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Fundamentals Of Financial Management 13th Revised Edition James Van Horne, John Wachowicz - Solutions
What is the total-value principle as it applies to capital structure?
Define the notion of arbitrage. How does it affect the issue of capital structure?
If there were no imperfections in financial markets, what capital structure should the firm seek? Why are market imperfections important considerations in finance? Which imperfections are most important?
What are bankruptcy costs? What are agency costs? How do they affect the valuation of the firm when it comes to financial leverage?
Why do institutional lenders no longer lend money to a corporation when it takes on too much debt?
Suppose that a company were to earn negligible profits and pay no taxes. How would this affect the firm's optimal capital structure?
The Lex I. Cographer Dictionary Company has net operating income of $10 million and $20 million of debt with a 7 percent interest rate. The earnings of the company are not expected to grow, and all earnings are paid out to shareholders in the form of dividends. In all cases, assume no taxes.a.
The Wannabee Company and the Gottahave Company are identical in every respect except that the Wannabee Company is not financially levered, whereas the Gottahave Company has $2 million in 12 percent bonds outstanding. There are no taxes, and capital markets are assumed to be perfect. The earnings of
The T. Boom Pickens Corporation has a $1 million capital structure and always maintains this book value amount. Pickens currently earns $250,000 per year before taxes of 50 percent, has an all-equity capital structure of 100,000 shares, and pays out all earnings in dividends. The company is
Gioanni Chantel Truffles, Inc., has $1 million in earnings before interest and taxes. Currently it is all-equity-financed. It may issue $3 million in perpetual debt at 15 percent interest in order to repurchase stock, thereby recapitalizing the corporation. There are no personal taxes.a. If the
Stinton Vintage Wine Company is currently family owned and has no debt. The Stinton family is considering going public by selling some of their stock in the company. Investment bankers tell them the total market value of the company is $10 million if no debt is employed. In addition to selling
Rebecca Isbell Optical Corporation is trying to determine an appropriate capital structure. It knows that, as its financial leverage increases, its cost of borrowing will eventually increase as will the required rate of return on its common stock. The company has made the following estimates for
Art Wyatt Pool Company wishes to finance a $15 million expansion program and is trying to decide between debt and external equity. Management believes that the market does not appreciate the company's profit potential and that the common stock is undervalued. What type of security (debt or common
Contrast a passive dividend policy with an active one.
Are stock dividends valuable to investors? Why or why not?
If we wish to raise share price, is it a good idea to have a reverse stock split7Explain.
As an investor, would you prefer the firm to repurchase its common stock by means of a self-tender offer or through open-market operations? Why?
If repurchase of stock has a favorable tax effect, why would a company ever want to pay a cash dividend?
When earnings falter, why are boards of directors of companies reluctant to reduce the dividend?
Why do lenders frequently place a formal restriction in the debt contract on the amount of dividends that can be paid?
What is a dividend reinvestment plan (DRIP) and how might it help shareholders?
How does an investor manufacture "homemade" dividends? What is the effect of the actions of a number of investors doing so, all other things held constant?
How do taxes affect the return to different investors? Are taxes a consideration in the dividend policy decision?
Why do companies with high growth rates tend to have low dividend-payout ratios and companies with low growth rates tend to have high dividend-payout ratios?
What is financial signaling as it relates to cash dividends, stock dividends/splits, and stock repurchase?
From a managerial standpoint, how do a firm's liquidity and ability to borrow affect its dividend-payout ratio?
As the firm's financial manager, would you recommend to the board of directors that the firm adopt as policy a stable dividend payment per share or a stable dividend-payout ratio? What are the disadvantages of each? Would the firm's industry influence your decision? Why?
What is a target dividend-payout ratio? An extra cash dividend7.
Define a stock dividend and a stock split. What is the impact of each on share value?
The DeWitt Company's shareholders' equity account (book value) as of December 31, 20X1, is as follows:Common stock ($5 par value; 1,000,000 shares)……………………. $ 5,000,000Additional paid-in capital…………………….……………………...
Tijuana Brass Instruments Company treats dividends as a residual decision. It expects to generate $2 million in net earnings after taxes in the coming year. The company has an all-equity capital structure, and its cost of equity capital is 15 percent. The company treats this cost as the
For each of the companies described here, would you expect it to have a low, medium, or high dividend-payout ratio? Explain why. a. A company with a large proportion of inside ownership, all of whom are high-income individuals b. A growth company with an abundance of good investment
Jumbo Shrimp Corporation and Giant Shrimp Company are in the same industry; both are publicly held with a large number of shareholders; and they have the following characteristics:On the basis of this information, which company is likely to have the higher dividend-payout ratio? Why?
The Oprah Corporation and the Harpo Corporation have had remarkably similar earnings patterns over the last five years. In fact, both firms have had identical earnings per share. Further, both firms are in the same industry, produce the same product, and face the same business and financial risks.
