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Questions and Answers of Finance

What does capital structure theory attempt to do? What lessons can be learned from capital structure theory? Be sure to address the MM models.
For each capital structure under consideration, calculate the levered beta, the cost of equity, and the WACC.
Now calculate the corporate value, the value of the debt that will be issued, and the resulting market value of equity. Discuss.
Calculate the resulting price per share, the number of shares repurchased, and the remaining shares. Discuss.
Considering only the capital structures under analysis, what is Pizza Palace’s optimal capital structure?
What other factors should managers consider when setting the target capital structure?
Barnes plans to use the ratios shown below as the starting point for discussions with SKI’s operating executives. He wants everyone to think about the pros and cons of changing each type of current
How can one distinguish between a relaxed but rational working capital policy and a situation in which a firm simply has a lot of current assets because it is inefficient? Does SKI’s working
Now, calculate the firm’s cash conversion cycle. Assume a 365 day year.
What might SKI do to reduce its cash without harming operations?
Should depreciation expense be explicitly included in the cash budget? Why or why
In his preliminary cash budget, Barnes has assumed that all sales are collected and, thus, that SKI has no bad debts. Is this realistic? If not, how would bad debts be dealt with in a cash budgeting
Barnes’ cash budget for the entire year, although not given here, is based heavily on his forecast for monthly sales. Sales are expected to be extremely low between May and September but then
What reasons might SKI have for maintaining a relatively high amount of cash?
What are the three categories of inventory costs? If the company takes steps to reduce its inventory, what effect would this have on the various costs of holding inventory?
Is there any reason to think that SKI may be holding too much inventory? If so, how would that affect EVA and ROE?
If the company reduces its inventory without adversely affecting sales, what effect should this have on the company’s cash position (1) in the short run and (2) in the long run? Explain in terms of
Barnes knows that SKI sells on the same credit terms as other firms in its industry. Use the ratios presented earlier to explain whether SKI’s customers pay more or less promptly than those of its
Does SKI face any risks if it tightens its credit policy?
If the company reduces its DSO without seriously affecting sales, what effect would this have on its cash position (1) in the short run and (2) in the long run? Answer in terms of the cash budget
Is it likely that SKI could make significantly greater use of accruals?
Assume that SKI buys on terms of 1/10, net 30, but that it can get away with paying on the 40th day if it chooses not to take discounts. Also, assume that it purchases $506,985 of equipment per year,
SKI tries to match the maturity of its assets and liabilities. Describe how SKI could adopt either a more aggressive or more conservative financing policy.
SKI tries to match the maturity of its assets and liabilities. Describe how SKI could adopt either a more aggressive or more conservative financing policy. Discuss.
Would it be feasible for SKI to finance with commercial paper?
Several reasons have been proposed to justify mergers. Among the more prominent are (1) tax considerations, (2) risk reduction, (3) control, (4) purchase of assets at below-replacement cost, (5)
Briefly describe the differences between a hostile merger and a friendly merger.
What are the steps in valuing a merger?
Use the data developed in the table to construct the L division's free cash flows for 2005 through 2008. Why are we identifying interest expense separately since it is not normally included in
Conceptually, what is the appropriate discount rate to apply to the cash flows developed in part c? What is your actual estimate of this discount rate?
What is the estimated horizon, or continuing, value of the acquisition; that is, what is the estimated value of the L division's cash flows beyond 2008? What is Lyons’ value to Hager’s
Assume that Lyons’ has 20 million shares outstanding. These shares are traded relatively infrequently, but the last trade, made several weeks ago, was at a price of $11 per share. Should Hager’s
How would the analysis be different if Hager’s intended to recapitalize Lyons’ with 40% debt costing 10% at the end of four years?
There has been considerable research undertaken to determine whether mergers really create value and, if so, how this value is shared between the parties involved. What are the results of this
What method is used to account for mergers?
What merger-related activities are undertaken by investment bankers?
What is a leveraged buyout (LBO)? What are some of the advantages and disadvantages of going private?
What are the major types of divestitures? What motivates firms to divest assets?
