Question: In general, does the market view the

> What are some differences in the analysis for a replacement project versus that for a new expansion project?

> What is the possible agency conflict between inside owner/managers and outside shareholders?

> Burnwood Tech plans to issue some $60 par preferred stock with a 6% dividend. A similar stock is selling on the market for $70. Burnwood must pay flotation costs of 5% of the issue price. What is the cost of the preferred stock?

> Refer to Problem 9-1. Return to the assumption that the company had $5 million in assets at the end of 2015, but now assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year? Why is

> Refer to Problem 9-1. What would be the additional funds needed if the company’s year-end 2015 assets had been $7 million? Assume that all other numbers, including sales, are the same as in Problem 9-1 and that the company is operating at full capacity.

> Refer to Problem 12-1. What is the project’s IRR? Data from Problem 12-1: A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%.

> A project has an initial cost of $40,000, expected net cash inflows of $9,000 per year for 7 years, and a cost of capital of 11%. What is the project’s NPV? (Hint: Begin by constructing a time line.)

> Suppose a company will issue new 20-year debt with a par value of $1,000 and a coupon rate of 9%, paid annually. The tax rate is 40%. If the flotation cost is 2% of the issue proceeds, then what is the after-tax cost of debt? Disregard the tax shield fro

> Messman Manufacturing will issue common stock to the public for $30. The expected dividend and the growth in dividends are $3.00 per share and 5%, respectively. If the flotation cost is 10% of the issue’s gross proceeds, what is the cost of external equi

> After discovering a new gold vein in the Colorado mountains, CTC Mining Corporation must decide whether to go ahead and develop the deposit. The most cost-effective method of mining gold is sulfuric acid extraction, a process that could result in environ

> Duggins Veterinary Supplies can issue perpetual preferred stock at a price of $50 a share with an annual dividend of $4.50 a share. Ignoring flotation costs, what is the company’s cost of preferred stock, rps?

> LL Incorporated’s currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL’s after-tax cost of debt?

> Most firms generate cash inflows every day, not just once at the end of the year. In capital budgeting, should we recognize this fact by estimating daily project cash flows and then using them in the analysis? If we do not, will this bias our results? If

> Fauver Enterprises declared a 3-for-1 stock split last year, and this year its dividend is $1.50 per share. This total dividend payout represents a 6% increase over last year’s pre-split total dividend payout. What was last year’s dividend per share?

> Suppose you own 2,000 common shares of Laurence Incorporated. The EPS is $10.00, the DPS is $3.00, and the stock sells for $80 per share. Laurence announces a 2-for-1 split. Immediately after the split, how many shares will you have, what will the adjust

> Gardial GreenLights, a manufacturer of energy-efficient lighting solutions, has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $15 million investment in new machinery. Gardial plans to

> JPix management is considering a stock split. JPix currently sells for $120 per share and a 3-for-2 stock split is contemplated. What will be the company’s stock price following the stock split, assuming that the split has no effect on the total market v

> A firm has 10 million shares outstanding with a market price of $20 per share. The firm has $25 million in extra cash (short-term investments) that it plans to use in a stock repurchase; the firm has no other financial investments or any debt. What is th

> The Wei Corporation expects next year’s net income to be $15 million. The firm’s debt ratio is currently 40%. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distrib

> sPetersen Company has a capital budget of $1.2 million. The company wants to maintain a target capital structure which is 60% debt and 40% equity. The company forecasts that its net income this year will be $600,000. If the company follows a residual dis

> If a company has an option to abandon a project, would this tend to make the company more or less likely to accept the project today?

> In general, do timing options make it more or less likely that a project will be accepted today?

> What factors should a company consider when it decides whether to invest in a project today or to wait until more information becomes available?

> How do simulation analysis and scenario analysis differ in the way they treat very bad and very good outcomes? What does this imply about using each technique to evaluate project riskiness?

> Why are interest charges not deducted when a project’s cash flows are calculated for use in a capital budgeting analysis?

> Why is it true, in general, that a failure to adjust expected cash flows for expected inflation biases the calculated NPV downward?

> Suppose a firm is considering two mutually exclusive projects. One has a life of 6 years and the other a life of 10 years. Would the failure to employ some type of replacement chain analysis bias an NPV analysis against one of the projects? Explain.

> When two mutually exclusive projects are being compared, explain why the short-term project might be ranked higher under the NPV criterion if the cost of capital is high, whereas the long-term project might be deemed better if the cost of capital is low.

> Explain why the NPV of a relatively long-term project, defined as one for which a high percentage of its cash flows are expected in the distant future, is more sensitive to changes in the cost of capital than is the NPV of a short-term project.

> What types of projects require the least detailed and the most detailed analysis in the capital budgeting process?

> What are some actions an entrenched management might take that would harm shareholders?

> Suppose a firm makes the policy changes listed below. If a change means that external, nonspontaneous financial requirements (AFN) will increase, indicate this by a (+); indicate a decrease by a (()( and indicate no effect or an indeterminate effect by a

> How is it possible for an employee stock option to be valuable even if the firm’s stock price fails to meet shareholders’ expectations?

