Questions and Answers of Corporate Finance Core Principles

Why do managers split their firms’ stock?
What are the advantages and disadvantages of retaining excess cash?
What kind of payout preference do tax codes typically create?
Without taxes or any other imperfections, why doesn’t it matter how the firm distributes cash?
What are the ways in which a corporation can distribute cash to its shareholders?
Rogot Instruments makes fine violins and cellos. It has $1 million in debt outstanding and equity valued at $2 million, and pays corporate income tax at rate 35%. Its cost of equity is 12% and its
Pelamed Pharmaceuticals had EBIT of $325 million in 2006, interest expenses of $125 million, and a corporate tax rate of 40%.a. What was Pelamed’s 2006 net income?b. What was the total of
Microsoft has no debt and a WACC of 9.2%. The average debt-to-value ratio for the software industry is 13%. What would its cost of equity be if it took on the average amount of debt for its
What is the pecking order hypothesis?
How can too much debt lead to excessive risk-taking?
How does the firm’s WACC change with leverage?
How do taxes affect the choice of debt versus equity?
What is a venture capital firm?
At the beginning of 2014, Apple’s beta was 1.4 and the risk-free rate was about 4.5%. Apple’s price was $84.84. Apple’s price at the end of 2014 was $198.08. If you estimate the market risk
How is the expected return of a portfolio related to the expected returns of the stocks in the portfolio?
What relationship is described by the security market line?
What does beta measure? How do we use beta?
What, intuitively, does the CAPM say drives expected return?
Using the data in the following table, estimate the average return and volatility for each stock. Realized Returns Year Stock A Stock B 21% 1998 -10% 1999 20% 30% 2000 5% 7% 2001 -5% -3% 2002 2% -8%
You hear on the news that the S&P/TSX Composite Index was down 2% today (the market’s return was 22%). You are thinking about your portfolio and your investments in BlackBerry and WestJet.a. If
The Chapter Resources section of MyFinanceLab has data on Microsoft and the S&P 500 from 1987 to 2006.a. Estimate Microsoft’s beta using linear regression over the periods 1987–1991,
Suppose the risk-free return is 4% and the market portfolio has an expected return of 10% and a standard deviation of 16%. Suppose Loblaw Companies Limited stock has a beta of 0.32. What is its
Why does a firm’s capital have a cost?
Why is it easier to determine the costs of preferred stock and of debt than it is to determine the cost of common equity?
What are the main assumptions you make when you use the WACC method?
What is the right way to adjust for the costs of raising external financing?
You work for HydroTech, a large manufacturer of high-pressure industrial water pumps. You report directly to the CFO and she has asked you to calculate Hydro Tech's WACC. You have gathered the
Does the holder of an option have to exercise it?
Explain the difference between a long position in a put and a short position in a call.
How are the profits from buying an option different from the payoff to the option at expiration?
What position has more downside exposure: a short position in a call or a short position in a put? That is, in the worst case, in which of these two positions would your losses be greater?
How are the payoffs to buying a call option related to the payoffs from writing a call option?
Can a European option with a later expiration date be worth less than an identical European option with an earlier expiration date?
What is the key assumption of the Binomial Option Pricing Model?
What is the maximum payoff that a long put option can have? How about a long call option?
Why don’t we need to know the probabilities of the states in the binominal tree in order to solve for the price of the option?
Can a call option be more valuable than the stock it is written on?
How can the Black-Scholes formula not include the expected return on the stock?
Explain put-call parity.
We know that equity in a company that borrows is analogous to a call option. Using put-call parity, express the position of equity holders in terms of a portfolio that includes put options.
What are some of the alternative sources from which private companies can raise equity capital?
What are the main sources of funding for private companies to raise outside equity capital?
IPOs are very cyclical. In some years, there are large numbers of IPOs; in other years, there are very few. Why is this cyclicality a puzzle?
What are the advantages of a rights offer?
In 2012, you founded Outdoor Recreation, Inc., a retailer specializing in the sale of equipment and clothing for recreational activities such as camping, skiing, and hiking. So far, your company has
What are the advantages to a company of selling stock in an SEO using a cash offer?
Your investment bankers price your IPO at $15 per share for 10 million shares. If the price at the end of the first day of trading is $17 per share,a. What was the percentage return on the first day
MacKenzie Corporation currently has 10 million shares of stock outstanding at a price of $40 per share. The company would like to raise money and has announced a rights issue. Every existing
What are the different types of corporate debt and how do they differ?
List the four types of corporate public debt that are typically issued.
Explain the difference between a secured corporate bond and an unsecured corporate bond.
What is the difference between a foreign bond and a Eurobond?
