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corporate finance

Questions and Answers of Corporate Finance

Business and Financial Risk Here are the estimated ROE distributions for Firms A, B. and C:a. Calculate the expected value and standard deviation for Firm Câ€˜s ROE. ROEA = 10.0%, ÏƒA = 5.5%;
WACC and Optimal Capital Structure Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use
Assume you have just been hired as business manager of PizzaPalace, a pizza restaurant located adjacent to campus. The company’s EBIT was $500,000 last year, and since the university’s enrollment
1. (a) What is business risk? What factors influence a firm’s business risk?(b) What is operating leverage, and how does it affect a firm’s business risk? Show the operating break-even point if a
Now, to develop an example that can be presented to PizzaPalace’s management to illustrate the effects of financial leverage, consider two hypothetical firms: Firm U, which uses no debt financing,
Assume you have just been hired as business manager of PizzaPalace, a pizza restaurant located adjacent to campus. The company's EBIT was $500,000 last year, and since the university's enrollment is
What does capital structure theory attempt to do? What lessons can be learned from capital structure theory? Be sure to address the MM model.Assume you have just been hired as business manager of
What does the empirical evidence say about capital structure theory? What are the implications for managers?Assume you have just been hired as business manager of PizzaPalace, a pizza restaurant
With the above points in mind, now consider the optimal capital structure for PizzaPalace.(1) For each capital structure under consideration, calculate the levered beta, the cost of equity, and the
Describe the recapitalization process and apply it to PizzaPalace. Calculate the resulting value of the debt that will be issued, the resulting marker value of equity, the price per share, the number
What is arbitrage, and how did Modigliani and Miller use the arbitrage concept in developing their theory that (with no corporate taxes) capital Structure has no effect on value or the cost of
What is the essence of Miller’s contribution to the theory of capital structure, and how does it relate to the earlier MM with-taxes position?
MM and Miller assumed that firms do not grow. If the grow, how would this affect the value of the debt tax shield? What does growth do to the required rate of return on equity and the WACC as a firm
MM and Miller also assumed that debt is riskless. How does the possibility of default on debt cause equity to take on the characteristics of an option? What types of incentives for shareholders does
Define each of following terms:a. MM Proposition I without taxes; with corporate taxesb. MM Proposition II without taxes; with corporate taxesc. Miller modeld. Financial distress costse. Agency
Explain, in words, how MM use the arbitrage process to prove the validity of Proposition I. Also, list the major MM assumptions and explain why each of these assumptions is necessary in the arbitrage
A utility company is supposed to be allowed to charge prices high enough to cover all costs, including its cost of capital. Public service commissions are supposed to take actions to stimulate
MM Model with Zero Taxes An unlevered firm has a value of $500 million. An otherwise identical but levered firm has $50 million in debt. Under the MM zero-tax model, what is the value of the levered
MM Model with Corporate Taxes An unlevered firm has a value of $800 million. An otherwise identical but levered firm has $60 million in debt. If the corporate tax rate is 35%, what is the value of
MM with and without Taxes International Associates (IA) is just about to commence operations as an international trading company. The firm will have book assets of $ 10 million, and it expects to
Business Week recently ran an article on companies’ debt policies, and the names Modigliani and Miller (MM) were mentioned several times as leading researchers on the theory of capital structure.
Assume that Firms U and L are in the same risk class, and that both have EBIT = $500,000. Firm U uses no debt financing, and its cost of equity is rsU = 14%. Firm L has $1 million of debt
Using the data given in part b, but now assuming that Firms L and U are both subject to a 40% corporate tax rate, repeat the analysis called for in b-(1) and b-(2) under the MM with-tax model.David
Now suppose investors are subject to the following tax rates: Td = 30% and Ts = 12%.(1) What is the gain from leverage according to the Miller mode1?(2) How does this gain compare with the gain in
What capital structure policy recommendation do the three theories (MM without taxes, MM with corporate taxes, and Miller) suggest to financial managers? Empirically, do firms appear to follow any
How is the analysis in part c different if Firms U and L are growing? Assume both firms are growing at a rate of 7% and that the investment in net operating assets required to support this growth is
What if L’s debt is risky? For the purpose of this example, assume the value of L’s operations is $4 million-which is the value of its debt plus equity. Assume also its debt Consists of 1-year
What is the value of L’s stock for volatilities between 0.20 and 0.95? What incentives might the manager of L have if she understands this relationship? What might debtholders do in response?David
In your judgment, what are some characteristics of the type of investor who would likely prefer a high dividend payout, and what are some characteristics of one who would prefer a low payout?Would
Describe the three theories that have been advanced regarding whether investors in the aggregate tend to favor high or low dividend payout ratios. What results were reached from empirical tests of
How should(a) Signaling and(b) The clientele effect be taken into account by a firm as it considers its dividend decision? Do signaling and clientele effects make it easier or harder to determine if
Describe the residual dividend model. Explain how it operates and how firms use it in practice. In your answer, discuss any influences signaling and the clientele effect might have on a firm’s
If a company is thinking about distributing excess cash through a stock repurchase program in lieu of continuing to pay regular cash dividends, what are some factors it should consider before making
What is a stock split? As an investor, would you like to see shares you own be split?
