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business
introduction to corporate finance

Questions and Answers of Introduction To Corporate Finance

Rights Stone Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly
Calculating Flotation Costs The St. Anger Corporation needs to raise $25 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to
Calculating Flotation Costs In the previous problem, if the SEC filing fee and associated administrative expenses of the offering are $900,000, how many shares need to be sold? LO.1
Calculating Flotation Costs The Green Hills Co. has just gone public. Under a firm commitment agreement, Green Hills received $19.75 for each of the 5 million shares sold. The initial offering price
Price Dilution Raggio, Inc., has 100,000 shares of stock outstanding. Each share is worth$90, so the company’s market value of equity is $9,000,000. Suppose the firm issues 20,000 new shares at the
Stock Offerings The Newton Company has 10,000 shares of stock that each sell for $40. Suppose the company issues 5,000 shares of the new stock at the following prices: $40, $20, and$10. What is the
Dilution Teardrop Inc., wishes to expand its facilities. The company currently has 10 million shares outstanding and no debt. The stock sells for $50 per share, but the book value per share is $40.
Dilution The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:INTERMEDIATE(Questions 10–18)Stock
Rights A company’s stock currently sells for $45 per share. Last week the firm issued rights to raise new equity. To purchase a new share, a stockholder must remit $10 and three rights.a. What is
Rights Summit Corp.’s stock is currently selling at $13 per share. There are 1 million shares outstanding. The firm is planning to raise $2 million to finance a new project. What are the ex-rights
Rights Hoobastink Mfg. is considering a rights offer. The company has determined that the ex-rights price would be $52. The current price is $55 per share, and there are 5 million shares outstanding.
Value of Right Show that the value of a right can be written as Value of a right PRO PX (PRO PS)/(N 1)where PRO, PS, and PX stand for the “rights-on” price, the subscription price, and
Selling Rights Wuttke Corp. wants to raise $3.65 million via a rights offering. The company currently has 490,000 shares of common stock outstanding that sell for $30 per share. Its underwriter has
Valuing a Right Mitsi Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of $40.
At the end of the discussion Dan asks Robin about the Dutch auction IPO process. What are the differences in the expenses to East Coast Yachts if it uses a Dutch auction IPO versus a traditional IPO?
Many of the employees of East Coast Yachts have shares of stock in the company because of an existing employee stock purchase plan. To sell the stock, the employees can tender their shares to be sold
Direct placement is likely to have more restrictive covenants. LO.1
It is easier to renegotiate a term loan and a private placement in the event of a default.It is harder to renegotiate a public issue because hundreds of holders are usually involved. LO.1
Life insurance companies and pension funds dominate the private placement segment of the bond market. Commercial banks are signifi cant participants in the term loan market. LO.1
The costs of distributing bonds are lower in the private market. LO.1
The written agreement describing the details of the long-term debt contract is called an indenture. Some of the main provisions are security, repayment, protective covenants, and call provisions. LO.1
There are many ways that shareholders can take advantage of bondholders. Protective covenants are designed to protect bondholders from management decisions that favor stockholders at
Unsecured bonds are called debentures or notes. They are general claims on the company’s value.Most public industrial bonds are unsecured. In contrast, utility bonds are usually secured. Mortgage
Long-term bonds usually provide for repayment of principal before maturity. This is accomplished by a sinking fund. With a sinking fund, the company retires a certain number of bonds each year.A
Most publicly issued bonds are callable. A callable bond is less attractive to bondholders than a noncallable bond. A callable bond can be bought back by the company at a call price that is less than
There are many different types of bonds, including fl oating-rate bonds, deep-discount bonds, and income bonds. This chapter also compared private placement with public issuance. LO.1
Bond Ratings U.S. Treasury bonds are not rated. Why? Often, junk bonds are not rated.Why? LO.1
Crossover Bonds Looking back at the crossover bonds we discussed in the chapter, why do you think split ratings such as these occur? LO.1
Rating Agencies A controversy erupted regarding bond rating agencies when some agencies began to provide unsolicited bond ratings. Why do you think this is controversial? LO.1
Bonds as Equity Recently several companies have issued bonds with 100-year maturities.Critics charge that the issuers are really selling equity in disguise. What are the issues here?Why would a
Bond Prices If interest rates fall, will the price of noncallable bonds move up higher than that of callable bonds? Why or why not? LO.1
Junk Bonds What is a “junk bond”? What are some of the controversies created by junk bond fi nancing? LO.1
