Chp. 17; Exercise Questions
1.) The Benly Company needs to raise funds for a major expansion. The company is debating whether to issue stock or to issue bonds. If the company issues bonds, then its debts will increase and it will be under additional stress to ensure that its revenues can cover the costs of its debt. If it issues stock, the current owners will lose power and influence. What should the company do? Explain your answer.
2.) What is the creditor-owner conflict? Explain why 100 percent equity might be inefficient. Explain why 100 percent debt might be inefficient.
3.) The marketing director of National Midland Mortgage has been arguing with senior management about building a $50 million publishing facility. Other managers worried about the assumptions in the analysis that support the investment-an increase in the number of mortgages processed and a reduction in processing costs. What if the mortgage market did not grow as expected?
4.) Bob Davies must decide whether to invest $100,000 in his own business or in another local business. Both investment projects have an expected life of five years. The cash flow of each is as follow:
|
Year
|
Davies
|
Other
|
|
1
|
$20,000
|
$10,000
|
|
2
|
$30,000
|
$10,000
|
|
3
|
$40,000
|
$30,000
|
|
4
|
$10,000
|
$40,000
|
|
5
|
$5,000
|
$50,000
|
Suppose the risk of the projects is the same and is accounted for by a risk premium of 6 percent per year. Would either investment make sense? Which would be better?
5.) An oil company recently evaluated a proposed investment for improvements in a particular type of refining equipment. According to the analysis, such improvements would require an investment of $15 million and would result in an incremental after-tax cash flow of $2 million per year for nine years following the year of the investment.
a.) If the discount rate is 10 percent, what is the net present value of this project?
b.) If the discount rate is 15 percent, what is the net present value of this project?
c.) What discount rate would you argue makes most sense in evaluating this project?
6.) What is the effect on a firm's cost of capital when a CEO is found to have engaged in unethical behavior? Explain.
7.) In 2010 few firms were investing in new projects or expanding. Yet, interest rates were extremely low. Why, with this very low cost of capital would firms not be investing in new projects?
Chp.18; Exercise Questions
1.) A large firm has two divisions: an upstream divisions that produces an output that is used by the downstream division. The downstream division could obtain that output from external firms as well as the upstream division. Should the firm allow the downstream division to purchase the product externally, or should it require that the firm use only the upstream division's product? Explain.
2.) Capital markets enable us to spend large sums of money that don't belong us. Would it be necessary to create an internal capital market if a firm was to be led by market-based management? Explain.
3.) What would be the CEO's role in a company led by market-based management?
4.) If market-based management is more efficient than the command and control of a hierarchy, why have firms not employed the strategy?
5.) Suppose economic profit was used to evaluate each division in a company. Describe how it would serve to foster the correct incentives inside the firm.
6.) What steps are necessary to create an internal market?
7.) BP relies on internal markets to collect information and help make decisions. Would the use of a predictive market related to oil well blowouts have predicted the 2010 Gulf of Mexico disaster? Explain your answer.
8.) What is the role of headquarters and the CEO in a factory-type firm? What is their role in a market-based firm?
9.) A recent book titled "The End of Management." Suppose the technology evolves in such a way that a high percentage of employees do not work in the company office. They telecommute or work offline. What then is the role of management? Is there one, or is the book title correct?
Chp.19: Exercise Questions
1.) The following is one standard accounting information, for each of the firms shown. Can you tell which firm is the most successful? Explain.
|
|
Boeing
|
Good Year
|
Liz Claiborne
|
Circuit City
|
|
Sales
|
5601
|
423
|
622
|
1767
|
|
Profit
|
254
|
26.9
|
56.2
|
31.6
|
|
Return on Sales
|
4.5%
|
5.2%
|
9%
|
1.8%
|
|
Return on Equity
|
10.2
|
13.9
|
15
|
14.5
|
2.) A cost of capital figure of each of the firms is listed below. Explain what this figure means.
|
Motorola
|
11.6
|
|
Hershey Foods
|
12.8
|
|
Home Depot
|
12.2
|
|
Dillard Department Store
|
10.5
|
|
Coco-Cola
|
12.0
|
3.) Explain why economic profit provided a better measure of profit than accounting profit.
4.) Explain what occurs when a new technology makes another one obsolete in terms of economic profits. Consider firm A to be an existing firm using the old technology. Firm B is the new firm with the new technology. Firm A earned positive profits for years, but with the entrance of Firm B, Firm A's goods and services are no longer desired.
5.) The following type of report occurs each quarter as firms announce their earnings:
Weaker-than-expected results last week from Exon Mobil have set a gloomy backcloth for results on Thursday from Royal Dutch/Shell. A consensus of Wall Street analysis polled by Thomson Financial/First Call had projected Chevron Texaco would report earnings of 70 cents per share. However the company said that after excluding special items and merging related expenses and both periods, operating earnings were 931 million (.88 cents). Using that math, the company beat the analysis; figure by .18 cents. The company said it lost 154 million in the first quarter, compared with the year ago quarter, in reframing, marketing, and transportation operations. The company said its profit margins in the last sector were at their lowest levels since the mid 1990's. Chevron stock closed up .90 cents, to $85.90, yesterday on the New York Stock Exchange.
a.) Why does the stock market react to earnings reports?
b.) What do the earnings mean?
6.) The manager of Global X is contemplating the purchase of a new machine that will cost $300,000 and has a useful life of five years. The machine is expected to yield cost reductions to Global X of $50,000 in year 1, $60,000 in year 2, $70,000 in year 3, and $80,000 in each year in years 4 and 5. Will the acquisition of the machine add value? Explain.
7.) Calculate the WACC-the weighted average cost of capital-using the following data:
Market value of debt= $30 million
Market value of equity= $50 million
Cost of debt= 9 percent
Tax rate= 40 percent
Cost of equity= 15 percent