In 2003, President Bush proposed a change in the tax law that would have eliminated the tax on dividends received by stockholder. The same proposal also would have increased the basis of stocks by
Define each of the following terms:a. Optimal distribution policyb. Dividend irrelevance theory; bird-in the-hand theory; tax effect theoryc. Information content, or signaling, hypothesis; clientele
Alternative Dividend Policies In 2009, the Keenan Company paid dividends totaling $.3.6 million on net income of $10.8 million. The year was normal, and for the past 10 years, earnings have grown at
(1) What is meant by the term “distribution policy”? How have dividend payouts versus stock repurchases changed over time?(2) The terms “irrelevance,”“dividend preference, or
Discuss(1) The information content, or signaling, hypothesis,(2) The clientele effect, and(3) Their effects on distribution policy.Southeastern Steel Company (SSC) was formed five years ago to
(1) Assume that SSC has an $800,000 capital budget planned for the coming year. You have determined its present capital structure (60% equity and 40% debt) is optimal. and its net income is
What are stock repurchases? Discuss the advantages and disadvantages of a firm repurchasing its own shares.Southeastern Steel Company (SSC) was formed five years ago to exploit a new
Describe the series of steps most firms take in setting dividend policy in practice.Southeastern Steel Company (SSC) was formed five years ago to exploit a new continuous-casting process. SSC’s
What are stock splits and stock dividends? What are the advantages and disadvantages of stock splits and stock dividends?Southeastern Steel Company (SSC) was formed five years ago to exploit a new
What is a dividend reinvestment plan (DRIP), and how does it work?Southeastern Steel Company (SSC) was formed five years ago to exploit a new continuous-casting process. SSC’s founders, Donald
What are some reasons why companies decide to go public? If going public is a good idea, why don’t all companies do so?
On the day an IPO comes out, the market price can rise above the following price of fall bellow that price. Is it more common for the market price to close above the offering price on the day of an
What is a rights offering? Why do companies issue rights rather than simply sell additional stock directly to investors? How is the value of a right determined? Should an individual stockholder sell
What is an original issue discount bond? How are such bonds priced, and how are their before-tax and after-tax rates of return calculated?
How do companies decide whether or not to refund their outstanding bonds? If the NPV as calculated in a bond refunding analysis is positive, does that mean that the company should call and refund the
Define each of the following terms:a. Going public; new issue market; initial public offering (IPO)b. public offering; private placementc. Venture capitalists; roadshow; spreadd. Securities and
Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast is feasible. The proposed expansion would require the firm
How are start-up firms usually financed?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast is feasible. The
Differentiate between a private placement and a public offering.Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire
Why would a company consider going public? What are some advantages and disadvantages?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion
(1) What are the steps of an initial public offering?(2) What criteria are important in choosing an investment bank?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the
Would companies going public use a negotiated deal or a competitive bid?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the
Would the sale be on an underwritten or best efforts basis?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast
Without actually doing any calculations, describe how the preliminary offering range for the price of an IPO would be determined.Randy’s, a family-owned restaurant chain operating in Alabama, has
What is a roadshow? What is book-building?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast is feasible. The
Describe the typical first-day return of an IPO and the long-term returns to IPO investors.Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion
What are the direct and indirect costs of an IPO?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast is
(1) What are equity carve-outs?(2) In what other ways are investment banks involved in issuing securities?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at
What is meant by “going private”? What are some advantages and disadvantages?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout
How do companies manage the maturity structure of their debt?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire Southeast
Under what conditions would a firm exercise a bond call provision?Randy’s, a family-owned restaurant chain operating in Alabama, has grown to the point at which expansion throughout the entire
Explain how firms manage the risk structure of their debt with each of the following:(1) Project financing(2) SecuritizationRandy’s, a family-owned restaurant chain operating in Alabama, has grown
Differentiate between an operating lease, a capital (or financial) lease, and a sale and leaseback arrangement. How might investors be misled by firms that use lease financing extensively, and what
What is a synthetic lease? How are such leases structured, and what is their primary purpose? Is it likely that the use of synthetic leases will increase or decrease?
