Questions and Answers of Corporate Finance Core Principles and Applications

Given the following information for Tara Ita Power Co., find the WACC. Assume the company’s tax rate is 21 percent.Debt: 7,000 5 percent coupon bonds outstanding, $1,000 par value, 20 years to
Brodsky Metals Corporation has 8.1 million shares of common stock outstanding and 150,000 5.8 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $41 per
An all-equity firm is considering the following projects:The T-bill rate is 3.5 percent, and the expected return on the market is 11 percent.a. Which projects have a higher expected return than the
Suppose your company needs $45 million to build a new assembly line. Your target debt-equity ratio is .45. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3
Southern Star Company needs to raise $75 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The
Pink, Inc., is considering a project that will result in initial aftertax cash savings of $4.1 million at the end of the first year, and these savings will grow at a rate of 3 percent per year
The IPO Investment Bank has the following financing outstanding. What is the WACC for the company?Debt: 80,000 bonds with a coupon rate of 5.8 percent and a current price quote of 106.4; the bonds
Tube, Inc., recently issued new securities to finance a new TV show. The project cost $29 million, and the company paid $1.57 million in flotation costs. In addition, the equity issued had a
Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material supply. The
Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s
Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of .45 and is considering building a new $40 million manufacturing
Trower Corp. has a debt-equity ratio of .65. The company is considering a new plant that will cost $145 million to build. When the company issues new equity, it incurs a flotation cost of 7 percent.
Fowler, Inc., has no debt outstanding and a total market value of $325,000. Earnings before interest and taxes, EBIT, are projected to be $31,000 if economic conditions are normal. If there is strong
Repeat parts (a) and (b) in Problem 1 assuming the firm has a tax rate of 21 percent.Data from Problem 1Fowler, Inc., has no debt outstanding and a total market value of $325,000. Earnings before
Kuchar Corporation is comparing two different capital structures, an all-equity plan, Plan I, and a levered plan, Plan II. Under Plan I, the company would have 125,000 shares of stock outstanding.
In Problem 4, use MM Proposition I to find the price per share of equity under each of the two proposed plans. What is the value of the firm?Data from Problem 4Kuchar Corporation is comparing two
Coldstream Corp. is comparing two different capital structures. Plan I would result in 4,950 shares of stock and $10,255 in debt. Plan II would result in 4,500 shares of stock and $23,440 in debt.
Ignoring taxes in Problem 6, what is the price per share of equity under Plan I? Plan II? What principle is illustrated by your answers?Data from Problem 6Coldstream Corp. is comparing two different
FCOJ, Inc., a prominent consumer products firm, is debating whether or not to convert its all-equity capital structure to one that is 35 percent debt. Currently, there are 7,100 shares outstanding
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all-equity financed with $550,000 in stock. XYZ uses both stock and perpetual debt; its stock is
Nolan Corp. uses no debt. The weighted average cost of capital is 8.9 percent. If the current market value of the equity is $47.8 million and there are no taxes, what is EBIT?
n the previous question, suppose the corporate tax rate is 23 percent. What is EBIT in this case? What is the WACC? Explain.Data from Previous Problem Nolan Corp. uses no debt. The weighted
Weston Industries has a debt-equity ratio of 1.4. Its WACC is 8.3 percent, and its cost of debt is 5.4 percent. The corporate tax rate is 24 percent.a. What is the company’s cost of equity
Shadow Corp. has no debt but can borrow at 5.75 percent. The firm’s WACC is currently 8.9 percent, and the tax rate is 22 percent.a. What is the firm’s cost of equity?b. If the firm converts to
Cede & Co. expects its EBIT to be $92,600 every year forever. The firm can borrow at 7 percent. The firm currently has no debt, and its cost of equity is 14 percent. If the tax rate is 22
In Problem 14, what is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision?Data from Problem 14Cede & Co. expects
Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $235,000 before interest per year in perpetuity, with each company
Tool Manufacturing has an expected EBIT of $51,600 in perpetuity and a tax rate of 24 percent. The firm has $90,000 in outstanding debt at an interest rate of 6.5 percent, and its unlevered cost of
Full Moon Corporation expects an EBIT of $28,650 every year forever. The company currently has no debt, and its cost of equity is 12.8 percent. The corporate tax rate is 23 percent.a. What is the
The Maxwell Company is financed entirely with equity. The company is considering a loan of $525,000. The loan will be repaid in equal principal installments over the next two years, and it has an
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 21,000 shares of stock outstanding, currently worth $23
Jenkins, Inc., has equity with a market value of $6.4 million and debt with a market value of $2.6 million. The cost of the debt is 7.5 percent per year. Treasury bills that mature in one year yield
The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The Knight Company’s 6 percent bonds sell at par value. Financial information for the two
Arya Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt-equity ratio is expected to rise from 20 percent to 35 percent. The firm
Green Manufacturing, Inc., plans to announce that it will issue $1.9 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with an annual coupon rate
Williamson, Inc., has a debt-equity ratio of 1.8. The company’s weighted average cost of capital is 9.1 percent and its pretax cost of debt is 5.6 percent. The corporate tax rate is 21 percent.a.
