Financial Markets And Corporate Strategy 2nd Edition Mark Grinblatt, Sheridan Titman - Solutions

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22.14. The National Basketball Association (NBA) has hired you as a consultant to figure out what the proper mix of Eastern and Western teams should be. An Eastern team has a return variance of .04, a Western team has a return variance of .09, and the correlation between the returns of an Eastern
22.13. Ford is considering building a factory to produce its new Taurus. The factory will cost $100 million and will produce 10,000 automobiles one year from now, but its cost and production can be scaled up or down. As an analyst at Ford, you run a regression of the historical sales margin of
22.12. Consider a two-factor model, where the factors are interest rate movements and changes in the exchange rate. Your company has a future cash flow with factor betas of 2 on the interest rate factor and 5 on the exchange rate factor. You would like to eliminate your sensitivity to both of these
22.11. Disney wants to borrow €24 million for three years while Metallgesellschaft wants to borrow US$20 million for three years. The spot exchange rate is currently €1.20/$. Suppose Disney and Metallgesellschaft can borrow Euros and dollars from their domestic banks at the following(annual)
22.10. General Motors has an obligation to deliver 2 million barrels of oil in six months at a fixed price of $25 per barrel. European options exist to buy oil in six months at $28 per barrel. Assume the six-month annualized (continuously compounded)riskless rate is 5 percent. Because of recent
22.9. Assume that EXCO has an obligation to deliver 1.5 million barrels of oil in nine months at a fixed price of $24 per barrel. Assume a constant convenience yield of 2 percent per year and a riskfree rate of 9 percent per annum compounded annually.a. How can EXCO hedge all the risk of this
22.8. Suppose you wish to hedge your exposure to oil prices by means of forwards and futures over the next year. You have the following information: the current price of oil is $20 per barrel and the riskfree rate of interest is 10 percent per year compounded annually. Assume that the spot price of
22.7. Your U.S. based company has an opportunity to break into the British market, but your CEO is concerned about the currency risk of such a venture. You estimate that sales in the United Kingdom will be £2 million (worst-case scenario)or £5 million (best-case scenario) over the next 10 months.
22.6. Assume that Dell Computer, a worldwide manufacturer and mail-order retailer of personal computers, has estimated the following regression associated with its operations in Europe. European profits, = $10 million + $8 million x ($/ 1-year forward exchange rate), + Eta. How should Dell Computer
22.5. Assume that Schering-Plough, a drug manufacturer, has discovered that it is cheaper to manufacture one of its drugs in France than anywhere else. All revenues from the drug will be in the United States. The company estimates that the costs of manufacturing the drug will be 100 million per
22.4. Assume that General Motors is planning to acquire an automobile company in Japan. The deal will probably be consummated within a year provided that approval is granted by the proper regulatory authorities in Japan and the United States. The two automakers have agreed upon the terms of the
22.3. Assume a two-factor model for next year's profits of ExxonMobil. The factors are one-year futures prices for oil and one-year futures prices for the US$/ exchange rate. The relevant factor equation is Profitxon $1 billion + $10 million FOLL = + $20 million F$/1 + EXON Assume that each
22.2. AB Cable, Wire, and Fiber plans to open up a new factory three years from now, at which point it plans to purchase 1 million pounds of copper.Assume zero-coupon risk-free yields are going to remain at a constant 5 percent (annually compounded rate) for all investment horizons, there is no
22.1. Consider, again, National Petroleum from Example 21.3 in Chapter 21. In addition to the forward contracts described in Example 21.3, National Petroleum also can buy (put) options that give them the right to sell the oil in one, two, or three years at an exercise price of $20 per barrel.The
20.9. Why do think AT&T was willing to spend $500 million to get pooling of interest accounting treatment in its acquisition of NCR?
20.8. One of the stated benefits of a management buyout is the improvement in management incentives. In many cases, however, the top managers do not change after the buyout. Explain why.
20.7. Tobacco companies have a large potential liability.In the future, they may be subject to extremely large product liability lawsuits. Discuss how this affects the incentives of tobacco companies to merge with food companies.