How do IRS regulations affect leasing decisions?
Assuming that FASB Statement 13 is working as it is supposed to work, should traditional leasing arrangements enable a firm to use more financial leverage than it otherwise could? How did synthetic
Define the term NAL as it is used in lease analysis, and then explain how the NAL is calculated.
Is leasing a zero sum game in the sense that any gain to the lessee is a cost to the lessor? If not, how might both parties gain from a lease transaction? In your answer, explain how the lessee and
Define each of the following terms:a. Lessee; lessorb. Operating lease; financial lease; sale-and-leaseback; combination lease; synthetic lease; SPE.c. Off-balance sheet financing; .capitalizingd.
(1) Who are the two parties to a lease transaction?(2) What are the five primary types of leases, and what are their characteristics?(3) How are leases classified for tax purposes?(4) What effect
(1) What is the present value cost of owning the equipment?(2) Explain the rationale for the discount rate you used to find the PV.Lewis Securities Inc. has decided to acquire a new market data and
What is Lewis’s present value cost of leasing the equipment?Lewis Securities Inc. has decided to acquire a new market data and quotation system for its Richmond home office. The system receives
What is the net advantage to leasing (NAL)? Does your analysis indicate that Lewis should buy or lease the equipment? Explain.Lewis Securities Inc. has decided to acquire a new market data and
Now assume the equipment’s residual value could be as low as $0 or as high as $400,000, but that $200,000 is the expected value. Since the residual value is riskier than the other cash flows in the
(1) The lessee compares the cost of owning the equipment with the cost of leasing it. Now put yourself in the lessor’s shoes. In a few sentences, how should you analyze the decision to write or not
Lewis’s management has been considering moving to a new downtown location, and they are concerned that these plans may come to fruition prior to the expiration of the lease. If the move occurs,
What’s the difference between operating and nonoperating assets, and between net operating working capital and net working capital? Why are these distinctions important to someone who is estimating
Whit is the definition of free cash flow (FCF), and how it is it related to the value of a firm’s operations as determined using the corporate valuation model?
What is value-based management, and how is it related to the corporate valuation model? Is value-based management a good way to run a business, or can you think of alternative systems that are likely
Define EVA and MVA, and indicate how those concepts are related to value-based management.
Why is corporate governance important to investors? Explain how each of the following is related to corporate governance;(a) Management entrenchment,(b) Hostile takeovers,(c) Incentive compensation
How does the free cash flow model differ from the dividend growth model, and what are the advantages and disadvantages of each model? Do these models produce the same answers to the total value of
You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a company that is seeking to increase its value. The company’s CEO and founder, Mia Kulpa, has asked you to estimate the value
1. What is the total value of a corporation? Who has claims on this value?2. What are nonoperating assets? How can their value be estimated?You have been hired as a consultant to Kulpa Fishing
The first acquisition target is a privately held company in a mature industry. The company currently has free cash flow of $20 million, its WACC is 10%, and it is expected to grow at a constant
The second acquisition target is a privately held company in a growing industry. The target has recently borrowed $40 million to finance its expansion; it has no other debt or preferred stock. It
(1) KFS is also interested in applying value-based management to its own divisions. Explain what value based management is.(2) What are the four value drivers? How does each of them affect value?You
What is expected return on invested capital (EROIC)? Why is the spread between EROIC and WACC so important?You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a company that is
KFS has two divisions. Both have current sales of $1,000, current expected growth of 5%, and a WACC of 10%. Division A has high profitability (OP = 6%) but high capital requirements (CR = 78%).
What is the EROlC of each division for 5% growth and for 6% growth? How is this related to intrinsic MVA?You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a company that is seeking
List six potential managerial behaviors that can harm a firm’s value.You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a company that is seeking to increase its value. The
The managers at KFS have heard that corporate governance can affect shareholder value. What is corporate governance? List five corporate governance provisions that are internal to a firm and are
What characteristics of the board of directors usually lead to effective corporate governance?You have been hired as a consultant to Kulpa Fishing Supplies (KFS), a company that is seeking to
(1) List three provisions in the corporate charter that affect takeovers.(2) Briefly describe the use of stock options in a compensation plan. What are some potential problems with stock options as a
(1) What is block ownership? How does it affect corporate governance?(2) Briefly explain how regulatory agencies and legal systems affect corporate governance.You have been hired as a consultant to
Bilbo Baggins wants to save money to meet three objectives. First, he would like to be able to retire 30 years from now with a retirement income of $28,000 per month for 20 years, with the first

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