> Name five key factors that affect a firm’s external financing requirements.

> Explain how net operating working capital is recovered at the end of a project’s life and why it is included in a capital budgeting analysis.

> How can the WACC be both an average cost and a marginal cost?

> Some liability and net worth items increase spontaneously with increases in sales. Put a check (✓) by those items listed below that typically increase Spontaneously: Accounts payable __________ Mortgage bonds __________ Notes payable to banks __________

> Calculate the after-tax cost of debt under each of the following conditions: a. rd of 13%, tax rate of 0% b. rd of 13%, tax rate of 20% c. rd of 13%, tax rate of 35%

> What is capital rationing, what conditions lead to it, and how should it be dealt with?

> What is a post-audit, and what is the purpose of this audit?

> What is the unequal life problem, under what conditions is it relevant, and how should it be dealt with?

> Under what conditions might you find more than one IRR for a project? How would you decide whether or not to accept the project? If you were comparing two mutually exclusive projects, one with a single IRR of 12% and the other with two different IRRs of

> If management’s goal is to maximize shareholder wealth, should it focus on the regular IRR or the MIRR? Explain your answer

> Why do conflicts sometimes arise between the net present value (NPV) and internal rate of return (IRR) methods; that is, what conditions can lead to conflicts? Can similar conflicts arise between modified internal rate of return (MIRR) and NPV rankings,

> Describe the six primary capital budgeting decision criteria. What are their pros and cons, and how are they related to maximizing shareholder wealth? Should managers use just one criterion, or are there good reasons for using two or more criteria in the

> Explain why sunk costs should not be included in a capital budgeting analysis but opportunity costs and externalities should be included.

> What would you expect to happen to an all-equity firm’s stock price if its management announced a recapitalization under which debt would be issued and used to repurchase common stock?

> Should firms focus on book value or market value capital structures? How would the calculated WACC be affected by the use of book weights rather than market weights?

> What does it mean to be at the optimal capital structure? What is optimized? What is maximized and what is minimized?

> What is the trade-off theory of capital structure? How does it differ from MM’s theory?

> Does the MM theory appear to be correct according to either empirical research or observations of firms’ actual behavior? How do assumptions affect your conclusion about whether the MM theory appears to be correct?

> Who are Modigliani and Miller (MM), and what were their conclusions regarding the effect of capital structure on a firm’s value and cost of capital under the assumption of no corporate taxes? How do their conclusions change when they introduce corporate

> What is financial risk? How is it related to business risk?

> What is business risk? List and then discuss some factors that affect business risk.

> In 2003, President Bush proposed a change in the tax law that would have eliminated the tax on dividends received by stockholders. The same proposal also would have increased the basis of stocks by the amount of new retained earnings per share—in effect

> Operating cash flows, rather than accounting profits, are used in project analysis. What is the basis for this emphasis on cash flows as opposed to net income?

> What is a stock split? As an investor, would you like to see shares you own be split?

> If a company is thinking about distributing excess cash through a stock repurchase program in lieu of continuing to pay regular cash dividends, what are some factors it should consider before making the change?

> Describe the residual dividend model. Explain how it operates and how firms use it in practice. In your answer, discuss any influences signaling and the clientele effect might have on a firm’s decision to use, not use, or modify this model.

> How should (a) signaling and (b) the clientele effect be taken into account by a firm as it considers its dividend decision? Do signaling and clientele effects make it easier or harder to determine if investors prefer high or low payout ratios? Do thes

> Describe the three theories that have been advanced regarding whether investors in the aggregate tend to favor high or low dividend payout ratios. What results were reached from empirical tests of these theories?

> In your judgment, what are some characteristics of the type of investor who would likely prefer a high dividend payout, and what are some characteristics of one who would prefer a low payout? Would you personally prefer to own a stock with a high or a lo

> Good managers not only identify and evaluate real options in projects—they also structure projects so as to create real options. Suppose a company is considering a project to build an electric generating plant. Name some real options that might be built

> Suppose a company uses the NPV method, along with risk-adjusted WACCs, to calculate project NPVs. However, it has not been considering real options in its capital budgeting decisions. Now suppose the company changes its capital budgeting process to take

> Option values are extinguished when they are exercised. How does this influence capital budgeting decisions? What considerations, or types of analysis, might lead management to “take the plunge” and proceed with a project rather than keep delaying it?

> Real options can be analyzed using a scenario approach with decision trees or using the Black-Scholes Option Pricing Model. What are the pros and cons of the two approaches? Is one procedure “better” than the other?

> In theory, market risk should be the only “relevant” risk. However, companies focus as much on stand-alone risk as on market risk. What are the reasons for the focus on stand-alone risk?

> What’s the difference between a financial option and a real option? What are some specific types of real options? Do real options just occur, or can they be “created”?

> What are real options, and why are they important to capital budgeting?

> Discuss some ways the company could estimate the project’s risk, and then explain how risk might be incorporated into the decision analysis.

