The IRS prohibits companies from borrowing money to buy tax-exempts and deducting the interest payments on the borrowing from taxable income. Should the IRS prohibit such activity? If it didn’t, would you advise the company to borrow to buy tax-exempts?
> True or false? a. Hedging transactions in an active futures market have zero or slightly negative NPVs. b. When you buy a futures contract, you pay now for delivery at a future date. c. The holder of a financial futures contract misses out on any dividen
> We described carried interest as an option. What kind of option? How does this option change incentives in a private-equity partnership? Can you think of circumstances where these incentive changes would be perverse, that is, potentially value-destroying
> Explain the structure of a private-equity partnership. Pay particular attention to incentives and compensation. What types of investment were such partnerships designed to make?
> Read Barbarians at the Gate (Further Reading). What agency costs can you identify? Do you think the LBO was well-designed to reduce these costs?
> The Sealed Air leveraged restructuring is described in the Chapter 18 Beyond the Page feature. Outline the similarities and differences between the RJR Nabisco LBO and the Sealed Air restructuring. Were the economic motives the same? Were the results the
> True, false, or “It depends on. . .”? a. Carve-out or spin-off of a division improves incentives for the division’s managers. b. Private-equity partnerships have limited lives. The main purpose is to force the general partners to seek out quick payback
> True or false? a. When a company becomes bankrupt, it is usually in the interests of stockholders to seek a liquidation rather than a reorganization. b. In Chapter 11 a reorganization plan must be presented for approval by each class of creditor. c. In
> Private-equity partnerships have a limited term. What are the advantages of this arrangement?
> Phoenix Motors wants to lock in the cost of 10,000 ounces of platinum to be used in next quarter’s production of catalytic converters. It buys three-month futures contracts for 10,000 ounces at a price of $1,300 per ounce. a. Suppose the spot price of pl
> What advantages have been claimed for public conglomerates?
> True or false? a. One of the first tasks of an LBO’s financial manager is to pay down debt. b. Once an LBO or MBO goes private, it almost always stays private. c. Targets for LBOs in the 1980s tended to be profitable companies in mature industries. d
> Table 26.4 contains spot and six-month futures prices for several commodities and financial instruments. There may be some money-making opportunities. See if you can find them, and explain how you would trade to take advantage of them. The interest rate
> Define the following terms: a. LBO b. MBO c. Spin-off d. Carve-out e. Asset sale f. Privatization g. Leveraged restructuring
> We described several problems with Chapter 11 bankruptcy. Which of these problems could be mitigated by negotiating a prepackaged bankruptcy?
> For what kinds of firm would an LBO or MBO transaction not be productive?
> Explain why equity can sometimes have a positive value even when companies file for bankruptcy.
> What is the difference between Chapter 7 and Chapter 11 bankruptcies?
> List the disadvantages of traditional U.S. conglomerates.
> What are the government’s motives in a privatization?
> Which of the following transactions are not likely to be classed as tax-free? a. A cash acquisition of assets. b. A merger in which payment is entirely in the form of voting stock.
> List some of the commodity futures contracts that are traded on exchanges. Who do you think could usefully reduce risk by buying each of these contracts? Who do you think might wish to sell each contract?
> Are the following hypothetical mergers horizontal, vertical, or conglomerate? a. IBM acquires Dell Computer. b. Dell Computer acquires Walmart. c. Walmart acquires Tyson Foods. d. Tyson Foods acquires IBM.
> Why may market-based financial systems be better in supporting innovation and in releasing capital from declining industries?
> What is meant by dual-class equity? Do you think it should be allowed or outlawed?
> Explain the distinction between a tax-free and a taxable merger. Are there circumstances in which you would expect buyer and seller to agree to a taxable merger?
> The Muck and Slurry merger has fallen through (see Section 31-2). But World Enterprises is determined to report earnings per share of $2.67. It therefore acquires the Wheelrim and Axle Company. You are given the following facts: Once again there are n
> As treasurer of Leisure Products, Inc., you are investigating the possible acquisition of Plastitoys. You have the following basic data: You estimate that investors currently expect a steady growth of about 6% in Plastitoys’ earnings and dividends. Un
> Suppose you obtain special information—information unavailable to investors—indicating that Backwoods Chemical’s stock price is 40% undervalued. Is that a reason to launch a takeover bid for Backwoods? Explain carefully.
> Sometimes the stock price of a possible target company rises in anticipation of a merger bid. Explain how this complicates the bidder’s evaluation of the target company.
