Corporate Finance 4th Edition David Hillier - Solutions

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5. What problems do you think Vodafone AirTouch might experience if they attempt to introduce what they view as “best operating practices” to the Mannesmann culture? How might these challenges be overcome? Be specific.
Should Warf buy or lease the equipment?Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain equipment for the production of the microphone for the keyboard.Because
Leasing vs. Purchase Why wouldn’t China Eastern Airlines purchase the planes if they were obviously needed for the company’s operations?
Reasons to Lease Why would ALC be willing to buy planes from Boeing and Airbus and then lease the planes to China Eastern Airlines? How is this different from just lending money to China Eastern Airlines to buy the planes?
Leasing What do you suppose happens to the plane at the end of the lease period?
L ease or Buy Assume that the tax rate is 35 percent. You can borrow at 8 percent before taxes. Should you lease or buy?
Leasing Cash Flows What are the cash flows from the lease from the lessor’s viewpoint? Assume a 35 percent tax bracket.
American and European Options What is the difference between an American option and a European option?
Options and Expiration Dates What is the impact of lengthening the time to expiration on an option’s value? Explain.
Options and Stock Price Volatility What is the impact of an increase in the volatility of the underlying stock’s return on an option’s value? Explain.
Insurance as an Option An insurance policy is considered analogous to an option. From the policyholder’s point of view, what type of option is an insurance policy? Why?
Equity as a Call Option It is said that the equityholders of a levered firm can be thought of as holding a call option on the firm’s assets. Explain what is meant by this statement.
You’re trying to value your options. What minimum value would you assign? What is the maximum value you would assign?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
Suppose that in three years the company’s stock is trading at $60. At that time, should you keep the options or exercise them immediately? What are some of the important determinants in making such a decision?As a newly minted MBA, you’ve taken a management position with Exotic Cuisines, Inc.,
Your options, like most employee stock options, are not transferable or tradable. Does this have a significant effect on the value of the options? Why?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
Why do you suppose employee stock options usually have a vesting provision? Why must they be exercised shortly after you depart the company even after they vest?As a newly minted MBA, you’ve taken a management position with Exotic Cuisines, Inc., a restaurant chain that just went public last
Employee Stock Options Why do companies issue options to executives if they cost the company more than they are worth to the executive? Why not just give cash and split the difference? Wouldn’t that make both the company and the executive better off ?
Real Options Your company owns a vacant lot in a suburban area. What is the advantage of waiting to develop the lot?
Warrants and Options What is the primary difference between a warrant and a traded call option?
Warrants Explain the following limits on the prices of warrants:a. If the stock price is below the exercise price of the warrant, the lower bound on the price of a warrant is zero.b. If the stock price is above the exercise price of the warrant, the lower bound on the price of a warrant is the
Convertible Bonds and Stock Volatility Suppose you are evaluating a callable, convertible bond. If the stock price volatility increases, how will this affect the price of the bond?
Convertible Bond Value What happens to the price of a convertible bond if interest rates increase?
Warrants and Convertibles Why do firms issue convertible bonds and bonds with warrants?
Conversion Ratio A convertible bond has a conversion price of $61.50. What is the conversion ratio of the bond?
Conversion Premium Eckely, Inc., recently issued bonds with a conversion ratio of 17.5. If the stock price at the time of the bond issue was $48.53, what was the conversion premium?
Convertible Bonds Hannon Home Products, Inc., recently issued $2 million worth of 8 percent convertible debentures. Each convertible bond has a face value of$1,000. Each convertible bond can be converted into 21.50 shares of common stock anytime before maturity. The stock price is $37.15, and the
Warrants The capital structure of Ricketti Enterprises, Inc., consists of 20 million shares of common stock and 1.5 million warrants. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $19. The current stock price is $25, and each warrant is worth
Cost of Current Assets Grohl Manufacturing, Inc., has recently installed a justin-time (JIT) inventory system. Describe the effect this is likely to have on the company’s carrying costs, shortage costs, and operating cycle.
Operating and Cash Cycles Is it possible for a firm’s cash cycle to be longer than its operating cycle? Explain why or why not.
