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Corporate Finance With Connect Access Card 10th Edition Stephen Ross ,Randolph Westerfield ,Jeffrey Jaffe - Solutions

Cost of Debt What steps can stockholders take to reduce the costs of debt?
M&M and Bankruptcy Costs How does the existence of financial distress costs and agency costs affect Modigliani and Miller’s theory in a world where corporations pay taxes?
Agency Costs of Equity What are the sources of agency costs of equity?
Observed Capital Structures Refer to the observed capital structures given in Table 17.3 of the text. What do you notice about the types of industries with respect to their average debt–equity ratios? Are certain types of industries more likely to be highly leveraged than others? What are some
Bankruptcy and Corporate Ethics Continental Airlines once filed for bankruptcy, at least in part, as a means of reducing labor costs. Whether this move was ethical or proper was hotly debated. Give both sides of the argument.
Unlevered Cost of Equity Beginning with the cost of capital equation—that is:RWACC = _ B_ _+S_ _S_ R S + _ B_ _+B_ _S_ R B show that the cost of equity capital for a levered firm can be written as follows:RS = R0 + BS_ (R0 − RB).
Firm Value Janetta Corp. has an EBIT rate of $975,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35 percent. The company also has a perpetual bond issue outstanding with a market value of $1.9
Nonmarketed Claims 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 outstanding that sell at a price of $38 per share. The corporate tax rate is 35
Capital Structure and Nonmarketed Claims 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 payments.His argument is that this action would increase the
Capital Structure and Growth Edwards Construction currently has debt outstanding with a market value of $85,000 and a cost of 9 percent. The company has EBIT of$7,650 that is expected to continue in perpetuity. Assume there are no taxes.a. What is the value of the company’s equity? What is the
Costs of Financial Distress 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 that the probability of the continuation of the current expansion is 80
Agency Costs Fountain Corporation’s 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 between two mutually exclusive projects.Assume that the project Fountain chooses will be the firm’s
Financial Distress 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 is projected that the company will generate a total cash flow of $185 million in
Personal Taxes, Bankruptcy Costs, and Firm Value 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 is:V L 5 V U 1 {1 2 [(1 2 t C )y(1 2 t B )]} 3 B 2
Personal Taxes, Bankruptcy Costs, and Firm Value 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 one institution that is willing to sell it back to
What is the expected value of the company in one year, with and without expansion?Would the company’s stockholders be better off with or without expansion? Why?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering opening several new restaurants.
What is the expected value of the company’s debt in one year, with and without the expansion?Sam McKenzie is the founder and CEO of McKenzie 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
One year from now, how much value creation is expected from the expansion? How much value is expected for stockholders? Bondholders?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering opening several new restaurants. Sally Thornton, the
If the company announces that it is not expanding, what do you think will happen to the price of its bonds? What will happen to the price of the bonds if the company does expand?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering opening several
If the company opts not to expand, what are the implications for the company’s future borrowing needs? What are the implications if the company does expand?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering opening several new restaurants.
Because of the bond covenant, the expansion would have to be financed with equity.How would it affect your answer if the expansion were financed with cash on hand instead of new equity?Sam McKenzie is the founder and CEO of McKenzie Restaurants, Inc., a regional company.Sam is considering opening
Dividend Policy 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 desired debt−equity ratio. Having done so, a firm pays out any leftover, or
Dividends and Stock Price Last month, Central Virginia Power Company, which had been having trouble with cost overruns on a nuclear power plant that it had been building, announced that it was “temporarily suspending dividend payments due to the cash flow crunch associated with its investment
Dividend Policy For initial public offerings of common stock, 2007 was a relatively slow year, with only about $35.6 billion raised by the process. Relatively few of the 159 firms involved paid cash dividends. Why do you think that most chose not to pay cash dividends?
Investment and Dividends 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? Would it be irrational for it to have municipal bonds in its portfolio?
Dividends and Stock Value 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 model is valid?
Bird-in-the-Hand Argument The bird-in-the-hand argument, which states that a dividend today is safer than the uncertain prospect of a capital gain tomorrow, is often used to justify high dividend payout ratios. Explain the fallacy behind this argument.
Dividends and Income Preference 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 this statement true or false? Why?
Dividends and Clientele 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 Neotech stock, but she is reluctant because Neotech has never paid a
Dividends and Taxes 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 advice. What would you suggest she do?
Dividends versus Capital Gains 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 another;therefore, a firm cannot increase its value by changing its
Dividend Irrelevancy 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 by increasing its dividend payout ratio. Explain the fallacy in this argument.