The Chris Clapper Copper Company declared a 25 percent stock dividend on March 10 to shareholders of record on April 1. The market price of the stock is $50 per share. You own 160 shares of the stock. a. If you sold your stock on March 20, what would be the price per share, all other things the
The firm earned $300,000 after taxes in 20X3 and paid out 50 percent of these earnings as cash dividends. The price on the firm's stock on December 30 was $5.SHERILL CORPORATION SHAREHOLDERS' EQUITYAS OF DECEMBER 30, 20X3Common stock ($1 par value; 1,000,000
Johore Trading Company has 2.4 million shares of common stock outstanding, and the present market price per share is $36. Its equity capitalization is as follows: Common stock ($2.00 par; 2,400,000 shares)…………………… $ 4,800,000 Additional paid-in
The H. M. Homes Company is primarily owned by several wealthy Texans. The firm earned $3,500,000 after taxes this year. With 1 million shares outstanding, earnings per share were $3.50. The stock recently has traded at $72 per share, among the current shareholders. Two dollars of this value is
What is the difference between a public and a private issue of securities?
What is the principal regulatory authority when it comes to security offerings? What is its function?
Which of the following companies would you expect to use a private placement of long-term debt as opposed to a public offering? a. An electric utility serving Chicago b. A $13-million-annual-volume maker of electronic components c. A consortium of oil companies to finance an oil discovery in the
In general, how do the costs of a private placement of a debt issue differ from those of a traditional (firm commitment) underwriting?
Has the availability of shelf registrations reduced the importance of private placements? Why?
What does a venture capitalist hope to gain from an investment in a new enterprise? How liquid is the investment?
Why is a security offering of new common stock often accompanied by a stock price reaction around the time of the announcement?
Define a shelf registration and an automatic shelf registration. What types of public companies can use a shelf registration and/or an automatic shelf registration?
How does a traditional (firm commitment) underwriting differ from a shelf registration?
As a best efforts offering is "cheaper" than a traditional (firm commitment) underwriting, why don't more companies make use of it?
In offering a new bond issue, the firm may decide to sell the bonds through a private placement or through a public issue. Evaluate these two alternatives.
Should the preemptive right be required of all companies that issue common stock or securities convertible into common stock?
Many major US corporations have extensively used rights offerings in the past. Why do you feel these corporations have chosen to raise funds with a rights offering rather than a public equity issue, especially when a fair percentage of the rights (2 to 5 percent) is never exercised?
What role does the subscription price play in a rights offering?
Define a standby arrangement and an oversubscription privilege. Why are they used? Which do you think is used more often?
Tex Turner Telecommunications Company needs to raise $1.8 billion (face value) of debt funds over the next two years. If it were to use traditional (firm commitment) under writings, the company would expect to have six underwritings over the two-year span. The underwriter spread would likely be
The Cliff Claven Artists School will issue 200,000 shares of common stock at $40 per share through a privileged subscription. The 800,000 shares of stock currently outstanding have a "rights-on" market price of $50 per share. a. Compute the number of rights required to buy a share of stock at
The stock of the HAL Computer Corporation is selling for $50 per share. The company then issues rights which allow holders to subscribe for one new share at $40 for each five rights held. a. What is the theoretical value of a right if the stock is selling "rights-on"? b. What is the theoretical
Two different companies are considering rights offerings. The current market price per share is $48 in both cases. To allow for fluctuations in market price, company X wants to set a subscription price of $42, whereas company Y feels a subscription price of $41.50 is in order. The number of rights
Contrast serial bonds and bonds requiring a sinking fund.
Why do most preferred stock issues have a cumulative feature? Would the company be better off with a noncumulative feature?
Why would a company ever wish to use dual-class common stock in its financing instead of straight common stock?
Why does most common stock have a low par value in relation to its market value?
The common stockholder is considered the residual owner of a corporation. What does this mean in terms of risk and return?
In any proxy attempt by an outside group to gain control of a company, the advantage lies with management. What are the reasons for this advantage?
If Congress were to eliminate the double taxation of dividends so that a company could deduct dividend payments in the same way it does interest payments for tax purposes, what would be the effect on preferred stock and common stock financing?
In the refunding decision, differential cash flows are discounted at the after-tax cost of debt. Explain why these cash flows are not discounted at the average cost of capital.
Are refundings by corporations likely to occur steadily over time? If not, when are waves of refundings likely to occur?
How does an income bond differ from a mortgage bond issue?
Explain why a commercial bank loan officer would be particularly concerned that debt owed by a corporate borrower to the principal stockholders or officers of the company be subordinated debt.
What are "junk bonds"? How might they be used in financing a corporation?
Why do callable bonds typically have a higher yield to maturity than noncallable bonds, holding all other things constant? Is the yield differential between callable and noncallable bonds likely to be constant over time? Why?
Because the dividend payments on preferred stock are not a tax-deductible expense, the explicit cost of this form of financing is high. What are some of the offsetting advantages to the issuing firm and to the investor that enable this type of security to be sold?
