1. When a company spins off a subsidiary by paying out shares in the subsidiary as a dividend to shareholders
a) The firm might believe the unit will be undervalued in the stock market at first and would rather do a spin-off than sell the subsidiary's s shares via an initial public offering
b) The firm can avoid paying corporate income taxes on the spin-off as opposed to paying capital gains taxes by selling off the subsidiary
c) A possible motivation for the spin off (rather than keeping the subsidiary) might be that the firm is becoming excessively bureaucratic and decision making is slowing down
2. A firm will be in existence for one time period. It anticipates that it will generate cash flows when liquidated of $600 million in a good economy and $400 million in a bad economy. The odds in the mind of the manager and the market are 50% of a good economy and 50% of a bad economy. The firm has a zero coupon bond that pays no interest. The face value of what is owed on the bond is $500 million to be paid in one time period. The bond currently trades for $440 million.
a) If the bond trades for $440 million in the market place, the YTM is (500/440) - 1 = 13.63%. This is the expected return on the bond.
b) The firm has a chance to take a project that pays $100 million in one year in any kind of economy and the investment required is $85 million and it is deemed positive NPV. The firm might not take the project if they are prohibited from taking on debt because the equity financing for an $85 million project will help to bailout the bondholders and the wealth transfer might wipe-out any benefits from the project to shareholders.
c) If the firm only owed bondholders $400 million in one year, there would be no concerns about passing up the project because it bails out bondholders.
3. The level of a firm's FCF used to value its enterprise value is unaffected by
a) Share repurchases funded by debt issues
b) A decision to repay bondholders by issuing equity
c) Increases in deferred income tax liabilities