20.6. When a firm with an extremely high price/earnings ratio purchases a firm with a very low price/earnings ratio in an exchange of stock, its earnings per share will increase. Do you think firms are more likely to acquire other firms when it results in an increase in their earnings per share? Is
20.5. Leveraged buyouts are observed mainly in industries with relatively stable cash flows and products that are not highly specialized. Explain why.
20.4. Diversified Industries has made a bid to purchase Cigmatics Inc., offering to exchange two Diversified shares for 1 share of Cigmatics. When this bid is announced, Diversified Industries’ shares drop 5 percent. Henry Clavett, the CEO, has asked you to interpret what this decline in stock
20.3. What type of firm would you prefer to work for: a diversified firm or a very focused firm? What does your answer to the above question tell you about one of the advantages or disadvantages of diversification?
20.2. Refer to exercise 20.1. Explain why John Jacobs is likely to make these changes following an LBO, but would not make the changes in the absence of an LBO.
20.1. Jacobs Industries is currently selling for $25 a share and pays a dividend of $2 a share per year. Analysts expect the earnings and dividends to grow 4 percent per year into the foreseeable future. The company has 1 million shares outstanding. John Jacobs, the CEO, would like to take the firm
19.17. Show in Example 19.7 that it never pays to issue debt in excess of $400 million.
19.16. Explain why the threat of hostile takeovers can make firms more short-term oriented.
19.15. Divided Industries recently announced a substantial increase in its dividend payout.Stockholders complained because the increased dividend would place an added tax burden on them. Subsequent to the announcement, however, the stock price of Divided Industries increased 10 percent. Does this
19.14. Innovative Technologies produces high-tech equipment for the agriculture industry. This is a very risky firm since the technology is not completely established and demand for farm equipment is very cyclical and interest-rate sensitive. As a new start-up, Innovative Tech cannot obtain
19.13. When firms increase leverage with exchange offers, what generally happens to their stock prices? Why might this be?
19.12. Gordon Wu (the largest shareholder of Hopewell)has just announced that he is planning to issue outof-the-money covered warrants on 10 percent of Hopewell’s outstanding stock. Does this announcement make you more or less optimistic about Hopewell’s future profits? Does it affect your
19.11. Mr. Chan and Mr. Smith are the CEOs of similar textile manufacturing firms. Chan is 64 years old and plans to retire next year. Smith is 52 years old and expects to remain with the firm for some time.Both firms have just announced 10 percent increases in their earnings. Which firm should
19.10. Analysts project that Infotech, an information services company, will have the following financial data for equally probable high and low states:The firm is currently financed entirely with equity.The growth opportunity consists of a positive NPV project with a required initial investment of
19.9. The following table describes management’s view of Abracadabra Corporation’s future cash flows along with the consensus view of outside analysts.If the analysts can be convinced that management’s beliefs are correct, the firm’s value will increase by $200. Assume that there are no tax
19.8. If it was known that management was selling shares at the same time as it was increasing leverage, how would this affect the credibility of the signal? Why? What other actions or motivations by management could affect the credibility of such a signal?
19.7. As economies develop, disclosure laws generally get tougher and accounting information becomes more informative. Briefly describe how such changes in the quality of information affect the incentives of firms to be financed by either debt or equity.
19.6. ABC Industries is considering an investment that requires the firm to issue new equity. The project will cost $100, but will add $120 to the firm’s value. Although management believes the firm’s value is $1,000 without the new project, outside investors value the firm at $600 without the
19.5. Why might a manager close to retirement select a higher debt ratio than a manager far from retirement?
19.4. Classical finance theory suggests that firms take projects with positive NPVs regardless of the amount of cash the firm has available. However, empirical evidence suggests that the amount that firms invest is heavily dependent on their available cash flows. Why might this be?
19.3. Exhibit 19.5 shows that stock prices of industrial firms react more negatively to stock issues than do utilities. Why do you think this is the case?
19.2. Why might a firm choose to increase its debt level in response to favorable information about its future prospects?
19.1. Describe how a firm’s investment decisions might be made differently if its management is highly concerned about the firm’s current stock price.