Repeat parts (a) and (b) in Problem 2 assuming the firm has a tax rate of 21 percent. Assume that the stock price will increase upon the announcement of the debt offering.Data from Problem 2a.
Connor Corp. has an EBIT of $535,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 13.2 percent, and the corporate tax rate is 21 percent. The
Sam Dugan is the founder and CEO of Dugan Restaurants, Inc., a regional company. Sam is considering opening several new restaurants. Sally Thornton, the company’s CFO, has been put in charge of the
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,
Edwards Construction currently has debt outstanding with a market value of $340,000 and a cost of 6 percent. The company has an EBIT of $20,400 that is expected to continue in perpetuity. Assume
Hominy, Inc., has debt outstanding with a face value of $2.15 million. The value of the firm if it were entirely financed by equity would be $11.4 million. The company also has 195,000 shares of
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
Sheaves Corporation economists estimate that a good business environment and a bad business environment are equally likely for the coming year. Management must choose between two mutually exclusive
Mid States 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.
Overnight Publishing Company (OPC) has $1.7 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
Schultz, Inc., has declared a dividend of $5.60 per share. Suppose capital gains are not taxed, but dividends are taxed at 25 percent. New IRS regulations require that taxes be withheld at the time
The owners’ equity accounts for Southern Lights International are shown here:Common stock ($1 par value)............ $ 22,000Capital surplus ........................................95,000Retained
For the company in Problem 2, show how the equity accounts will change if:a. The company declares a 4-for-1 stock split. How many shares are outstanding now? What is the new par value per share?b.
The balance sheet for Kare Corp. is shown here in market value terms. There are 6,400 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 the company has announced it is going to repurchase $12,160 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 Desktop Manufacturing is shown here. The company has declared a 25 percent stock dividend. The stock goes ex dividend tomorrow (the chronology for a stock dividend
The company with the common equity accounts shown here has declared a stock dividend of 12 percent at a time when the market value of its stock is $73 per share. What effects on the equity accounts
In the previous problem, suppose the company instead decides on a 5-for-1 stock split. The firm’s 74 cent per share cash dividend on the new (post-split) shares represents an increase of 10 percent
For initial public offerings of common stock, 2018 was a fairly ordinary year, with about $33.5 billion raised by the process. Relatively few of the 134 firms involved paid cash dividends. Why do you
The Spector Company currently has 65,000 outstanding shares selling at $87 each. The firm is contemplating the declaration of a dividend of $9 at the end of the fiscal year that just began. Assume
You own 1,000 shares of stock in Avondale Corporation. You will receive a $2.34 per share dividend in one year. In two years, the company will pay a liquidating dividend of $74 per share. The
In the previous problem, suppose you want only $200 total in dividends the first year. What will your homemade dividend be in two years?Data from Previous ProblemYou own 1,000 shares of stock in
The net income of Steel City Corporation is $130,000. The company has 30,000 outstanding shares, and a 100 percent payout policy. The expected value of the firm one year from now is $2.43 million.
White Chocolate Co. has a current period cash flow of $1.35 million and pays no dividends. The present value of the company’s future cash flows is $17.8 million. The company is entirely financed
The Sharpe Co. just paid a dividend of $2.34 per share of stock. Its target payout ratio is 50 percent. The company expects to have earnings per share of $6.10 one year from now.a. If the adjustment
The Gecko Company and the Gordon Company are two firms whose business risk is the same but have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of
National Business Machine Co. (NBM) has $2.6 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.
After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. The company’s managers must choose between investing the cash in Treasury bonds that yield 3.5
Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $77.a. Are the call options in the money? What is the intrinsic value of an RWJ
Use the option quote information shown below to answer the questions that follow. The stock is currently selling for $93.a. Suppose you buy 10 contracts of the February 90 call option. How much will
A stock is currently selling for $51 per share. A call option with an exercise price of $55 sells for $2.79 and expires in three months. If the risk-free rate of interest is 3.9 percent per year,
A put option that expires in five months with an exercise price of $60 sells for $3.19. The stock is currently priced at $57, and the risk-free rate is 4.1 percent per year, compounded continuously.
