Question: In Regardless of Your Major: Capital Structure

> Traid Winds Corporation, a firm in the 34 percent marginal tax bracket with a 15 percent required rate of return or discount rate, is considering a new project that involves the introduction of a new product. This project is expected to last five years,

> In the chapter introduction, we noted that computer company Dell is an industry leader in its working-capital management practices. Describe how the firm came to have this reputation.

> What would be the probable effect of each of the following on a firm’s cash position? a. A new advertising campaign that results in more rapidly rising sales. b. A delay in the payment of the firm’s accounts payable. c. A decision to offer a more liberal

> Compare and contrast discretionary and spontaneous sources of short-term financing.

> Distinguish among the three components of a firm’s overall planning process: the short-term operating financial plan, the long-term operating financial plan, and the strategic plan.

> Describe the percent-of-sales method of financial forecasting.

> Forecasting a firm’s future sales is the key element in developing a financial plan, yet forecasting can be extremely difficult in some industries. If forecast accuracy is very poor, does this mean that the financial planning process is not worthwhile? E

> What is the primary objective of the financial planning process?

> In Regardless of Your Major: Financial Planning Engages Everyone on page 554, we learned that financial planning engages everyone throughout the organization. How do marketing and accounting specialists contribute to the financial planning process?

> Cousin Harold runs a pharmacy but likes to dabble in common stock investing as a hobby. One day last week he called you to find out what had happened to his portfolio because one of the stocks he owns had announced the decision to repurchase 10 percent o

> In Finance for Life: The Importance of Dividends on page 541, we learned about the importance of dividend reinvestment to creating personal wealth through investing in stocks. Many companies now offer dividend reinvestment plans. What are these plans, a

> Garcia’s Truckin’, Inc., is considering the purchase of a new production machine for $200,000. The purchase of this machine would result in an increase in earnings before interest and taxes of $50,000 per year. To operate this machine properly, workers w

> Describe the dividend distribution process, including the importance of the declaration date, date of record, and ex-dividend date.

> Your Aunt Mary recently called to ask you about a letter she had just received from her stockbroker. She said that the letter notified her that one of the stocks she owns will be paying a 10 percent stock dividend, so her 100 shares will now be 110 share

> What is a stock dividend, and how is it similar to a stock split?

> A firm’s dividend policy is generally characterized in terms of two attributes. Explain each.

> Explain what a firm’s dividend policy is as if you were talking to your grandmother, who has had no formal education in business.

> In Regardless of Your Major: Firms Almost Never Decrease Their Dividend on page 528, we learned that firms try to sustain their dividend payout even during economic downturns. Use the internet to determine what Royal Dutch Shell did with respect to its

> What is the current U.S. tax policy with regard to the taxation of dividend income and capital gains income resulting from a share repurchase? If the individual stockholder could choose whether to receive a cash dividend or to have the firm engage in a s

> Your Uncle Bob has no formal education in business or finance but has been investing in the stock market for many years. At a recent family reunion, Uncle Bob told you that he liked to invest in stocks with a very long history of paying cash dividends. D

> Under what conditions is the firm’s dividend policy not important to its investors?

> Why is a stable dividend payout policy popular from the viewpoint of the corporation? Is it also popular with investors? Why?

> Raymobile Motors is considering the purchase of a new production machine for $500,000. The purchase of this machine would result in an increase in earnings before interest and taxes of $150,000 per year. To operate this machine properly, workers would ha

> In the introduction, we pointed out that Emerson Electric Co. (EMR) had paid cash dividends for 53 consecutive years. Look up the company’s cash dividend for the most recent year. What is the dividend for that year?

> Describe why capital structure is relevant to the value of the firm. Discuss the potential violations of both of the basic assumptions that support the M&M capital structure theory.

> Under the conditions of the M&M capital structure theory, the firm’s financing decisions do not have an impact on firm value. When this theory holds (i.e., is true), how do the firm’s financing decisions affect the firm’s weighted average cost of capital

> What does Figure 15.2 have to say about the impact of a firm’s financing decisions on firm cash flows? Figure 15.2: Debt or bonds 20% or $100,000 Debt or bonds 40% or Equity or Total cash flows are $200,000 common stock the same,

> What are the two fundamental assumptions that are used to support the M&M capital structure theory? Describe each in commonsense terms.

> What is the significance of the notion that a firm’s financing decisions are irrelevant? What does this mean to the financial manager?

> What is financial leverage? What is meant by the use of the terms favorable and unfavorable with regard to financial leverage?

> What are non-interest-bearing liabilities? Give some examples. Why are non- interest-bearing liabilities not included in the firm’s capital structure?