18.9. Suppose that you are designing the compensation contract for the Chicago Bulls’ new coach. Two main alternatives are possible. In (a) you will design his bonus based on the total number of wins during the season and the team’s success during the playoffs and will ignore any specific
18.8. Cybertex’s management currently owns 1 percent of the firm’s outstanding shares. The firm is currently financed with 50 percent debt and 50 percent equity but is planning to increase its leverage ratio to 80 percent debt by borrowing and using the funds to repurchase shares. Management
18.7. The tendency of firms to use stock-based compensation is higher for firms with higher market-to-book ratios. Provide two explanations for this empirical observation.
18.6. You are a member of the compensation committee of the board of directors for both Chrysler and Chevron. How should the compensation contracts for the CEOs of these two companies differ?
18.5. As a Washington policy analyst, you are asked to comment on a proposed law that would make it more difficult for large outside shareholders to extract private benefits from the partial control they can exert over management. How would such a law affect the incentives of outside shareholders
18.4. Consider three similar firms that differ only in the extent to which they are controlled by their boards of directors. In firm 1, the board has complete control of the investment decisions, operating decisions, and financing choices. In firm 2, the board is unable to monitor investment and
18.3. John Jacobs, the CEO of High Tech Industries, owns 51 percent of the shares of his $50 million company. The firm is starting a new project that requires $25 million in new equity capital. Jacobs is considering two ways to fund the project. The first is to issue $25 million in new equity. The
18.2. Discuss the factors that determine whether firms are likely to have large ownership concentrations.
18.1. Discuss why managers might tend to want their organizations to grow.
17.16. Over the past 20 years, the transaction costs associated with issuing and repurchasing debt and equity securities have declined. What effect do you think this change has had on capital structure choices?
17.15. Explain why grocery store prices tended to increase in markets where one or more of the main competitors initiated an LBO. (Hint: Think of market share as an investment.)
17.14. In 1999 Chrysler had close to $10 billion in cash on its balance sheet invested in short-term securities. Kerkorian, Chrysler’s largest shareholder, wanted Chrysler to use the cash to buy back shares. At the very least, Kerkorian thought that the cash, which yields about 4 percent, should
17.13. You have been hired by Dell Computer Corporation to advise it on its capital structure.This $75 billion company would like to raise an additional $25 billion to acquire the assets of one of its competitors. It currently has very little debt, but it is considering borrowing the entire $25
17.12. Compton Industries currently has 2 million shares outstanding at $3 per share. Because the company is having financial difficulties, it also has $50 million in face value of long-term outstanding debt that is selling at only 60 percent of its face value. As Compton’s CEO, you estimate that
17.11. As the CEO of Mega Corp., which do you prefer:a competitor with high leverage or one with low leverage? Under what conditions will you act more or less aggressively if your competitor is highly leveraged?
17.10. Compass Computers has suffered an unexpected loss and is currently having financial difficulties.Explain why Compass may choose not to issue equity to solve its financial problems. If Compass does not issue equity, should it change its product market strategy to account for the firm’s
17.9. Weston Tractor is a cyclical business that is forced to lay off workers during downturns. The CEO estimates that they saved $50 million during the last recession by laying off excess labor.However, the company had additional expenses of $70 million three years later when it had to retrain the
17.8. Describe the trade-offs involved when firms decide how to price their products. What are the costs and benefits of raising prices? How do interest rates affect the decision? How do leverage ratios affect the decision?
17.7. Comparing the indirect costs of bankruptcy, explain why Apple includes very little debt in its capital structure while Marriott International uses a fairly large amount of debt.
17.6. Carcinogens-R-Us and Lung Decay, two cigarette producers of comparable size, are struggling for market share in a declining market. Carcinogens-R-Us has just undergone a leveraged buyout and is able to meet its fixed expenses with its existing market share, but it may be forced into
17.5. BCD Manufacturing is considering repurchasing 40 percent of its common stock. Management estimates the tax savings from such a move to be$48 million, based on the addition of $1 billion of debt at a rate of 12 percent with a 40 percent marginal tax rate. However, the company’s suppliers are
17.4. You are the manager of a company that produces automobiles. A union contract will come up for renegotiation in two months and you wish to increase your firm’s bargaining power prior to hearing the union’s initial demands. The union is likely to ask for a 25 percent increase from existing
17.3. Compare qualitatively the indirect bankruptcy costs of operating a franchised hotel to that of running a high-tech start-up computer firm.
