Questions and Answers of Principles Corporate Finance

For which types of investors is there a personal tax disadvantage of debt?
Safeco Inc. has no debt, and maintains a policy of holding $$10$ million in excess cash reserves, invested in risk-free Treasury securities. If Safeco pays a corporate tax rate of 21%, what is the
Rogot Instruments makes fine violins and cellos. It has $$1.1$ million in debt outstanding, equity valued at $$2.2$ million, and pays corporate income tax at a rate of 40%. Its cost of equity is
Rumolt Motors has 13 million shares outstanding with a price of $$17$ per share. In addition, Rumolt has issued bonds with a total current market value of $$313$ million. Suppose Rumolt’s
Suppose Microsoft has 8.15 billion shares outstanding and pays a marginal corporate tax rate of 37%. If Microsoft announces that it will payout $52 billion in cash to investors through a combination
PMF, Inc., can deduct interest expenses next year up to 30% of EBIT. This limit is equally likely to be $$10$ million, $$15$ million, or $$20$ million. Its corporate tax rate is 35%, and
Krell Industries has a share price of $$21.44$ today. If Krell is expected to pay a dividend of $$0.78$ this year, and its stock price is expected to grow to $$24.63$ at the end of the year,
NoGrowth Corporation currently pays a dividend of $1.36 per year, and it will continue to pay this dividend forever. What is the price per share if its equity cost of capital is 15% per year?
In mid-2018, some analysts recommended that General Electric (GE) suspend its dividend payments to preserve cash needed for investment. Suppose you expected GE to stop paying dividends for two years
Cooperton Mining just announced it will cut its dividend from $$4.27$ to $$2.67$ per share and use the extra funds to expand. Prior to the announcement, Cooperton’s dividends were expected to
Suppose Amazon.com, Inc. pays no dividends but spent $2.98 billion on share repurchases last year. If Amazon’s equity cost of capital is 7.6%, and if the amount spent on repurchases is expected to
Benchmark Metrics, Inc. (BMI), an all-equity financed firm, reported EPS of $$4.52$ in 2016.Despite the economic downturn, BMI is confident regarding its current investment opportunities.But due to
IDX Technologies is a privately held developer of advanced security systems based in Chicago.As part of your business development strategy, in late 2016 you initiate discussions with IDX’s founder
Consider the following data for the airline industry for July 2018. Discuss the potential challenges of using multiples to value an airline. Company Name Market Capitalization Enterprise Forward
For an investment horizon from 1926 to 2021, which of the following investments had the highest return: the S&P 500, small stocks, world portfolio, corporate bonds, or Treasury bills? Which had the
For an investment horizon of just one year, which of these investments was the most variable? Which was the least variable?
What are the two most common measures of risk, and how are they related to each other?
How do we calculate the average annual return of an investment?
We have 96 years of data on the S&P 500 returns, yet we cannot estimate the expected return of the S&P 500 very accurately. Why?
What is the excess return?
Do expected returns of well-diversified large portfolios of stocks appear to increase with volatility?
Do expected returns for individual stocks appear to increase with volatility?
Under what circumstances will risk be diversified in a large portfolio of insurance contracts?
Explain why the risk premium of diversifiable risk is zero.
Why is the risk premium of a security determined only by its systematic risk?
Define the beta of a security.
How can you use a security’s beta to estimate its cost of capital?
If a risky investment has a beta of zero, what should its cost of capital be according to the CAPM? How can you justify this?
For the assumptions in part (a) of Problem 5, assuming a cost of capital of 12%, calculate the following:a. The break-even annual sales price decline.b. The break-even annual unit sales increase.Data
Assume Evco, Inc., has a current price of $$45$ and will pay a $$2.05$ dividend in one year, and its equity cost of capital is 16%. What price must you expect it to sell for right after paying
Anle Corporation has a current price of $$17,$ is expected to pay a dividend of $$2$ in one year, and its expected price right after paying that dividend is \($18.a. What is Anle’s expected
How does scenario analysis differ from sensitivity analysis, and it what ways can it be used?
Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be low in cholesterol and contain no trans fats. The firm expects that sales of the new
Kokomochi is considering the launch of an advertising campaign for its latest dessert product, the Mini Mochi Munch. Kokomochi plans to spend $$4.78$ million on TV, radio, and print advertising
Cellular Access, Inc. is a cellular telephone service provider that reported net income of $$251$ million for the most recent fiscal year. The firm had depreciation expenses of $$90$ million,
You are a manager at Percolated Fiber, which is considering expanding its operations in synthetic fiber manufacturing. Your boss comes into your office, drops a consultant’s report on your desk,
Beryl’s Iced Tea currently rents a bottling machine for $$51,000$ per year, including all maintenance expenses. It is considering purchasing a machine instead, and is comparing two options:a.
Billingham Packaging is considering expanding its production capacity by purchasing a new machine, the XC-750. The cost of the XC-750 is $$2.68$ million. Unfortunately, installing this machine will
You are considering purchasing a defunct mine in Africa. Your firm has developed a method to extract valuable rare earth minerals from the mining entrails. The cost of the mine together with the
Consider the following bonds:a. What is the percentage change in the price of each bond if its yield to maturity falls from 6% to 5%?b. Which of the bonds A–D is most sensitive to a 1% drop in the
A BBB-rated corporate bond has a yield to maturity of 13.7%. A U.S. Treasury security has a yield to maturity of 11.7%. These yields are quoted as APRs with semiannual compounding.Both bonds pay
Using vertical common-size analysis and restating the balance sheets using total assets as the benchmark to analyze changes at Tab between fiscal year 2003 and fiscal year 2005, an analyst would
Using vertical common-size analysis of the income statement of Tab for 2005, the cost of sales relative to the benchmark is closest to:A. 75%.B. 80%.C. 85%. Tab, Inc., Income Statements for Fiscal
Using horizontal common-size analysis of the income statement of Tab for 2005, the cost of sales relative to the benchmark of 2003 is closest to:A. 95%.B. 118%.C. 123%. Tab, Inc., Income Statements
The difference between a company’s operating cycle and its net operating cycle is:A. the number of days that it takes, on average, for the company to sell its inventory.B. the number of days that
The net operating cycle is:A. inversely related to a company’s need for liquidity.B. the length of time it takes for an investment in inventory to be returned from collected accounts.C. the sum of
A measure of the extent to which a company is able to satisfy its short-term obligations is referred to as:A. a liquidity ratio.B. an activity ratio.C. a financial leverage ratio.
Which of the following best describes the relationship between the current ratio and the cash ratio?A. The current ratio and the cash ratio should not bear any relation to one another.B. The current
Suppose a company has earnings before taxes of $20 billion and its income tax is 35% of its earnings before taxes. If the company has an interest expense of $2 billion, its interest coverage ratio is
If a company has a net profit margin of 12% and a tax rate of 40%, the before-tax profit margin is closest to:A. 7.2%.B. 12.4%.C. 20.0%.
If a company’s operating profit margin is 4% and its total asset turnover is 1.5 times, its operating return on assets is:A. 2.7%.B. 6.0%.C. 7.3%.
The DuPont system allows us to break down the return on equity into:A. return on assets and the financial leverage ratio.B. profit margin, the tax retention ratio, and inventory turnover.C. gross
Suppose that LaPearla’s revenues are expected to grow at a rate of 10% and all elements of the income statement and balance sheet are sales-driven except for the tax burden, which remains at 30%.
