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Questions and Answers of Corporate Finance

Most firms like to have their stock selling at a high P/E ratio, and they also like to have extensive public ownership (many different shareholders). Explain how stock dividends or stock splits may
Indicate whether the following statements are true or false. If the statement is false, explain why.a. If a firm repurchases its stock in the open market, the shareholders who tender the stock are
Axel Telecommunications has a target capital structure that consists of 70% debt and 30% equity. The company anticipates that its capital budget for the upcoming year will be $3,000,000. If Axel
Gamma Medical’s stock trades at $90 a share. The company is contemplating a 3-for-2 stock split. Assuming that the stock split will have no effect on the market value of its equity, what will be
Beta Industries has net income of $2,000,000, and it has 1,000,000 shares of common stock outstanding. The company’s stock currently trades at $32 a share Beta is considering a plan in which it
After a 5-for-1 stock split, Strasburg Company paid a dividend of $0.75 per new share, which represents a 9% increase over last year’s pre-split dividend. What was last year’s dividend per share?
Northern Pacific Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 40% with a $10
Welch Company is considering three independent projects, each of which requires a $5 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are
Bowles Sporting Inc. is prepared to report the following income statement (shown in thousands of dollars) for the year 2009.Sales $15,200Operating costs including depreciation 11,900EBIT $
Rubenstein Bros. Clothing is expecting to pay an annual dividend per share of $0.75 out of annual earnings per share of $2.25. Currently, Rubenstein Bros.’ stock is selling for $12.50 per share.
In 2008, Keenan Company paid dividends totaling $3,600,000 on net income of $10.8 million. Note that 2008 was a normal year and that for the past 10 years, earnings have grown at a constant rate of
Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, and its shareholders expect the dividend to
What is meant by the term dividend policy?
Explain briefly the dividend irrelevance theory that was put forward by Modigliani and Miller. What were the key assumptions underlying their theory?
Why do some investors prefer high-dividend-paying stocks, while other investors prefer stocks that pay low or nonexistent dividends?
Discuss (1) The information content, or signaling, hypothesis; (2) The clientele effect; and (3) Their effects on dividend policy.
Assume that SSC has an $800,000 capital budget planned for the coming year. You have determined that its present capital structure (60% equity and 40% debt) is optimal, and its net income is
In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy? Discuss.
What are the advantages and disadvantages of the residual policy? (Hint: Don’t neglect signaling and clientele effects.)
What is a dividend reinvestment plan (DRIP), and how does it work? Discuss.
Describe the series of steps that most firms take in setting dividend policy in practice. Discuss.
What are stock repurchases? Discuss the advantages and disadvantages of a firm’s repurchasing its own shares.
How would each of the following scenarios affect a firm?s cost of debt, rd(1 ? T); its cost of equity, rs; and its WACC? Indicate with a plus (+), a minus (?), or a zero (0) if the factor would
Assume that the risk-free rate increases. What impact would this have on the cost of debt?
What impact would it have on the cost of equity? How should the capital structure weights used to calculate the WACC be determined?
Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be “reasonable” costs of capital for
The WACC is a weighted average of the costs of debt, preferred stock, and common equity. Would the WACC be different if the equity for the coming year came solely in the form of retained earnings
Tunney Industries can issue perpetual preferred stock at a price of $47.50 a share. The stock would pay a constant annual dividend of $3.80 a share. What is the company’s cost of preferred stock,
Percy Motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company’s outstanding bonds is 9%, and its tax rate is 40%.