> Respond to the following comments. a. “Our cost of debt is too darn high, but our banks won’t reduce interest rates as long as we’re stuck in this volatile widget-trading business. We’ve got to acquire other companies with safer income streams.” b. “Merg
> Briefly define the following terms: a. Purchase accounting b. Tender offer c. Poison pill d. Golden parachute e. Synergy
> True or false? a. Sellers almost always gain in mergers. b. Buyers usually gain more than sellers in acquisitions. c. Firms that do unusually well tend to be acquisition targets. d. Merger activity in the United States varies dramatically from year to ye
> Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce mark
> On some catastrophe bonds, payments are reduced if the claims against the issuer exceed a specified sum. In other cases payments are reduced only if claims against the entire industry exceed some sum. What are the advantages and disadvantages of the two
> Which of the following motives for mergers make economic sense? a. Merging to achieve economies of scale. b. Merging to reduce risk by diversification. c. Merging to redeploy cash generated by a firm with ample profits but limited growth opportunities. d
> Look again at Table 31.3. Suppose that B Corporation’s fixed assets are reexamined and found to be worth $12 million instead of $9 million. How would this affect the AB Corporation’s balance sheet under purchase accounting? How would the value of AB Corp
> Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed its terms to 2/10, EOM, net 60. The initial effect of the
> Look again at the last problem. Suppose (a) that it costs $95 to classify each new credit applicant and (b) that an almost equal proportion of new applicants falls into each of the four categories. In what circumstances should Mr. Khana not bother to u
> Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on
> Phoenix Lambert currently sells its goods cash-on-delivery. However, the financial manager believes that by offering credit terms of 2/10 net 30 the company can increase sales by 4%, without significant additional costs. If the interest rate is 6% and th
> Listed below are some common terms of sale. Can you explain what each means? a. 2/30, net 60 b. 2/5, EOM, net 30 c. COD
> Consider three securities: a. A floating-rate bond b. A preferred share paying a fixed dividend c. A floating-rate preferred If you were responsible for short-term investment of your firm’s excess cash, which security would you probably prefer to hol
> Look back at Section 30-2. Cast Iron’s costs have increased from $1,000 to $1,050. Assuming there is no possibility of repeat orders, answer the following: a. When should Cast Iron grant or refuse credit? b. If it costs $12 to determine whether a custome
> Company X sells on a 1/30, net 60 basis. Customer Y buys goods invoiced at $1,000. a. How much can Y deduct from the bill if Y pays on day 30? b. What is the effective annual rate of interest if Y pays on the due date rather than on day 30? c. How wou
> Large businesses spend millions of dollars annually on insurance. Why? Should they insure against all risks or does insurance make more sense for some risks than others?
> What are the trade-offs involved in the decision of how much inventory the firm should carry?
> Galenic, Inc., is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed a numerical credit scoring system based on a small number
> Reliant Umbrellas has been approached by Plumpton Variety Stores of Nevada. Plumpton has expressed interest in an initial purchase of 5,000 umbrellas at $10 each on Reliant’s standard terms of 2/30, net 60. Plumpton estimates that if the umbrellas prove
> Suppose you are a wealthy individual paying 35% tax on income. What is the expected after-tax yield on each of the following investments? a. A municipal note yielding 7.0% pretax. b. A Treasury bill yielding 10% pretax. c. A floating-rate preferred st
> In 2006 agency bonds sold at a yield of 5.32%, while high-grade tax-exempts of comparable maturity offered 3.7% annually. If an investor receives the same after-tax return from corporates and tax-exempts, what is that investor’s marginal rate of tax? Wha
> In Section 30-4 we described a three-month bill that was issued on an annually compounded yield of 5.16%. Suppose that one month has passed and the investment still offers the same annually compounded return. What is the percentage discount? What was you
> A three-month Treasury bill and a six-month bill both sell at a discount of 10%. Which offers the higher annual yield?
