Question: Nadir, an unlevered firm, has expected earnings

> Assume now that you have uncovered the following facts about the types of projects STL takes: • The projects are primarily infrastructure projects, requiring large initial investments and long gestation periods. • Most of the new projects will be in emer

> You have been hired as a management consultant by AD Corporation to evaluate whether it has an appropriate amount of debt (the company is worried about a leveraged buyout). You have collected the following information on AD’s current po

> You have been asked to estimate the debt ratio for a firm with the following financing details: • The firm has two classes of shares outstanding: 50,000 shares of class A stock, with 2 voting rights per share, trading at $100 per share, and 100,000 share

> You have been hired as a capital budgeting analyst by a sporting goods firm that manufactures athletic shoes and has captured 10% of the overall shoe market (the total market is worth $100 million a year). The fixed costs associated with manufacturing th

> An income bondholder receives interest payments only if the firm makes income. If the firm does not make interest payments in a year, the interest is cumulated and paid in the first year the firm makes income. A preferred stock receives preferred dividen

> You are provided with the projected income statements for a project: • The tax rate is 40%. • The project required an initial investment of $15,000and an additional investment of $2,000 at the end of year 2. â&#1

> Assume that you have half of your money invested in Times Mirror, the media company, and the other half invested in Unilever, the consumer product giant. The expected returns and standard deviations on the two investments are summarized below: Estimate t

> You are interested in creating a portfolio of two stocks—Coca Cola and Texas Utilities. Over the last decade, an investment in Coca Cola stock would have earned an average annual return of 25%, with a standard deviation in returns of 36%. An investment i

> There are some corporate strategists who have suggested that firms focus on maximizing market share rather than market prices. When might this strategy work, and when might it fail?

> How would your answers to the last two questions change if you were told that Lube Oil started the year with $120 million in debt and ended the year with $135 million?

> UJ Gas is a utility that has followed a policy of increasing dividends every quarter by 5% over dividends in the prior year. The company announces that it will increase quarterly dividends from $1.00 to $1.02 next quarter. What price reaction would you e

> Under what conditions will the return on equity on a project be equal to the IRR, estimated from cash flows to equity investors, on the same project?

> Netsoft is a company that manufactures networking software. In the current year, the firm reported operating earnings before interest and taxes of $200 million (operating earnings does not include interest income), and these earnings are expected to grow

> STL has asked you for advice on putting together the details of the new debt issues it is planning to make. What information would you need to obtain to provide this advice?

> As CEO of a major corporation, you have to make a decision on how much you can afford to borrow. You currently have 10 million shares outstanding, and the market price per share is $50. You also currently have about $200 million in debt outstanding (mark

> A small manufacturing firm, which has limited access to capital, has a capital rationing constraint of $150 million and is faced with the following investment projects(numbers in millions): a. Which of these projects would you accept? Why? b. What is the

> You have been asked to calculate the debt ratio for a firm that has the following components to its financing mix: • The firm has 1 million shares outstanding, trading at $50 per share. • The firm has $25 million in straight debt, carrying a market inter

> You have just done a regression of monthly stock re- turns of HeavyTech, a manufacturer of heavy machinery, on monthly market returns over the past five years and come up with the following regression: The standard deviation of the stock is 50%, and the

> Maximizing stock prices does not make sense because investors focus on short-term results and not on the long-term consequences. Comment.

> You are analyzing a convertible preferred stock with the following characteristics for the security: • There are 50,000 preferred shares outstanding, with a face value of $100 and a 6% preferred dividend rate. • The firm has straight preferred stock outs

> Lube Oil, in Question 3, paid a dividend of $20 million and bought back $25 million in stock. Estimate how much the cash balance of the firm changed during the year.

> Cell Phone is a cellular firm that reported net income of $50 million in the most recent financial year. The firm had $1 billion in debt, on which it reported interest expenses of $100 million in the most recent financial year. The firm had depreciation

> DGF Corporation has come to you for some advice on how best to increase their leverage over time. In the most recent year, DGF had an EBITDA of $300 million, owed $1 billion in both book value and market value terms and had a net worth of $2 billion (the

> Plastico is interested in how it compares with its competitors in the same industry. a. Taking each of these variables, explain at an intuitive level whether you would expect Plastico to have more or less debt than its competitors and why. b. You have al

> Answer true or false to the following statements: a. The return on equity for a project will always be higher than the return on capital on the same project. b. If the return on capital is less than the cost of equity, the project should be rejected. c.

> Genting Berhad is a Malaysian conglomerate with holdings in plantations and tourist resorts. The beta estimated for the firm, relative to the Malaysian stock exchange, is 1.15, and the long-term local currency risk free rate in Malaysia is 11.5%. a. Esti

> You have been given the following information on a project: • It has a five-year lifetime • The initial investment in the project will be $25 million, and the investment will be depreciated straight line, down to a salvage value of $10 million at the end

> You are in a world where there are only two assets, gold and stocks. You are interested in investing your money in one, the other, or both assets. Consequently, you collect the following data on the returns on the two assets over the last six years. a.

> Stock prices are much too volatile for financial markets to be efficient. Comment.

> IOU has $5 billion in debt outstanding (carrying an interest rate of 9%) and 10 million shares trading at $50 per share. Based on its current EBIT of $200 million, its optimal debt ratio is only 30%. The firm has a beta of 1.20, and the current Treasury

> 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?

> 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.

> Longs Drug, a large U.S. drugstore chain operating primarily in northern California, had sales per share of $122 on which it reported earnings per share of $2.45 and paid a dividend per share of $1.12. The dividends at the company is expected to grow 6%

> 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