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corporate finance

Questions and Answers of Corporate Finance

Table 12.10 shows a condensed income statement and balance sheet for Androscoggin Copper?s Rumford smelting plant. a. Calculate the plant?s EVA. Assume the cost of capital is 9 percent. b. As
Here are a few questions about compensation schemes that tie top management’s compensation to the rate of return earned on the company’s common stock.a. Today’s stock price depends on
Herbal Resources is a small but profitable producer of dietary supplements for pets. This is not a high-tech business, but Herbal’s earnings have averaged around $1.2 million after tax, largely on
List and define the agency problems likely to be encountered in a firm’s capital investment decisions.
Large brokerage and investment companies, such as Merrill Lynch and Morgan Stanley Dean Witter, employ squadrons of security analysts. Each analyst devotes full time to an industry—aerospace, for
What is meant by delegated monitoring? Who are these monitors and what roles do they play?
True or false? Explain briefly.a. Book profitability measures are biased measures of true profitability for individual assets. However, these biases “wash out” when firms hold a balanced mix of
Calculate the year-by-year book and economic profitability for investment in polyzone production, as described in Chapter. Use the cash flows and competitive spreads shown in Table 11.2. What is the
Suppose that the cash flows from Nodhead's new supermarket are as follows: a. Recalculate economic depreciation. Is it accelerated or decelerated? b. Rework Tables 12.7 and 12.8 to show the
Is there an optimal level of agency costs? How would you define it?
Suppose it were possible to measure and track economic income and the true economic value of a firm’s assets. Would there be any remaining need for EVA? Discuss.
Reconstruct Table 12.9 assuming a steady-state growth rate of 10 percent per year. Your answer will illustrate a fascinating theorem, namely, that book rate of return equals the economic rate of
Consider an asset with the following cash flows:The firm uses straight-line depreciation. Thus, for this project, it writes off $4 million per year in years 1, 2, and 3. The discount rate is 10
The following are extracts from two newsletters sent to a stockbroker?s clients: Investment Letter?March 2001. Kipper Parlors was founded earlier this year by its president, Albert Herring. It plans
In our Nodhead example, true depreciation was decelerated. That is not always the case. For instance, figure shows how on average the value of a Boeing 737 has varied with its age.28 Table 12.11
How would you respond to the following comments?a. “Efficient market, my eye! I know lots of investors who do crazy things.”b. “Efficient market? Balderdash! I know at least a dozen people who
Respond to the following comments:a. “The random-walk theory, with its implication that investing in stocks is like playing roulette, is a powerful indictment of our capital markets.”b. “If
Which of the following observations appear to indicate market inefficiency? Explain whether the observation appears to contradict the weak, semi-strong, or strong form of the efficient-market
Look again at Figure. a.Is the steady rise in the stock price before the split evidence of market inefficiency? b. How do you think those stocks performed that did not increase their dividends by an
Stock splits are important because they convey information. Can you suggest some other financial decisions that do so?
Here are alphas and betas for Intel and Conagra for the 60 months ending October 2001. Alpha is expressed as a percent per month. Explain how these estimates would be used to calculate an abnormal
It is sometimes suggested that stocks with low price–earnings ratios tend to be under priced. Describe a possible test of this view. Be as precise as possible.
“If the efficient-market hypothesis is true, then it makes no difference what securities a company issues. All are fairly priced.” Does this follow?
“If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin.” Explain why this is not so.
“If the efficient-market hypothesis is true, the pension fund manager might as well select a portfolio with a pin.” Explain why this is not so.
The bottom graph in Figure 13.1 shows the actual performance of the Standard and Poor?s 500 Index for a five-year period. Two financial managers, Alpha and Beta, are contemplating this chart. Each
What does the efficient-market hypothesis have to say about these two statements?a. “I notice that short-term interest rates are about 1 percent below long-term rates. We should borrow
We suggested that there are three possible interpretations of the small-firm effect: a required return for some unidentified risk factor, a coincidence, or market inefficiency.Write three brief
“It may be true that in an efficient market there should be no patterns in stock prices, but, if everyone believes that they do exist, then this belief will be self-fulfilling.” Discuss.
Column (a) in Table 13.1 shows the monthly return on the British FTSE 100 index from August 1999 through July 2001. Columns (b) and (c) show the returns on the stocks of two firms. Both announced
On May 15, 1997, the government of Kuwait offered to sell 170 million BP shares, worth about $2 billion. Goldman Sachs was contacted after the stock market closed in London and given one hour to
Bond dealers buy and sell bonds at very low spreads. In other words, they are willing to sell at a price only slightly higher than the price at which they buy. Used-car dealers buy and sell cars at
“An analysis of the behavior of exchange rates and bond prices around the time of international assistance for countries in balance of payments difficulties suggests that on average prices decline
“An analysis of the behavior of exchange rates and bond prices around the time of international assistance for countries in balance of payments difficulties suggests that on average prices decline
In Table 14.3 Rajan and Zingales use both book and market values of equity to measure debt ratios. Which measure results in the lower ratio?Why?