If LaPearla’s long-term debt and paid-in capital accounts remain at their 2005 levels, the tax rate remains at the 2005 rate, and all other income statement and balance sheet accounts are
The acquisition of Sky Systems by Modern Auto and the acquisition of Sky Systems by HiFly, respectively, would be examples of a:A. vertical merger and a horizontal merger.B. conglomerate merger and a
If Sky Systems were to be acquired by Modern Auto under the terms of the original offer, the post-merger EPS of the new company would be closest to:A. $$2.00$.B. $$2.32$.C. $$2.63$.Modern Auto,
Are Wilhelm’s two statements about his shareholders benefiting from the diversification effect of the merger and about the increase in the stock price, respectively, correct?Modern Auto, an
Which of the following defenses best describes the role of HiFly in the acquisition scenario?A. Crown jewel.B. Pac-Man.C. White knight.Modern Auto, an automobile parts supplier, has made an offer to
Suppose HiFly acquires Sky Systems for the stated terms. The gain to Sky Systems shareholders resulting from the merger transaction would be closest to:A. $$25$ million.B. $$160$ million.C.
If HiFly and Sky Systems attempt to merge, the increase in the Herfindahl–Hirschman Index (HHI) and the probable action by the Department of Justice and the FTC, respectively, in response to the
What is the present value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the constant growth model to determine terminal
What is the value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the cash flow multiple method to determine terminal
The average stock price of High Tech for the three relative valuation ratios (if it is traded at the mean of the three valuations) is closest to:A. $$35.21$.B. $$39.38$.C. $$40.56$.Kinetic
Taking into account the mean takeover premium on recent comparable takeovers, what would be the estimate of the fair acquisition price of High Tech based on the comparable company approach?A.
The fair acquisition price of High Tech using the comparable transaction approach is closest to:A. $$35.22$.B. $$40.86$.C. $$41.31$.Kinetic Corporation is considering acquiring High Tech
Are Smith’s two comments about his analysis correct?A. Both of his comments are correct.B. Both of his comments are incorrect.C. His first comment is correct, and his second comment is
The value the CEO estimated based on comparable company analysis is closest to:A. $$37.33$.B. $$39.30$.C. $$40.80$.Mark Zin and Stella Lee are CEO and CFO, respectively, of Moonbase
The divestiture technique that Lee is recommending is most likely:A. a spin-off.B. a split-off.C. an equity carve-out.Mark Zin and Stella Lee are CEO and CFO, respectively, of Moonbase
With regard to poison pills and puts, Lee’s comments are:A. correct.B. incorrect with regard to the poison put.C. incorrect with regard to the poison pill.Mark Zin and Stella Lee are CEO and CFO,
Which statement by Zin provides the most support for a strong governance rating?A. Statement 1.B. Statement 2.C. Statement 3.Mark Zin and Stella Lee are CEO and CFO, respectively, of Moonbase
Which policy of the Statement of Corporate Governance is least likely to ensure effective contributions from the board of directors?A. Policy #1.B. Policy #2.C. Policy #3.Mark Zin and Stella Lee are
Is Zin’s comment that good governance practice does not preclude Steris from serving on either of the two committees of the Moonbase board correct?A. Yes.B. No, good governance practice precludes
Using the discounted cash flow approach and assuming that Durtech’s terminal value is based on the cash flow multiple method, Logan’s best estimate of Durtech’s current value per share is
Logan’s best response to the supervisor’s question concerning the sensitivity of the enterprise value to the terminal growth rate assumption is closest to:A. –36.5%.B. –28.5%.C. –24.8%.Josh
Based on Exhibit A and the mean of each of the valuation ratios, Logan’s estimate of Durtech’s value per share should be closest to:A. $$30.44$.B. $$33.67$.C. $$34.67$.Josh Logan is a
Based on the premium on a recent comparable transaction, Logan’s best estimate of the takeover premium for Durtech is closest to:A. 19.9%.B. 23.9%.C. 35.8%.Josh Logan is a buy-side equity analyst
Using comparable transaction analysis, Logan’s estimate of the fair acquisition value per share for Durtech is closest to:A. $$35.52$.B. $$42.59$.C. $$44.00$.Josh Logan is a buy-side equity
The best justification for Logan’s conclusion concerning possible government antitrust action is that:A. the post- and pre-merger HHI are both between 1000 and 1800.B. the change in the HHI is 100
If investors have homogeneous expectations, the market is efficient, and there are no taxes, no transactions costs, and no bankruptcy costs, the Modigliani and Miller Proposition I states that:A.
