Question: Longs Drug, a large U.S. drugstore

> Plastico is considering a major change in its capital structure. It has three options: • Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it an AAA-rated firm (AAA rated debt is yielding 11% in the marke

> You are analyzing a new security that has been promoted as equity, with the following features: • The dividend on the security is fixed in dollar terms for the life of the security, which is 20 years. • The dividend is not tax-deductible. • In the case o

> You own a rental building in the city and are interested in replacing the heating system. You are faced with the following alternatives: a. A solar heating system, which will cost $12,000 to install and $500 a year to run and will last forever (assume th

> Consider again the project described in Problem 1 (assume that the depreciation reverts to a straight line). Assume that 40% of the initial investment for the project will be financed with debt, with an annual interest rate of 10% and a balloon payment o

> Biogen, a biotechnology firm, had a beta of 1.70 in 1995. It had no debt outstanding at the end of that year. a. Estimate the cost of equity for Biogen, if the Treasury bond rate is 6.4%. b. What effect will an increase in long-term bond rates to 7.5% ha

> The following table summarizes the annual returns you would have made on two companies—Scientific Atlanta, a satellite and data equipment manufacturer, and AT&T, the telecomm giant, from 1988 to 1998. a. Estimate the average and sta

> Stockholders can transfer wealth from bondholders through a variety of actions. How would the following actions by stockholders transfer wealth from bondholders? a. An increase in dividends b. A leveraged buyout c. Acquiring a risky business How would bo

> In December 1995, Boise Cascade’s stock had a beta of 0.95. The Treasury bill rate at the time was 5.8%, and the Treasury bond rate was 6.4%. The firm had debt out- standing of $1.7 billion and a market value of equity of $1.5 billion; the corporate marg

> Consolidated Power is a regulated electric utility that has equity with a market value of $1.5 billion and debt outstanding of $3 billion. A consultant notes that this is a high debt ratio relative to the average across all firms, which is 27%, and sugge

> Unitrode, which makes analog/linear integrated circuits for power management, is a firm that has not used debt in the financing of its projects. The managers of the firm contend that they do not borrow money because they want to maintain financial flexib

> XYZ Pharma is a pharmaceutical company that traditionally has not used debt to finance its projects. Over the past 10 years, it has also reported high returns on its projects and growth and made substantial research and development expenses over the time

> Handy and Harman, a leading fabricator of precious metal alloys, pays out only 23% of its earnings as dividends. The average dividend payout ratio for metal fabricating firms is 45%. The average growth rate in earnings for the entire sector is 10% (Handy

> Assume that personal investors pay a 40% tax rate on interest income and only a 20% tax rate on equity income. If the corporate tax rate is 30%, estimate whether debt has a tax benefit, relative to equity. If a firm with no debt and $100 million in marke

> You are analyzing the dividend policy of Black and Decker, a manufacturer of tools and appliances. The following table summarizes the dividend payout ratios, yields, and expected growth rates of other firms in the waste disposal business. a. Compare Blac

> Between 1988 and 2013, we saw an increase in the percentage of cash returned to stockholders in the form of dividends. Why?

> A firm that has no debt has a market value of $100 million and a cost of equity of 11%. In the Miller–Modigliani world. a. what happens to the value of the firm as the leverage is changed (assume no taxes)? b. what happens to the cost of capital as the l

> You are an institutional investor and have collected the following information on five maritime firms to assess their dividend policies The average risk-free rate during the period was 7%, and the average return on the market was 12%. a. Assess which of

> You are analyzing Tiffany’s, an upscale retailer, and find that the regression estimate of the firm’s beta is 0.75; the standard error for the beta estimate is 0.50. You also note that the average unlevered beta of comparable specialty retailing firms is

> How would your answers to the previous problem change if Manpower is in plans to pay off its outstanding debt of $100 million next year and become a debt-free company?