It is sometimes suggested that since retained earnings provide the bulk of industry’s capital needs, the securities markets are largely redundant. Do you agree?
In 1999 Pfizer had 9,000 million shares of common stock authorized, 4,260 million in issue, and 3,847 million outstanding (figures rounded to the nearest million). Its equity account was as
Inbox Software was founded in 1998. 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 14.4)
Look back at Table 14.4. a. Suppose that Heinz issued an additional 50 million shares at $30 a share. Rework Table 14.4 to show the company's equity after the issue. b. Suppose that Heinz
Suppose that East Corporation has issued voting and nonvoting stock. Investors hope that holders of the voting stock will use their power to vote out the company’s incompetent management. Would you
In 2001 Beta Corporation earned gross profits of $760,000.a. Suppose that it is financed by a combination of common stock and $1 million of debt. The interest rate on the debt is 10 percent, and the
Which of the following features would increase the value of a corporate bond? Which would reduce its value?a. The borrower has the option to repay the loan before maturity.b. The bond is convertible
The shareholders of the Pickwick Paper Company need to elect five directors. There are 200,000 shares outstanding. How many shares do you need to own to ensure that you can elect at least one
The shareholders of the Pickwick Paper Company need to elect five directors. There are 200,000 shares outstanding. How many shares do you need to own to ensure that you can elect at least one
Can you think of any new kinds of security that might appeal to investors? Why do you think they have not been issued?
Can you think of any new kinds of security that might appeal to investors? Why do you think they have not been issued?
Here is a further vocabulary quiz. Briefly explain each of the following:a. Zero-stage vs. first- or second-stage financing.b. After-the-money valuation.c. Mezzanine financing.d. Road show.e.
a. “A signal is credible only if it is costly.” Explain why management’s willingness to invest in Marvin’s equity was a credible signal. Was its willingness to accept only part of the venture
Describe the alternative procedures for IPOs of common stock. What are their advantages and disadvantages?
In the UK initial public offerings of common stock are usually sold by an offer for sale. Mr. Bean has observed that on average these stocks are underpriced by about 9 percent and for some years has
Get a hold of 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?
Why are the costs of debt issues less than those of equity issues? List the possible reasons.
“For small issues of common stock, the issue costs to about 10 percent of the proceeds. This means that the opportunity cost of external equity capital is about 10 percentage points higher than
There are three reasons that a common stock issue might cause a fall in price:(a) The price fall is needed to absorb the extra supply,(b) The issue causes temporary price pressure until it has been
There are three reasons that a common stock issue might cause a fall in price:(a) The price fall is needed to absorb the extra supply,(b) The issue causes temporary price pressure until it has been
In what circumstances is a private placement preferable to a public issue? Explain.
Construct a simple example to show the following:a. Existing shareholders are made worse off when a company makes a cash offer of new stock below the market price.b. Existing shareholders are not
In 1998 the Pandora Box Company made a rights issue at $5 a share of one new share for every four shares held. Before the issue there were 10 million shares outstanding and the share price was $6.a.
Problem 11 contains details of a rights offering by Pandora Box. Suppose that the company had decided to issue new stock at $4. How many new shares would it have needed to sell to raise the same sum
a. Why do venture capital companies prefer to advance money in stages? If you were the management of Marvin Enterprises, would you have been happy with such an arrangement? With the benefit of
Explain the difference between a uniform-price auction and a discriminatory auction. Why might you prefer to sell securities by one method rather than another?
Here is recent financial data on Pisa Construction, Inc. Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $80,000 to finance expansion into a promising
Do you think that there could be a shortage of finance for new ventures? Should the government help to provide such finance and, if so, how?
This question reviews some of the difficulties encountered in interpreting accounting numbers.a. Give four examples of important assets, liabilities, or transactions which may not be shown on the
Discuss alternative measures of financial leverage. Should the market value of equity be used or the book value? Is it better to use the market value of debt, the book value, or the book value
Suppose that at year-end 1999 Executive Paper had unused lines of credit that would have allowed it to borrow a further $300 million. Suppose also that it used this line of credit to raise
How would the following actions affect a firm’s current ratio?a. Inventory is sold.b. The firm takes out a bank loan to pay its suppliers.c. A customer pays its overdue bills.d. The firm uses cash
Sara Togas sells all its output to Federal Stores. The following table shows selected financial data, in millions, for the two firms:Calculate the sales-to-assets ratio, the profit margin, and the
United Ratio’s common stock has a dividend yield of 4 percent. Its dividend per share is $2, and it has 10 million shares outstanding. If the market-to-book ratio is 1.5, what is the total book
As you can see, someone has spilled ink over some of the entries in the balance sheet and income statement of Transylvania Railroad (Table 29.12). Can you use the following information to work out
Here are some data for five companies in the same industry: You have been asked to calculate a measure of the industry price?earnings ratio. Discuss the possible ways that you might calculate such
Describe some of the ways that the choice of accounting technique can temporarily depress or inflate earnings.
