FINA 4001 Final

According to a study by Lee et all, during the period of 1990 to 2008, the direct costs for IPOs in the smallest range of proceeds is:

25.22

How many types of costs are associated with issuing securities to the public?

6

According to a study by Lee et all, during period 1990-2008, which of the following range of IPOs has the highest percentage of total of direct costs and underpricing? A. 2.00-9.99 B. 20.00-39.99 C. 80.00-99.99 D. 500.00 and up

A

Firms should never give up a possitive NPV project to increase a dividend (or to pay dividend for the first time)

A

Which of the following is the most common method of issuing securities for cash? A. Firm commitment B. Best effort C. Dutch auction underwriting

A

Which of the following is typically not true about VENTURE CAPITALISM? A. They are friends and family with little knowledge of the product's industry and little experiene backing start-up companies B. They are financial intermediaries that raise funds from outside investors C. They play an active role in overseeing, advisng, and monitoring the companies in which they invest. D. They generally do not want to own the investment forever.

A

Which of the following statements is FALSE? A. Increasing the pay-for-performance sensitivity comes with the added benefit of reducing managers' risk. B. Stock and option grants give managers a direct incentive to increase the stock price to make their stock or options as valuable as possible. C. By tying compensation to performance, the shareholders effectively give the manager an ownership stake in the firm. D. During the 1990s, most companies adopted compensation policies that more directly gave managers an ownership stake by including grants of stock or stock options to executives. E. In the absence of monitoring, the other way the conflict of interest between managers and owners can be mitigated is by closely aligning their interests through the managers' compensation policy.

A

Which of the followings are examples of the external governance system? A. Governance analysts, such as Institutional Shareholder Services (ISS) and Glass Lewis. B. Credit ratings agencies such as Fitch, Standard and Poor's, and Moody's C. Outside shareholders (or dissidents) such as Carl Icahn or Warren Buffett D. Capital structure

A, B, & C

Examples of agency costs

A. Company with a significant probility of bankruptcy has an incentive to take large risks B. Company with a significant probility of bankruptcy has an incentive to underinvest C. Company with a significant probility of bankruptcy has an incentive to pay out extra dividends leaving less in the firm for the bondholders

Which of the following statements is (are) correct?

A. Some people have argued that debt acts as a "self-enforcing" governance device reducing management's ability to make poor decisions that might destroy shareholder value. B. Incentive pays such as stock and stock options can provide incentives for managers to act in shareholder interests. C. Independent board members are perceived to be better monitors of management performance. D. One recent innovation that might mitigate the negative effect of incentive pay is compensation clawback. This policy would allow the company to recover any compensation that had been paid to executives but that was later found to be based on misstated financials.

What can firms do to reduce costs of debt?

Add protective covenants as part of the loan agreement, and consolidate debt

What are the two key responsibilities of the board of directors?

Advise the senior management and Monitor the senior management

What is the agency cost of debt? Explain how agency costs of debt might occur?

Agency cost of debt is the conflicts between shareholders and debtholders 3 situations where agency costs of debt might occur: - Incentive to take large risks which will harm bondholders as the firm will be riskier than the bondholders expected while shareholders might get a high payout in case of success. - Incentive toward underinvestment: shareholders (managers) have the incentive to reject projects with small but positive NPV because if the company goes bankrupt, the money made by the firm goes to debtholders while shareholders do not get anything - Expropriating debtholders: companies give out all the money to shareholders through dividends while it should conserve cash to pay to debtholders.

Which of the followign statement is CORRECT? A. Right offerings is an issue of common stock to existing shareholders and potential investors B. A rights offering give shareholder the option to buy a specified numbers of new shares from the firm at a specified price within a specified time, after which the rights expire C. Rights offering is very common in the US. D. All of the above E. None of the abve

B

Which of the following statements is FALSE? A. Researchers have hypothesized that boards with a majority of outside directors are better monitors of managerial effort and actions. B. Studies have found that firms with independent boards make fewer value-creating acquisitions but are more likely to act in shareholders' interests if targeted in an acquisition. C. One early study showed that a board was more likely to fire the firm's CEO for poor performance if the board had a majority of outside directors. D. Although the firm's stock price increases on the announcement of its addition of an independent board member, the increased firm value appears to come from the potential for the board to make better decisions on acquisitions and CEO turnover rather than from improvements in the firm's operating performance. E. In the United States, the board of directors has a clear fiduciary duty to protect the interests of both the owners of the firm (the shareholders) and the interests of other stakeholders in the firm (such as the employees).

