Ask Question, Ask an Expert


Ask Financial Management Expert

Answer the following problems clearly, completely, yet concisely.

1. Lockheed Martin’s management desires to find out whether they have excess debt capacity. Its present market value of equity is $40 b and its book value of debt is $ 4b. The company’s EBIT last year was about $4b. The present beta of the company’s stock is 0.5, marginal tax rate is 30%. Suppose that prtesent five-year Treasuries yield 2.0% and ten-year Treasuries yields 3.0%. For cost of equity calculation, suppose that risk-free rate is 3% and market risk-premium is 4%. Using the table below as broad guidelines, will the firm minimize WACC at no debt, present level of debt, 25% debt, or 50% debt? Describe all your steps in the calculation. Suppose that the firm size will remain the same under all scenarios (Debt issued will be used to repurchase shares).

                                         AAA       AA      A      BBB     BB     B         CCC
EBIT interest coverage (x)  23.8        19.5   8.0     4.7     2.5    1.2       0.4
Five year yield spreads       50            57     60      120    280    525      900
Ten year yield spreads       64            72      87     160     350   600      1320

2. a. You are engineering a Leveraged-Buy-Out (LBO) of ACME Industries, an industrial bottle maker. After the LBO, the firm would be financed with 90% debt and 10% equity. Fred Farber, the CEO, will own 30% of the shares. Fred thinks that the proposed capital structure is too highly levered and points out that, in the first few years, the firm will not be able to use all its debt tax shields. Initially, the interest payments are $400m per year and EBIT is only $300m per year. However, EBIT is projected to increase 20% per year for the next five years. Provide Fred a true tax argument that supports the high level of debt. Take into account his personal taxes as well as corporate taxes. Does your tax argument depend on whether Fred wants to dilute his ownership of the company in the future?

b. Debt is always cheaper than equity. How will you respond to this comment?

3. a. Provide at least 4 reasons why the firm might prefer to repurchase stock than to pay out dividends. What factors have influenced the strong growth in repurchase over last two decades?

b. Dividends are tangible. Unrecognized capital gain is paper money. Therefore Dividends are always preferable to no payouts by the firm. Discuss.

4. a. What are short-term and long-term market reactions after an IPO? What are the potential reasons for these returns?

b. How do you describe the lack of IPO activity in the United States in recent years?

5. Consider a recent merger between two major corporations. describe the terms of the merger (cash or stock, premium, changes in management / directors, etc.). describe the motivations behind these terms and whether you feel that these are appropriate.

6. Using exs from news reports within the last one year about public companies, describe how the concepts of adverse selection and moral hazard. describe the problems created in these situations and the extent of the problems that this has created for the firms. How have these firms attempted to reduce these problems?

7. Consider an intermediary (preferably the firm you work for). describe how your firm creates value for its clients based on taxes, transactions costs, information asymmetry, regulations, and efficient markets.

8. In May 2003, Gencorp acquired Sequa Corp.’s propulsion subsidiary ARC for $133million in cash and $11 million in transactions costs. Table below lists selected information about ARC at the time of acquisition (‘000s):
Sales $ 300,000
Operating income (loss) $ 8,000
Total assets $ 250,000
Capital expenditures $ 20,000
Depreciation and amortization $ 25,000
Intangible Assets (process technology) $ 20,000
Over the next three years,

a. ARC sales will increase by 5% each year (with or without the merger). Part of the reason for the merger is Gencorp’s expectation that ARC would achieve this growth at the expense of Gencorp’s propulsion division (with or without the merger).

b. Operating income will remain as the same fraction of sales.

c. Capital spending needs to be maintained at current levels and depreciation will remain constant. But, the acquisition lowers Gencorp’s capital spending, without any further loss in sales, by $5,000 a year, for the next three years. Assume that the lowered capital expenditures will have no impact on depreciation. After three years,

d. free cash flows to the firm (ARC) are expected to grow at a constant rate of 3% forever, with or without the merger. No impact on Gencorp after year 3.
The average beta for the industry is 1.5, with a market value based debt ratio of 50%. As part of the combined firm the debt ratio can be increased to 60% without any change in the pre-tax cost of debt of 7.5%. Market risk premium is 4% and risk- free rate is 5%. Marginal tax rate is 30%. Is the acquisition beneficial for Gencorp’s shareholders?

Financial Management, Finance

  • Category:- Financial Management
  • Reference No.:- M91297

Have any Question? 

Related Questions in Financial Management

Investing in a hydropower plant with 5 mw power costs

Investing in a hydropower plant with 5 MW power costs 3,500,000 euro . 1,300,000 euro will be invested by the investor while the rest of the World Bank loans with interest of 9 %. Contract Build Operate and Transfer is ( ...

Scale economies are important in markets that are not

Scale economies are important in markets that are not perfectly competitive. What is the key role of scale economies in the analysis of markets that are monopolistically competitive? What is the key role in oligopoly?

Answer the same questions as exercise 11 but using monthly

Answer the same questions as Exercise 1.1 but using monthly stock returns for IBM, CRSP value-weighted index (VW), CRSP equal-weighted index (EW), and S&P composite index from January 1975 to December 2003. The returns o ...

Question 1what are the characteristics of financial

Question 1 What are the characteristics of financial instruments in terms of standardization and information? Question 2 Define risk, how risk is measured and how an investor is compensated for risk. Question 3 Describe ...

Find the minutes of the most recent fomc meeting either at

Find the minutes of the most recent FOMC meeting, either at the library in the Federal Reserve Bulletin or on the Internet at www.federal (Because the FOMC meets about every six weeks, minutes appear in 8 of ...

In some states a local government that reduces its tax base

In some states, a local government that reduces its tax base receives additional aid for local public good provision from the state government. Why will cities be more likely to offer tax breaks in this circumstance? Why ...

Production of a good is characterized by external scale

Production of a good is characterized by external scale economies. Currently there is no trade in the product, and the product is produced in two countries. If trade is opened in this product, all production will be driv ...

Assignment1the primary reason the annual report is

ASSIGNMENT 1. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows ...

Suppose the economy starts with output at potential then a

Suppose the economy starts with output at potential. Then a supply shock occurs: oil prices rise sharply. The Fed is partly accommodative: it raises the real interest rate, but not by enough to keep inflation from rising ...

The market demand for stuffed rabbits is q 2600 - 20p and

The market demand for stuffed rabbits is Q = 2,600 - 20P, and the government intends to place a $4 per bunny tax on stuffed rabbit purchases. Calculate the deadweight loss of this tax when: a. Supply of stuffed rabbits i ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

A cola-dispensing machine is set to dispense 9 ounces of

A cola-dispensing machine is set to dispense 9 ounces of cola per cup, with a standard deviation of 1.0 ounce. The manuf

What is marketingbullwhat is marketing think back to your

What is Marketing? • "What is marketing"? Think back to your impressions before you started this class versus how you

Question -your client david smith runs a small it

QUESTION - Your client, David Smith runs a small IT consulting business specialising in computer software and techno

Inspection of a random sample of 22 aircraft showed that 15

Inspection of a random sample of 22 aircraft showed that 15 needed repairs to fix a wiring problem that might compromise

Effective hrmquestionhow can an effective hrm system help

Effective HRM Question How can an effective HRM system help facilitate the achievement of an organization's strate