Questions and Answers of Corporate Finance Core Principles

The Speith Co. and the McIlroy Co. have both announced IPOs at $30 per share. One of these is undervalued by $8, and the other is overvalued by $5, but you have no way of knowing which is which. You
Blue 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 determined
The Clifford Corporation has announced a rights offer to raise $45 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a
Sheary, Inc., is proposing a rights offering. Presently, there are 375,000 shares outstanding at $60 each. There will be 65,000 new shares offered at $57 each.a. What is the new market value of the
Cash Offer versus Rights Offer McCanless International is planning to raise fresh equity capital by selling a large new issue of common stock. McCanless is currently a publicly traded corporation,
DeAngelo Bank offers your firm a discount interest loan with an interest rate of 8.7 percent for up to $20 million, and in addition requires you to maintain a compensating balance of 4 percent
In exchange for a $400 million fixed commitment line of credit, your firm has agreed to do the following:1. Pay 1.85 percent per quarter on any funds actually borrowed.2. Maintain a compensating
Wildcat, Inc., has estimated sales (in millions) for the next four quarters asSales for the first quarter of the year after this one are projected at $175 million. Accounts receivable at the
A bank offers your firm a revolving credit arrangement for up to $60 million at an interest rate of 1.63 percent per quarter. The bank also requires you to maintain a compensating balance of 5
You’ve worked out a line of credit arrangement that allows you to borrow up to $55 million at any time. The interest rate is .68 percent per month. In addition, 4 percent of the amount that you
Music City, Inc., has an average collection period of 36 days. Its average daily investment in receivables is $103,000. What are annual credit sales? What is the receivables turnover?
Essence of Skunk Fragrances, Ltd., sells 3,500 units of its perfume collection each year at a price per unit of $395. All sales are on credit with terms of 1/10, net 40. The discount is taken by 70
A firm offers terms of 1/10, net 25. 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
Following are the most recent balance sheets for Country Kettles, Inc. Excluding accumulated depreciation, determine whether each item is a source or a use of cash, and the amount. COUNTRY KETTLES,
Here are some important figures from the budget of Cornell, Inc., for the second quarter of 2017:The company predicts that 5 percent of its credit sales will never be collected, 35 percent of its
The following is the sales budget for Shleifer, Inc., for the first quarter of 2017:Credit sales are collected as follows:65 percent in the month of the sale20 percent in the month after the sale15
Lewellen Products has projected the following sales for the coming year:Sales in the year following this one are projected to be 15 percent greater in each quarter.a. Calculate payments to suppliers
Your firm has an average collection period of 38 days. Current practice is to factor all receivables immediately at a discount of 1.5 percent. What is the effective cost of borrowing in this case?
Consider the following financial statement information for the Zamboni Icers Corporation:All sales are on credit. Calculate the operating and cash cycles. How do you interpret your answer? BEGINNING
McConnell Corp. has a book value of equity of $11,640. Long-term debt is $7,100. Net working capital, other than cash, is $2,845. Fixed assets are $14,970. How much cash does the company have? If
The Litzenberger Company has projected the following quarterly sales amounts for the coming year:a. Accounts receivable at the beginning of the year are $275. The company has a 45-day collection
As a newly minted MBA, you’ve taken a management position with Exotic Cuisines, Inc., a restaurant chain that just went public last year. The company’s restaurants specialize in exotic main
In addition to the five factors discussed in the chapter, dividends also affect the price of an option. The Black−Scholes option pricing model with dividends isC = S × e−dt × N(d1) − E ×
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 $125 million,
Suppose Sunburn Sunscreen (Problem 18) and Frostbite Thermalwear (Problem 20) have decided to merge. Since the two companies have seasonal sales, the combined firm’s return on assets will have a
Watson Corp. has a zero coupon bond that matures in five years with a face value of $75,000. The current value of the company’s assets is $61,000, and the standard deviation of its return on
Eagle Industries has a zero coupon bond issue that matures in two years with a face value of $75,000. The current value of the company’s assets is $58,000, and thestandard deviation of the return
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
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
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 riseabove $1,310 per ounce, the
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 $60 and oneyear until expiration. Currently, the
A company has a single zero coupon bond outstanding that matures in 10 years and has a face value of $12 million. The current value of the company’s assets is $10.7 million, and the standard
Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $22,000 that matures in one year. The current market value of the firm’s assets is $23,200. The standard
Sunburn Sunscreen has a zero coupon bond issue outstanding with a $15,000 face value that matures in one year. The current market value of the firm’s assets is $16,100. The standard deviation of
A stock is currently priced at $35. A call option with an expiration of one year has an exercise price of $40. The risk-free rate is 3 percent per year, compounded continuously, and the standard
A call option has an exercise price of $65 and matures in six months. The current stock price is $68, and the risk-free rate is 4 percent per year, compounded continuously. What is the price of the
The net income of Wheeler Corporation is $115,000. The company has 30,000 outstanding shares, and a 100 percent payout policy. The expected value of the firm one year from now is $1,650,000. The
In the previous problem, suppose Rami has announced it is going to repurchase $9,000 worth of stock. What effect will this transaction have on the equity of the firm? How many shares will be
The Harpe 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 $1.95 per share dividend in one year. In two years, the company will pay a liquidating dividend of $65 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?In the Previous ProblemYou own 1,000 shares of stock in
A stock is currently priced at $58. 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 $55 and one year until
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
What are the deltas of a call option and a put option with the following characteristics? Whatdoes the delta of the option tell you?Stock price = $59Exercise price = $55Risk-free rate = 5% per year,
You own a lot in Key West, Florida, that is currently unused. Similar lots have recently sold for $1.45 million. Over the past five years, the price of land in the area has increased 7 percent per
What are the prices of a call option and a put option with the following characteristics?Stock price = $96Exercise price = $100Risk-free rate = 3% per year, compounded continuouslyMaturity = 2
What are the prices of a call option and a put option with the following characteristics?Stock price = $68Exercise price = $65Risk-free rate = 4% per year, compounded continuouslyMaturity = 3
A put option and a call option with an exercise price of $90 expire in four months and sell for $7.05 and $11.74, respectively. If the stock is currently priced at $94.13, what is the annual
A put option and a call option with an exercise price of $60 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 that expires in five months with an exercise price of $60 sells for $2.87. The stock is currently priced at $58, and the risk-free rate is 4.1 percent per year, compounded continuously.