What are holding companies? What are their advantages and disadvantages?
Discuss, in general, what it means for the brothers to set a credit and collections policy.
What is the firm’s expected days sales outstanding (DSO)?
What are its expected average daily sales (ADS)?
What is its expected average accounts receivable level?
Assume that the firm’s profit margin is 25 percent. How much of the receivables balance must be financed? What would the firm’s balance sheet figures for accounts receivable, notes payable and
If bank loans have a cost of 12 percent, what is the annual dollar cost of carrying the receivables?
What are some factors that influence (1) a firm's receivables level and (2) the dollar cost of carrying receivables?
Assuming that the monthly sales forecasts given previously are accurate, and that customers pay exactly as was predicted, what would the receivables level be at the end of each month? To reduce
What are the firm’s forecasted average daily sales for the first 3 months? For the entire half-year the day’s sales outstanding is commonly used to measure receivables performance. What DSO is
Construct aging schedules for the end of March and the end of June (use the format given below). Do these schedules properly measure customers' payment patterns? If not, why not?
Construct the uncollected balances schedules for the end of March and the end of June. Use the format given below. Do these schedules properly measure customers' payment patterns?
Assume that it is now July of year 1, and the brothers are developing pro forma financial statements for the following year. Further, assume that sales and collections in the first half-year matched
Assume now that it is several years later. The brothers are concerned about the firm's current credit terms, which are now net 30, which means that contractors buying building products from the firm
Under the current credit policy, what is the firm's days sales outstanding (DSO)? What would the expected DSO be if the credit policy change were made?
What is the dollar amount of the firm's current bad debt losses? What losses would be expected under the new policy?
What would be the firm's expected dollar cost of granting discounts under the new policy?
What is the firm's current dollar cost of carrying receivables? What would it be after the proposed change?
What is the incremental after-tax profit associated with the change in credit terms? Should the company make the change? (Assume a tax rate of 40 percent.)
Suppose the firm makes the change, but its competitors react by making similar changes to their own credit terms, with the net result being that gross sales remain at the current $1,000,000 level.
The brothers are considering taking out a 1-year bank loan for $100,000 to finance part of their working capital needs and have been quoted a rate of 8 percent. What is the effective annual cost rate
How large would the loan actually be in each of the cases in part f?
If you bought a share of stock, what would you expect to receive, when would you expect to receive it, and would you be certain that your expectations would be met?
If most investors expect the same cash flows from Companies A and B but are more confident that A`s cash flows will be closer to their expected value, which company should have the higher stock
What is a firm’s intrinsic value? its current stock price? Is the stock’s “true long-run value” more closely related to its intrinsic value or to its current price?
When is a stock said to be in equilibrium? At any given time, would you guess that most stocks are in equilibrium as you defined it? Explain.
Suppose three honest individuals gave you their estimates of Stock Xs intrinsic value. One person is your current roommate, the second person is a professional security analyst with an excellent
Is it better for a firm`s actual stock price in the market to be under, over, or equal to its intrinsic value? Would your answer be the same from the standpoints of stockholders in general and a CEO
If a company`s board of directors wants management to maximize shareholder wealth, should the CEO`s compensation be set as a fixed dollar amount, or should the compensation depend on how well the
What are the four forms of business organization? What are the advantages and disadvantages of each?
Should stockholder wealth maximization be thought of as a long-term or a short-term goal? For example, if one action increases a firm`s stock price from a current level of $20 to $25 in 6 months and
What are some actions that stockholders can take to ensure that managements and stockholders interests are aligned?
The president of Southern Semiconductor Corporation (SSC) made this statement in the companys annual report SSCs primary goal is to increase the value of our common stockholders equity. Later in the
Investors generally can make one vote for each share of stock they hold. TIAA-CREF is the largest institutional shareholder in the United States; therefore, it holds many shares and has mote votes
Edmund Enterprises recently made a large investment to upgrade its technology. While these improvements wont have much effect on performance in the short run, they are expected to reduce future costs
Suppose you were a member of Company Xs board of directors and chairperson of the companys compensation committee. What factors should your committee consider when setting the CEOs compensation?