17.2. As a potential employee, why might you be interested in the employer’s capital structure?
17.1. What are the differences between direct and indirect bankruptcy costs? Who bears these costs?Explain your answer by referring to a real situation from the recent past.
16.16. Atways Industries is involved in two similar mining projects. The Wyoming project was financed through the firm’s internal cash flows and appears as an asset on its balance sheet. The Montana project was set up as a wholly owned subsidiary of Atways. The subsidiary was financed 20 percent
16.15. You have been hired as a bond analyst for Bull Sterns. A highly leveraged firm, Emax Industries, has switched to a more flexible management process that enables it to change its investment strategy more quickly. How do you expect this change in the management process to affect bond values?
16.14. With debtor in possession (DIP) financing, bankrupt firms are able to obtain additional amounts of debt that is senior to the firm’s existing debt. Explain how the firm’s existing debt holders can benefit from this.
16.13. Assume now that if Ajax Manufacturing (see exercise 16.12) uses a more capital-intensive manufacturing process, it can produce a greater number of widgets at a lower variable cost. Given the greater fixed costs, the cash flows are only $5 million in an unfavorable economy with the
16.12. Consider the case of Ajax Manufacturing which just completed an R&D project on widgets that required a $70 million bond obligation. The R&D effort resulted in an investment opportunity that will cost $75 million and generate cash flows of $85 million in the event of a recession ( prob.
16.11. Why are debt holder–equity holder incentive problems less severe for firms that borrow short term rather than long term?
16.10. In the event of bankruptcy, the control of a firm passes from the equity holders to the debt holders.Describe differences in the preferences of the equity holders and debt holders and how decisions following bankruptcy proceedings are likely to change.
16.9. Suppose you are hired as a consultant for Tailways, Inc., just after a recapitalization that increased the firm’s debt-to-assets ratio to 80 percent. The firm has the opportunity to take on a risk-free project yielding 10 percent, which you must analyze. You note that the risk-free rate is
16.8. ABC Corp., which currently has no assets, is considering two projects that each cost $100.Project A pays off $120 next year in the good state of the economy and $90 in the bad state of the economy. Project B pays off $140 next year in the good state of the economy and $60 in the bad state of
16.7. Describe the relation between the zero-beta expected return on common stock and the zerobeta expected return on corporate bonds in an economy where stock returns are taxed more favorably than bond returns, interest payments are tax deductible, and bankruptcy costs are important determinants
16.6. In Japan, financial institutions hold significant equity interests in the borrowing firms. How does this affect the costs of financial distress and bankruptcy?
16.5. Sigma Design, a computer interface start-up firm with no tangible assets, has invested $50,000 in R&D. The success of the R&D effort as well as the state of the economy will be observed in one year. If the R&D is successful ( prob. 90%), Sigma requires a $53,000 investment to start
16.4. Hiroko Fashion Corporation (HFC) can pursue either project Dress or project Cosmetic, with possible payoffs at year-end as follows:Each project costs $6 million at the beginning of the year. Assume there are no taxes, there are no direct bankruptcy costs, all investors are risk neutral, and
16.3. A firm has a senior bond obligation of $20 due this period and $100 next period. It also has a subordinated loan of $40 owed to Jack and Jill and due next period. It has no projects to provide cash flows this period. Therefore, if the firm cannot get a loan of $20, it must liquidate. The firm
16.2. Nigel decides he can make zippers at night for one period and will have cash flows next period of$210 if the economy is favorable, and $66 if the economy is unfavorable. One-third of these proceeds must be paid out in taxes if the firm is all equity financed; however, because of the tax
16.1. A firm has $100 million in cash on hand and a debt obligation of $100 million due in the next period. With this cash, it can take on one of two projects—A or B—which cost $100 million each.Assume that the firm cannot raise any additional outside funds. If the economy is favorable, project
15.10. You are engineering an LBO of Acme Industries, an industrial bottle maker. After the LBO, the firm will be financed 90 percent with debt and 10 percent with equity. Fred Farber, the CEO, will own 30 percent of the shares. Fred thinks the proposed capital structure is too highly levered and
15.9 Alpha Corporation earned $150 million in beforetax profits in 1996. Its corporate tax rate is 35 percent. Daniel Reptella, who owns 20 percent of the firm’s shares, has a personal marginal tax rate of 40 percent. From Daniel’s perspective, what is the effective tax rate on Alpha’s
15.8 The XYZ Corporation has an expected dividend of$4 one period from now. This dividend is expected to grow by 2 percent per period.a. What is the value of a share of stock, assuming that the appropriate discount rate for expected future dividends—e.g., the expected rate of appreciation in the
15.7. Suppose that the capital gains tax rate is expected to increase in three years. How would this affect Bill Gates’s decision on whether Microsoft should use some of the company’s excess cash to repurchase shares?