A stock is currently selling for $47 per share. A call option with an exercise price of $50 sells for $2.61 and expires in three months. If the risk-free rate of interest is 3.9 percent per year,
Use the option quote information shown below to answer the questions that follow. The stock is currently selling for $97.a. Suppose you buy 10 contracts of the February 95 call option. How much will
Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $82.a. Are the call options in the money? What is the intrinsic value of an RWJ
National Business Machine Co. (NBM) has $2.3 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.
As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend.
The Sharpe Co. just paid a dividend of $2.65 per share of stock. Its target payout ratio is 50 percent. The company expects to have earnings per share of $6.30 one year from now.a. If the adjustment
Gibson Co. has a current period cash flow of $1.6 million and pays no dividends. The present value of the company’s future cash flows is $18.3 million. The company is entirely financed with equity,
Campbell Corporation is evaluating an extra dividend versus a share repurchase. In either case, $10,988 would be spent. Current earnings are $4.50 per share, and the stock currently sells for $84 per
In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 85 cent per share cash dividend on the new (post-split) shares represents an increase of 10
The company with the common equity accounts shown here has declared a 12 percent stock dividend at a time when the market value of its stock is $62 per share. What effects on the equity accounts will
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 balance sheet for Rami Corp. is shown here in market value terms. There are 7,200 shares of stock outstanding.The company has declared a dividend of $1.25 per share. The stock goes ex dividend
Roll Corporation (RC) currently has 310,000 shares of stock outstanding that sell for $91 per share. Assuming no market imperfections or tax effects exist, what will the share price be after:a. RC
The owners’ equity accounts for Southern Lights International are shown here:Common stock. ($1 par value).....................$ 25,000Capital
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
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
Ash, Inc., has declared a $7.25 per-share dividend. 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
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
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
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
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.
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 Widow Jones to purchase some
For initial public offerings of common stock, 2015 was a below average year, with about $21.9 billion raised by the process. Relatively few of the 117 firms involved paid cash dividends. Why do you
Hornqvist, Inc., has debt outstanding with a face value of $2.65 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
Edwards Construction currently has debt outstanding with a market value of $310,000 and a cost of 6 percent. The company has an EBIT of $18,600 that is expected to continue in perpetuity. Assume
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,
Connor Corp. has an EBIT of $460,000 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 35 percent. The
Hatter, Inc., has equity with a market value of $7.1 million and debt with a market value of $3.2 million. The cost of the debt is 7.5 percent per year. Treasury bills that mature in one year yield 4
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?In problemColdstream Corp. is comparing two different capital
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 $45 million manufacturing
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
Matroyshka, Inc., has a target debt–equity ratio of .45. Its WACC is 9.6 percent, and the tax rate is 35 percent.a. If the company’s cost of equity is 12.4 percent, what is its pretax cost of
In the previous problem, suppose the company’s stock has a beta of 1.20. The risk-free rate is 3.1 percent, and the market risk premium is 7 percent. Assume that the overall cost of debt is the
Johansen Corporation has a target capital structure of 75 percent common stock and 25 percent debt. Its cost of equity is 12.1 percent, and the cost of debt is 6.3 percent. The relevant tax
Stephenson Real Estate Company was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The
Williamson, Inc., has a debt−equity ratio of 1.7. The firm’s weighted average cost of capital is 8.4 percent, and its pretax cost of debt is 5.3 percent. The corporate tax rate is 35
Green Manufacturing, Inc., plans to announce that it will issue $1.6 million of perpetual debt and use the proceeds to repurchase common stock. The bonds will sell at par with an annual coupon rate
Martin 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
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
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 19,000 shares of stock outstanding, currently worth $23
The Maxwell Company is financed entirely with equity. The company is considering a loan of $640,000. The loan will be repaid in equal principal installments over the next two years, and it has an
Full Moon Corporation expects an EBIT of $27,750 every year forever. The company currently has no debt, and its cost of equity is 12.8 percent. The corporate tax rate is 35 percent.a. What is the
Tool Manufacturing has an expected EBIT of $48,700 in perpetuity and a tax rate of 35 percent. The firm has $90,000 in outstanding debt at an interest rate of 6.5 percent, and its unlevered cost of
Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $275,000 before interest per year in perpetuity, with each company
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?In problem 14Cede & Co. expects its
Cede & Co. expects its EBIT to be $81,400 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 35
Shadow Corp. has no debt but can borrow at 5.85 percent. The firm’s WACC is currently 9.2 percent, and the tax rate is 35 percent.a. What is the firm’s cost of equity?b. If the firm converts to
Weston Industries has a debt−equity ratio of 1.4. Its WACC is 8.3 percent, and its cost of debt is 5.7 percent. The corporate tax rate is 35 percent.a. What is the company’s cost of equity
Silence Corp. uses no debt. The weighted average cost of capital is 8.6 percent. If the current market value of the equity is $51.3 million and there are no taxes, what is EBIT?
ABC Co. and XYZ Co. are identical firms in all respects except for their capital structures. ABC is all equity financed with $650,000 in stock. XYZ uses both stock and perpetual debt; its stock is

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