> Nadir, an unlevered firm, has expected earnings before interest and taxes of $2 million per year. Nadir’s tax rate is 40%, and the market value is V = E = $12 million. The stock has a beta of 1, and the risk-free rate is 9%. [Assume tha

> Assess the likelihood that the following firms will be taken over, based on your understanding of the free cash flow hypothesis. You can assume that earnings and free cash flows are highly correlated. a. A firm with high-growth prospects, good projects,

> The chief financial officer of Adobe Systems, a software manufacturing firm, has approached you for some advice regarding the beta of his company. He subscribes to a service that estimates Adobe System’s beta each year, and he has noticed that the beta e

> Manpower, which provides nongovernment employment services in the United States, reported net income of $128 million in 1995. It had capital expenditures of $50 million and depreciation of $24 million in 1995, and its working capital was $500 million (on

> XCV, Inc., which manufactures automobile parts for assembly, is considering the costs and the benefits of leverage. The CFO notes that the return on equity of the firm, which is only 12.75% now based on the current policy of no leverage, could be increas

> Southwestern Bell, a phone company, is considering expanding its operations into the media business. The beta for the company at the end of 1995 was 0.90, and the debt-to-equity ratio was 1. The media business is expected to be 30% of the overall firm va

> You are comparing the dividend policies of three dividend-paying utilities. You have collected the following information on the ex-dividend behavior of these firms. If you were a tax-exempt investor, which company would you use to make â€&#156

> Accounting rates of return are based on accounting income and book value of investment, whereas internal rates of return are based on cash flows and take into account the time value of money. Under what conditions will the two approaches give you similar

> Assume that Cracker Barrel, from Problem 20, wants to continue with its policy of not paying dividends. You are the CEO of Cracker Barrel and have been confronted by dissident stockholders, demanding to know why you are not paying out your FCFE (estimate

> 21. A small, private firm has approached you for advice on its capital structure decision. It is in the specialty retailing business, and it had an EBIT last year of $500,000. • The book value of equity is $1.5 million, but the estimated market value is

> Answer true or false to the following questions relating to the free cash flow hypothesis (as developed by Jensen). a. Companies with high operating earnings have high free cash flows. b. Companies with large capital expenditures relative to earnings hav

> You are an analyst for a sporting goods corporation that is considering a new project that will take advantage of excess capacity in an existing plant. The plant has a capacity to produce 50,000 tennis racquets, but only 25,000 are being produced current

> As the result of stockholder pressure, RJR Nabisco is considering spinning off its food division. You have been asked to estimate the beta for the division and decide to do so by obtaining the beta of comparable publicly traded firms. The average beta of

> You have been asked to analyze a project where the analyst has estimated the return on capital to be 37% over the ten-year lifetime of the project. The cost of capital is only 12%, but you have concerns about using the re- turn on capital as an investmen

> Time Warner is considering a sale of its publishing division. The division had earnings EBITDA of $550 million in the most recent year (depreciation was $150 million), growing at an estimated 5% a year (you can assume that depreciation grows at the same

> Cracker Barrel, which operates restaurants and gift stores, is reexamining its policy of paying minimal dividends. In 1995, Cracker Barrel reported net income of $66 million; it had capital expenditures of $150 million in that year and claimed depreciati

> NYNEX, the phone utility for the New York City area, has approached you for advice on its capital structure. In 1995, NYNEX had debt outstanding of $12.14 billion and equity outstanding of $20.55 billion. The firm had an EBIT of $1.7 billion and faced a

> MiniSink is a manufacturing company that has $100 million in debt outstanding and 9 million shares trading at $100 per share. The current beta is 1.10, and the interest rate on the debt is 8%. In the latest year, MiniSink reported a net income of $7.50 p

> WestingHome is a manufacturing company that has accumulated a net operating loss of $2 billion over time. It is considering borrowing $5 billion to acquire another company. a. Based on the corporate tax rate of 36%, estimate the present value of the tax

> Your company is considering producing a new product. You have a production facility that is currently used to only 50% of capacity, and you plan to use some of the excess capacity for the new product. The production facility cost $50 million 5 years ago

