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Corporate Finance
Tom Scott is the owner, president, and primary salesperson for Scott Manufacturing. Because of this, the company’s profits are driven by the amount of work Tom does. If he works 40 hours each week,
Dream, Inc., has debt outstanding with a face value of $6 million. The value of the firm if it were entirely financed by equity would be $17.85 million. The company also has 350,000 shares of stock
Suppose the president of the company in the previous problem stated that the company should increase the amount of debt in its capital structure because of the tax-advantaged status of its interest
Steinberg Corporation and Dietrich Corporation are identical firms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies’ economists agree
Fountain Corporations economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of Fountain must choose
Good Time Company is a regional chain department store. It will remain in business for one more year. The probability of a boom year is 60 percent and the probability of a recession is 40 percent. It
When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero
Overnight Publishing Company (OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm’s debt is held by
Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company. Sam is considering opening several new restaurants. Sally Thornton, the companys CFO, has been put
What are the two types of risk that are measured by a levered beta?
Zoso is a rental car company that is trying to determine whether to add 25 cars to its fleet. The company fully depreciates all its rental cars over five years using the straight-line method. The new
Gemini, Inc., an all-equity firm, is considering a $1.7 million investment that will be depreciated according to the straight-line method over its four-year life. The project is expected to generate
Milano Pizza Club owns three identical restaurants popular for their specialty pizzas. Each restaurant has a debt–equity ratio of 40 percent and makes interest payments of $41,000 at the end of
If Wild Widgets, Inc., were an all-equity company, it would have a beta of .85. The company has a target debt–equity ratio of .40. The expected return on the market portfolio is 11 percent, and
North Pole Fishing Equipment Corporation and South Pole Fishing Equipment Corporation would have identical equity betas of 1.10 if both were all equity financed. The market value information for each
Daniel Kaffe, CFO of Kendrick Enterprises, is evaluating a 10-year, 8 percent loan with gross proceeds of $5,850,000. The interest payments on the loan will be made annually. Flotation costs are
Shattered Glass, Inc., is an all-equity firm. The cost of the company’s equity is currently 11 percent, and the risk-free rate is 3.5 percent. The company is currently considering a project that
National Electric Company (NEC) is considering a $45 million project in its power systems division. Tom Edison, the company’s chief financial officer, has evaluated the project and determined that
Bolero, Inc., has compiled the following information on its financing costs:The company is in the 35 percent tax bracket and has a target debtequity ratio of 60 percent. The target
Triad Corporation has established a joint venture with Tobacco Road Construction, Inc., to build a toll road in North Carolina. The initial investment in paving equipment is $80 million. The
For the company in the previous problem, what is the value of being able to issue subsidized debt instead of having to issue debt at the terms it would normally receive? Assume the face amount and
MVP, Inc., has produced rodeo supplies for over 20 years. The company currently has a debt–equity ratio of 50 percent and is in the 40 percent tax bracket. The required return on the firm’s
Neon Corporation’s stock returns have a covariance with the market portfolio of .0415. The standard deviation of the returns on the market portfolio is 20 percent, and the expected market risk
Stackhouse Industries has a new project available that requires an initial investment of $4.5 million. The project will provide unlevered cash flows of $675,000 per year for the next 20 years. The
Seger, Inc., is an unlevered firm with expected annual earnings before taxes of $21 million in perpetuity. The current required return on the firm’s equity is 16 percent, and the firm distributes
Mojito Mint Company has a debt–equity ratio of .35. The required return on the company’s unlevered equity is 13 percent, and the pretax cost of the firm’s debt is 7 percent. Sales revenue for
Lone Star Industries just issued $235,000 of perpetual 8 percent debt and used the proceeds to repurchase stock. The company expects to generate $118,000 of earnings before interest and taxes in
Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .40, but the industry target debt–equity ratio
Cheek Products, Inc. (CPI) was founded 53 years ago by Joe Cheek and originally sold snack foods such as potato chips and pretzels. Through acquisitions, the company has grown into a conglomerate
It is sometimes suggested that firms should follow a “residual” dividend policy. With such a policy, the main idea is that a firm should focus on meeting its investment needs and maintaining its
The Phew Charitable Trust pays no taxes on its capital gains or on its dividend income or interest income. Would it be irrational for it to have low-dividend, high-growth stocks in its portfolio?