Dividends and Stock 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 finding imply about the information content of initial dividends?
Dividends and Taxes 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 dividend is paid. Lee Ann sells for $115 per share, and the stock is about to go
Stock Dividends The owners’ equity accounts for Hexagon International are shown here:Common stock ($1 par value) $ 30,000 Capital surplus 185,000 Retained earnings 627,500 Total owners’ equity $842,500a. If Hexagon stock currently sells for $37 per share and a 10 percent stock dividend is
Stock Splits and Stock Dividends 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 has a five-for-three stock split?b. RC has a 15 percent stock
Regular Dividends The balance sheet for Levy Corp. is shown here in market value terms. There are 12,000 shares of stock outstanding.Market Value Balance Sheet Cash $ 55,000 Equity $465,000 Fixed assets 410,000 Total $465,000 Total $465,000 The company has declared a dividend of $1.90 per share.
Share Repurchase 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 outstanding? What will the price per share be after the repurchase? Ignoring tax effects,
Stock Dividends The market value balance sheet for Outbox Manufacturing is shown here. Outbox has declared a stock dividend of 25 percent. The stock goes exdividend tomorrow (the chronology for a stock dividend is similar to that for a cash dividend). There are 20,000 shares of stock outstanding.
Stock Dividends 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 distribution of the stock dividend have?Common stock ($1 par value) $ 410,000 Capital
Stock Splits In the previous problem, suppose the company instead decides on a five-for-one stock split. The firm’s 45 cent per share cash dividend on the new(postsplit) shares represents an increase of 10 percent over last year’s dividend on the presplit stock. What effect does this have on
Dividends and Stock Price 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 declaration of a $4 dividend at the end of the fiscal year that just began.
Homemade Dividends You own 1,000 shares of stock in Avondale Corporation.You will receive a dividend of $1.10 per share in one year. In two years, Avondale will pay a liquidating dividend of $56 per share. The required return on Avondale stock is 14 percent. What is the current share price of your
Homemade Dividends In the previous problem, suppose you want only $500 total in dividends the first year. What will your homemade dividend be in two years?
Stock Repurchase 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 share. There are 800 shares outstanding. Ignore taxes and other imperfections in
Dividends and Firm Value 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 appropriate discount rate for Novis is 12 percent, and the dividend tax rate is
Dividend Policy 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 and has 600,000 shares outstanding.Assume the dividend tax rate is zero.a. What is the
Dividend Smoothing 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 adjustment rate is .3 as defined in the Lintner model, what is the dividend one year from
Expected Return, Dividends, and Taxes The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 5.5 percent. Suppose the capital gains tax rate is zero,
Dividends and Taxes 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. Once we consider the role of taxes, however, this is not necessarily true. One
Dividends versus Reinvestment 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. The resulting investment income will be paid out as a special dividend
Dividends versus Reinvestment After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 8 percent or paying the cash out to investors who would invest in the bonds
Tom believes the company should use the extra cash to pay a special one-time dividend.How will this proposal affect the stock price? How will it affect the value of the company?Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electronics engineers Tom Miller and Jessica
Jessica believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Jessica’s proposals affect the company?Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electronics engineers Tom Miller and
Nolan is in favor of a share repurchase. He argues that a repurchase will increase the company’s P/E ratio, return on assets, and return on equity. Are his arguments correct?How will a share repurchase affect the value of the company?Electronic Timing, Inc. (ETI), is a small company founded 15
Another option discussed by Tom, Jessica, and Nolan would be to begin a regular dividend payment to shareholders. How would you evaluate this proposal?Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electronics engineers Tom Miller and Jessica Kerr. ETI manufactures
One way to value a share of stock is the dividend growth, or growing perpetuity, model.Consider the following: The dividend payout ratio is 1 minusb, where b is the “retention”or “plowback” ratio. So, the dividend next year will be the earnings next year, E 1 , times 1 minus the retention
Does the question of whether the company should pay a dividend depend on whether the company is organized as a corporation or an LLC?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
Incremental Cash Flows Which of the following should be treated as an incremental cash flow when computing the NPV of an investment?a. A reduction in the sales of a company’s other products caused by the investment.b. An expenditure on plant and equipment that has not yet been made and will be
Incremental Cash Flows Your company currently produces and sells steel shaft golf clubs. The board of directors wants you to consider the introduction of a new line of titanium bubble woods with graphite shafts. Which of the following costs are not relevant?a. Land you already own that will be used
Cash Flow and Depreciation “When evaluating projects, we’re only concerned with the relevant incremental aftertax cash flows. Therefore, because depreciation is a noncash expense, we should ignore its effects when evaluating projects.” Critically evaluate this statement.
