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business
introduction to corporate finance

Questions and Answers of Introduction To Corporate Finance

What are the pros and cons of the international sales plan? What additional risks will the company face? LO.1
What will happen to the company’s profi ts if the dollar strengthens? What if the dollar weakens? LO.1
Ignoring taxes, what are East Coast Yacht’s projected gains or losses from this proposed arrangement at the current exchange rate of $1.20/€? What will happen to profi ts if the exchange rate
How can the company hedge its exchange rate risk? What are the implications for this approach? LO.1
Taking all factors into account, should the company pursue international sales further?Why or why not? LO.1
The tax subsidy to debt: This was discussed in Chapter 15, where we pointed out that for perpetual debt the value of the tax subsidy is tCB. (tC is the corporate tax rate, and B is the value of the
The costs of issuing new securities: As we will discuss in detail in Chapter 20, investment bankers participate in the public issuance of corporate debt. These bankers must be compensated for their
The costs of financial distress: The possibility of financial distress, and bankruptcy in particular, arises with debt financing. As stated in the previous chapter, financial distress imposes costs,
Subsidies to debt financing: The interest on debt issued by state and local governments is not taxable to the investor. Because of this, the yield on tax-exempt debt is generally substantially below
The APV formula can be written as:UCF 1 1 0 tt t ( R )ΣAdditional effects of debt Initial investment There are four additional effects of debt:• Tax shield from debt financing.• Flotation
The FTE formula can be written as:LCF 1Initial investment Amount 1t St t ( R )( Σborrowed) LO.1
The WACC formula can be written as:UCF 1Initial investment 1 WACC tt t ( R )Σ LO.1
Corporations frequently follow this guideline:• Use WACC or FTE if the firm’s target debt-to-value ratio applies to the project over its life.• Use APV if the project’s level of debt is known
The APV method is used frequently for special situations like interest subsidies, LBOs, and leases. The WACC and FTE methods are commonly used for more typical capital budgeting situations. The APV
The beta of the equity of the firm is positively related to the leverage of the firm. LO.1
APV How is the APV of a project calculated? LO.1
WACC and APV What is the main difference between the WACC and APV methods? LO.1
FTE What is the main difference between the FTE approach and the other two approaches? LO.1
Beta and Leverage What are the two types of risk that are measured by a levered beta? LO.1
NPV and APV Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line
APV Gemini, Inc., an all-equity firm, is considering a $2.4 million investment that will be depreciated according to the straight-line method over its four-year life. The project is expected to
Flow to Equity Milano Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt–equity ratio of 40 percent and makes interest payments of $29,500 at
WACC If Wild Widgets, Inc., were an all-equity company, it would have a beta of 1.1. The company has a target debt–equity ratio of 0.40. The expected return on the market portfolio is 13 percent,
Beta and Leverage North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.25 if both were all equity financed. The market value
NPV of Loans Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 9 percent loan with gross proceeds of $4,250,000. The interest payments on the loan will be made annually.Flotation
NPV for an All-Equity Company Shattered Glass, Inc., is an all-equity firm. The cost of the company’s equity is currently 16 percent, and the risk-free rate is 6 percent. The company is currently
WACC National Electric Company (NEC) is considering a $50 million project in its power systems division. Tom Edison, the company’s chief financial officer, has evaluated the project and determined
WACC Bolero, Inc., has compiled the following information on its financing costs:Type of Financing Book Value Market Value Cost Long-term debt $ 2,000,000 $ 2,000,000 3.5%Short-term debt 9,000,000
APV Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is$25 million. The
What is the adjusted present value of this project? LO.1
APV For the company in the previous problem, what is the value of being able to issue subsidized debt instead of having to issue debt at the terms it would normally receive? Assume the face amount
APV MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt–equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm’s
WACC Neon Corporation’s stock returns have a covariance with the market portfolio of 0.048. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk
APV, FTE, and WACC Seger, Inc., is an unlevered firm with expected annual earnings before taxes of $35 million in perpetuity. The current required return on the firm’s equity is 20 percent, and the