A $1000 face value convertible bond has a conversion ratio of 40 and is about to mature. Ignoring any transaction costs, what price must the stock surpass in order for you to convert?
You are the CFO of RealNetworks on July 1, 2008. The company’s stock price is $9.70 and its convertible debt (as shown in Table 15.7 ) is now callable.a. What is the value of the shares the
What is the effect of including a standard call feature on the price a company can receive for its bonds?
Why does a convertible bond have a lower yield than an otherwise identical bond without the option to convert?
When will the yield to maturity be higher than the yield to call for a bond with a standard call feature?
What constitutes a firm’s capital structure?
What are some factors a manager must consider when making a financing decision?
Explain what is wrong with the following argument: “If a firm issues debt that is risk free because there is no possibility of default, the risk of the firm’s equity does not change. Therefore,
How does leverage affect the risk and cost of equity for the firm?
What are the channels through which financing choices can affect firm value?
What is the relationship between a bond’s price and its yield to maturity?
Does a bond’s yield to maturity determine its price, or does the price determine the yield to maturity?
What is the risk-free interest rate for a five-year maturity?
If a bond’s yield to maturity does not change, how does its cash price change between coupon payments?
Your company currently has 6% coupon-rate bonds (coupons are paid semi-annually) with 10 years to maturity and a price of $1078. If you want to issue new 10-year coupon bonds at par, what coupon rate
Your firm has a credit rating of A. You notice that the credit spread for five-year maturity A debt is 85 basis points (0.85%). Your firm’s five-year debt has a coupon rate of 6%. You see that new
If you own 15,000 shares of stock of Kenneth Cole Productions and it pays a dividend of $0.18 per share, then what is the total dividend you will receive?
Which two components make up the total return to an investor in a share of stock?
What are some key differences between preferred and common stock?
What discount rate do you use to discount the future cash flows of a stock?
How can the DDM be used with changing growth rates in future dividends?
Assume Coleco pays an annual dividend of $1.50 and has a share price of $37.50. It announces that its annual dividend will increase to $1.75. If its dividend yield is to stay the same, what should
What are some of the drawbacks of the DDM?
What are the advantages of valuing a stock based on discounted free cash flows?
What is the reasoning behind valuation by multiples and what are the major assumptions?
NoGrowth Corporation currently pays a dividend of $0.50 per quarter, and it will continue to pay this dividend forever. What is the price per share of NoGrowth stock if the firm’s equity cost of
Summit Systems just paid an annual dividend of $1.50. If you expect Summit’s dividend to grow by 6% per year, what is its price per share if the firm’s equity cost of capital is 11%?
What are the implications of the efficient markets hypothesis for corporate managers?
Laurel Enterprises expects earnings next year of $4 per share and has a 70% retention rate, which it plans to keep constant. Its equity cost of capital is 10%, which is also its expected return on
Why don’t investors always trade rationally?
DFB, Inc. expects earnings this year of $5 per share, and it plans to pay a $3 dividend to shareholders. DFB will retain $2 per share of its earnings to reinvest in new projects that have an expected
Why would excessive trading lead to lower realized return?
Portage Bay Enterprises has no debt and is expected to have free cash flow of $10 million next year. It is then expected to grow at a rate of 3% per year forever. If Portage Bay’s equity cost of
Consider the valuation of Nike given in Example 7.7.a. Suppose you believe Nike’s initial revenue growth rate will be between 7% and 11% (with growth slowing linearly to 5% by year 2018). What
Suppose that in July 2013, Nike had EPS of $2.52 and a book value of equity of $12.48 per share.a. Using the average P/E multiple in Table 7.2 , estimate Nike€™s share price.b. What range
Assume that Coca-Cola Company has a share price of $43. The firm will pay a dividend of $1.24 in one year, and you expect Coca-Cola to raise this dividend by approximately 7% per year in
Why doesn’t the NPV decision rule depend on the investor’s preference?
You are preparing to produce some goods for sale. You will sell them in one year and you will incur costs of $80,000 immediately. If your cost of capital is 7%, what is the minimum dollar amount
Under what conditions will the IRR rule and the NPV rule give the same accept/reject decision?
When is it possible to have multiple IRRs?
When should you use the equivalent annual annuity?
What is the intuition behind the profitability index?
What does the profitability index tell you?
Your firm is considering a project that will cost $4.55 million up front, generate cash flows of $3,500,000 per year for three years, and then have a cleanup and shutdown cost of $6,000,000 in the
Daily Enterprises is purchasing a $10 million machine. It will cost $50,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value.
What are pro forma incremental earnings?
What is the role of NWC in projects?
Recall the SPI Phone 86 example from this chapter. Suppose the SPI Phone 86s will be housed in warehouse space that the company could have otherwise rented out for $200,000 per year during years 1 to

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