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business
principles corporate finance
Corporate Finance 6th International Edition Stephen Ross, Randolph Westerfield, Jeffrey Jaffe - Solutions
• Why should firms draw up financial plans?
• What are the two dimensions of the financial planning process?
• Describe the procedure of a dividend payment.
• Why should the price of a stock change when it goes ex-dividend?
• Do dividends have information content?
• What are tax clienteles?
18.1 Identify and describe each of the following dates that are associated with a dividend payment on common stock:February 16 February 24 February 26 March 14
18.9 National Business Machine Co. (NBM) has $2 million of extra cash. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets.The resulted investment income will be paid out as a special dividend at the end of three years. In this case, the firm can
18.11 In their 1970 paper on dividends and taxes, Elton and Gruber reported that the exdividend–date drop in a stock’s price as a percentage of the dividend should equal the ratio of 1 minus the ordinary income tax rate to 1 minus the capital gains rate; that is,where Pe The ex-dividend stock
18.12 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 themselves.a. If the corporate
18.16 Suppose the Du Pont Company currently has outstanding series 4.50, nonconvertible preferred stock that pays an annual dividend of $4.50. Du Pont has also issued 11-percent bonds that will mature in 10 years. The stock and bonds have about the same risk.a. The current price of the 4.50
18.17 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 dividendpayout ratios. Explain the fallacy behind the argument.
18.18 The desire for current income is not a valid explanation for preference for high-currentdividend policy, as investors can always create homemade dividends by selling a portion of their stocks. Comment.
18.19 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 in order to maximize her after-tax returns and she has asked for your advice. What would you suggest she do?
18.21 Last month Central Virginia Power Company, which had been having trouble with cost overruns on a nuclear plant that it had been building, announced that it was “temporarily suspending dividend payments due to the cash flow crunch associated with its investment program.”When the
18.27 Empirical research 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?
• Describe the basic procedures in a new issue.
• What is a registration statement?
• Describe a firm-commitment underwriting and a best-efforts underwriting.
• Suppose that a stockbroker calls you up out of the blue and offers to sell you some shares of a new issue. Do you think the issue will do better or worse than average?
• What are some reasons that the price of stock drops on the announcement of a new equity issue?
• Describe the costs of a new issue of common stock.
• What conclusions emerge from analyses of Tables 19.6 and 19.7?
• Describe the details of a rights offering.
• What are the questions that financial management must answer in a rights offering?
• Why might a firm prefer a general cash offering to a rights offering?
• Describe shelf registration.
• What are the arguments against shelf registration?
• What are the different sources of venture-capital financing?
• What are the different stages for companies seeking venture-capital financing?
• What is the private equity market?
• What is Rule 144A?
19.2a. What does the Securities Exchange Act of 1933 regulate?b. What does the Securities Exchange Act of 1934 regulate?
19.3 What are the comparative advantages of a competitive offer and a negotiated offer, respectively?
19.4 Define the following terms related to underwriting.a. Firm commitmentb. Syndicatec. Spreadd. Best efforts
19.5a. Who bears the risk in firm-commitment underwriting? Explain.b. Who bears the risk in best-efforts underwriting? Explain.
19.7 In 1980 a certain assistant professor of finance bought 12 initial public offerings of common stock. He held each of these for approximately one month and then sold them. The investment rule he followed was to submit a purchase order for every firm-commitment initial public offering of oil-
19.8 What are the possible reasons for why the stock price typically drops on the announcement of a seasoned new equity issue?
19.9 What are the costs of new issues?
19.15 Megabucks Industries is planning to raise fresh equity capital by selling a large new issue of common stock. Megabucks is a publicly traded corporation, and is trying to choose between an underwritten cash offer and a rights offering (not underwritten) to current shareholders. Megabucks’
19.16 Explain why shelf registration has been used by many firms instead of syndication.
19.17 Who are the different suppliers of venture capital?
19.18 What are the uses for the proceeds from an IPO?
19.19 Every IPO is unique, but what are the basic empirical regularities in IPOs?
24.11 At issuance of McArthur Corp.’s convertible bonds, one of the two following sets of characteristics was true.Which of the relationships do you believe was more likely to have prevailed? Why? A B Offering price of bond $900 $1,000 Bond value (straight debt) $900 $ 950 Stock price $ 20 $ 30
24.12 The following facts apply to a convertible security:a. What is the minimum price at which the convertible should sell?b. What accounts for any premium in the market price of the convertible over the value of the common stock into which it can be converted? Conversion price Coupon rate Par
25.20 The following balance sheet is for Besdall Community Bank.a. What is the duration of Besdall’s assets?b. What is the duration of Besdall’s liabilities?c. Is Besdall Community Bank immune from interest-rate risk? Federal funds deposits Accounts-receivable loans Short-term loans Market
25.22 Consider the following balance sheet for California Commercial Bank.a. What is the duration of California’s assets? What is the duration of liabilities?b. Is the bank immunized from interest-rate risk? CALIFORNIA COMMERCIAL BANK Market Value Balance Sheet Market Value ($ million) Duration
25.21 Refer to the previous problem. To what values must the durations of Besdall Community Bank change to make the bank immune from interest-rate risk ifa. Only the durations of the liabilities change?b. Only the durations of the assets change?