Shortage Costs What are the costs of shortages? Describe them.
Operating and Cash Cycles What impact did this change in payables policy have on BlueSky’s operating cycle? Its cash cycle?
Cash Equation McConnell Corp. has a book value of equity of $13,205. Longterm debt is $8,200. Net working capital, other than cash, is $2,205. Fixed assets are$18,380. How much cash does the company have? If current liabilities are $1,630, what are current assets?
Short-Term Finance Policy Cleveland Compressor and Pnew York Pneumatic are competing manufacturing firms. Their financial statements are printed here.a. How are the current assets of each firm financed?b. Which firm has the larger investment in current assets? Why?c. Which firm is more likely to
Size of Accounts Receivable The Paden Corporation has annual sales of $34 million.The average collection period is 33 days. What is the average investment in accounts receivable as shown on the balance sheet?
ACP and Receivables Turnover Bell Tolls, Inc., has an average collection period of 36 days. Its average daily investment in receivables is $58,300. What are annual credit sales? What is the receivables turnover?
Merger Rationale Explain why diversification per se is probably not a good reason for merger.
Corporate Split In July 2011, fast food restaurant chain Wendy’s/Arby’s announced that it had sold its Arby’s restaurants and would change its name back to Wendy’s.Arby’s was purchased by the private equity firm Roark Capital Group. Arby’s was the 11th restaurant chain purchased by
Merger and Taxes Describe the advantages and disadvantages of a taxable merger as opposed to a tax-free exchange. What is the basic determinant of tax status in a merger? Would an LBO be taxable or nontaxable? Explain.
Cash versus Stock as Payment In Problem 10, are the shareholders of Firm T better off with the cash offer or the stock offer? At what exchange ratio of B shares to T shares would the shareholders in T be indifferent between the two offers?
Prepackaged Bankruptcy What is prepackaged bankruptcy? What is the main benefit of prepackaged bankruptcy?
Financial Distress Why doesn’t financial distress always cause firms to die?
APR What is the absolute priority rule?
DIP Loans What are DIP loans? Where do DIP loans fall in the APR?
Bankruptcy Ethics Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such cases the firm is using bankruptcy laws “as a sword rather than a shield.” Is this an ethical tactic?
SML Cost of Equity Estimation If you use the stock beta and the security market line to compute the discount rate for a project, what assumptions are you implicitly making?
SML Cost of Equity Estimation What are the advantages of using the SML approach to finding the cost of equity capital? What are the disadvantages? What are the specific pieces of information needed to use this method? Are all of these variables observable, or do they need to be estimated? What are
Cost of Capital Suppose Tom O’Bedlam, president of Bedlam Products, Inc., has hired you to determine the firm’s cost of debt and cost of equity capital.a. The stock currently sells for $50 per share, and the dividend per share will probably be about $5. Tom argues, “It will cost us $5 per
Company Risk versus Project Risk Both Dow Chemical Company, a large natural gas user, and Superior Oil, a major natural gas producer, are thinking of investing in natural gas wells near Houston. Both are all-equity financed companies. Dow and Superior are looking at identical projects. They’ve
Divisional Cost of Capital Under what circumstances would it be appropriate for a firm to use different costs of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier divisions or the more conservative divisions tend
Leverage Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market line? Why?
Beta What factors determine the beta of a stock? Define and describe each.
Calculating Cost of Equity The Dybvig Corporation’s common stock has a beta of 1.21. If the risk-free rate is 3.5 percent and the expected return on the market is 11 percent, what is Dybvig’s cost of equity capital?
Calculating Cost of Debt Advance, Inc., is trying to determine its cost of debt.The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 8 percent annually. What is Advance’s pretax
Calculating Cost of Debt Shanken Corp. issued a 30-year, 6.2 percent semiannual bond 7 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35 percent.a. What is the pretax cost of debt?b. What is the aftertax cost of debt?c. Which is more relevant, the
Calculating Cost of Debt For the firm in the previous problem, suppose the book value of the debt issue is $70 million. In addition, the company has a second debt issue on the market, a zero coupon bond with 12 years left to maturity; the book value of this issue is $100 million and the bonds sell
Calculating WACC Mullineaux Corporation has a target capital structure of 70 percent common stock and 30 percent debt. Its cost of equity is 13 percent, and the cost of debt is 6 percent. The relevant tax rate is 35 percent. What is Mullineaux’s WACC?