> The tax implications of leasing versus buying a piece of equipment can sometimes favor leasing and at other times favor buying. Explain.

> Use Figure 15-9 to describe potential differences between leasing a piece of equipment with a capital lease and purchasing the equipment using a bank loan. Figure 15-9: Вuying Leasing Capital Markets (c.g., commercial banks and insurance companies)

> Landcruisers Plus (LP) has operated an online retail store selling off-road truck parts. As the name implies, the firm specializes in parts for the venerable Toyota FJ40, which is known throughout the world for its durability and off-road prowess. The fa

> In Finance in a Flat World: Capital Structures Around the World on page 510, we learned that capital structures differ dramatically in different countries around the world. What are some possible causes for the observed differences?

> A firm is considering replacing its current production facility with a new robotics production facility. As a result of this move, the firm’s fixed costs will increase dramatically. To finance this new project, the firm is considering either issuing comm

> What is financial flexibility, and why is it an important consideration when evaluating a financing decision?

> How does a firm’s financial structure differ from its capital structure?

> Do you think firms with stable income streams should use higher or lower levels of debt in their capital structures? Why?

> Explain how industry norms might be used by the financial manager in the design of the company’s financing mix

> The Ballard Corporation is considering adding more debt to its capital structure and has asked you to provide it with some guidance. After looking at future levels of Ballard’s EBIT, you feel very confident that in the future it will consistently be abov

> What is EBIT-EPS analysis, and how is it used in making financing decisions?

> Describe how each of the four financial ratios found in is used to help managers make financing decisions.

> What does the term benchmarking mean with respect to making financing decisions?

> Weir’s Trucking, Inc., is considering the purchase of a new production machine for $100,000. The purchase of this new machine would result in an increase in earnings before interest and taxes of $25,000 per year. To operate this machine properly, workers

> What are agency costs, and how do they become a relevant consideration in determining a firm’s capital structure?

> How does the presence of financial distress costs, combined with the tax deductibility of interest (and the resulting interest tax savings), affect a firm’s weighted average cost of capital as the firm increases its use of debt financing from no debt to

> What are financial distress costs, and how are they related to the firm’s financing decisions?

> What are interest tax savings, and how do they affect the relevance of a firm’s financing decisions?

> In the chapter introduction, we discussed the Starbucks (SBUX) acquisition of Seattle’s Best Coffee Company in 2003. Discuss the relevance of Seattle’s Best’s WACC as the opportunity cost of funds that should be used in valuing the acquisition. What if S

> The financial crisis of 2007–2009 and the ensuing attempts by the Federal Reserve to stave off a deepening recession affected the cost of capital for all firms. Specifically, although very short-term Treasury bill rates were driven to near zero as invest

> Companies that face large investments that they cannot finance internally through the retention of earnings must go to the financial markets to raise the needed funds. When they do this, they will incur what are commonly referred to as flotation costs. D

> Divisional WACCs are the most popular method used in practice to risk adjust the cost of capital. Describe how you might go about estimating divisional WACCs. What are the pros and cons of using divisional WACCs?

> What are the pros and cons of using risk-adjusted costs of capital for individual investments?

> Marlin Manufacturing is considering whether to add new capacity to its production line with the addition of a $1 million assembly center. This purchase would result in an increase in earnings before interest and taxes of $400,000 per year. It would cost

> Looking back at Regardless of Your Major: Understanding the Role of the Cost of Capital on page 446, what should be the opportunity cost of funds in valuing the cash flows from the ownership of a McDonald’s franchise? How would you respond to your friend

> What are the basic sources of financing included in a firm’s capital structure? Specifically, what financing sources are excluded from the firm’s capital structure when calculating firm WACC?

> Describe the three-step process for estimating WACC.

> Figure 14.3 contains average yields to maturity for corporate bonds of differing maturities and default ratings. The yields are based on spreads to Treasury securities. Using the figure, what is the spread to Treasury for an A-rated corporate bond with a

> Explain the rationale given for the differences we observe in interest rates among countries discussed in Finance in a Flat World: Why Do Interest Rates Differ Among Countries? on page 468.

> What is a firm’s WACC?

> List and describe the types of real options often encountered in investment opportunities. Why is it important to identify real options as part of the risk analysis of new investments?

> What is the difference between accounting break-even and NPV break-even? Which will offer the higher break-even level of output, and why?

> Describe each of the five steps involved in carrying out a simulation analysis to assess project risk.