Suppose you are a director of an energy company that has three divisions-natural gas, oil, and retail (gas stations). These divisions operate independently from one another, but all division managers
Consider the following investments* An investor short sells a stock at a price S, and writes an al-the-money call option on the same stock with a strike price of k* An investor buys one put with a
Consider a fixed-payer, plain vanilla, interest rate swap paid in arrears with the following characteristics:(1) The start date is in 12 months, the maturity is 24 months.(2) Floating rate is 6 month
Let the arbitrage-free 3-month futures prices for wheat be denoted by Ft. Suppose it costs c$ to store 1 ton of wheat for 12 months and s$ per year to insure the same quantity. The (simple) interest
An at-the money call written on a stock with current price St = 100 trades at 3. The corresponding at-the –money put trades at 3.5. There are no transaction costs and the stock does nor pay any
You are given the price of a nondividend paying stock St and a European call option Ct in a world where there are only two possible states The true probabilities of the two states are given by {Pu
In an economy there are two states of the world and four assets. You are given the following prices for three of these securities in different states of the world: ?Current? prices for A, B, C are
Consider a stock St and a plain vanilla, at-the-money, put option written on this stock. The option expires at time t + Δ, where Δ denotes a small interval. At time t, there are only two possible
A four-step binomial tree for the price of a stock St is to be calculated using the up and sown ticks given as follows: u = 1.15 ? ? ? ? ? d = 1/u These up and down movements apply to one-month
You are given the following information concerning a stock denoted by St(1) Current value =102.(2) Annual volatility = 30%.(3) You are also given the spot rate r = 50%, which is known to constant
Suppose you are given the following data: (1) Risk-free yearly interest rate is r = 6%. (2) The stock price follows: St ? St?1 = ?St + ?St?t Where the ? is a serially uncorrelated binomial process
Using the data in the previous question, you are now asked to approximate the current value of a European call option on the stock St. the option has a strike price of 100, and a maturity of 100
Write the sequences {Xn} for n = 1, 2, 3, where(a) Xn = an,(b) Xn = (1 + 1/n)n,(c) Xn = (–n) n-1/n!,Are the sequences {Xn}, given above, convergent?Suppose the yearly interest rate is 55. Let Δ be
If it exits, find the limit of the following sequences for n = 1, 2, 3.(a) xn = (–1)n(b) xn = sin (nπ/3)(c) xn = n(–1)n(d) xn = sin (nπ/3) + (–1)n/nIs this sequence bounded?
Determine the following limits:
Show that the partial sum isconvergent.
Show that the partial sum Sn defined by the recursion formula:Sn+1 = √38nWith S1 = 1, converges to 3. Use mathematical induction
Does the series Converge as N ? ??
SupposeXn = aXn – 1 + 1With X0 given. Write Xn as a partial sum. When does this partial sum converge?
Consider the function: f (x) = x3 (a) Take the integral and calculate ?10f(x)dx (b) Now consider splitting the interval [0, 1] into 4 pieces, x0 = 0 x1x2x3x4 = 1 Where you choose the xi. They may or
Now consider the function f (x) discussed in this chapter: (a) Take the integral and calculate (b) again, split the interval [0, 1] into 4 pieces,X0 = 0 By choosing the xi numerically.Calculate
Consider the following functions Take the partials with respect to x, y, z,respectively.
Suppose you can bet on an American presidential election in which c of the candidates is an incumbent. The market offers you the following payoffs R You can take either side of the bet Let the true
Now place yourself exactly in the same setting as before, where the market quotes the above R. It just happens that you have a close friend who offers you the following separate bet, R*: Note that
You are given two discrete random variables X. Y that assume the possible values 0, 1 according to the following joint distribution: (a) What are the marginal distributions of X and Y?(b) Are x
We let the random variable Xn be a binomial process Where each Bi is independent and is distributed according to (a) Calculate the probabilities P(X4 > k) for k 0, 1, 2, 4 and plot the

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