> Lockboxes The financial manager of JAC Cosmetics is considering opening a lockbox in Pittsburgh. Checks cleared through the lockbox will amount to $10,000 per day. The lockbox will make cash available to the company three days earlier than is currently t
> A parent company settles the collection account balances of its subsidiaries once a week. (That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire transfer is $10. A check costs $.80. Cash transferred by wir
> a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is concerned about increasing volatility in interest rates. He decides to hedge using bond futures contracts. Should he buy or sell such contracts? b. The treasurer of Ze
> Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lockbox system. She forecasts that 300 payments a day will be made to lockboxes, with an average payment size of $1,500. The bank’s charge for operating the lockboxe
> Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $180 million annually. First National, Knob’s principal bank, offers to establish a new concentration banking system for a fl
> Look again at the previous problem. Suppose another month has passed, so the bill has only one month left to run. It is now selling at a discount of 3%. What is the yield? What was your realized return over the two months? Previous problem: In Section 30
> Look at the previous problem. Assume that the change in credit terms results in a 2% increase in sales. Recalculate the effect of the changed credit terms. Previous problem: Until recently, Augean Cleaning Products sold its products on terms of net 60, w
> As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6%. He believes that imposing a more stringent credit policy might reduce sales by 5% and reduce the bad debt ratio to
> Some of the items in the previous problem involve a cash discount. For each of these, calculate the rate of interest paid by customers who pay on the due date instead of taking the cash discount.
> For each item below, choose the investment that best fits the accompanying description: a. Maturity often overnight (repurchase agreements/bankers’ acceptances) b. Maturity never more than 270 days (tax-exempts/commercial paper) c. Issued by the U.S.
> In October 2008, six-month (182-day) Treasury bills were issued at a discount of 1.4%. What was the annual yield?
> Complete the passage that follows by choosing the appropriate terms from the following list: lockbox banking, Fedwire, CHIPS, concentration banking. Firms can increase their cash resources by speeding up collections. One way to do this is to arrange for
> How should your willingness to grant credit be affected by differences in (a) the profit margin, (b) the interest rate, (c) the probability of repeat orders? In each case illustrate your answer with a simple example.
> You own a $1 million portfolio of aerospace stocks with a beta of 1.2. You are very enthusiastic about aerospace but uncertain about the prospects for the overall stock market. Explain how you could hedge out your market exposure by selling the market sh
> True or false? a. Exporters who require greater certainty of payment arrange for the customers to sign a bill of lading in exchange for a sight draft. b. It makes sense to monitor the credit manager’s performance by looking at the proportion of bad deb
> Look back at the discussion in Section 30-2 of credit decisions with repeat orders. If p1 = .8, what is the minimum level of p2 at which Cast Iron is justified in extending credit?
> The Branding Iron Company sells its irons for $50 apiece wholesale. Production cost is $40 per iron. There is a 25% chance that wholesaler Q will go bankrupt within the next year. Q orders 1,000 irons and asks for six months’ credit. Should you accept th
> The lag between the purchase date and the date on which payment is due is known as the terms lag. The lag between the due date and the date on which the buyer actually pays is the due lag, and the lag between the purchase and actual payment dates is the
> Table 29.19 shows the 2016 financial statements for the Executive Cheese Company. Annual depreciation is 10% of fixed assets at the beginning of the year, plus 10% of new investment. The company plans to invest a further $200,000 per year in
> Bio-Plasma Corp. is growing at 30% per year. It is all-equity-financed and has total assets of $1 million. Its return on equity is 20%. Its plowback ratio is 40%. a. What is the internal growth rate? b. What is the firm’s need for external financing th
> a. What is the internal growth rate of Eagle Sport (see Problem 24) if the dividend payout ratio is fixed at 60% and the equity-to-asset ratio is fixed at two-thirds? b. What is the sustainable growth rate? Problem 24: The financial statements of Eagle S
> The financial statements of Eagle Sport Supply are shown in Table 29.18. For simplicity, “Costs” include interest. Assume that Eagle’s assets are proportional to its sales. a. Find Eagle&
> a. Use the Dynamic Mattress model (Tables 29.9 to 29.11) and the spreadsheets to produce pro forma income statements, balance sheets, and statements of cash flows for 2016 and 2017. Assume business as usual except that now sales and costs are planned to
> Construct a new model for Dynamic Mattress based on your answer to Problem 21. Does your model generate a feasible financial plan for 2016? Problem 21: The balancing item in the Dynamic long-term planning model is borrowing. What is meant by balancing i
> What is basis risk? In which of the following cases would you expect basis risk to be serious? a. A broker owning a large block of Disney common stock hedges by selling index futures. b. An lowa corn farmer hedges the selling price of her crop by selling