> You are trying to estimate the beta of a private firm that manufactures home appliances. You have managed to obtain betas for publicly traded firms that also manufacture home appliances. The private firm has a debt equity ratio of 25% and faces a tax rat

> You have been asked to assess whether Walgreen, a drugstore chain, is correctly priced relative to its competitors in the drugstore industry. The following are the price/sales ratios, profit margins, and other relative details of the firms in the drugsto

> Assume now that you have been asked to forecast cash flows that you will have available to repurchase stock and pay dividends during the next five years for Conrail (from Problem 18). In making these forecasts, you can assume the following: • Net income

> Intel has an EBIT of $3.4 billion and faces a marginal tax rate of 36.50%. It currently has $1.5 billion in debt out- standing, and a market value of equity of $51 billion. The beta for the stock is 1.35, and the pretax cost of debt is 6.80%. The Treasur

> A business in the 45% tax bracket is considering borrowing money at 10%. a. What is the after-tax interest rate on the debt? b. What is the after-tax interest rate if only half of the interest expense is allowed as a tax deduction? c. Would your answer c

> You are examining the viability of a capital investment in which your firm is interested. The project will require an initial investment of $500,000 and the projected revenues are $400,000 a year for five years. The projected cost-of-goods-sold is 40% of

> You are helping a manufacturing firm decide whether it should invest in a new plant. The initial investment is expected to be $50 million, and the plant is expected to generate after-tax cash flows of $5 million a year for the next twenty years. There wi

> Chrysler, the automotive manufacturer, had a beta of 1.05 in 1995. It had $13 billion in debt outstanding in that year and 355 million shares trading at $50 per share. The firm had a cash balance of $8 billion at the end of 1995. The marginal tax rate wa

> Now assume that Plastico is considering a project that re- quires an initial investment of $100 million and has the following projected income statement (depreciation for the project is expected to be $5 million a year forever): This project is going to

> Barring the case of multiple IRRs, is it possible for the NPV of a project to be positive while the IRR is less than the discount rate? Explain.

> You are analyzing the dividend policy of Conrail, a major railroad, and you have collected the following information from the past five years The average debt ratio during this period was 40%, and the total noncash working capital at the end of 1990 was

> You are trying to evaluate whether United Airlines (UAL) has any excess debt capacity. In 1995, UAL had 12.2 million shares outstanding at $210 per share and debt outstanding of approximately $3 billion (book as well as market value). The debt had a rati

> MVP, a manufacturing firm with no debt outstanding and a market value of $100 million, is considering borrowing $40 million and buying back stock. Assuming that the interest rate on the debt is 9% and that the firm faces a tax rate of 35%, answer the fol

> You run a financial service firm where you replace your employee’s computers every three years. You have 5,000 employees, and each computer costs $2,500 currently—the old computers can be sold for $500. The new computers are generally depreciated straigh

> You are trying to estimate the NPV of a three-year project, where the discount rate is expected to change over time. a. Estimate the NPV of this project. Would you take this project? b. Estimate the IRR of this project. How would you use the IRR to decid

> Time Warner, the entertainment conglomerate, has a beta of 1.61. Part of the reason for the high beta is the debt left over from the leveraged buyout of Time by Warner in 1989, which amounted to $10 billion in 1995. The market value of equity at Time War

> You are trying to estimate a price per share on an IPO of a company involved in environmental waste disposal. The company has a book value per share of $20 and earned $3.50 per share in the most recent time period. Although it does not pay dividends, the

> Z-Tec, a firm providing Internet services, reported net income of $10 million in the most recent year, while making $25 million in capital expenditures (depreciation was $5 million). The firm had no working capital needs and uses no debt. a. Can the firm

> A commodity bond links interest and principal payments to the price of a commodity. Differentiate a commodity bond from a straight bond and then from equity. How would you factor these differences into your analysis of the debt ratio of a company that ha

> In 1995, an analysis of the capital structure of Reebok provided the following results on the cost of capital and firm value. This analysis was based on the 1995 EBIT of $420 million and a tax rate of 36.90%. a. Why is the optimal debt ratio for Reebok s