According to Modigliani and Miller’s Proposition II without taxes:A. the capital structure decision has no effect on the cost of equity.B. investment and the capital structure decisions are
Suppose the weighted average cost of capital of the Gadget Company is 10%. If Gadget has a capital structure of 50% debt and 50% equity, a before-tax cost of debt of 5%, and a marginal tax rate of
The current weighted average cost of capital (WACC) for Van der Welde is 10%. The company announced a debt offering that raises the WACC to 13%. The most likely conclusion is that for Van der
All else equal, the use of long-maturity debt is expected to be greater in those markets in which:A. inflation is low.B. capital markets are passive and illiquid.C. the legal system’s protection of
According to the pecking order theory:A. new debt is preferable to new equity.B. new debt is preferable to internally generated funds.C. new equity is always preferable to other sources of capital.
According to the static trade-off theory:A. debt should be used only as a last resort.B. companies have an optimal level of debt.C. the capital structure decision is irrelevant.
MBG is best described as currently:A. 25% debt financed and 75% equity financed.B. 33% debt financed and 66% equity financed.C. 75% debt financed and 25% equity financed.Barbara Andrade is an equity
Based on Exhibits A and B, the current after-tax cost of debt for MBG is closest to:A. 2.80%.B. 5.20%.C. 7.65%.Barbara Andrade is an equity analyst who covers the entertainment industry for
Based on Exhibits A and B, MBG’s current cost of equity capital is closest to:A. 10.30%.B. 10.80%.C. 12.75%.Barbara Andrade is an equity analyst who covers the entertainment industry for Greengable
Based on Exhibits A and B, what debt-to-total capital ratio would minimize MBG’s weighted average cost of capital?A. 20%.B. 30%.C. 40%.Barbara Andrade is an equity analyst who covers the
Holding operating earnings constant, an increase in the marginal tax rate to 40% would:A. result in a lower cost of debt capital.B. result in a higher cost of debt capital.C. not affect the
According to the pecking order theory, MBG’s announced capital structure change:A. is optimal because debt is cheaper than equity on an after-tax basis.B. may be optimal if new debt is issued after
Based on the Modigliani and Miller (MM) propositions with corporate taxes, Aquarius’s WACC is closest to:A. 3.38%.B. 7.87%.C. 11.25%.Lindsay White, CFA, is an analyst with a firm in London,
Based on MM propositions with corporate taxes, what is Bema’s weighted average cost of capital after the completion of their announced debt-financed share repurchase program?A. 6.52%.B. 7.83%.C.
Based on Exhibit C and White’s notes, which of the following is least consistent with White’s conclusion regarding Bema’s announcement?A. Bema’s bonding costs will be higher than
Based on the MM propositions with corporate taxes, Garth’s cost of equity after the debt issuance is closest. to:A. 10.00%.B. 10.85%.C. 11.33%.Lindsay White, CFA, is an analyst with a firm in
Based on Exhibit C and White’s notes, which of the following is most consistent with White’s conclusion regarding Garth’s announcement?A. Garth has more business risk than does Holte.B. Garth
Based on White’s conclusion regarding determining the appropriate method of raising capital, Vega should raise capital in the following order:A. debt, internal financing, equity.B. equity, debt,
The payment of a 10% stock dividend by a company will result in an increase in that company’s:A. current ratio.B. financial leverage.C. contributed capital.
If a company’s common shares trade at relatively very low prices, that company would be most likely to consider the use of a:A. stock split.B. stock dividend.C. reverse stock split.
In a recent presentation, Doug Pearce made two statements about dividends:Statement 1: “A stock dividend will increase share price, all other things being equal.”Statement 2: “One practical

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