From the standpoint of the preferred stock issuer, why is it desirable to have a call feature?
How does a money market preferred (MMP) stock differ from regular preferred stock?
Gillis Manufacturing Company has in its capital structure $20 million of 13.5 percent sinking-fund debentures. The sinking-fund call price is $1,000 per bond, and sinking-fund payments of $1 million in face amount of bonds are required annually. At present, the yield to maturity on the debentures
Five years ago, Zapada International issued $50 million of 10 percent, 25-year debentures at a price of $990 per bond to the public. The call price was originally $1,100 per bond the first year after issuance, and this price declined by $10 each subsequent year. Zapada is now "calling" the bonds in
Crakow Machine Company wishes to borrow $10 million for 10 years. It can issue either a noncallable bond at 11.40 percent interest or a bond callable at the end of 5 years for 12 percent. For simplicity, we assume that the bond will be called only at the end of year 5. The interest rate that is
The O.K. Railroad needs to raise $9.5 million for capital improvements. One possibility is a new preferred stock issue - 8 percent dividend, $100 par value - stock that would yield 9 percent to investors. Flotation costs for an issue this size amount to 5 percent of the total amount of preferred
Lost Dutchman Silver Mining Company has 200,000 shares of $7 cumulative preferred stock outstanding, $100 par value. The preferred stock has a participating feature. If dividends on the common stock exceed $1 per share, preferred stockholders receive additional dividends per share equal to
Mel Content, a disgruntled stockholder of the Penultimate Corporation, desires representation on the board. The Penultimate Corporation, which has 10 directors, has 1 million shares outstanding. a. How many shares would Mel have to control to be assured of 1 directorship under a plurality voting
The US Zither Corporation has $50 million of 14 percent debentures outstanding, which are due in 25 years. USZ could refund these bonds in the current market with new 25-year bonds, sold to the public at par ($1,000 per bond) with a 12 percent coupon rate. The spread to the underwriter is 1
What reasons can you cite for a firm's use of intermediate-term debt? Why isn't(a) Long-term debt substituted in its place?(b) Short-term debt substituted in its place?
How does a financial lease differ from an operating lease? How does a full-service (or maintenance) lease differ from a net lease7.
Contrast a sale and leaseback with direct leasing.
In general, how is lease financing treated from an accounting standpoint versus debt financing?
Discuss the probable impact that a sale and leaseback arrangement will have on the following: a. Liquidity ratios b. Return on investment c. Return on equity d. The risk class of the corporation's common stock e. The price of the corporation's common stock
Some business people consider that the risk of obsolescence and inflexibility is being transferred from the lessee to the lessor. How is the lessor induced to accept higher risk and greater inflexibility?
In your opinion, would the following factors tend to favor borrowing or leasing as a financing alternative? Why?a. Increased corporate tax rateb. Faster accelerated depreciationc. Rising price leveld. Increased residual value of the leased assete. An increase in the risk-free interest rate
Why do insurance companies not compete more actively with banks to provide short-and intermediate-term financing?
What is the purpose of protective covenants in a term loan agreement?
How does a revolving credit agreement differ from a line of credit7.
How should a lender go about setting (a) The working capital protective covenant in a loan agreement? (b) The capital expenditure covenant in a loan agreement?
As a borrower, how would you approach negotiating the working capital and capital expenditure restrictions a lender wished to impose?
How does a chattel mortgage differ from a conditional sales contract when it comes to financing equipment?
Chapter 1 suggests that the decision-making processes of investing in assets (buying assets) and of financing assets (raising funds) are two separate and distinct functions of the financial manager. This chapter suggests that, at least in the case of leasing, the decision making processes cannot be
On January 1, Acme Aglet Corporation is contemplating a four-year, $3 million term loan from the Fidelity First National Bank. The loan is payable at the end of the fourth year and would involve a loan agreement that would contain a number of protective covenants. Among these restrictions are that
Given the following information, compute the annual lease payment (paid in advance) that a lessor will require: a. Purchase price of $260,000, interest rate of 13 percent, 5-year lease period, and no residual value b. Purchase price of $138,000, interest rate of 6 percent, 9-year lease period, and
Volt Electronics Company is considering leasing one of its products in addition to selling it outright to customers. The product, the Volt Tester, sells for $18,600 and has an economic life of eight years. a. To earn 12 percent interest, what annual lease payment must Volt require as lessor?
Fez Fabulous Fabrics wishes to acquire a $100,000 multifacet cutting machine. The machine is expected to be used for eight years, after which there is a $20,000 expected residual value. If Fez were to finance the cutting machine by signing an eight-year "true" lease contract, annual lease payments
Valesquez Ranches, Inc., wishes to use a new truck fueled by compressed natural gas that costs $80,000. The ranch intends to operate the truck for five years, at the end of which time it is expected to have a $16,000 residual value. Assume that the asset falls in the three-year property class for
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