How would rapid inflation affect the accuracy and relevance of a manufacturing company’s balance sheet and income statement? Does your answer depend on how much debt the company has issued?
In 1970 United Airlines bought four new jumbos for $21.8 million each. These planes were written down straight-line over 16 years to a residual value of $0.2 million each. However, they could have
In 1970 United Airlines bought four new jumbos for $21.8 million each. These planes were written down straight-line over 16 years to a residual value of $0.2 million each. However, they could have
The British food company Ranks Hovis McDougall (RHM) believed that some of its most valuable assets were its brand names. Yet these assets are not usually shown on the balance sheet. In 1988 RHM
Suppose you wish to use financial ratios to estimate the risk of a company’s stock. Which of those that we have described in this chapter are likely to be helpful? Can you think of other
List the major elements of a completed financial plan.
“There is no finance in financial planning models.” Explain.
What are the dangers and disadvantages of using a financial model? Discuss.
Should a financial plan be considered an unbiased forecast of future cash flows, earnings, and other financial variables? Why or why not?
Our model of Executive Paper is an example of a top-down planning model. Some firms use a bottom-up financial planning model, which incorporates forecasts of revenues and costs for particular
Corporate financial plans are often used as a basis for judging subsequent performance. What do you think can be learned from such comparisons? What problems are likely to arise, and how might you
What problems are likely to be encountered in keeping the financial plan up-to-date?
The balancing item in the Executive Paper model is borrowing. What is meant by balancing item? How would the model change if dividends were made the balancing item instead? In that case how would you
Construct a new model for Executive Paper based on your answer to question 26. Does your model generate a feasible financial plan for 2000?
Executive Paper’s financial manager believed that revenues in 2000 would rise by as much as 50 percent or by as little as 10 percent. Recalculate the pro forma financial statements under these two
a. Use the Executive Paper model (Tables 29.6???29.8) to produce pro forma income statements, balance sheets, and sources and uses of funds statements for 2000 and 2001. Assume business as usual
Table 29.13 shows the 2001 financial statements for the Executive Cheese Company. Annual depreciation is 10 percent of fixed assets at the beginning of the year, plus 10 percent of new investment.
Table 29.14 contains financial statements for Dynastatics Corporation. Although the company has not been growing, it now plans to expand and will increase net fixed assets (that is, assets net of
The financial statements of Eagle Sport Supply are shown in Table 29.15. For simplicity, ?Costs? include interest. Assume that Eagle?s assets are proportional to its sales. a. Find Eagle?s
a. What is the internal growth rate of Eagle Sports (see problem 32) if the dividend payout ratio is fixed at 60 percent and the equity-to-asset ratio is fixed at 2/3?b. What is the sustainable
Bio-Plasma Corp. is growing at 30 percent per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 20 percent. Its plowback ratio is 40 percent.a. What is the
Take another look at Geomorph Trading?s balance sheet in quiz question 9, and consider the following additional information: The ?R&R reserve? covers the future costs of removal of an oil
Table 30.10 lists data from the budget of Rite well Publishers. Half the company sales are for cash on the nail; the other half are paid for with a one-month delay. The company pays all its credit
If a firm pays its bills with a 30-day delay, what fraction of its purchases will be paid in the current quarter? In the following quarter? What if the delay is 60 days?
Which items in Table 30.9 would be affected by the following events? a. There is a rise in interest rates. b. Suppliers demand interest for late payment. c. Dynamic receives an unexpected bill in
Table 30.12 shows Dynamic Mattress?s year-end 1999 balance sheet, and Table 30.13 shows its income statement for 2000. Work out statements of sources and uses of cash and sources and uses of funds
Work out a short-term financing plan for Dynamic Mattress Company, assuming the limit on the line of credit is raised from $38 to $50 million. Otherwise keep to the assumptions used in developing
Dynamic Mattress decides to lease its new mattress-stuffing machines rather than buy them. As a result, capital expenditure in the first quarter is reduced by $30 million, but the company must make
Dynamic Mattress decides to lease its new mattress-stuffing machines rather than buy them. As a result, capital expenditure in the first quarter is reduced by $30 million, but the company must make
Any of the assets mentioned in the preceding question could be acceptable collateral under certain circumstances if appropriate safeguards were taken. What circumstances?
Interest rates on bank loans exceed rates on commercial paper. Why don’t all firms issue commercial paper rather than borrow from banks?
Do you think you could make money by setting up a firm which would(a) Issue commercial paper and(b) Relend money to businesses at a rate slightly higher than the commercial paper rate but still less
In some countries the market for long-term corporate debt is limited, and firms turn to short-term bank loans to finance long-term investments in plant and machinery. When a short-term loan comes
Axle Chemical Corporation’s treasurer has forecasted a $1 million cash deficit for the next quarter. However, there is only a 50 percent chance this deficit will actually occur. The treasurer

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