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theory of corporate finance

Questions and Answers of Theory Of Corporate Finance

What is a good predictor for future IPO waves?
What are the main empirical regularities about IPO pricing and stock returns?
What are various reasons why IPOs are underpriced?
What fraction of the firm is usually sold in an IPO?
If shares in successful IPOs are oversubscribed by a factor of 3, and if offerings are equally likely to either appreciate or depreciate by about 15% on the first day of trading, what would you
Here is another winner’s curse example. A painting is up for auction.There are 5 bidders, you among them. Each bidder has a private signal(opinion) about the value of the painting. One of them
Evaluate: IPOs should be underpriced by about 10–15%, because the average rate of return on the stock market is about 10–15%, too.
How could a coercive seasoned equity rights offering work?
Assume that there is a rights offering for a firm that is worth $500 million and that offers its shareholders the right to buy 1 extra share for each share they already own. The “discount” price
How does a coercive bond exchange offer work?
How can managers reduce the likelihood that they will run out of cash?
Are existing capital structures necessarily optimal?
Does the pecking order necessarily imply that firms are financed like a financing pyramid?
What is the financing pyramid? Is it a good description of empirical reality?
Evaluate: If a theory predicts that issuing equity is more expensive than issuing debt, a pecking order should naturally arise.
What is the financing pecking order?
What is the effect of a share repurchase on the firm’s size and the firm’s debt ratio in a perfectmarket?
A $500 million firmis financed by $250 million in debt and $250 million in equity. If the market value does not change, describe some actions that managers can undertake to increase firm size to $600
Is the level of corporate debt under the complete control and at the discretion of management?
When do firms usually experience their most dramatic changes in capital structure?
Describe the financial mechanisms that can change capital structures and firm sizes.
What should be your two main questions when deciding on capital structure actions?
In the in-a-pinch models, is the expected growth rate of each financial data item plus one a linear function of the expected growth rate of sales plus one?
Does it make sense for the net income coefficient to have a negative coefficient on the first term?
Complete the 2002 forecast in the cash flow statement model in Table 20.4 on page 748.Create a forecast for 2003. (Iterate on depreciation and investing to determine sensible inputs into both.)
Pick any publicly traded corporation today.Have yourself and a number of your friends work out three types of pro formas: one if you are a bidder for the corporation, one if you are the owner of the
Come up with a pro forma for a company assigned by your instructor. (This makes a good final project for a corporate finance course.)
When would you believe pro formas in real life to be objective, and when would you believe them to be tailored to what the audience wants to hear?
Can agency issues affect the numbers in your pro formas?
When would you want to use only one of your three calibration tools? When would you want to use all three?
When would you want to calibrate your pro forma model to available market data? Do you believe most pro formas are calibrated, whether they state it or not? Is caution advisable?
If your course covered this: What would be the alternative to using the CAPM for determining the appropriate cost of capital?Look back at the appendix of Chapter 9. Can you compute the cost of
Can you compute the market beta of PepsiCo prevailing in early 2002 based on 3 years of daily stock returns? (You can download the data from Yahoo! Finance.) Would your beta estimate be different
How can you obtain a discount rate for use in your financial analysis?
In a detailed projection, does it make sense to project the cash flow statement before you project the income statement?
What specific methods can you use to forecast individual financial statement items, such as SG&A? Discuss.
Look over a general income statement and balance sheet. Make a good guess and justify which financial statement items are likely to increase more than one to one with sales, which are likely to
What are the problems with a simple projection of historical sales growth rates?
What are common and reasonable detailed projection period horizons?
Are internal pro formas or external pro formas usually more accurate?
Usually, pro formas are not very trustworthy. They may look professional, but no one has a true crystal ball for complex businesses.
Our forecast of PepsiCo’s value went wrong primarily in our sales forecasts that were not optimistic enough.
You can estimate the required stated cost of capital on debt by relating variables such as interest coverage ratios to the firm’s credit ratings, which in turn would give you a good estimate of the
Yes, capital structure can influence the numbers in your pro forma. You need to take your capital structure into account when projecting the pro forma inputs because the world is not a
You cannot infer from the percentage of the value that sits in the terminal value which of the two pro formas is more reliable! For instance, you can put more or less into the terminal value by
The biggest common mistake in contemplating pro formas may be forgetting about the probability of total failure and business shutdown.
A computer spreadsheet is the main tool to help you build pro formas. If you are very sophisticated, you might consider a Monte Carlo simulator, too (explained in Section 20.7C).
Your three main calibration tools are to change your three inputs of the pro forma analysis: the cash flow forecasts in the initial period (themselves based on sales and other items), the cost of
Calibration occurs in the context of publicly traded corporations. It means that you are changing your estimates to obtain a value that is in line with the actual observed market value.
Yes, unfortunately, present value estimates (usually) remain sensitive to the assumption about the eternal growth rate of earnings or cash flows.
(a) No, it would not be better to use PepsiCo’s rate of 7.5% as the CAPM risk-free rate. The CAPM requires the risk-free rate, not PepsiCo’s expected interest rate (and definitely not its