Taxes and WACC Miller Manufacturing has a target debt–equity ratio of .55. Its cost of equity is 14 percent, and its cost of debt is 7 percent. If the tax rate is 35 percent, what is Miller’s WACC?
Finding the Capital Structure Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 13 percent, and its cost of debt is 6.5 percent. The tax rate is 35 percent. What is Fama’s debt–equity ratio?
Book Value versus Market Value Filer Manufacturing has 8.3 million shares of common stock outstanding. The current share price is $53, and the book value per share is $4. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million and a coupon rate
Calculating the WACC In the previous problem, suppose the company’s stock has a beta of 1.2. 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 weighted average implied by the two outstanding debt issues. Both bonds make
Finding the WACC Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent.Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 105 percent of par;the bonds make semiannual payments.Common
Finding the WACC Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual bonds outstanding, par value$1,000 each. The common stock currently sells for $34 per share and has a beta of 1.20, and the bonds have 20 years to maturity and sell for
SML and WACC An all-equity firm is considering the following projects:Project Beta IRR W .80 9.4%X .95 10.9 Y 1.15 13.0 Z 1.45 14.2 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 firm’s 11 percent cost
Calculating Flotation Costs Suppose your company needs $20 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3 percent. Your boss has decided to fund the project by borrowing money
Calculating Flotation Costs Southern Alliance Company needs to raise $55 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 company has a target capital structure of 65 percent common stock, 5
WACC and NPV Och, Inc., is considering a project that will result in initial aftertax cash savings of $3.5 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target debt–equity ratio of.55, a cost of equity of 13 percent,
Preferred Stock and WAC C The Saunders Investment Bank has the following financing outstanding. What is the WACC for the company?Debt: 60,000 bonds with a coupon rate of 6 percent and a current price quote of 109.5; the bonds have 20 years to maturity.230,000 zero coupon bonds with a price quote of
Flotation Costs Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $19 million, and the company paid $1,150,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation
Calculating the Cost of Equity Floyd Industries stock has a beta of 1.3. The company just paid a dividend of $.95, and the dividends are expected to grow at 4.5 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 4.3 percent. The most recent stock
Firm Valuation 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 current cash flow from assets for Arras is $7.5 million. The cash flows are expected to
Flotation Costs and NPV Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .55.It’s considering building a new $50 million manufacturing facility. This new plant is expected to generate aftertax cash flows of
Flotation Costs Trower Corp. has a debt–equity ratio of .85. 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 8 percent. The flotation cost on new debt is 3.5 percent. What is the initial cost of the
1 We mentioned in the last chapter that, according to theory, firms should create all-debt capital structures under corporate taxation. Because firms generally employ moderate amounts of debt in the real world, the theory must have been missing something at that point. We stated in this chapter
2 Because financial distress costs are substantial and the shareholders ultimately bear them, firms have an incentive to reduce costs. Protective covenants and debt consolidation are two common cost reduction techniques.
3 Because costs of financial distress can be reduced but not eliminated, firms will not finance entirely with debt. Figure 19.1 illustrates the relationship between firm value and debt. In the figure, firms select the debt–equity ratio at which firm value is maximized.
4 Signalling theory argues that profitable firms are likely to increase their leverage because the extra interest payments will offset some of the pre-tax profits. Rational shareholders will infer higher firm value from a higher debt level. Thus investors view debt as a signal of firm value.
5 Managers owning a small proportion of a firm’s equity can be expected to work less, maintain more lavish expense accounts and accept more pet projects with negative NPVs than managers owning a large proportion of equity. Because new issues of equity dilute a manager’s percentage interest in
6 The pecking order theory implies that managers prefer internal to external financing. If external financing is required, managers tend to choose the safest securities, such as debt. Firms may accumulate slack to avoid external equity.