> If the company’s capital budgeting analyst decided to show all projected cash flows, both positive and negative, in current dollars rather than inflation-adjusted dollars, would this affect the calculated NPV?

> If Congress shortened depreciation lives for tax purposes, how would this affect the energy project’s NPV, assuming nothing else changes?

> Define (a) externalities and (b) sunk costs, and then give examples of each that might be involved in a proposal by an energy company to build a new coal-fired electric power generating unit. How would these factors be worked into the analysis?

> How do project cash flows as calculated in this chapter affect a firm’s corporate free cash flows as defined in Chapter 6 and then used in Chapter 9 to calculate a firm’s value? How does a proposed project’s estimated NPV affect the value of the firm?

> At any one time, should the same WACC be used to evaluate each of a company’s capital budgeting projects? If not, how should the WACC be adjusted for the different projects?

> For a given firm, why does WACC change over time? Can the firm control the factors that lead to changes in the WACC and thus determine its WACC?

> How do flotation costs affect the cost of capital? Are these costs about the same for each of the three capital components? How do they change as the firm raises larger and larger amounts of capital, and how do flotation costs affect the way a company ra

> Distinguish among beta (or market) risk, within-firm (or corporate) risk, and stand-alone risk for a project being considered for inclusion in a firm’s capital budget.

> Describe each of the following methods for estimating the cost of equity: (a) the CAPM, (b) DCF, and (c) the bond-yield-plus-risk-premium. Where can you obtain inputs for each of these methods, and how accurate are estimates based on each procedure? C

> What weights should be used when you calculate the WACC? Discuss the choice between book value and market value weights, and the role of the “target” capital structure for a firm whose actual capital structure is far removed from the target.

> What are the main components of a company’s cost of capital? Rank these components from lowest to highest cost (a) on a before-tax and (b) on an after-tax cost basis, and explain why these differences exist.

> How have events such as the accounting frauds at AIG, Enron, WorldCom, and several other companies affected people’s ideas about corporate governance, the government’s role in corporate governance, and the use of options for management compensation?

> What are some of the pros and cons of using stock options to compensate managers?

> Managers of corporations don’t always take actions that are in the best interest of the corporation’s owners. What are some of those actions, and how can corporations structure the management contract to help control them?

> What is an agent and what is a principal? What kinds of situations in companies give rise to conflicts between these two, called agency conflicts?

> The funds requirement can be forecasted by the forecasted financial statement approach, but you could also use the AFN formula. What is this formula, and how does it operate? What are its advantages and disadvantages relative to the financial statement m

> Define the following terms and then explain the role they might play in your forecast. (a) Economies of scale. (b) Lumpy assets. (c) Excess capacity.

> Why is corporate governance important to investors? Explain how each of the following is related to corporate governance: (a) management entrenchment, (b) hostile takeovers, (c) incentive compensation plans, (d) greenmail, (e) poison pills, (f) str

> Define each of the following terms: a. Project cash flow; accounting income b. Incremental cash flow; sunk cost; opportunity cost; externality; cannibalization; expansion project; replacement project c. Net operating working capital changes; salvage valu

> A major component of financial planning is to forecast future financial statements. If you had a company’s balance sheets and income statements for the past 5 years but no other information, how could you use the forecasted financial statement approach t

> List and discuss briefly the major components of a firm’s financial plan. What role do projections of financial statements play in the development of the financial plan?

> The Yoran Yacht Company (YYC), a prominent sailboat builder in Newport, may design a new 30-foot sailboat based on the “winged” keels first introduced on the 12-meter yachts that raced for the America’s Cup. First, YYC would have to invest $10,000 at t

> Singleton Supplies Corporation (SSC) manufactures medical products for hospitals, clinics, and nursing homes. SSC may introduce a new type of X-ray scanner designed to identify certain types of cancers in their early stages. There are a number of uncerta

> The Bartram-Pulley Company (BPC) must decide between two mutually exclusive investment projects. Each project costs $6,750 and has an expected life of 3 years. Annual net cash flows from each project begin 1 year after the initial investment is made and

> DeYoung Entertainment Enterprises is considering replacing the latex molding machine it uses to fabricate rubber chickens with a newer, more efficient model. The old machine has a book value of $450,000 and a remaining useful life of 5 years. The current

> The Everly Equipment Company’s flange-lipping machine was purchased 5 years ago for $55,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $5,500 per year for each year of its remaining life. As older flange-lip

> Madison Manufacturing is considering a new machine that costs $350,000 and would reduce pre-tax manufacturing costs by $110,000 annually. Madison would use the 3-year MACRS method to depreciate the machine, and management thinks the machine would have a

> Shao Industries is considering a proposed project for its capital budget. The company estimates the project’s NPV is $12 million. This estimate assumes that the economy and market conditions will be average over the next few years. The

> Define each of the following terms: a. Capital budgeting; regular payback period; discounted payback period b. Independent projects; mutually exclusive projects c. DCF techniques; net present value (NPV) method; internal rate of return (IRR) method; prof

> St. Johns River Shipyard’s welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. A new welder will cost $182,5