B

Which of the following is NOT a part of the internal governance mechanisms? A. Board of directors B. Managerial incentives C. Law and regulation D. Bylaw and Charter provisions E. Internal control systems

C

Which of the following statement about shelf registration is CORRECT? A. Shelf registration permits a corporation to register an offering that it reasonably expects to sell within the next FIVE years B. ALL companies are allowed shelf registration C. Only companies that meet a certain qualifications are allowed shelf registration

C

Which of the following statement is (are) CORRECT? A. Investors purchasing shares before the declaration date will receive the current dividend, whereas investors buyinng shares on or after this date will not receive dividend. B. Investors purchasing shares before the record date will receive the current dividend, whereas investors buying shares on or after this date will not receive dividend. C.Investors purchasing shares before the ex-dividend date will receive the current dividend, whereas investors buying shares on or after this date will not receive dividend. D. Investors purchasing shares before the payment date will receive the current dividend, whereas investors buying shares on or after this date will not receive dividend. E. All of the above

C

Which of the following statement is (are) CORRECT? A. Stock price will fall on the dividend declaration date. B. Stock price will fall on the record date. C. Stock price will fall on the ex-dividend date. D. All of the above E. None of the above

C

Which of the following statement is NOT correct? A. Senior executives serve on the board are called "inside" board members B. board members are not employed full time by the firm and are called "outsiders." C. All outside directors are considered to be "independent" directors D. Independent board members are perceived to be better monitors of management performance E. Boards are typically organized into different subcommittees charged with oversight of specific issues

C

Which of the following statement(s) about pecking order theory is (are) NOT correct? A. Firms prefer to use internal financing to external financing B. Firms prefer to issue debts than to issue equity C. Pecking order theory implies that there is a target amount of leverage to maximize firm value D. Pecking order theory implies that companies like financial slack E. All of the above

C

Which of the following statement(s) is (are) INCORRECT? A. Dividend usually refers to as cash distribution of earnings. B. Distribution from capital often refers as liquidating dividend. C. Dividend can only paid out in cash D. When a firm declares a stock spllit, it increases the number of shares outstanding E. Stock repurchase is another form of cash payout.

C

Which of the following statements is NOT correct? A. Lawyer fees are example of direct costs of financial distress B. Studies have shown that although large in absolute amount, these costs are actually small as a percentage of firm value. C. Impaired ability to conduct business is an example of direct cost of financial distress D. It is quite difficult to measure indirect costs of fincnail distress

C

Which one of the following statements is correct? A. If an acquisition is made with cash, then the cost of that acquisition is dependent upon the acquisition gains. B. Acquisitions made by exchanging shares of stock are normally taxable transactions. C. The management of an acquiring firm may put itself at risk of losing control of the firm if they make acquisitions using shares of stock. D. The stockholders of the acquiring firm will be better off when an acquisition results in losses if the acquisition was made with cash rather than with stock. E. Acquisitions based on legitimate business purposes are not taxable transactions regardless of the means of financing used.

C

The Sarbanes-Oxley Act requires all of the following EXCEPT ________. A. audit partners rotate every five years to limit the likelihood that auditing relationships become too cozy over long periods of time B. strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from the same firm that it audits C. senior management and the boards of public companies to be comfortable enough with the process through which funds are allocated and controlled, and outcomes monitored throughout the firm, to be willing to attest to their effectiveness and validity D. the auditor must personally attest to the accuracy of the financial statements presented to shareholders and to sign a statement to that effect E. None of the above

D

Which of the following are typically ways for companies to repurchase their own shares? A. Buy shares in the open market B. Institute a tender offer C. Buy shares from specific individual stock holders D. All of the above E. None of the above

D

Which of the following is NOT a part of the EXTERNAL governance mechanisms? A.Law, Regulation, and Politics B. The market for corporate control C. The media D. Poison pill E. Academics

D

Which of the followings are the goals of executive compensation (or pay) packages ? A. To attract executives B. To retain executives C. To align the interests of executives and shareholders D. All of the above E. Only A and B

D

Defensive merger tactics are designed to thwart unwanted takeovers and mergers. Do such activities work to the advantage of stockholders all of the time? Are these types of activities ethical? Who do you think benefits most from these activities?

Defensive tactics "insulate" existing management from the vagaries of the marketplace and may allow ineffective management to remain in charge. Obviously, defensive maneuvers do not always act in the best interest of shareholders and many students will argue that management benefits most from these activities. The ethics debate about these issues is always an interesting one.