> Define the following terms: a. Spot price b. Forward vs. futures contract c. Long vs. short position d. Basis risk e. Mark to market f. Net convenience yield
> How would the lessee in Figure 25.1 evaluate the NPV of the lease? Sketch the correct valuation procedure. Then suppose that the equity lessor wants to evaluate the lease. Again sketch the correct procedure. (Hint: APV. How would you calculate the c
> How does the position of an equipment lessor differ from the position of a secured lender when a firm falls into bankruptcy? Assume that the secured loan would have the leased equipment as collateral. Which is better protected, the lease or the loan? Doe
> The Safety Razor Company has a large tax-loss carry forward and does not expect to pay taxes for another 10 years. The company is therefore proposing to lease $100,000 of new machinery. The lease terms consist of eight equal lease payments prepaid annual
> Nodhead College needs a new computer. It can either buy it for $250,000 or lease it from Compulease. The lease terms require Nodhead to make six annual payments (prepaid) of $62,000. Nodhead pays no tax. Compulease pays tax at 35%. Compulease can depreci
> A lease with a varying rental schedule is known as a structured lease. Try structuring the Greymare Bus Lines lease to increase value to the lessee while preserving the value to the lessor. Assume that Greymare does not pay tax. (Note: In practice the t
> In Section 25-5 we stated that if the interest rate were zero, there would be no advantage in postponing tax and therefore no advantage in leasing. Value the Greymare Bus Lines lease with an interest rate of zero. Assume that Greymare does not pay tax. C
> In Section 25-5 we listed four circumstances in which there are potential gains from leasing. Check them out by conducting a sensitivity analysis on the Greymare Bus Lines lease, assuming that Greymare does not pay tax. Try, in turn, a. a lessor tax rat
> n Section 25-4 we showed that the lease offered to Greymare Bus Lines had a positive NPV of $820 if Greymare paid no tax and a +$700 NPV to a lessor paying 35% tax. What is the minimum lease payment the lessor could accept under these assumptions? What i
> Piglet Pies has issued a zero-coupon 10-year bond that can be converted into 10 Piglet shares. Comparable straight bonds are yielding 8%. Piglet stock is priced at $50 a share. a. Suppose that you had to make a now-or-never decision on whether to convert
> The Surplus Value Company had $10 million (face value) of convertible bonds outstanding in 2015. Each bond has the following features. Face value....................................$1,000 Conversion price..........................$25 Current cal
> Johnny Jones’s high school derivatives homework asks for a binomial valuation of a 12-month call option on the common stock of the Overland Railroad. The stock is now selling for $45 per share and has an annual standard deviation of 24%
> Explain carefully why bond indentures may place limitations on the following actions: a. Sale of the company’s assets. b. Payment of dividends to shareholders. c. Issue of additional senior debt.
> a. If interest rates rise, will callable or noncallable bonds fall more in price? b. Sometimes you encounter bonds that can be repaid after a fixed interval at the option of either the issuer or the bondholder. If the exercise price of each option is the
> Suppose that a company simultaneously issues a zero-coupon bond and a coupon bond with identical maturities. Both are callable at any time at their face values. Other things equal, which is likely to offer the higher yield? Why?
> After a sharp change in interest rates, newly issued bonds generally sell at yields different from those of outstanding bonds of the same quality. One suggested explanation is that there is a difference in the value of the call provisions. Explain how th
> a. Residential mortgages may stipulate either a fixed rate or a variable rate. As a borrower, what considerations might cause you to prefer one rather than the other? b. Why might holders of mortgage pass-through certificates wish the mortgages to have a
> Elixir Corporation has just filed for bankruptcy. Elixir is a holding company whose assets consist of real estate worth $80 million and 100% of the equity of its two operating subsidiaries. It is financed partly by equity and partly by an issue of $400 m
> Proctor Power has fixed assets worth $200 million and net working capital worth $100 million. It is financed partly by equity and partly by three issues of debt. These consist of $250 million of First Mortgage Bonds secured only on the company’s fixed as
> Bond prices can fall either because of a change in the general level of interest rates or because of an increased risk of default. To what extent do floating-rate bonds and puttable bonds protect the investor against each of these risks?
> Suppose that the J.C. Penney bond was issued at face value and that investors continue to demand a yield of 8.25%. Sketch what you think would happen to the bond price as the first interest payment date approaches and then passes. What about the price of
> Maple Aircraft has issued a 4¾% convertible subordinated debenture due 2020. The conversion price is $47.00 and the debenture is callable at 102.75% of face value. The market price of the convertible is 91% of face value, and the price of the common is $
> For which of the following options might it be rational to exercise before maturity? Explain briefly why or why not. a. American put on a non-dividend-paying stock. b. American call—the dividend payment is $5 per annum, the exercise price is $100, a