> Assume that SmallTech has net income of $1 million and that the earnings will increase in proportion with the additional capital raised. a. Estimate the earning per share that SmallTech will have after the rights issue described in the last problem. b. A

> You are the manager of a grocery store, and you are considering offering baby-sitting services to your customers. You estimate that the licensing and set up costs will amount to $150,000 initially and that you will be spending about $60,000 annually to p

> The following equation is reproduced from the study by Fama and French of returns between 1963 and 1990. where MV is the market value of equity in hundreds of millions of dollar and BV is the book value of equity in hundreds of millions of dollars. The r

> NCH, which markets cleaning chemicals, insecticides, and other products, paid dividends of $2.00 per share on earnings of $4.00 per share. The book value of equity per share was $40.00, and earnings are expected to grow 5% a year in the long term. The st

> Boston Turkey is a publicly traded firm, with the following income statement and balance sheet from its most recent financial year: Boston Turkey expects its revenues to grow 10% next year and its expenses to remain at 40% of revenues. The depreciation a

> You have run a series of regressions of firm value changes at Motorola, the semiconductor company, against changes in a number of macroeconomic variables. The results are summarized here: Change in Firm Value = 0.05 − 3.87(Change in Long − Term Interest

> Kansas City Southern, a railroad company, had debt out- standing of $985 million and 40 million shares trading at $46.25 per share in March 1995. It earned $203 million in EBIT, and faced a marginal tax rate of 36.56%. The firm was interested in estimati

> You are analyzing a project with a thirty-year lifetime, with the following characteristics: • The project will require an initial investment of $20 million and additional investments of $5 million in year 10 and $5 million in year20. • The project will

> You have just run a regression of monthly returns on MAD, a newspaper and magazine publisher, against returns on the S&P 500, and arrived at the following result: The regression has an R 2 of 22%. The current Treasure bill rate is 5.5% and the curren

> A closely held, publicly traded firm faces self-imposed capital rationing constraints of $100 million in this period and $75 million in the next period. It has to choose among the following projects (in millions): Set up the linear programming problem, a

> One of the arguments made for having legislation restricting hostile takeovers is that unscrupulous speculators may take over well-run firms and destroy them for personal gain. Allowing for the possibility that this could happen, do you think that this i

> You are analyzing an investment decision, in which you will have to make an initial investment of $10 million and you will be generating annual cash flows to the firm of$2 million every year, growing at 5% a year, forever. a. Estimate the NPV of this pro

> The following were the P/E ratios of firms in the aerospace/defense industry with additional data on expected growth and risk: a. Estimate the average and median P/E ratios. What, if anything, would these averages tell you? b. An analyst concludes that T

> NoLone, an all-equity manufacturing firm, has net in- come of $100 million currently and expects this number to grow at 10% a year for the next three years. The firm’s working capital increased by $10 million this year and is expected to increase by the

> The following table summarizes the results of regressing changes in firm value against changes in interest rates for six major footwear companies: Change in Firm Value = a + b(Change in Long − Term Interest Rates) a. How would you use t

> Bethlehem Steel, one of the oldest and largest steel companies in the United States, is considering the question of whether it has any excess debt capacity. The firm has $527 million in market value of debt outstanding and $1.76 billion in market value o

> You have been asked for advice on a rights offering by a firm with 10 million shares outstanding trading at $50 per share. The firm needs to raise $100 million in new equity. Assuming that the rights subscription price is $25, answer the following questi

> You work for a firm that has limited access to capital markets. As a consequence, it has only $20 million available for new investments this year. The firm does have a ready supply of good projects, and you have listed all the projects. a. Based on the p

> You have run a regression of monthly returns on Amgen, a large biotechnology firm, against monthly returns on the S&P 500 Index, and come up with the following output: The current one-year Treasury bill rate is 4.8% and the current thirty-year bond r

> Societies attempt to keep private interests in line by legislating against behavior that might create social costs (such as polluting the water). If the legislation is comprehensive enough, does the problem of social costs cease to exist? Why or why not?

