Question: Consider the following project:
The internal

> Suppose that there are just three types of investors with the following tax rates: The remaining stock is held by the institutions. All three groups simply seek to maximize their after-tax income. These investors can choose from three types of stock offe

> Consider the following two statements: “Dividend policy is irrelevant,” and “Stock price is the present value of expected future dividends.” (See Chapter 4.) They sound contradictory. This question is designed to show that they are fully consistent. The

> The middle-of-the-road party holds that dividend policy doesn’t matter because the supply of high-, medium-, and low-payout stocks has already adjusted to satisfy investors’ demands. Investors who like generous dividends hold stocks that give them all th

> “Many companies use stock repurchases to increase earnings per share. For example, suppose that a company is in the following position: Net profit………………………………………..……$10 million Number of shares before repurchase…………..1 million Earnings per share……………….……

> Generous dividend payouts and high price–earnings multiples are correlated positively. Does this imply that paying out cash as dividends instead of repurchases increases share price?

> Comment briefly on each of the following statements: a. “Unlike American firms, which are always being pressured by their shareholders to increase dividends, Japanese companies pay out a much smaller proportion of earnings and so enjoy a lower cost of c

> An article on stock repurchase in the Los Angeles Times noted: “An increasing number of companies are finding that the best investment they can make these days is in themselves.” Discuss this view. How is the desirability of repurchase affected by compan

> How in practice do managers of public firms meet short-run earnings targets? By creative accounting?

> Hors d’Age Cheeseworks has been paying a regular cash dividend of $4 per share each year for over a decade. The company is paying out all its earnings as dividends and is not expected to grow. There are 100,000 shares outstanding selling for $80 per shar

> Respond to the following comment: “It’s all very well saying that I can sell shares to cover cash needs, but that may mean selling at the bottom of the market. If the company pays a regular cash dividend, investors avoid that risk.”

> Here are key financial data for House of Herring, Inc.: Earnings per share for 2018 …………..….. $5.50 Number of shares outstanding…….40 million Target payout ratio……………………………..50% Planned dividend per share………………..$2.75 Stock price, year-end 2018…………….…..$

> House of Haddock has 5,000 shares outstanding and the stock price is $140. The company is expected to pay a dividend of $20 per share next year and thereafter the dividend is expected to grow indefinitely by 5% a year. The President, George Mullet, now m

> Look back one last time at Problem 17. How would you value Little Oil if it paid out $500,000 in cash dividends year in and year out, with no expected growth or decline? Remaining free cash flow will be used to repurchase shares. Assume that Little Oil’s

> We stated in Section 16-3 that MM’s proof of dividend irrelevance assumes that new shares are sold at a fair price. Look back at Problem 17. Assume that new shares are issued in year 1 at $10 a share. Show who gains and who loses. Is dividend policy stil

> Little Oil has outstanding one million shares with a total market value of $20 million. The firm is expected to pay $1 million of dividends next year, and thereafter the amount paid out is expected to grow by 5% a year in perpetuity. Thus the expected di

> Does the good news conveyed by the announcement of a dividend increase mean that a firm can increase its stock price in the long run simply by paying cash dividends? Explain.

> Investors and financial managers focus more on changes in cash dividends than on the level of cash dividends. Why?

> Half shell Seafood is still generating good profits, but growth is slowing down. How should its CFO decide when to start up a program of paying out cash to stockholders? What questions should the CFO ask?

> Fill in the blanks: “A project’s economic income for a given year equals the project’s _____ less its _____ depreciation. New projects may take several years to reach full profitability. In these cases book income is _____ than economic income early in t

> Some types of investors prefer dividend-paying stocks because dividends provide a regular, convenient source of income. Does demand from these investors necessarily lift the prices of dividend-paying stocks relative to stocks of companies that pay no div

> Surf & Turf Hotels is a mature business, although it pays no cash dividends. Next year’s earnings are forecasted at $56 million. There are 10 million outstanding shares. The company has traditionally paid out 50% of earnings by repurchases and reinvested