Sinking Funds Sinking funds have both positive and negative characteristics for bondholders.Why? LO.1
Mortgage Bonds Which is riskier to a prospective creditor—an open-end mortgage or closed-end mortgage? Why? LO.1
Public Issues versus Direct Financing Which of the following are characteristics of public issues, and which are characteristics of direct fi nancing?a. SEC registration required.b. Higher interest
Bond Ratings In general, why don’t bond prices change when bond ratings change? LO.1
Accrued Interest You purchase a bond with an invoice price of $1,140. The bond has a coupon rate of 7.2 percent, and there are fi ve months to the next semiannual coupon date. What is the clean price
Accrued Interest You purchase a bond with a coupon rate of 6.5 percent and a clean price of $865. If the next semiannual coupon payment is due in three months, what is the invoice price? LO.1
Bond Refunding KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 12 percent and 30 years to maturity. The current market interest rates on these bonds is 11 percent.In one year, the
Bond Refunding New Business Ventures, Inc., has an outstanding perpetual bond with a 10 percent coupon rate that can be called in one year. The bonds make annual coupon payments.The call premium is
Bond Refunding Bowdeen Manufacturing intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at $1,250. One-year interest rates are 11 percent.There is a 60
Bond Refunding Illinois Industries has decided to borrow money by issuing perpetual bonds with a coupon rate of 8 percent, payable annually. The one-year interest rate is 8 percent. Next year, there
Bond Refunding An outstanding issue of Public Express Airlines debentures has a call provision attached. The total principal value of the bonds is $250 million, and the bonds have an annual coupon
Valuing the Call Feature Consider the prices in the following three Treasury issues as of February 24, 2006:6.500 May 12n 106:10 106:12 –13 5.28 8.250 May 12 103:14 103:16 –3 5.24 12.000 May 12
Bond Ratings Look up Coca-Cola (KO), Gateway (GTW), AT&T (T), and Navistar International(NAV). For each company, follow the “Financial Highlights” link and fi nd the bond rating. Which companies
Bond Indentures Look under the Edgar link for American Electric Power (AEP) and fi nd the most recent bond issue for the company. What was the amount of bonds issued? What are the coupon rate,
How many of the coupon bonds must East Coast Yachts issue to raise the $30 million? How many of the zeroes must it issue? LO.1
In 20 years, what will be the principal repayment due if East Coast Yachts issues the coupon bonds? What if it issues the zeroes? LO.1
What are the company’s considerations in issuing a coupon bond compared to a zero coupon bond? LO.1
Suppose East Coast Yachts issues the coupon bonds with a make-whole call provision.The make-whole call rate is the Treasury rate plus 0.40 percent. If East Coast calls the bonds in 7 years when the
Are investors really made whole with a make-whole call provision? LO.1
Operating leases are usually not fully amortized. This means that the payments required under the terms of the lease are not enough to recover the full cost of the asset for the lessor. This occurs
Operating leases usually require the lessor to maintain and insure the leased assets. LO.1
Perhaps the most interesting feature of an operating lease is the cancellation option.This option gives the lessee the right to cancel the lease contract before the expiration date. If the option to
As in other leases, the lessee uses the assets and makes periodic lease payments. LO.1
As in other leases, the lessor purchases the assets, delivers them to the lessee, and collects the lease payments. However, the lessor puts up no more than 40 to 50 percent of the purchase price. LO.1
The lenders supply the remaining financing and receive interest payments from the lessor. Thus, the arrangement on the right side of Figure 21.1 would be a leveraged lease if the bulk of the
For manufacturer lessors, the basis for determining depreciation is the manufacturer’s cost. For third-party lessors, the basis is the sales price that the lessor paid to the manufacturer. Because
However, the manufacturer must recognize a profit for tax purposes when selling the asset to the third-party lessor. The manufacturer’s profit for some equipment can be deferred if the manufacturer
The more sensitive the value of an asset is to use and maintenance decisions, the more likely it is that the asset will be purchased instead of leased. They argue that ownership provides a better
Price discrimination opportunities may be important. Leasing may be a way of circumventing laws against charging too low a price. LO.1
Leases can be separated into two polar types. Though operating leases allow the lessee to use the equipment, ownership remains with the lessor. Although the lessor in a financial lease legally owns
When a firm purchases an asset with debt, both the asset and the liability appear on the firm’s balance sheet. If a lease meets at least one of a number of criteria, it must be capitalized. This
Firms generally lease for tax purposes. To protect its interests, the IRS allows financial arrangements to be classified as leases only if a number of criteria are met. LO.1