> Finance in a Flat World: Currency Risk on page 422 discussed the currency risk that multinational firms face. Between July 2008 and December 2009, the value of the yen relative to the U.S. dollar went up by about 17 percent, and as a result, when compani

> The Guo Chemical Corporation is considering the purchase of a chemical analysis machine. The purchase of this machine will result in an increase in earnings before interest and taxes of $70,000 per year. The machine has a purchase price of $250,000, and

> OTR Trucking runs a fleet of long-haul trucks and has recently expanded into the Midwest, where it has decided to build a maintenance facility. This project will require an initial cash outlay of $20 million and will generate annual cash inflows of $4.5

> How do you perform a sensitivity analysis of an investment proposal, and what is its purpose? Contrast the use of scenario analysis with that of simulation analysis.

> What is the objective of project risk analysis, and why is it critical to the investment decision-making process?

> Regardless of Your Major: Project Risk for Entrepreneurs on page 410 discussed the risks that entrepreneurs face, with about 40 percent of new businesses shutting their doors during their first year. If you had to pick a business to start, what would it

> What are sunk costs, and how should they be considered when evaluating an investment’s cash flows?

> Describe net operating working capital, and explain how changes in this quantity affect an investment proposal’s cash flows.

> If depreciation is not a cash flow item, why does it affect the level of cash flows from a project?

> Discuss how free cash flow differs from a firm’s operating cash flow.

> When a firm finances a new investment, it often borrows part of the money, so the interest and principal payments this creates are incremental to the project’s acceptance. Why are these expenditures not included in the project’s cash flow computation?

> New investments often require that the firm invest additional money in working capital. Give some examples of what this means.

> Corporate overhead expenses related to utilities and other corporate expenses are generally not relevant to the analysis of new investment opportunities. Why?

> You are considering adding new elliptical trainers to your firm’s product line of fitness equipment, and you feel you can sell 5,000 of these per year for five years (after which time this project is expected to shut down when it is learned that being fi

> In Regardless of Your Major: The Internet on Airline Flights—Making It Happen on page 374, we described an investment proposal involving the sale of internet services on airlines. How would you approach the problem of calculating the cash flows for such

> Throughout the examples in this chapter, we have assumed that the initial investment in working capital is later recaptured when the project ends. Is this a realistic assumption? Do firms always recover 100 percent of their investment in accounts receiva

> For years, GM treated each car brand as if it were a separate company, considering all new car sales as incremental sales. Critically evaluate this position.

> In Finance in a Flat World: Entering New Markets on page 390, we described the importance of thinking globally when making investments. Pick a new product that you have just learned about that is being sold domestically, and describe how the product migh

> When McDonald’s moved into India, it faced a particularly difficult task. The major religion in India is the Hindu religion, and Hindus don’t eat beef—in fact, most of the 1 billion people living in India are vegetarians. Still, McDonald’s ventured into

> Should anticipated inflation be incorporated into project cash flow forecasts? If so, how?

> What are opportunity costs, and how should they affect an investment’s cash flows? Give an example.

> Should overhead expense ever be considered when evaluating investment cash flows?

> As you saw in the introduction, the Toyota Prius took some of its sales away from other Toyota products. Toyota has also licensed its hybrid technology to Ford Motor Company, which allowed Ford to introduce a Ford Fusion hybrid in 2010 that traveled 39 m

> The opening vignette on page 301 described Google first going public in 2004. Prior to going public, did Google’s stock have a market price? What principles would go into determining the value of a company that hadn’t gone public yet?

> As part of its planning for the coming Christmas season, Criswell Motorsports is considering whether to expand its product line that currently consists of skateboards to include gaspowered skateboards. The company feels it can sell 2,000 of these per yea

> The market’s required yield on preferred stock is actually a promised rate of return. Explain this statement.

> Compare the methods for valuing preferred stock and common stock.

> In Finance for Life: Herd Mentality on page 303, we learned that it is common for investors to follow the investment lead of others. If they are all investing in dotcom firms or biotech firms, you might be swayed to jump on the bandwagon and do the same.

> Why would a preferred stockholder want to have the cumulative dividend feature?

> Because preferred stock dividends must be paid before common stock dividends, should preferred stock be considered a liability and appear on the right side of the balance sheet alongside of the firm’s long-term debt?

> Why is preferred stock referred to as a hybrid security?

> Regardless of Your Major: Getting Your Fair Share on page 302 focuses on the valuation of a new business venture. If you were faced with the need to value this business, what would you want to know about the business?

> What is the difference between the expected return and the promised or contractual yield to maturity on a bond?

> Distinguish among a bond’s coupon interest rate, current yield, and yield to maturity.

> Why does a bond’s par or face value differ from its market value?

> The Heritage Farm Implement Company is considering an investment that is expected to generate revenues of $3 million per year. The project will also involve annual cash expenses (including both fixed and variable costs) of $900,000, while increasing depr