Capital Budgeting Considerations A major college textbook publisher has an existing finance textbook. The publisher is debating whether to produce an “essentialized”version, meaning a shorter (and lower-priced) book. What are some of the considerations that should come into play?To answer the
Erosion In evaluating the Cayenne, would you consider the possible damage to Porsche’s reputation as erosion?
Calculating Project NPV Raphael Restaurant is considering the purchase of a$9,000 soufflé maker. The soufflé maker has an economic life of five years and will be fully depreciated by the straight-line method. The machine will produce 1,500 soufflés per year, with each costing $2.30 to make and
Calculating Project NP V The Best Manufacturing Company is considering a new investment. Financial projections for the investment are tabulated here. The corporate tax rate is 34 percent. Assume all sales revenue is received in cash, all operating costs and income taxes are paid in cash, and all
Calculating Project NPV Down Under Boomerang, Inc., is considering a new three-year expansion project that requires an initial fixed asset investment of$1.4 million. The fixed asset will be depreciated straight-line to zero over its threeyear tax life, after which it will be worthless. The project
Calculating Project Cash Flow from Assets In the previous problem, suppose the project requires an initial investment in net working capital of $285,000 and the fixed asset will have a market value of $225,000 at the end of the project. What is the project’s Year 0 net cash flow? Year 1? Year 2?
Project Evaluation Your firm is contemplating the purchase of a new $670,000 computer-based order entry system. The system will be depreciated straight-line to zero over its five-year life. It will be worth $50,000 at the end of that time. You will save $240,000 before taxes per year in order
Calculating Salvage Value An asset used in a four-year project falls in the five-year MACRS class for tax purposes. The asset has an acquisition cost of $7,100,000 and will be sold for $1,400,000 at the end of the project. If the tax rate is 35 percent, what is the aftertax salvage value of the
Calculating NPV Howell Petroleum is considering a new project that complements its existing business. The machine required for the project costs $3.8 million. The marketing department predicts that sales related to the project will be $2.5 million per year for the next four years, after which the
Calculating EAC You are evaluating two different silicon wafer milling machines.The Techron I costs $215,000, has a three-year life, and has pretax operating costs of$35,000 per year. The Techron II costs $270,000, has a five-year life, and has pretax operating costs of $44,000 per year. For both
C ost-Cutting Proposals Massey Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for $640,000 is estimated to result in $270,000 in annual pretax cost savings. The press falls in the MACRS five-year class, and it will have a salvage
Comparing Mutually Exclusive Projects Hagar Industrial Systems Company(HISC) is trying to decide between two different conveyor belt systems. System A costs $290,000, has a four-year life, and requires $85,000 in pretax annual operating costs. System B costs $405,000, has a six-year life, and
Comparing Mutually Exclusive Projects Suppose in the previous problem that HISC always needs a conveyor belt system; when one wears out, it must be replaced.Which system should the firm choose now?
Comparing Mutually Exclusive Projects Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,900,000 and will last for six years. Variable costs are 35 percent of sales, and fixed costs are$195,000 per year. Machine B costs $5,700,000 and
Capital Budgeting with Inflatio n Consider the following cash flows on two mutually exclusive projects:Year Project A Project B 0 2$50,000 2$65,000 1 30,000 29,000 2 25,000 38,000 3 20,000 41,000 The cash flows of project A are expressed in real terms, whereas those of project B are expressed in
Inflation and Company Value Sparkling Water, Inc., expects to sell 2.8 million bottles of drinking water each year in perpetuity. This year each bottle will sell for$1.25 in real terms and will cost $.90 in real terms. Sales income and costs occur at year-end. Revenues will rise at a real rate of 6
Calculating Nominal Cash Flow Etonic Inc. is considering an investment of$365,000 in an asset with an economic life of five years. The firm estimates that the nominal annual cash revenues and expenses at the end of the first year will be$245,000 and $70,000, respectively. Both revenues and expenses
Cash Flow Valuation Phillips Industries runs a small manufacturing operation.For this fiscal year, it expects real net cash flows of $190,000. Phillips is an ongoing operation, but it expects competitive pressures to erode its real net cash flows at 4 percent per year in perpetuity. The appropriate
Equivalent Annual Cost Bridgton Golf Academy is evaluating different golf practice equipment. The “Dimple-Max” equipment costs $94,000, has a three-year life, and costs $8,600 per year to operate. The relevant discount rate is 12 percent. Assume that the straight-line depreciation method is
Calculating Project NPV Scott Investors, Inc., is considering the purchase of a $360,000 computer with an economic life of five years. The computer will be fully depreciated over five years using the straight-line method. The market value of the computer will be $60,000 in five years. The computer