We showed that risk-free cash flows should be discounted at the aftertax risk-free rate. Because both lease payments and depreciation tax shields are nearly riskless, all relevant cash flows in the
Though this method is simple, it lacks certain intuitive appeal. We presented an alternative method in the hopes of increasing the reader’s intuition. Relative to a lease, a purchase generates debt
If the lessor is in the same tax bracket as the lessee, the cash flows to the lessor are exactly the opposite of the cash flows to the lessee. Thus, the sum of the value of the lease to the lessee
Leasing versus Borrowing What are the key differences between leasing and borrowing?Are they perfect substitutes? LO.1
Leasing and IRR What are some of the potential problems with looking at IRRs in evaluating a leasing decision? LO.1
Leasing Comment on the following remarks:a. Leasing reduces risk and can reduce a firm’s cost of capital.b. Leasing provides 100 percent financing.c. If the tax advantages of leasing were
Accounting for Leases Discuss the accounting criteria for determining whether a lease must be reported on the balance sheet. In each case, give a rationale for the criterion. LO.1
IRS Criteria Discuss the IRS criteria for determining whether a lease is tax deductible. In each case give a rationale for the criterion. LO.1
Sale and Leaseback Why might a firm choose to engage in a sale and leaseback transaction?Give two reasons. LO.1
Leasing Cost Explain why the aftertax borrowing rate is the appropriate discount rate to use in lease evaluation.Refer to the following example for Questions 10–12. In June 2004, Skymark Airlines
Leasing versus Purchase Why wouldn’t Skymark purchase the plane since it was obviously needed for the company’s operations? LO.1
Reasons to Lease Why would Royal Brunei Airlines be willing to buy a plane from Boeing and then lease it to Skymark? How is this different from just lending money to Skymark to buy the plane? LO.1
Leasing What do you suppose happens to the plane at the end of the lease period? LO.1
Lease or Buy Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should you lease or buy? LO.1
Leasing Cash Flows What are the cash flows from the lease from the lessor’s viewpoint?Assume a 35 percent tax bracket. LO.1
Finding the Break-Even Payment What would the lease payment have to be for both lessor and lessee to be indifferent about the lease? LO.1
Taxes and Leasing Cash Flows Assume that your company does not contemplate paying taxes for the next several years. What are the cash flows from leasing in this case? LO.1
Setting the Lease Payment In the previous question, over what range of lease payments will the lease be profitable for both parties? LO.1
MACRS Depreciation and Leasing Rework Problem 1 assuming that the scanner will be depreciated as three-year property under MACRS (see Chapter 7 for the depreciation allowances). LO.1
Lease or Buy Super Sonics Entertainment is considering buying a machine that costs$350,000. The machine will be depreciated over five years by the straight-line method and will be worthless at that
Lease or Buy What is the NAL for Wildcat? What is the maximum lease payment that would be acceptable to the company? LO.1
Leasing and Salvage Value Suppose it is estimated that the equipment will have an aftertax residual value of $500,000 at the end of the lease. What is the maximum lease payment acceptable to Wildcat
Deposits in Leasing Many lessors require a security deposit in the form of a cash payment or other pledged collateral. Suppose Lambert requires Wildcat to pay a $200,000 security deposit at the
Setting the Lease Price Raymond Rayon Corporation wants to expand its manufacturing facilities. Liberty Leasing Corporation has offered Raymond Rayon the opportunity to lease a machine for $1,500,000
Lease or Buy Wolfson Corporation has decided to purchase a new machine that costs $4.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The
Automobile Lease Payments Automobiles are often leased, and there are several terms unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car
Lease versus Borrow Return to the case of the diagnostic scanner discussed in Problems 1 through LO.1
Suppose the entire $3,000,000 purchase price of the scanner is borrowed. The rate on the loan in 8 percent, and the loan will be repaid in equal installments. Create a leaseversus-buy analysis that
Why is this so? LO.1
Lease or Buy High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine
Should Warf buy or lease the equipment? LO.1
Nick mentions to James Hendrix, the president of Hendrix Leasing, that although the company will need the equipment for four years, he would like a lease contract for two years instead. At the end of
In the leasing discussion, James informs Nick that the contract could include a purchase option for the equipment at the end of the lease. Hendrix Leasing offers three purchase options:a. An option
James also informs Nick that the lease contract can include a cancellation option. The cancellation option would allow Warf Computers to cancel the lease on any anniversary date of the contract. In
Exercising the option: The act of buying or selling the underlying asset via the option contract. LO.1
Strike or exercise price: The fi xed price in the option contract at which the holder can buy or sell the underlying asset. LO.1

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