Type of "dilution" associated with the issuance of stock that is ambiguously bad:

Dilution of stock price

Which of the following are considered factors favoring high dividend policy? A. Desire for current income B. Agency cost C. Information content of dividends and dividends signaling D. Behavior finance E. All of the above

E

Which of the following are considered the advantages of share repurchase to cash dividend? A. Flexibility B. Tax C. Maintain (or increase) existing stock option value which prefered by managers D. Favorable stock marekt reaction E. All of the above

E

Which of the following areTRUE about dividend in the US? A. Corporate dividend are substantial B. More companies pay dividend C. Companies smooth dividends D. All of the above E. Only A and C

E

Which of the following statement is INCORRECT? A. There is a separation of ownership and control in many companies B. Different people might think of the term "corporate governance" differently C. We can also classify corporate governance mechanisms as internal or external of the company. D. Corporate governance is a complex system of factors that interact with each other E. None of the above

E

Which of the following statement(s) is(are) true? A. The higher the level of debt used, the higher the value of tax shield B. The higher the level of debt used, the higher the value of financial distress costs C. the debt level that maximize the value of the firm is the point where the increase in the present value of costs from an additional dollar of debt equals the incease in teh present value of the tax shield D. At the optimal amount of debt, the firm's cost of capital is minimized and the value of the firm is maximized. E. All of the above

E

Which of the following statements about the Sarbanes-Oxley Act of 2002 (SOX) is INCORRECT? A. It was only after the passage of the Sarbanes-Oxley Act of 2002 that the NYSE and NASDAQ adopted listing standards requiring that all boards have 100% independent audit, compensation, and nominating/governance committees. B. SOX mandated that boards have at least 50% "independent" outside directors C. SOX mandated that the CEO does not also hold dual position (i.e. CEO also is the chair of the board of directors) D. SOX mandated that all directors stand annually for election (as opposed to the "staggered" or "classified" board where only some directors stand for election each year E. Both C and D

E

A firm can offer its securites to the underwriter on either a competive or a negotiated basis. In a negotiated offer, the issuing firms sells its securites to the underwriter with the highest bid.

False

According to Example 17.1, in recession, both Knight Corp.'s bondholders and Day Corp.'s bondholder are paid in full because it is company obligation to pay debtholders.

False

Because debtholders can't vote like shareholders, debt has no impact on corporate governance.

False

Because issuing companies usually use underwriter, undepricing in IPO is a rare event.

False

Section 404 of Sarbanes-Oxley Act of 2002 (SOX) requires that only CEO has to certify that the firm's internal controls are effective.

False

The "entrenchment" view argues that the presence of a poison pill, classified board, or other antitakeover measure, forces outside shareholders to negotiate with the board and management who can then get the best price for current shareholders.

False

Which of the following statements concerning acquisitions are correct? I. Being acquired by another firm is an effective method of replacing senior management. II. The net present value of an acquisition should have no bearing on whether or not the acquisition occurs. III. Acquisitions are often relatively complex from an accounting and tax point of view. IV. The value of a strategic fit is easy to estimate using discounted cash flow analysis.

I and III only

A proposed acquisition may create synergy by: I. increasing the market power of the combined firm. II. improving the distribution network of the acquiring firm. III. providing the combined firm with a strategic advantage. IV. reducing the utilization of the acquiring firm's assets.

I, II, and III only

Which of the following may tend to keep dividends low? I. A state law restricting dividends in excess of retained earnings II. A term contained in bond indenture agreements III. The desire to maintain constant dividends over time IV. Flotation costs

II and III only

Which of the following represent potential tax gains from an acquisition? I. A reduction in the level of debt II. An increase in surplus funds III. The use of net operating losses IV. An increased use of leverage

III and IV only

What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?

Increasing the pay-for-performance sensitivity comes at the cost of burdening managers with risk. Besides increasing managers' risk exposure, increasing the sensitivity of managerial pay and wealth to firm performance has some other negative effects. For example, often options are granted "at the money," meaning that the exercise price is equal to the current stock price. Managers therefore have an incentive to manipulate the release of financial forecasts so that bad news comes out before options are granted (to drive the exercise price down) and good news comes out after options are granted. Studies have found evidence that the practice of timing the release of information to maximize the value of CEO stock options is widespread.

Leslie purchased 100 shares of GT, Inc. stock on Wednesday, June 7th. Marti purchased 100 shares of GT, Inc. stock on Thursday, July 8th. GT declared a dividend on June 20th to shareholders of record on July 12th and payable on August 1st. Which one of the following statements concerning the dividend paid on August 1st is correct given this information?

Leslie is entitled to the dividend but Marti is not

Rudy's, Inc. and Blackstone, Inc. are all-equity firms. Rudy's has 1,500 shares outstanding at a market price of $22 a share. Blackstone has 2,500 shares outstanding at a price of $38 a share. Blackstone is acquiring Rudy's for $36,000 in cash. What is the merger premium per share?

Merger premium per share = ($36,000 ÷ 1,500) - $22 = $2

Sometimes the management of a target firm fights a takeover attempt even when that attempt appears to be in the best interest of the shareholders. Why would management take this stance?

Often, the management of the target firm is replaced after an acquisition. If management believes this may be the case, they may fight the takeover attempt in an effort to maintain their current positions. In other cases, management may fight the attempt if they feel that by doing so, they may increase the amount paid by the acquiring firm.

The anti-takeover measure that allows the board to limit an outside shareholders' ability to gain control of the company by diluting their ownership is called _________.