25.19 Mr. and Mrs. Chaikovski have a son who is going to enter a music college three years from today. Annual school expenses of $20,000 will occur at the beginning of each year for four years. What is the duration of Mr. and Mrs. Chaikovski’s liability as parents?Assume the annual borrowing rate
25.18 Calculate the duration of a four-year, $1,000 face-value bond with a 5-percent coupon rate, selling at par.
25.17 Calculate the duration of a four-year, $1,000 face-value bond with a 9-percent coupon rate, selling at par.
25.16 Calculate the duration of a three-year, $1,000 face-value bond with a 9-percent coupon rate, selling at par.
25.14 Calculate the duration of a perpetuity that pays $100 at each year-end. Assume the annual discount rate of 12 percent. What if the discount rate is 10 percent?
25.13 Available are three zero-coupon, $1,000 face-value bonds. All of these bonds are initially priced using an 11-percent interest rate. Bond A matures one year from today, bond B matures five years from today, and bond C matures 10 years from today.a. What is the current price of each bond?b. If
25.12 Refer to question 25.11. There are four-month T-bond futures available. A single contract is for $100,000 of T-bonds.a. Suppose that between today and your meeting with the president of MAX, the market rate of interest rises to 12 percent.i. How much is MAX’s president willing to pay you
25.5a. How is a short hedge created?b. In what type of situation is a short hedge a wise strategy?c. How is a long hedge created?d. In what type of situation is a long hedge a wise strategy?
25.3 The following table lists the closing prices for wheat futures contracts. Suppose you bought one contract at $5.00 at the opening of trade on March 15.March 15 $5.03 March 16 $5.08 March 17 $5.12 March 18 $5.10 March 19 $4.98a. Suppose that on March 18 you receive from your broker a notice of
25.2 Explain the three ways in which futures contracts and forward contracts differ.
25.1 Define:a. Forward contractb. Futures contract
• Show that a currency swap is equivalent to a series of forward contracts.
• How is the concept of duration used to reduce interest-rate risk?
• What is duration?
• Give examples of hedging with futures contracts on bonds.
• What are the differences between forward contracts on bonds and futures contracts on bonds?
• How are forward contracts on bonds priced?
• What is a rolling stack strategy?
• Under what circumstances is each of the two hedges used?
• Define short and long hedges.
• Why do exchanges require futures contracts to be marked to the market?
• How is a futures contract related to a forward contract?
• Give examples of forward contracts in your life.
24.16 A $1,000 par convertible debenture has a conversion price for common stock of $180 per share. With the common stock selling at $60, what is the conversion value of the bond?
24.7 A warrant entitles the holder to buy 10 shares of common stock at $21 per share. When the market price of the stock is $15, will the market price of the warrant equal zero? Why or why not?
24.3a. What is the primary difference between warrants and calls?b. What is the implication of that difference?
24.2 Explain why the following limits on warrant prices exist.a. The lower limit is zero if the stock price is below the exercise price.b. The lower limit is stock price less exercise price if the stock price is above the exercise price.c. The upper limit is the price of the stock.
24.1 Define:a. Warrantsb. Convertibles
• When should firms force conversion of convertibles? Why?
• What is wrong with the Expensive Lunch story?
• What is wrong with the Free Lunch story?
• Describe the payoff structure of convertible bonds.
• What three elements make up the value of a convertible bond?
• What are the conversion ratio, the conversion price, and the conversion premium?
• How can the firm hurt warrant holders?
• Why does dilution occur when warrants are exercised?
• What is the key difference between a warrant and a traded call option?
5. Under what circumstances are warrants and convertibles converted into common stock?
4. Why do some companies issue bonds with warrants and convertible bonds?
3. What are the differences between warrants, convertibles, and call options?
2. What impact do warrants and convertibles have on the value of the firm?
1. How can warrants and convertibles be valued?
23.6 Suppose in the previous problem, you think it is likely that expected sales will be revised upward to 15,000 units if the first year is a success and downward to zero units if the first year is a failure. Success or failure are equally likely. What is the NPV of the project?
23.2 Mr. Hurt has been quoted as saying that he doesn’t want stock options. He has said he would be satisfied with straight pay of $1.25 million. The board of directors disagrees.Who is right?
• Why does a strict NPV calculation typically understate the value of a firm or project?
22.25 It is said that the equity in a levered firm is like a call option on the underlying assets.Explain what is meant by this statement.
22.22a. Use the Black-Scholes model to price a call with the following characteristics:Stock price = $70 Strike price = $90 Time to expiration = 6 months Stock-price variance = 0.25 Risk-free interest rate = 0.06b. What does put-call parity imply the price of the corresponding put will be?
22.21a. Use the Black-Scholes model to price a call with the following characteristics:Stock price = $45 Strike price = $52 Time to expiration = 6 months Stock-price variance = 0.40 Risk-free interest rate = 0.065b. What does put-call parity imply the price of the corresponding put will be?
22.20 Use the Black-Scholes model to price a call with the following characteristics:Stock price = $52 Strike price = $48 Time to expiration = 120 days Stock-price variance= 0.04 Risk-free interest rate = 0.05
22.19 Use the Black-Scholes model to price a call with the following characteristics:Stock price = $62 Strike price = $70 Time to expiration =4 weeks Stock-price variance = 0.35 Risk-free interest rate = 0.05
22.15a. If the risk of a stock increases, what is likely to happen to the prices of call options on the stock? Why?b. If the risk of a stock increases, what is likely to happen to the price of put options on the stock? Why?
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