Chapter 1: Corporate Finance and the Financial Manager (стр. 5 )

4. Explain the mechanics of an auction IPO.

In an auction IPO, the company that goes public lets the market determine the price by auctioning off the company. Investors place bids over a set period of time. An auction IPO sorts the bids from high to low and sells the stock at the highest price that will sell all of the offered shares. All winning bidders pay this price, even if they initially bid something higher.

5. List and discuss four characteristics about IPOs that are puzzling.

First, on average IPOs appear to be underpriced; the price at the end of trading on the first day is often substantially higher than the IPO price. Second, the number of issues is highly cyclical; when times are good, there are many new issues, when times are bad, the number of issues dries up. Third, the costs of the IPO are very high and it is unclear why firms are willing to incur such high costs. Fourth, the long-run performance of a newly public company is poor; on average, a 3- to 5-year buy-and-hold strategy appears to be a bad investment.

6. For each of the characteristics, identify its relevance to financial managers.

Because IPOs are underpriced, the firm is not raising as much capital as it would if the stock price were higher. Issuance of new stock is highly cyclical, meaning that when the stock market is weak firms either forego raising capital or choose other alternatives. Because IPO costs are high, the amount of capital that the firm actually gets to use is low relative to the amount investors have paid. The poor long-run performance of newly public companies raises the question of what the situation was that caused these companies to need to raise capital in the first place.

7. What is the difference between a cash offer and a rights offer for a seasoned equity offering?

In a cash offer, a firm offers the new shares to investors at large. In a rights offer, a firm offers the new shares only to existing shareholders.

8. What is the typical stock price reaction to an SEO?

Researchers have found that the stock price reaction to an SEO is negative on average. Often the value destroyed by the price decline can be a significant fraction of the new money raised.

Chapter 15: Debt Financing

1. List four types of corporate public debt that are typically issued.

Four types of corporate debt that are typically issued are notes, debentures, mortgage bonds, and asset-backed bonds.

2. What are the four categories of international bonds?

Domestic bonds are bonds that are issued by a local entity and traded in a local market, but purchased by foreigners. Foreign bonds are bonds issued by a foreign company in a local market and are intended for local investors. Eurobonds are international bonds that are not denominated in the local currency of the country in which they are issued. Global bonds combine the features of domestic, foreign, and Eurobonds, and are offered for sale in several different markets simultaneously.

3. What happens if an issuer fails to live up to a bond covenant?

If the issuer fails to live up to any covenant, the bond goes into default. That event may lead the firm into bankruptcy.

4. Why can bond covenants reduce a firm’s borrowing cost?

The stronger the covenants in the bond contract, the less likely the issuer will default on the bond, and so the lower the interest rate investors will require to buy the bond. That is, by including more covenants, issuers can reduce their costs of borrowing.

5. Do callable bonds have a higher or lower yield than otherwise identical bonds without a call feature? Why?

The issuer will exercise the call option only when the market rates are lower than the bond’s coupon rate. Therefore, the holder of a callable bond faces reinvestment risk precisely when it hurts. This makes the callable bonds relatively less attractive to the bondholder than the identical noncallable bonds. Consequently, callable bonds will trade at a lower price and therefore have a higher yield than otherwise identical bonds without a call feature.

6. What is a sinking fund?

A sinking fund provision requires a company to make regular payments into a sinking fund administered by a trustee over the life of the bond. These payments are then used to repurchase bonds.

Chapter 16: Capital Structure

1. What constitutes a firm’s capital structure?

A firm’s capital structure is the relative amounts of debt, equity, and other securities it has outstanding.

2. What are some factors a manger must consider when making a financing decision?

A manager must consider the future amounts promised to security holders in exchange for the cash raised today, whether the securities will trade at a fair price in the market, the tax consequences, transactions costs, and changes in future investment opportunities when making financing decisions.

3. How does leverage affect the risk and cost of equity for the firm?

As more leverage is used, equity becomes more risky and the cost of equity increases.