The most common model to estimate the cost of capital in pro formas is the CAPM.
You would want to use asset betas if you are trying to determine the value of the firm. You would want to use equity betas if you are trying to determine the value of the equity. This in turn depends
Yes, ratio analysis does make sense—indeed, it may make more sense in a pro forma context than it does in a historical context.
Yes, the income statement and cash flow statement are linked. The latter even begins with net income. In addition, there can also be many other relevant linkages that you would expect a reasonable
Economies of scale manifest themselves in a coefficient that is not one to one with sales. For costs, (e.g., COGS) this means a smaller coefficient; for gains (e.g., earnings), this means a larger
The “base forecast” for pro formas is usually sales. It will in turn influence COGS, SG&A, and so on.
It is usually better to forecast earnings than cash flows because earnings are more smooth.
The intermediate projections are still very important, because your terminal projection is based off of the intermediate projections.
You would choose a longer detailed projection horizon if your growth phase is longer before you get to a stable business phase. You would also choose a longer horizon if your discount rate is smaller.
The growth rate of earnings or cash flows is probably easier to predict in 20 years, when it is likely to be“normal.” It is in the start-up phase (i.e., in 2 years) that most new businesses have
The three components that you need to work out are your choice of horizon, your detailed financial projections, and your terminal market value estimate.
Entrepreneurs are inside analysts. They are often primarily interested in working capital management and secondarily in a present value analysis.
A full pro forma analysis forces you to think more about the economics of your business, and about issues such as working capital and cash management.
How trustworthy are business pro formas?
Where did our forecast of PepsiCo’s value go wrong?
How can you estimate the required stated cost of capital on debt if you were to change the firm’s leverage ratio?
Can capital structure issues affect the numbers in your pro forma?
If you produce a pro forma for a firm in which 60% of the value sits in the terminal value and one in which 90% of the value sits in the terminal value, which pro forma is more reliable?
What may be the biggest common mistake in contemplating most pro formas?
What is the main computer tool for building pro formas?
What are your three main calibration tools?
What exactly does the technical term “calibration” mean in the context of a pro forma?
Are your present value estimates (usually) sensitive to your assumption about the eternal growth rate of earnings or cash flows, assuming that they are used only in the terminal value forecast?
You should always worry about something you have overlooked or that does not fit together. In Section 20.5A on page 751, for example, PepsiCo’s bonds were rated A+ in 2001. Such bonds carried an
What is the most common model used to estimate the cost of capital in pro formas?
When would you want to use asset betas, and when would you want to use equity betas?
Are the income statement and the cash flow statement linked?
How do economies of scale manifest themselves in line item forecasts?
What financial statement line item plays the role of a “base forecast” off of which many other forecasts are often derived?
If you do a direct projection, is it usually better to project cash flows or earnings based on the last 3 years of data?
Assume that it is easier in your business to forecast the long-run growth rate than it is to forecast the growth rate over the next 5 years. Further assume that 80% of the present value will sit in
What considerations would push you toward a longer detailed projection horizon?
Is it usually easier to predict the growth rate of earnings (or cash flows)of new businesses in 2 years or in 20 years?
What are the three main components of a pro forma that you need to work out?
What are usually the two most important projection goals for a pro forma analysis for an entrepreneur?
What does a full pro forma analysis force you to do that a simpler projection would not?
What is the survey evidence that there is an agency conflict between shareholders and managers when it comes to dividends? Can it be interpreted differently?
How do managers view dividends and share repurchases differently? Which do they seem to prefer?
What are the dividend targets that different U.S. corporations seem to try to peg? If you cannot ask the executives, can you learn from the behavior of the firm what they peg their dividend targets
If the stock price drops on average by 0.65%from the cum-day to the ex-day when dividends of 1% of the firm are paid, then what is the marginal income tax rate?
Would you expect trading volume to be higher for dividend-paying stocks on the declaration date or around the cum-date/ex-date?
Comparing the dividend announcement effect of 24 basis points to a typical daily standard deviation(80 basis points) and round-trip transaction costs (about 30 basis points) suggests that firms
In an efficient market, when should the stock price react to the value consequences of a dividend change? Discuss the effect both on the total return and on the capital gain.Which should be larger?
Do more or fewer firms pay dividends in the 2000s than in the 1970s? Is this a trend?
Think about the non-tax-related differences between share repurchases and dividends.Describe the firms in which each difference would be relatively more important.
Considering the differences other than personal income taxes, what companies should pay dividends rather than repurchase shares?How important is the right choice between the two?
How would the value change if a firm decides to increase its dividend payout, and if financial distress and agency/signaling costs are the only relevant concerns?
Can the firm’s EPS go down if the firmtakes on a positive-NPV project?
Consider a firm with 80 shareholders, including yourself, who each own 1 share worth $10.In addition, I own 20 shares (for a firm total of 100 shares) and I am trying to fire the management. To

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