APV, FTE, and WACC Lone Star Industries just issued $160,000 of perpetual 10 percent debt and used the proceeds to repurchase stock. The company expects to generate $75,000 of earnings before
Projects That Are Not Scale Enhancing Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .40, but
Locate the annual income statements for Walt Disney (DIS) and calculate the marginal tax rate for the company for the last year. Next, find the beta for Disney in the S&P stock report. Using the
The dividend policy of a firm is irrelevant in a perfect capital market because the shareholder can effectively undo the firm’s dividend strategy. If a shareholder receives a greater dividend than
Stockholders will be indifferent between dividends and share repurchases in a perfect capital market. LO.1
Because dividends in the United States are taxed, companies should not issue stock to pay out a dividend. LO.1
Also because of taxes, firms have an incentive to reduce dividends. For example, they might consider increasing capital expenditures, acquiring other companies, or purchasing financial
In a world with personal taxes, a strong case can be made for repurchasing shares instead of paying dividends. LO.1
Nevertheless, there are a number of justifications for dividends even in a world with personal taxes:a. Investors in no-dividend stocks incur transaction costs when selling off shares for current
The stock market reacts positively to increases in dividends (or an initial payment) and negatively to decreases in dividends. This suggests that there is information content in dividend
High (low) dividend firms should arise to meet the demands of dividend-preferring (capital gains–preferring) investors. Because of these clienteles, it is not clear that a firm can create value by
Dividend Policy Irrelevance How is it possible that dividends are so important, but at the same time dividend policy is irrelevant? LO.1
Stock Repurchases What is the impact of a stock repurchase on a company’s debt ratio?Does this suggest another use for excess cash? LO.1
Dividend Chronology On Tuesday, December 8, Hometown Power Co.’s board of directors declares a dividend of 75 cents per share payable on Wednesday, January 17, to shareholders of record as of
When is the ex-dividend date? If a shareholder buys stock before that date, who gets the dividends on those shares—the buyer or the seller? LO.1
Dividends and Stock Price If increases in dividends tend to be followed by (immediate)increases in share prices, how can it be said that dividend policy is irrelevant? LO.1
Dividend Policy For initial public offerings of common stock, 2005 was a relatively slow year, with only about $28.4 billion raised by the process. Relatively few of the 162 firms involved paid cash
Ex-Dividend Stock Prices How do you think this tax law change affects ex-dividend stock prices? LO.1
Stock Repurchases How do you think this tax law change affected the relative attractiveness of stock repurchases compared to dividend payments?13.. Dividends and Stock Value The growing perpetuity
Dividends and Taxes Lee Ann, Inc., has declared a $6 per-share dividend. Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be withheld
Stock Dividends The owners’ equity accounts for Hexagon International are shown here:Common stock ($1 par value) $ 10,000 Capital surplus 180,000 Retained earnings 586,500 Total owners’ equity
Stock Splits and Stock Dividends Roll Corporation (RC) currently has 150,000 shares of stock outstanding that sell for $65 per share. Assuming no market imperfections or tax effects exist, what will
Regular Dividends The balance sheet for Levy Corp. is shown here in market value terms.There are 5,000 shares of stock outstanding.The company has declared a dividend of $1.50 per share. The stock
Share Repurchase In the previous problem, suppose Levy has announced it is going to repurchase$4,025 worth of stock. What effect will this transaction have on the equity of the firm?How many shares
Stock Dividends The market value balance sheet for Outbox Manufacturing is shown here.Outbox has declared a 25 percent stock dividend. The stock goes ex dividend tomorrow (the chronology for a stock
Stock Dividends The company with the common equity accounts shown here has declared a 12 percent stock dividend when the market value of its stock is $20 per share. What effects on the equity
Stock Splits In the previous problem, suppose the company instead decides on a five-forone stock split. The firm’s 70 cent per share cash dividend on the new (postsplit) shares represents an
Residual Dividend Policy Soprano, Inc., a litter recycling company, uses a residual dividend policy. (See Concept Question 3.) A debt–equity ratio of .80 is considered optimal.Earnings for the
Residual Dividend Policy Worthington Corporation has declared an annual dividend of$0.80 per share. For the year just ended, earnings were $7 per share.a. What is Worthington’s payout ratio?b.
