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1. When company spins off subsidiary by paying out shares in subsidiary as dividend to shareholders

 

a) Firm might believe unit will be undervalued in stock market at first and would rather do spin-off than sell subsidiary's s shares via initial public offering

 

b) Firm can avoid paying corporate income taxes on spin-off as opposed to paying capital gains taxes by selling off the subsidiary

 

c) Possible motivation for spin off (rather than keeping the subsidiary) might be that firm is becoming excessively bureaucratic and decision making is slowing down 

 

2. Firm will be in existence for one time period. It expects that it will make cash flows when liquidated of $600 million in good economy and $400 million in bad economy. Odds in mind of manager and market are 50% of a good economy and 50% of bad economy. Firm has a zero coupon bond which pays no interest. Face value of what is owed on bond is $500 million to be paid in one time period. Bond at present trades for $440 million.

 

a) If bond trades for $440 million in market place, YTM is (500/440) - 1 = 13.63%. This is expected return on the bond.

 

b) Firm has chance to take project which pays $100 million in one year in any kind of economy and investment required is $85 million and it is deemed positive NPV. Firm might not take project if they are prohibited from taking on debt as equity financing for $85 million project will help to bailout bondholders and wealth transfer might wipe-out any benefits from the project to shareholders.

 

c) If firm only owed bondholders $400 million in one year, there would be no concerns about passing up project since it bails out bondholders.

 

3. Level of firm's FCF used to value its enterprise value is unaffected by

 

a) Share repurchases funded by debt issues

 

b) Decision to repay bondholders by issuing equity

 

c) Increases in deferred income tax liabilities

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  • Category:- Accounting Basics
  • Reference No.:- M917265

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