firms?

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