4. In a perfect capital market, can you lower the firm’s WACC by relying more on debt capital?

No, in perfect capital markets the advantage of using additional lower cost debt capital is exactly offset by the increased riskiness and cost of equity.

5. How does the interest tax deduction affect firm value?

The interest tax deduction creates an interest tax shield due to the tax savings. The value of the firm increases by the present value of the interest tax shield.

6. How does the firm’s WACC change with leverage?

The firm’s WACC declines as the firm increases its reliance on debt financing and the benefit of the interest tax deduction grows.

7. What are the direct costs of bankruptcy?

The direct costs of bankruptcy include the hiring of outside professionals, such as legal and accounting experts, consultants, appraisers, auctioneers, and others with experience selling distressed assets.

8. Why are the indirect costs of financial distress likely to be more important than the direct costs of bankruptcy?

The indirect costs are difficult to measure accurately but are often much larger than the direct costs of bankruptcy. The firm can face these costs even if it is not yet in financial distress if there is a significant possibility of bankruptcy in the future. Some examples of indirect costs are loss of customers, loss of suppliers, increased labor costs, and the fire sale of assets.

9. According to the tradeoff theory, how should a financial manager determine the right capital structure for a firm?

Increasing leverage increases the interest tax shield but also increases the possibility of financial distress. The firm should increase its leverage up to the point at which the tax savings that result from increasing leverage are just offset by the increased probability of incurring the costs of financial distress.

10. Why would managers in one industry choose different capital structures than those in another industry?

The costs and the likelihood of financial distress vary by panies that have tangible assets that can easily be liquidated have lower costs of financial distress than a firm that lacks tangible assets. Also, companies with more stable cash flows have a lower probability of financial distress than companies with very volatile cash flows.

11. How can too much debt lead to excessive risk taking?

When a company is near financial distress, shareholders have an incentive to invest in risky, negative-NPV projects. If the project fails, the shareholders are no worse off because the firm was headed for default anyway. If the project succeeds, the shareholders avoid default and retain ownership of the company.

12. What is the “pecking order” hypothesis?

The pecking order hypothesis states that to avoid “lemons cost” managers will fund investments using retained earnings, followed by debt, and will only choose to issue equity as a last resort.

Chapter 17: Payout Policy

1. How is a stock’s ex-dividend date determined, and what is its significance?

A stock’s ex-dividend date is 2 business days prior to the record date. Anyone who purchases the stock on or after the ex-dividend date will not receive the dividend.

2. What is an open-market share repurchase?

An open market share repurchase occurs when a firm buys shares of its own stock in the open market like any other investor.

3. Explain the misconception that when a firm repurchases its own shares, the price rises due to the decrease in the supply of shares outstanding.

When a firm repurchases its own shares, the supply of shares is reduced but the value of the firm’s assets declines when it spends its cash to buy the shares. If the firm repurchases its shares at their market prices, these two effects offset each other, and the share price is unchanged.

4. In a perfect capital market, how important is the firm’s decision to pay dividends versus repurchase shares?

As Modigliani and Miller make clear, the value of a firm, ultimately derives from its underlying free cash flow. A firm’s free cash flow determines the level of payouts that it can make to its investors. In a perfect capital market, whether these payouts are made through dividends or share repurchases does not matter.

5. Under what conditions will investors have a tax preference for share repurchases rather than dividends?

Investors will have a tax preference for share repurchases rather than dividends when the capital gains tax rate is lower than the tax rate on dividends.

6. What is the dividend puzzle?

The dividend puzzle stems from the fact that the tax rate on dividends has been higher than the tax rate on capital gains. This tax disadvantage should lead firms to choose share repurchases over dividends, but some firms have paid and continue to pay dividends despite this disadvantage.

7. Is there an advantage for a firm to retain its cash instead of paying it out to shareholders in perfect capital markets?

In perfect capital markets, the firm value is independent of the decision to pay out or retain capital.

8. How do corporate taxes affect the decision of a firm to retain excess cash?