> Go back to the first Rational Demiconductor balance sheet one more time. Assume that Rational does not win the lawsuit (see Problem 5) and is left with only $1 million in surplus cash. Nevertheless Rational decides to pay a cash dividend of $2Â&nbs

> Go back to the first Rational Demiconductor balance sheet. Now assume that Rational wins a lawsuit and is paid $1 million in cash. Its market capitalization rises by that amount. It decides to pay out $2 per share instead of $1 per share. Explain what ha

> Look again at Problem 3. Assume instead that the CFO announces a stock repurchase of $4 per share instead of a cash dividend. a. What happens to the stock price when the repurchase is announced? Would you expect the price to increase to $90? Explain bri

> Seashore Salt Co. has surplus cash. Its CFO decides to pay back $4 per share to investors by initiating a regular dividend of $1 per quarter or $4 per year. The stock price jumps to $90 when the pay-out is announced. a. Why does the stock price increase

> Here are several “facts” about typical corporate dividend policies. Which are true and which false? a. Companies decide each year’s dividend by looking at their capital expenditure requirements and then distributing whatever cash is left over. b. Manag

> In 2014, Entergy paid a regular quarterly dividend of $.83 per share. a. Match each of the following dates. (A1) Friday, July 25 (B1) Record date (A2) Monday, August 11 (B2) Payment date (A3) Tuesday, August 12 (B3) Ex-dividend date (A4) Thursday, Augus

> Explain the difference between a uniform-price auction and a discriminatory auction. Why might you prefer to sell securities by one method rather than another?

> For each of the following pairs of issues, which is likely to involve the lower proportionate underwriting and administrative costs? a. A large issue/a small issue b. A bond issue/a common stock issue c. Initial public offering/subsequent issue of sto

> The Modern Language Corporation earned $1.6 million on net assets of $20 million. The cost of capital is 11.5%. Calculate the net ROI and EVA.

> After each of the following issue methods, we have listed two types of issue. Choose the one more likely to employ that method. a. Rights issue (initial public offer/further sale of an already publicly traded stock) b. Rule 144A issue (international bo

> Here is recent financial data on Pisa Construction, Inc. Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $80,000 to finance expansion into a promising market. Pisa’s financial advisers thi

> a. Why do venture capital companies prefer to advance money in stages? If you were the management of Marvin Enterprises, would you have been happy with such an arrangement? With the benefit of hindsight did First Meriam gain or lose by advancing money in

> Refer to the Marvin Prospectus Appendix at the end of this chapter to answer the following questions. a. If there is unexpectedly heavy demand for the issue, how many extra shares can the underwriter buy? b. How many shares are to be sold in the primar

> Suppose that in April 2019 Van Dyck Exponents offered 100 shares for sale in an IPO. Half of the shares were sold by the company and the other half by existing shareholders, each of whom sold exactly half of their existing holding. The offering price to

> Suppose that instead of having a rights issue of new stock at €4 (see Problem 15), Pandora decided to make a general cash offer at €4. Would existing shareholders still be just as well off? Explain. Problem 15: Problem 14 contains details of a rights of

> Problem 14 contains details of a rights offering by Pandora Box. Suppose that the company had decided to issue new stock at €4. How many new shares would it have needed to sell to raise the same sum of money? Recalculate the answers to questions (b) to (

> In 2012, the Pandora Box Company made a rights issue at €5 a share of one new share for every four shares held. Before the issue there were 10 million shares outstanding and the share price was €6. a. What was the total amount of new money raised? b. Th

> Construct a simple example to show the following: a. Existing shareholders are made worse off when a company makes a cash offer of new stock below the market price. b. Existing shareholders are not made worse off when a company makes a rights issue of n

> There are three reasons that a common stock issue might cause a fall in price: (a) the price fall is needed to absorb the extra supply, (b) the issue causes temporary price pressure until it has been digested, and (c) management has information that stoc

> Here are several questions about economic value added or EVA. a. Is EVA expressed as a percentage or a dollar amount? b. Write down the formula for calculating EVA. c. What is the difference, if any, between EVA and residual income? d. What is the point

> Why are the costs of debt issues less than those of equity issues? List the possible reasons.