Calculating NPV and IRR for a Replacement A firm is considering an investment in a new machine with a price of $18 million to replace its existing machine. The current machine has a book value of $6 million and a market value of $4.5 million. The new machine is expected to have a four-year life,
Project Analysis and Inflation Sanders Enterprises, Inc., has been considering the purchase of a new manufacturing facility for $270,000. The facility is to be fully depreciated on a straight-line basis over seven years. It is expected to have no resale value after the seven years. Operating
Calculating Project NPV With the growing popularity of casual surf print clothing, two recent MBA graduates decided to broaden this casual surf concept to encompass a “surf lifestyle for the home.” With limited capital, they decided to focus on surf print table and floor lamps to accent
Calculating Project NPV You have been hired as a consultant for Pristine Urban-Tech Zither, Inc. (PUTZ), manufacturers of fine zithers. The market for zithers is growing quickly. The company bought some land three years ago for $1 million in anticipation of using it as a toxic waste dump site but
Calculating Project NPV Pilot Plus Pens is deciding when to replace its old machine. The machine’s current salvage value is $2.2 million. Its current book value is $1.4 million. If not sold, the old machine will require maintenance costs of $845,000 at the end of the year for the next five years.
EAC and Inflation Office Automation, Inc., must choose between two copiers, the XX40 or the RH45. The XX40 costs $900 and will last for three years. The copier will require a real aftertax cost of $120 per year after all relevant expenses. The RH45 costs $1,400 and will last five years. The real
Project Analysis and Inflation Dickinson Brothers, Inc., is considering investing in a machine to produce computer keyboards. The price of the machine will be$975,000, and its economic life is five years. The machine will be fully depreciated by the straight-line method. The machine will produce
P roject Evaluatio n Aguilera Acoustics, Inc. (AAI), projects unit sales for a new seven-octave voice emulation implant as follows:Year Unit Sales 1 83,000 2 92,000 3 104,000 4 98,000 5 84,000 Production of the implants will require $1,500,000 in net working capital to start and additional net
Calculating Required Savings A proposed cost-saving device has an installed cost of $640,000. The device will be used in a five-year project but is classified as threeyear MACRS property for tax purposes. The required initial net working capital investment is $55,000, the marginal tax rate is 35
Calculating a Bid Price Another utilization of cash flow analysis is setting the bid price on a project. To calculate the bid price, we set the project NPV equal to zero and find the required price. Thus the bid price represents a financial break-even level for the project. Guthrie Enterprises
Financial Break-Even Analysis The technique for calculating a bid price can be extended to many other types of problems. Answer the following questions using the same technique as setting a bid price; that is, set the project NPV to zero and solve for the variable in question.a. In the previous
Calculating a Bid Price Your company has been approached to bid on a contract to sell 15,000 voice recognition (VR) computer keyboards a year for four years. Due to technological improvements, beyond that time they will be outdated and no sales will be possible. The equipment necessary for the
Replacement Decisions Suppose we are thinking about replacing an old computer with a new one. The old one cost us $450,000; the new one will cost $580,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $130,000 after five
Project Analysi s Benson Enterprises is evaluating alternative uses for a three-story manufacturing and warehousing building that it has purchased for $1,450,000. The company can continue to rent the building to the present occupants for $61,000 per year. The present occupants have indicated an
Project Analysis and Inflatio n The Biological Insect Control Corporation (BICC)has hired you as a consultant to evaluate the NPV of its proposed toad ranch.BICC plans to breed toads and sell them as ecologically desirable insect control mechanisms. They anticipate that the business will continue
Project Analysis and Inflatio n Sony International has an investment opportunity to produce a new HDTV. The required investment on January 1 of this year is$165 million. The firm will depreciate the investment to zero using the straight-line method over four years. The investment has no resale
Project Analysis and Inflation After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products. The first is a medication for headache pain. The second is a pill for headache and arthritis pain. Both products
After extensive research and development, Goodweek Tires, Inc., has recently developed a new tire, the SuperTread, and must decide whether to make the investment necessary to produce and market it. The tire would be ideal for drivers doing a large amount of wet weather and off-road driving in
Firm Value What rule should a firm follow when making financing decisions? How can firms create valuable financing opportunities?

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