The growing perpetuity model expresses the value of a share of stock as the present value of the expected dividends from that stock. How can you conclude that dividend policy is irrelevant when this
The desire for current income is not a valid explanation of preference for high current dividend policy because investors can always create homemade dividends by selling a portion of their stocks. Is
Cap Henderson owns Neotech stock because its price has been steadily rising over the past few years and he expects this performance to continue. Cap is trying to convince Sarah Jones to purchase some
Your aunt is in a high tax bracket and would like to minimize the tax burden of her investment portfolio. She is willing to buy and sell to maximize her aftertax returns, and she has asked for your
If the market places the same value on $1 of dividends as on $1 of capital gains, then firms with different payout ratios will appeal to different clienteles of investors. One clientele is as good as
In spite of the theoretical argument that dividend policy should be irrelevant, the fact remains that many investors like high dividends. If this preference exists, a firm can boost its share price
Empirical research has found that there have been significant increases in stock price on the day an initial dividend (i.e., the first time a firm pays a cash dividend) is announced. What does this
Lee Ann, Inc., has declared a $9.50 per-share dividend. Suppose capital gains are not taxed, but dividends are taxed at 15 percent. New IRS regulations require that taxes be withheld when the
The owners’ equity accounts for Hexagon International are shown here: Common stock ($1 par value) ....... $ 30,000Capital surplus .............. 185,000Retained earnings
Roll Corporation (RC) currently has 330,000 shares of stock outstanding that sell for $64 per share. Assuming no market imperfections or tax effects exist, what will the share price be after? a. RC
The balance sheet for Levy Corp. is shown here in market value terms. There are 12,000 shares of stock outstanding.The company has declared a dividend of $1.90 per share. The stock goes ex dividend
In the previous problem, suppose Levy has announced it is going to repurchase $22,800 worth of stock. What effect will this transaction have on the equity of the firm? How many shares will be
The market value balance sheet for Outbox Manufacturing is shown here. Outbox has declared a stock dividend of 25 percent. The stock goes ex-dividend tomorrow (the chronology for a stock dividend is
The company with the common equity accounts shown here has declared a stock dividend of 15 percent when the market value of its stock is $45 per share. What effects on the equity accounts will the
The Mann Company belongs to a risk class for which the appropriate discount rate is 10 percent. Mann currently has 220,000 outstanding shares selling at $110 each. The firm is contemplating the
Flychucker Corporation is evaluating an extra dividend versus a share repurchase. In either case $4,000 would be spent. Current earnings are $2.10 per share, and the stock currently sells for $46 per
The net income of Novis Corporation is $85,000. The company has 25,000 outstanding shares and a 100 percent payout policy. The expected value of the firm one year from now is $1,725,000. The
Gibson Co. has a current period cash flow of $1.1 million and pays no dividends. The present value of the company’s future cash flows is $15 million. The company is entirely financed with equity
The Sharpe Co. just paid a dividend of $1.80 per share of stock. Its target payout ratio is 40 percent. The company expects to have an earnings per share of $4.95 one year from now. a. If the
National Business Machine Co. (NBM) has $4 million of extra cash after taxes have been paid. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets.
Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electronics engineers Tom Miller and Jessica Kerr. ETI manufactures integrated circuits to capitalize on the complex
What are the comparative advantages of a competitive offer and a negotiated offer, respectively?
What are the possible reasons why the stock price typically drops on the announcement of a seasoned new equity issue?
Megabucks Industries is planning to raise fresh equity capital by selling a large new issue of common stock. Megabucks, a publicly traded corporation, is trying to choose between an underwritten cash
Explain why shelf registration has been used by many firms instead of syndication.
Every IPO is unique, but what are the basic empirical regularities in IPOs?
Stone Shoe Co. has concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights offering. It has correctly
The St. Anger Corporation needs to raise $45 million to finance its expansion into new markets. The company will sell new shares of equity via a general cash offering to raise the needed funds. If
The Green Hills Co. has just gone public. Under a firm commitment agreement, Green Hills received $26.04 for each of the 7 million shares sold. The initial offering price was $28 per share, and the
Raggio, Inc., has 135,000 shares of stock outstanding. Each share is worth $75, so the company’s market value of equity is $10,125,000. Suppose the firm issues 30,000 new shares at the following
The Newton Company has 50,000 shares of stock that each sell for $40. Suppose the company issues 9,000 shares of new stock at the following prices: $40, $20, and $10. What is the effect of each of
The Metallica Heavy Metal Mining (MHMM) Corporation wants to diversify its operations. Some recent financial information for the company is shown here:Stock price ..............................