Residual Dividend Policy Red Zeppelin Corporation follows a strict residual dividend policy. (See Concept Question 3.) Its debt–equity ratio is 3.a. If earnings for the year are $180,000, what is
Residual Dividend Policy Preti Rock (PR), Inc., predicts that earnings in the coming year will be $56 million. There are 12 million shares, and PR maintains a debt–equity ratio of 2.a. Calculate
Dividends and Stock Price The Mann Company belongs to a risk class for which the appropriate discount rate is 10 percent. Mann currently has 100,000 outstanding shares selling at $100 each. The firm
Homemade Dividends You own 1,000 shares of stock in Avondale Corporation. You will receive a 70 cent per share dividend in one year. In two years, Avondale will pay a liquidating dividend of $40 per
Homemade Dividends In the previous problem, suppose you want only $200 total in dividends the first year. What will your homemade dividend be in two years? LO.1
Stock Repurchase Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $5,000 would be spent. Current earnings are $0.95 per share, and the stock currently
Dividends and Firm Value The net income of Novis Corporation is $32,000. The company has 10,000 outstanding shares and a 100 percent payout policy. The expected value of the firm one year from now is
Dividend Policy Gibson Co. has a current period cash flow of $1.2 million and pays no dividends. The present value of the company’s future cash flows is $15 million. The company is entirely
Dividend Smoothing The Sharpe Co. just paid a dividend of $1.25 per share of stock. Its target payout ratio is 40 percent. The company expects to have an earnings per share of $4.50 one year from
Dividend Payouts Use the annual financial statements for General Mills (GIS), Boston Beer(SAM), and US Steel (X) to find the dividend payout ratio for each company for the last three years. Why would
Tom believes the company should use the extra cash to pay a special one-time dividend.How will this proposal affect the stock price? How will it affect the value of the company? LO.1
Jessica believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Jessica’s proposals affect the company? LO.1
Nolan is in favor of a share repurchase. He argues that a repurchase will increase the company’s P/E ratio, return on assets, and return on equity. Are his arguments correct?How will a share
Another option discussed by Tom, Jessica, and Nolan would be to begin a regular dividend payment to shareholders. How would you evaluate this proposal? LO.1
One way to value a share of stock is the dividend growth, or growing perpetuity, model.Consider the following: The dividend payout ratio is 1 minusb, where b is the “retention”or “plowback”
Does the question of whether the company should pay a dividend depend on whether the company is organized as a corporation or an LLC? LO.1
Start-up: Financing for firms that started within the past year. Funds are likely to pay for marketing and product development expenditures. LO.1
First-round financing: Additional money to begin sales and manufacturing after a firm has spent its start-up funds. LO.1
Second-round financing: Funds earmarked for working capital for a firm that is currently selling its product but still losing money. LO.1
Third-round financing: Financing for a company that is at least breaking even and is contemplating an expansion. This is also known as mezzanine financing. LO.1
Fourth-round financing: Money provided for firms that are likely to go public within half a year. This round is also known as bridge financing. LO.1
Large issues have proportionately much lower costs of issuing equity than small ones. LO.1
Firm commitment underwriting is far more prevalent for large issues than is best-efforts underwriting.Smaller issues probably primarily use best efforts because of the greater uncertainty of these
Rights offerings are cheaper than general cash offers and eliminate the problem of underpricing.Yet most new equity issues are underwritten general cash offers. LO.1
Shelf registration is a new method of issuing new debt and equity. The direct costs of shelf issues seem to be substantially lower than those of traditional issues. LO.1
Venture capitalists are an increasingly important influence in start-up firms and subsequent financing. LO.1
Debt versus Equity Offering Size In the aggregate, debt offerings are much more common than equity offerings and typically much larger as well. Why? LO.1
Debt versus Equity Flotation Costs Why are the costs of selling equity so much larger than the costs of selling debt? LO.1
Bond Ratings and Flotation Costs Why do noninvestment-grade bonds have much higher direct costs than investment-grade issues? LO.1
Underpricing in Debt Offerings Why is underpricing not a great concern with bond offerings? LO.1
IPO Pricing The Eyetech IPO was underpriced by about 54 percent. Should Eyetech be upset at Merrill Lynch over the underpricing? LO.1
IPO Pricing In the previous two questions, how would it affect your thinking to know that in addition to the 6.5 million shares offered in the IPO, Eyetech had an additional 32 million shares
Competitive and Negotiated Offers What are the comparative advantages of a competitive offer and a negotiated offer, respectively? LO.1
Seasoned Equity Offers What are the possible reasons why the stock price typically drops on the announcement of a seasoned new equity issue? LO.1
Shelf Registration Explain why shelf registration has been used by many firms instead of syndication. LO.1
IPOs Every IPO is unique, but what are the basic empirical regularities in IPOs? LO.1
Rights Offerings Again, Inc., is proposing a rights offering. Presently there are 350,000 shares outstanding at $85 each. There will be 70,000 new shares offered at $70 each.a. What is the new market

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