> In some U.K. IPOs any investor may be able to apply to buy shares. Mr. Bean has observed that on average these stocks are underpriced by about 9% and for some years has followed a policy of applying for a constant proportion of each issue. He is therefor

> a. “A signal is credible only if it is costly.” Explain why management’s willingness to invest in Marvin’s equity was a credible signal. Was its willingness to accept only part of the venture capital that would eventually be needed also a credible signal

> Here is a further vocabulary quiz. Briefly explain each of the following: a. Zero-stage vs. first- or second-stage financing b. Carried interest c. Rights issue d. Road show e. Best-efforts offer f. Qualified institutional buyer g. Blue-sky laws h

> Associated Breweries is planning to market alcohol-free beer. To finance the venture it proposes to make a rights issue at $10 of one new share for each two shares held. (The company currently has outstanding 100,000 shares priced at $40 a share.) Assumi

> You need to choose between making a public offering and arranging a private placement. In each case the issue involves $10 million face value of 10-year debt. You have the following data for each: A public issue: The interest rate on the debt would be 8

> True or false? a. Venture capitalists typically provide first-stage financing sufficient to cover all development expenses. Second-stage financing is provided by stock issued in an IPO. b. Underpricing in an IPO is only a problem when the original inve

> Explain what each of the following terms or phrases means: a. Venture capital b. Book building c. Underwriting spread d. Registration statement e. Winner’s curse

> True or false? Explain briefly. a. Book profitability measures are biased measures of true profitability for individual assets. However, these biases “wash out” when firms hold a balanced mix of old and new assets. b. Systematic biases in book profitabil

> Monitoring alone can never completely eliminate agency costs in capital investment. Briefly explain why.

> Herbal Resources is a small but profitable producer of dietary supplements for pets. This is not a high-tech business, but Herbal’s earnings have averaged around $1.2 million after tax, largely on the strength of its patented enzyme for making cats nonal

> Table 12.5 shows a condensed income statement and balance sheet for Androscoggin Copper’s Rumford smelting plant. a. Calculate the plant’s EVA. Assume the cost of capital is 9%. b. As Table 12.5 shows, the plant is carried on Androscoggin’s books at $48.

> Use the Beyond the Page feature to access the Excel program for calculating the profitability of the Nodhead project. Now suppose that the cash flows from Nodhead’s new supermarket are as follows:
a. Recalculate economic depreciation. Is it accelerate

> Calculate the year-by-year book and economic profitability for investment in polyzone production, as described in Chapter 11. Use the cash flows and competitive spreads shown in Table 11.2, and assume straight-line depreciation over 10 years. What is the

> Here are a few questions about compensation schemes that tie top management’s compensation to the rate of return earned on the company’s common stock. a. Today’s stock price depends on investors’ expectations of future performance. What problems does thi

> We noted that management compensation must in practice rely on results rather than on effort. Why? What problems are introduced by not rewarding effort?

> In our Nodhead example, true depreciation was decelerated. That is not always the case. For instance, Table 12.6 shows how on average the market value of a Boeing 737 has varied with its age26 and the cash flow needed in each year to provide a 10% return

> Consider an asset with the following cash flows:
The firm uses straight-line depreciation. Thus, for this project, it writes off $4 million per year in years 1, 2, and 3. The discount rate is 10%. a. Show that economic depreciation equals book deprec

> Ohio Building Products (OBP) is considering the launch of a new product which would require an initial investment in equipment of $30,800 (no investment in working capital is required). The forecast profits from the product are as follows:
No cash flo

> Use the Beyond the Page feature to access the Excel program for measuring the profitability of the Nodhead project. Reconstruct Table 12.4 assuming a steady-state growth rate of 10% per year. Your answer will illustrate a fascinating theorem, namely, tha

> Define the following: (a) Agency costs in capital investment, (b) private benefits, (c) empire building, (d) entrenching investment, (e) delegated monitoring.