Javits & Sons’ common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of $3.00 a share at the end of the year (D1 ! $3.00), and the constant growth rate is 5%
The future earnings, dividends, and common stock price of Carpetto Technologies Inc. are expected to grow 7% per year. Carpetto’s common stock currently sells for $23.00 per share; its last
The Evanec Company’s next expected dividend, D1, is $3.18; its growth rate is 6%; and its common stock now sells for $36.00. New stock (external equity) can be sold to net $32.40 per share.a. What
Patton Paints Corporation has a target capital structure of 40% debt and 60% common equity, with no preferred stock. Its before-tax cost of debt is 12%, and its marginal tax rate is 40%. The
The Patrick Company?s cost of common equity is 16%, its before-tax cost of debt is 13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate
Klose Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming
Hook Industries’ capital structure consists solely of debt and common equity. It can issue debt at rd = 11%, and its common stock currently pays a $2.00 dividend per share (D0 = $2.00). The
Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 10% as long as it finances at its target capital structure, which calls
Ballack Co.’s common stock currently sells for $46.75 per share. The growth rate is a constant 12%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio
Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 13%, a before-tax cost of debt of 10%,
The Bouchard Company’s EPS was $6.50 in 2008, up from $4.42 in 2003. The company pays out 40% of its earnings as dividends, and its common stock sells for $36.00.a. Calculate the past growth rate
Sidman Products’ common stock currently sells for $60.00 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60, and it finances only with common
Adams Corporation is considering four average-risk projects with the following costs and rates of return:The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 30%.
Ziege Systems is considering the following independent projects for the coming year:Ziege’s WACC is 10%, but it adjusts for risk by adding 2% to the WACC for high-risk projects and subtracting 2%
The following table gives Foust Company?s earnings per share for the last 10 years. The common stock, 7.8 million shares outstanding, is now (1/1/09) selling for $65.00 per share. The expected
Here is the condensed 2008 balance sheet for Skye Computer Company (in thousands of dollars):2008Current assets $ 2,000Net fixed assets 3,000Total assets $ 5,000Current liabilities $ 900Long-term
What sources of capital should be included when you estimate Coleman’s WACC?
Should the component costs be figured on a before-tax or an after-tax basis?
Based on common sense, how highly correlated do you think the project would be with the firm's other assets? (Give a correlation coefficient or range of coefficients based on your judgment.)
What is the market interest rate on Coleman’s debt and its component cost of debt?
Should you use the nominal cost of debt or the effective annual cost?
What is the firm’s cost of preferred stock?
Coleman’s preferred stock is riskier to investors than its debt, yet the preferred’s yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a
Why is there a cost associated with retained earnings?
What is Coleman’s estimated cost of common equity using the CAPM approach?
What is the estimated cost of common equity using the DCF approach?
What is the bond-yield-plus-risk-premium estimate for Coleman’s cost of common equity?
What is your final estimate for rs?
Explain in words why new common stock has a higher cost than retained earnings.
What are two approaches that can be used to adjust for flotation costs?
Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common
What is Coleman’s overall, or weighted average, cost of capital (WACC)? Ignore flotation costs.
What factors influence Coleman’s composite WACC?
Should the company use the composite WACC as the hurdle rate for each of its projects? Explain.
How are project classifications used in the capital budgeting process?
What are three potential flaws with the regular payback method? Does the discounted payback method correct all three flaws? Explain.
Why is the NPV of a relatively long-term project (one for which a high percentage of its cash flows occurs in the distant future) more sensitive to changes in the WACC than that of a short-term
What is a mutually exclusive project? How should managers rank mutually exclusive projects?
If two mutually exclusive projects were being compared, would a high cost of capital favor the longer-term or the shorter-term project? Why? If the cost of capital declined, would that lead firms
Discuss the following statement: If a firm has only independent projects, a constant WACC, and projects with normal cash flows, the NPV and IRR methods will always lead to identical capital budgeting
Why might it be rational for a small firm that does not have access to the capital markets to use the payback method rather than the NPV method?
Project X is very risky and has an NPV of $3 million. Project Y is very safe and has an NPV of $2.5 million. They are mutually exclusive, and project risk has been properly considered in the NPV
What reinvestment rate assumptions are built into the NPV, IRR, and MIRR methods? Give an explanation (other than “because the text says so”) for your answer.