15.6. Hunter Industries has generated $1 million in excess of its investment needs. The firm can invest the excess cash in Treasury bonds at 8 percent or distribute the cash to shareholders as a dividend.Assume that the corporate tax rate is 40 percent and that the firm is owned by three different
15.5. Suppose you are a manager who wants to retain as much as possible of the firm’s earnings in order to increase the size of the firm. How would you react to proposals to repurchase shares that would make it less costly to distribute cash to shareholders?How does your reaction relate to your
15.4. Hot Shot Uranium Mines is issuing stock for the first time and needs to determine an initial proportion of debt and equity. In its first years, the firm will have substantial tax write-offs as it amortizes the uranium in the mine. In later years, however, it will have high taxable earnings.
15.3. The Tax Reform Act of 1986 removed the tax preference for capital gains. Does this eliminate the tax preference for share repurchases over dividends?
15.2. You are considering buying IBM stock which is trading today at $98 a share. IBM is going exdividend tomorrow, paying out $2.00 per share. If you believe the stock will drop to $96.50 following the dividend, should you buy the stock before or after the dividend payment? Explain how your answer
15.1. Explain why the proportion of earnings distributed in the form of a share repurchase has increased substantially over the past 25 years.
14.14. The Jack and Tyler Pizza Co. is financed entirely with equity and has grown very quickly over the past 8 years. The firm has hired the consulting firm of Stephanie & Chiara, LLC, to analyze the firm’s financing. The consulting firm recommends that the firm borrow $100 million (face value)
14.13. ABC, Inc., financed with both equity and $10 million in perpetual debt, has pretax cash flow estimates for the current year as follows:Probability Pretax Cash Flow 0.3 $1.5 million 0.5 $2 million 0.2 $4 million The corporate tax rate is 40 percent, the effective personal tax rate on equity
14.12. Jeff started an Internet company, Finstrat.com, which, unlike others in the industry, generated taxable earnings almost immediately. Jeff owns 10 percent of the shares, and the rest of the shares are held by tax-exempt institutions. The firm needs to raise $100 million in new capital. Jeff
14.11. X-Tex Industries has large depreciation tax deductions and can thus eliminate all of its taxable income with a relatively small amount of debt. In contrast, Unique Scientific Equipment Corporation is generating a substantial amount of taxable income. Despite the tax advantage of debt, Unique
14.10. Real estate investment trusts (REITs) are companies set up to manage investment properties like office buildings and apartment houses. REITs are not subject to corporate taxes and are required to pass through 95 percent of their income to their shareholders who are taxed at the personal
14.9. Restaurant chains like McDonald’s sometimes franchise their restaurants and sometimes own them outright. The franchised restaurants are usually owned by individuals who hold them in subchapter S corporations which pass income through directly to the owners. There is no corporate tax on this
14.8. During the early 1990s, most new airplanes were leased by the airlines. This was not true during the early and mid-1980s. Explain why.
14.7. Assume the corporate tax rate is 50 percent, AAA corporate bonds are trading at a yield of 9 percent, and municipal bonds are trading at a yield of 6 percent. How can the shareholders of an AAArated firm gain by increasing the leverage of their firm without increasing the leverage of their
14.6. Explain how inflation affects the capital structure decision. Does inflation affect the capital structure choice differently for different firms?

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Financial Markets And Corporate Strategy 2nd Edition Mark Grinblatt, Sheridan Titman - Solutions

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