A put option and a call option with an exercise price of $50 and three months to expiration sell for $3.87 and $4.89, respectively. If the risk-free rate is 2.7 percent per year, compounded
A put option and a call option with an exercise price of $80 expire in four months and sell for $7.05 and $11.74, respectively. If the stock is currently priced at $84.17, what is the annual
What are the prices of a call option and a put option with the following characteristics?Stock price = $79Exercise price = $75Risk-free rate = 4% per year, compounded continuouslyMaturity = 3
What are the prices of a call option and a put option with the following characteristics?Stock price = $87Exercise price = $90Risk-free rate = 3% per year, compounded continuouslyMaturity = 2
What are the deltas of a call option and a put option with the following characteristics? What does the delta of the option tell you?Stock price = $68Exercise price = $60Risk-free rate = 5% per
You own a lot in Key West, Florida, that is currently unused. Similar lots have recently sold for $1.1 million. Over the past five years, the price of land in the area has increased 7 percent per
In the previous problem, suppose you wanted the option to sell the land to the buyer in one year. Assuming all the facts are the same, describe the transaction that would occur today. What is the
You are given the following information concerning options on a particular stock:Stock price = $68Exercise price = $70Risk-free rate = 4% per year, compounded continuouslyMaturity = 6 monthsStandard
A stock is currently priced at $66. The stock will either increase or decrease by 13 percent over the next year. There is a call option on the stock with a strike price of $60 and one year until
In the previous problem, assume the risk-free rate is only 4 percent. What is the risk-neutral value of the option now? What happens to the risk-neutral probabilities of a stock price increase and a
A call option has an exercise price of $70 and matures in six months. The current stock price is $74, and the risk-free rate is 4 percent per year, compounded continuously. What is the price of the
Sunburn Sunscreen has a zero coupon bond issue outstanding with a face value of $12,000 that matures in one year. The current market value of the firm’s assets is $13,800. The standard deviation of
Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $20,000 that matures in one year. The current market value of the firm’s assets is $21,900. The standard
A company has a single zero coupon bond outstanding that matures in 10 years and has a face value of $10 million. The current value of the company’s assets is $8.8 million, and the standard
Ken is interested in buying a European call option written on Southeastern Airlines, Inc., a non-dividend-paying common stock, with a strike price of $70 and one year until expiration. Currently, the
Rob wishes to buy a European put option on BioLabs, Inc., a non-dividend-paying common stock, with a strike price of $70 and six months until expiration. The company’s common stock is currently
Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $1,390 per ounce, the
An investor is said to take a position in a “collar” if she buys the asset, buys an out-of-the-money put option on the asset, and sells an out-of-the-money call option on the asset. The two
Eagle Industries has a zero coupon bond issue that matures in two years with a face value of $100,000. The current value of the company’s assets is $81,000, and the standard deviation of the return
Watson Corp. has a zero coupon bond that matures in five years with a face value of $85,000. The current value of the company’s assets is $69,000, and the standard deviation of its return on assets
Masters Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $110 million,
Geller Corp. has a book value of equity of $12,490. Long-term debt is $7,230. Net working capital, other than cash, is $3,155. Fixed assets are $15,120. How much cash does the company have? If
What are the costs of shortages? Describe them.
Consider the following financial statement information for the Emma Corporation:All sales are on credit. Calculate the operating and cash cycles. How do you interpret your answer? Item Beginning
Your firm has an average collection period of 34 days. Current practice is to factor all receivables immediately at a discount of 1.2 percent. What is the effective cost of borrowing in this case?
The following is the sales budget for Shleifer, Inc., for the first quarter of 2020:Credit sales are collected as follows:65 percent in the month of the sale20 percent in the month after the sale15
Here are some important figures from the budget of Cornell, Inc., for the second quarter of 2020:The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its
You place an order for 425 units of inventory at a unit price of $108. The supplier offers terms of 1/10, net 30.a. How long do you have to pay before the account is overdue? If you take the full
A firm offers terms of 1/10, net 30. What effective annual interest rate does the firm earn when a customer does not take the discount? Without doing any calculations, explain what will happen to
Lupo, Inc., has an average collection period of 34 days. Its average daily investment in receivables is $109,000. What are annual credit sales? What is the receivables turnover?
You’ve worked out a line of credit arrangement that allows you to borrow up to $65 million at any time. The interest rate is .53 percent per month. In addition, 4 percent of the amount that you
A bank offers your firm a revolving credit arrangement for up to $50 million at an interest rate of 1.71 percent per quarter. The bank also requires you to maintain a compensating balance of 5

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