A firm has a $100 million capital budget. It is considering two projects, each costing $100 million. Project A has an IRR of 20%; has an NPV of $9 million; and will be terminated after 1 year at a
Refer to Problem 11-1. What is the project’s MIRR?
Refer to Problem 11-1. What is the project’s discounted payback?
Your division is considering two projects with the following net cash flows (in millions): a. What are the projects? NPVs assuming the WACC is 5%? 10%? 15%? b. What are the projects? IRRs at each
A firm with a 14% WACC is evaluating two projects for this year’s capital budget. After-tax cash flows, including depreciation, are as follows:a. Calculate NPV, IRR, MIRR, payback, and discounted
A mining company is considering a new project. Because the mine has received a permit, the project would be legal; but it would cause significant harm to a nearby river. The firm could spend an
An electric utility is considering a new power plant in northern Arizona. Power from the plant would be sold in the Phoenix area, where it is badly needed. Because the firm has received a permit, the
A firm with a WACC of 10% is considering the following mutually exclusive projects: Which project would you recommend?Explain.
Project S costs $15,000, and its expected cash flows would be $4,500 per year for 5 years. Mutually exclusive Project L costs $37,500, and its expected cash flows would be $11,100 per year for 5
A company is analyzing two mutually exclusive projects, S and L, with the following cash flows:The company’s WACC is 10%. What is the IRR of the better project? (Hint: The better project may or may
A firm is considering two mutually exclusive projects, X and Y, with the following cash flows: The projects are equally risky, and their WACC is 12%. What is the MIRR of the project that maximizes
K. Kim Inc. must install a new air conditioning unit in its main plant. Kim must install one or the other of the units; otherwise, the highly profitable plant would have to shut down. Two units are
An oil drilling company must choose between two mutually exclusive extraction projects, and each costs $12 million. Under Plan A, all the oil would be extracted in 1 year, producing a cash flow at t
A company is considering two mutually exclusive expansion plans. Plan A requires a $40 million expenditure on a large-scale integrated plant that would provide expected cash flows of $6.4 million per
A company has a 12% WACC and is considering two mutually exclusive investments (that cannot be repeated) with the following net cash flows:a. What is each project’s NPV?b. What is each project’s
A store has 5 years remaining on its lease in a mall. Rent is $2,000 per month, 60 payments remain, and the next payment is due in 1 month. The mall’s owner plans to sell the property in a year and
A mining company is deciding whether to open a strip mine, which costs $2 million. Net cash inflows of $13 million would occur at the end of Year 1. The land must be returned to its natural state at
A project has annual cash flows of $7,500 for the next 10 years and then $10,000 each year for the following 10 years. The IRR of this 20-year project is 10.98%. If the firm’s WACC is 9%, what is
Project X costs $1,000, and its cash flows are the same in Years 1 through 10. Its IRR is 12%, and its WACC is 10%. What is the project’s MIRR?
A project has the following cash flows: This project requires two outflows at Years 0 and 2, but the remaining cash flows are positive. Its WACC is 10%, and its MIRR is 14.14%. What is the Year 2
Your division is considering two projects. Its WACC is 10%, and the projects? after-tax cash flows (in millions of dollars) would be as follows: a. Calculate the projects? NPVs, IRRs, MIRRs,
What is capital budgeting? Are there any similarities between a firm’s capital budgeting decisions and an individual’s investment decisions?
What is the difference between independent and mutually exclusive projects? Between projects with normal and nonnormal cash flows?
Define the term net present value (NPV). What is each project’s NPV?
What is the rationale behind the NPV method? According to NPV, which project(s) should be accepted if they are independent? Mutually exclusive?
Allied typically adds or subtracts 3% to its WACC to adjust for risk. After adjusting for risk, should the lemon juice project be accepted? Should any subjective risk factors be considered before the
Define the term internal rate of return (IRR). What is each project’s IRR?
Based on your judgment, what do you think the project's correlation coefficient would be with respect to the general economy and thus with returns on "the market"? How would correlation with the

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