> Taxes are a cost, and, therefore, changes in tax rates can affect consumer prices, project lives, and the value of existing firms. The following problem illustrates this. It also illustrates that tax changes that appear to be “good for business” do not a

> The world airline system is composed of the routes X and Y, each of which requires 10 aircraft. These routes can be serviced by three types of aircraft—A, B, and C. There are 5 type A aircraft available, 10 type B, and 10 type C. These aircraft are ident

> The manufacture of polysyllabic acid is a competitive industry. Most plants have an annual output of 100,000 tons. Operating costs are $.90 a ton, and the sales price is $1 a ton. A 100,000-ton plant costs $100,000 and has an indefinite life. Its current

> Sulphur Ridge Mining is considering the development of a new calonium mine at Moose Bend in northern Alberta. The mine would require an upfront investment of $110 million and would produce 100,000 tons of high-grade calonium a year, which is small compar

> Modify Table 19.1 on the assumption that competition eliminates any opportunities to earn more than WACC on new investment after year 7 (PVGO = 0). How does the valuation of Rio change? Table 19.6 is a simplified book balance sheet for Devon Energy in Se

> Modify Table 19.1 on the assumption that competition eliminates any opportunities to earn more than WACC on new investment after year 7 (PVGO = 0). How does the valuation of Rio change? Table 19.1: Latest Year Forecast 2 3 4 5 6 7 Sales 83.6 89.5 95.

> The WACC formula assumes that debt is rebalanced to maintain a constant debt ratio D/V. Rebalancing ties the level of future interest tax shields to the future value of the company. This makes the tax shields risky. Does that mean that fixed debt levels

> You are asked to value a large building in northern New Jersey. The valuation is needed for a railroad bankruptcy settlement. Here are the facts: a. The settlement requires that the building’s value equal the PV of the net cash proceeds the railroad woul

> In footnote 15 we referred to the Miles–Ezzell discount rate formula, which assumes that debt is not rebalanced continuously, but at one-year intervals. Derive this formula. Then use it to unlever Sangria’s WACC and calculate Sangria’s opportunity cost o

> Chiara Company’s management has made the projections shown in Table 19.5. Use this table as a starting point to value the company as a whole. The WACC for Chiara is 12% and the long-run growth rate after year 5 is 4%. The company has $5

> The Bunsen Chemical Company is currently at its target debt ratio of 40%. It is contemplating a $1 million expansion of its existing business. This expansion is expected to produce a cash inflow of $130,000 a year in perpetuity. The company is uncertain

> Consider a project to produce solar water heaters. It requires a $10 million investment and offers a level after-tax cash flow of $1.75 million per year for 10 years. The opportunity cost of capital is 12%, which reflects the project’s business risk. a.

> Suppose the project described in Problem 17 is to be undertaken by a university. Funds for the project will be withdrawn from the university’s endowment, which is invested in a widely diversified portfolio of stocks and bonds. However,

> Consider another perpetual project like the crusher described in Section 19-1. Its initial investment is $1,000,000, and the expected cash inflow is $95,000 a year in perpetuity. The opportunity cost of capital with all-equity financing is 10%, and the p

> Digital Organics (DO) has the opportunity to invest $1 million now (t = 0) and expects after-tax returns of $600,000 in t = 1 and $700,000 in t = 2. The project will last for two years only. The appropriate cost of capital is 12% with all-equity financin

> How will Rensselaer Felt’s WACC and cost of equity change if it issues $50 million in new equity and uses the proceeds to retire long-term debt? Assume the company’s borrowing rates are unchanged. Use the three-step procedure from Section 19-3.