7 The market timing theory suggests that there is no pecking order or trade-off of capital structure choices. Observed debt ratios are simply a function of past market to book valuations and the timing of funding requirements. Firms will have more equity if they needed funding when market to book
8 Berens and Cuny (1995) argue that significant equity financing can be explained by real growth and inflation, even in a world of low bankruptcy costs.
9 Debt–equity ratios vary across industries. We present three factors determining the target debt–equity ratio:(a) Taxes: Firms with high taxable income should rely more on debt than firms with low taxable income.(b) Types of assets: Firms with a high percentage of intangible assets such as
1 Costs of Financial Distress What are the direct and indirect costs of bankruptcy? Briefly explain each and provide a practical example of these costs.
2 Description of Financial Distress Costs Are managers liable to act differently when their firm is in financial distress? Explain your answer using practical examples.
3 Rationale for the Tax Benefits of Debt Despite the significant costs of high leverage, tax systems around the world have a built-in debt bias. Why do you think this is?
4 Trade-off Theory Explain what is meant by the trade-off theory of capital structure choice. Your answer should discuss the main costs and benefits of debt within this model and its empirical limitations.
5 Signalling Explain how managers can signal to the market the value of their firm through their capital structure decisions. Do you think this is an effective strategy? Explain.
7 Pecking Order Theory Explain what is meant by the pecking order theory and how it relates to observed capital structures of companies. Where does a deeply discounted equity rights issue fit into the pecking order of financing choices? Explain your answer.
8 Growth and the Debt–equity Ratio How does growth affect the desired debt to equity ratio of a company? Explain the impact of growth opportunities in the context of the static trade-off theory and pecking order theory of capital structure.
9 Market Timing Theory Is the market timing theory of financing choices consistent with the pecking order theory or trade-off theory? Explain your answer.
10 Observed Capital Structures In all countries, it appears that some firms have a target debt ratio while others do not have one. What does this say about the validity of the trade-off theory, pecking order theory and market timing theory? Explain.REGULAR
11 Shareholder Incentives Do you agree or disagree with the following statement? ‘A firm’s shareholders will never want the firm to invest in projects with negative net present values.’ Why? What steps can shareholders take to reduce the costs of debt?
12 Debt and Risk You have been asked the following questions: ‘If debt can reduce the weighted average cost of capital for project appraisal, why does it then increase the risk of a company? Is it possible for a financial manager to diversify bankruptcy risk away like other risks?’ What are
13 Capital Structure Decisions During the last few years, many companies have suffered major trading losses because of the poor economic climate. Assume your firm has found itself in this situation and is considering a major redevelopment investment to exploit nascent growth opportunities. Due to
14 Observed Capital Structures Refer to the observed capital structures given in Figure 19.4. What do you notice about the types of industries with respect to their average debt–asset ratios? Are certain types of industries more likely to be highly leveraged than others? What are some possible
15 Costs of Bankruptcy What is the average cost of bankruptcy? Why do bankruptcy costs differ both within a country and between countries? What type of costs are incurred in financial distress? Use an example to illustrate your answer.
16 Bankruptcy and Corporate Ethics Explain the ethical considerations of the following:(a) Firms sometimes use the threat of a bankruptcy filing to force creditors to renegotiate terms. Critics argue that in such cases the firm is using bankruptcy laws ‘as a sword rather than a shield’.(b) A
17 Firm Value Hoy plc has a profit before interest and taxes of £900,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 17 per cent, and the corporate tax rate is 20 per cent. The company also has a perpetual bond issue outstanding with a
1 Financing Decisions and Firm Value What are the three ways a firm can create value from financing opportunities? Provide an example to illustrate each way.
3 Efficient Market Hypothesis Explain what is meant by the efficient market hypothesis. Define the three forms of market efficiency and explain each form with respect to how you can make a profit through trading. Create a diagram explaining your answer.
7 Behavioural Biases in Corporate Finance Review two cognitive biases corporate managers may exhibit. Use an example to illustrate their impact on firm value.

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Corporate Finance 4th Edition David Hillier - Solutions

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