> Now assume that the facts in Problem 1 remain unchanged except for the depreciation method, which is switched to an accelerated method with the following depreciation schedule: Depreciable asset = Initial investment − Salvage value a. E

> LimeAde, a large soft drink manufacturing firm, is faced with the decision of how much to pay out as dividends to its stockholders. It expects to have a net income of $1,000 (after depreciation of $500), and it has the following projects: The firmâ

> Railroad companies in the United States tend to have long-term, fixed rate, dollar denominated debt. Explain why.

> Upjohn, another major pharmaceutical company, is also considering whether it should borrow more. It has $664 million in book value of debt outstanding and 173 million shares outstanding at $30.75 per share. The company has a beta of 1.17, and faces a tax

> You are the owner of a small and successful firm with an estimated market value of $50 million. You are considering going public. a. What are the considerations you would have in choosing an investment banker? b. You want to raise $20 million in new fina

> You are the manager of a specialty retailing firm that is considering two strategies for getting into the Malaysian retail market. Under the first strategy, the firm will make an initial investment of $10 million and can expect to capture about 5% of the

> You have to pick between three mutually exclusive projects with the following cash flows to the firm: The cost of capital is 12%. a. Which project would you pick using the NPV rule? b. Which project would you pick using the IRR rule? c. How would you exp

> You have just run a regression of monthly returns of American Airlines (AMR) against the S&P 500 over the past five years. You have misplaced some of the output and are trying to derive it from what you have. a. You know the R2 of the regression is 0.36,

> You are using the arbitrage pricing model to estimate the expected return on Bethlehem Steel and have derived the following estimates for the factor betas and risk premia: a. Which risk factor is Bethlehem Steel most exposed to? Is there any way, within

> You run a regression of monthly returns of Mapco, an oil- and gas-producing firm, on the S&P 500 Index and come up with the following output for the period 1991–1995. Intercept of the regression = 0.06% X-coefficient of the regression = 0.46 Standard err

> It has been argued by some that convertible bonds (i.e., bonds that are convertible into stock at the option of the bondholders) provide one form of protection against expropriation by stockholders. On what is this argument based?

> Boise Cascade also had debt outstanding of $1.7 billion and a market value of equity of $1.5 billion; the corporate marginal tax rate was 36%. a. Assuming that the current beta of 0.95 for the stock is a reasonable one, estimate the unlevered beta for th

> Businesses with severe capital rationing constraints should use IRR more than NPV. Do you agree? Explain.

> You have been asked to value Office Help, a private firm providing office support services in the New York area. The firm reported pretax operating income of $10 million in its most recent financial year on revenues of $100 million. In the most recent fi

> InTech, a computer software firm that has never paid dividends before, is considering whether it should start doing so. This firm has a cost of equity of 22% and a cost of debt of 10% (the tax rate is 40%). The firm has $100 million in debt outstanding a

> You are trying to decide whether the debt structure that Bethlehem Steel has currently is appropriate, given its assets. You regress the changes in firm value against changes in interest rates and arrive at the following equation Change in Firm Value = 0

> Pfizer, one of the largest pharmaceutical companies in the United States, is considering what its debt capacity is. In March 1995, Pfizer had an outstanding market value of equity of $24.27 billion, debt of $2.8 billion, and an AAA rating. Its beta was 1

> IPOs are difficult to value because firms going public tend to be small, and little information is available about them. Investment bankers have to underprice IPOs because they bear substantial pricing risk. Do you agree with this statement? How would yo

> You are the supervisor of a town where the roads are in need of repair. You have a limited budget and are considering two options: • You can patch up the roads for $100,000, but you will have to repeat this expenditure every year to keep the roads in rea

> Assume that you are advising a Turkish firm on corporate financial questions and that you do not believe that the Turkish stock market is efficient. Would you recommend stock price maximization as the objective? If not, what would you recommend?

> You have a project that does not require an initial in- vestment but has its expenses spread over the life of the project. Can the IRR be estimated for this project? Why or why not?