> Table 19.4 shows a simplified balance sheet for Rensselaer Felt. Calculate this company’s weighted-average cost of capital. The debt has just been refinanced at an interest rate of 6% (short term) and 8% (long term). The expected rate of return on the co

> Table 19.3 shows a book balance sheet for the Wishing Well Motel chain. The company’s long-term debt is secured by its real estate assets, but it also uses short-term bank loans as a permanent source of financing. It pays 10% interest on the bank debt an

> The Cambridge Opera Association has come up with a unique door prize for its December 2019 fund-raising ball: Twenty door prizes will be distributed, each one a ticket entitling the bearer to receive a cash award from the association on December 31, 2020

> Suppose KCS Corp. buys out Patagonia Trucking, a privately owned business, for $50 million. KCS has only $5 million cash in hand, so it arranges a $45 million bank loan. A normal debt-to-value ratio for a trucking company would be 50% at most, but the ba

> Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later its debt ratio is down to 15% (D/V = .15). The interest rate has dropped to 8.6%. Recalculate Federated’s WACC under these new assumptions. The company’s busines

> The WACC formula seems to imply that debt is “cheaper” than equity—that is, that a firm with more debt could use a lower discount rate. Does this make sense? Explain briefly.

> Consider a project lasting one year only. The initial outlay is $1,000 and the expected inflow is $1,200. The opportunity cost of capital is r = .20. The borrowing rate is rD = .10, and the tax shield per dollar of interest is Tc = .35. a. What is the pr

> Whispering Pines, Inc., is all-equity-financed. The expected rate of return on the company’s shares is 12%. a. What is the opportunity cost of capital for an average-risk Whispering Pines investment? b. Suppose the company issues debt, repurchases shares

> A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0). What is the project’s APV in the following cases? a. If the firm invests, it has to raise $500,000 by a stock issue. Issue costs are 15% of net proceeds. b. If the firm invests

> True or false? The APV method a. Starts with a base-case value for the project. b. Calculates the base-case value by discounting project cash flows, forecasted assuming all equity financing, at the WACC for the project. c. Is especially useful when debt

> What is meant by the flow-to-equity valuation method? What discount rate is used in this method? What assumptions are necessary for this method to give an accurate valuation?

> True or false? Use of the WACC formula assumes a. A project supports a fixed amount of debt over the project’s economic life. b. The ratio of the debt supported by a project to project value is constant over the project’s economic life. c. The firm rebal

> Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of America, using the following information: Debt: $75,000,000 book value outstanding. The debt is trading at 90% of book value. The yield to maturity is 9%. Equity: 2,500,000

> Photographic laboratories recover and recycle the silver used in photographic film. Stikine River Photo is considering purchase of improved equipment for their laboratory at Telegraph Creek. Here is the information they have: a. The equipment costs $100,

> To finance the Madison County project, Wishing Well needs to arrange an additional $80 million of long-term debt and make a $20 million equity issue. Underwriting fees, spreads, and other costs of this financing will total $4 million. How would you take

> The U.S. government has settled a dispute with your company for $16 million. The government is committed to pay this amount in exactly 12 months. However, your company will have to pay tax on the award at a marginal tax rate of 35%. What is the award wo

> You are considering a five-year lease of office space for R&D personnel. Once signed, the lease cannot be canceled. It would commit your firm to six annual $100,000 payments, with the first payment due immediately. What is the present value of the lease

> Most financial managers measure debt ratios from their companies’ book balance sheets. Many financial economists emphasize ratios from market-value balance sheets. Which is the right measure in principle? Does the trade-off theory propose to explain book

> Some corporations’ debt–equity targets are expressed not as a debt ratio but as a target debt rating on the firm’s outstanding bonds. What are the pros and cons of setting a target rating rather than a target ratio?

> The possible payoffs from Ms. Ketchup’s projects (see Example 18.1) have not changed but there is now a 40% chance that Project 2 will pay off $24 and a 60% chance that it will pay off $0. a. Recalculate the expected payoffs to the bank and Ms. Ketchup i

> Ronald Masulis analyzed the stock price impact of exchange offers of debt for equity or vice versa.35 In an exchange offer, the firm offers to trade freshly issued securities for seasoned securities in the hands of investors. Thus, a firm that wanted to

> “I was amazed to find that the announcement of a stock issue drives down the value of the issuing firm by 30%, on average, of the proceeds of the issue. That issue cost dwarfs the underwriter’s spread and the administrative costs of the issue. It makes c