A company’s stock currently sells for $68 per share. Last week the firm issued rights to raise new equity. To purchase a new share, a stockholder must remit $11 and three rights.a. What is the
Summit Corp.’s stock is currently selling at $32 per share. There are 1 million shares outstanding. The firm is planning to raise $2 million to finance a new project. What are the ex-rights stock
Hoobastink Mfg. is considering a rights offer. The company has determined that the ex-rights price will be $61. The current price is $68 per share, and there are 10 million shares outstanding. The
Wuttke Corp. wants to raise $5,375,000 via a rights offering. The company currently has 950,000 shares of common stock outstanding that sell for $55 per share. Its underwriter has set a subscription
Mitsi Inventory Systems, Inc., has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of $30. At the close of
Larissa Warren and Dan Ervin have been discussing the future of East Coast Yachts. The company has been experiencing fast growth, and the future looks like clear sailing. However, the fast growth
What are the key differences between leasing and borrowing? Are they perfect substitutes?
What are some of the potential problems with looking at IRRs when evaluating a leasing decision?
Comment on the following remarks:a. Leasing reduces risk and can reduce a firm’s cost of capital.b. Leasing provides 100 percent financing.c. If the tax advantages of leasing were eliminated,
Discuss the accounting criteria for determining whether a lease must be reported on the balance sheet. In each case give a rationale for the criterion.
Discuss the IRS criteria for determining whether a lease is tax deductible. In each case give a rationale for the criterion.
What is meant by the term off–balance sheet financing? When do leases provide such financing, and what are the accounting and economic consequences of such activity?
Why might a firm choose to engage in a sale and leaseback transaction? Give two reasons.
Why wouldn’t China Eastern Airlines purchase the planes if they were obviously needed for the company’s operations?
Why would ALC be willing to buy planes from Boeing and Airbus and then lease the planes to China Eastern Airlines? How is this different from just lending money to China Eastern Airlines to buy the
Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should you lease or buy?You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner
What would the lease payment have to be for both the lessor and the lessee to be indifferent about the lease?You work for a nuclear research laboratory that is contemplating leasing a diagnostic
Assume that your company does not contemplate paying taxes for the next several years. What are the cash flows from leasing in this case?You work for a nuclear research laboratory that is
In the previous question, over what range of lease payments will the lease be profitable for both parties?You work for a nuclear research laboratory that is contemplating leasing a diagnostic scanner
Rework Problem 1 assuming that the scanner will be depreciated as three-year property under MACRS.In Problem 1 Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should
Super Sonics Entertainment is considering buying a machine that costs $540,000. The machine will be depreciated over five years by the straight-line method and will be worthless at that time. The
Quartz Corporation is a relatively new firm. Quartz has experienced enough losses during its early years to provide it with at least eight years of tax loss carryforwards. Thus, Quartz’s effective
What is the NAL for Wildcat? What is the maximum lease payment that would be acceptable to the company?The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted
Suppose it is estimated that the equipment will have an aftertax residual value of $700,000 at the end of the lease. What is the maximum lease payment acceptable to wildcat now?The Wildcat Oil
Many lessors require a security deposit in the form of a cash payment or other pledged collateral. Suppose Lambert requires Wildcat to pay a $500,000 security deposit at the inception of the lease.
Monster Magnet Manufacturing is considering leasing some equipment. The annual lease payment would be $375,000 per year for six years. The appropriate interest rate is 8 percent and the company is in
An asset costs $550,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The corporate tax rate is 34 percent, and the appropriate interest
Wolfson Corporation has decided to purchase a new machine that costs $3.2 million. The machine will be depreciated on a straight-line basis and will be worthless after four years. The corporate tax
An asset costs $620,000 and will be depreciated in a straight-line manner over its three-year life. It will have no salvage value. The lessor can borrow at 7 percent and the lessee can borrow at 9
Automobiles are often leased, and there are several terms unique to auto leases. Suppose you are considering leasing a car. The price you and the dealer agree on for the car is $36,000. This is the
Return to the case of the diagnostic scanner discussed in Problems 1 through 6. Suppose the entire $5,200,000 purchase price of the scanner is borrowed. The rate on the loan is 8 percent, and the
High electricity costs have made Farmer Corporation’s chicken-plucking machine economically worthless. Only two machines are available to replace it. The International Plucking Machine (IPM) model
Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain equipment
What is the difference between an American option and a European option?
When you take out an ordinary student loan, it is usually the case that whoever holds that loan is given a guarantee by the U.S. government, meaning that the government will make up any payments you
An insurance policy is considered analogous to an option. From the policyholder’s point of view, what type of option is an insurance policy? Why?
It is said that the equityholders of a levered firm can be thought of as holding a call option on the firm’s assets. Explain what is meant by this statement.
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