Poison Pill

Which of the following is NOT a part of the internal governance system?

SEC

The empirical evidence strongly indicates that the stockholders of the target firm realize large wealth gains as a result of a takeover bid but the stockholders in the acquiring firm gain little, if anything. Although there exists no definitive answer as to why this is the case, several possible explanations have been proposed. List and explain three of these possible explanations for the minimal returns to the acquiring firm's stockholders.

Size differentials, competition in the takeover market, lack of achieving merger gains, management goals other than the best interests of the shareholders, and early announcements of corporate acquisition intent.

Bankruptcy is the ultimate financial distress where ownership of the firm's assets is legally transferred from stockholders to bondholders.

True

If a company decides to issue a new security to less than 35 investors, it can be treated as a private issue and a registration statement is not required.

True

If executive pay is sensitive to firm performance, then managers have incentives to make decisions that improve performance, and increase shareholder wealth.

True

Incentive pay might have a negative effect because if managers have the potential to get a large bonus based on accounting performance, or a big payoff on their stock-based compensation if the stock price increases, they might be tempted to manipulate the financial reports to make the firm's accounting performance (and thus the stock price) look better than it actually is.

True

Managers with only a small ownership interest have an incentive for wasteful behavior because they only bear a small portion of the costs and they reap all the benefits.

True

The firm's stock price tends to decline on the announcement of a new issue of common stock (i.e. SEO).

True

The general procedures followed in public issue of bonds are the same as those for stocks.

True

The shareholders as a group elect a board of directors to monitor managers. The directors themselves, however, have the same conflict of interest-monitoring is costly and in many cases directors do not get significantly greater benefits than other shareholders from monitoring the managers closely.

True

The Winter Wear Company has expected earnings before interest and taxes of $2,100, an unlevered cost of capital of 14% and a tax rate of 34%. The company also has $2,800 of debt that carries a 7% coupon. The debt is selling at par value. If there is no bankruptcy cost, what is the value of this firm?

VU = [$2,100 × (1 - .34)] ÷ .14 = $9,900; VL = $9,900 + (.34 × $2,800) = $10,852

Cassandra's Boutique has 2,100 shares outstanding at a market price per share of $26. Sally's has 3,000 shares outstanding at a market price of $41 a share. Neither firm has any debt. Sally's is acquiring Cassandra's for $58,000 in cash. The incremental value of the acquisition is $2,500. What is the value of Cassandra's Boutique to Sally's?

Value of Cassandra's to Sally's = (2,100 × $26) + $2,500 = $57,100

The value of a firm is maximized when the:

WACC is minimized

1. Fountain Corporation's economists estimate that a good business environment and a bad business environment are equally likely for the coming year. The managers of Fountain must choose between two mutually exclusive projects. Assume that the project Fountain chooses will be the firm's only activity and that the firm will close one year from today. Fountain is obligated to make a $3,800 payment to bondholders at the end of the year. The projects have the same systematic risk but different volatilities. Consider the following information pertaining to the two projects: a) What is the expected value of the firm if the low-volatility and high-volatility project is undertaken? b) What is the expected value of the firm's equity if the low-volatility and high-volatility project is undertaken? c) Which project would Fountain's stockholders prefer? d) Suppose bondholders are fully aware that stockholders might choose to maximize equity value rather than total firm value and opt for the high-volatility project. To minimize this agency cost, the firm's bondholders decide to use a bond covenant to stipulate that the bondholders can demand a higher payment if Fountain chooses to take on the high-volatility project. What payment to bondholders would make stockholders indifferent between the two projects?

a) low risk: $3975 high risk: $3975 b) low risk: $175 high risk: $475 c) high risk d)Expected value of equity = $175 = .50($0) + .50($4,750 - X) Payment to bondholders X = $4,400

Red Apple Inc.is analyzing the possible acquisition of Green Pear Inc.. Neither firm has debt. The forecasts of Red Apple Inc.show that the purchase would increase its annual aftertax cash flow by $350,000 indefinitely. The current market value of Green Pear Inc. is $7 million. The current market value of Red Apple Inc.is $20 million. The appropriate discount rate for the incremental cash flows is 8 percent. Red Apple Inc.is trying to decide whether it would offer 35 percent of its stock or $11 million in cash to Green Pear Inc. a) What is the synergy from the merger? b) What is the value of Green Pear Inc. to Red Apple Inc.? c) What is the cost to Red Apple Inc. of each alternative? d) What is the NPV to Red Apple Inc. of each alternative? e) What alternative should Red Apple Inc. use?

a. Synergy value = $350,000 / .08 = $4,375,000 b. The value of Green Pear Inc. to Red Apple Inc.= $4,375,000 + 7,000,000 = $11,375,000 c. Cash costs = $11 million. Stock costs = .35($11,375,000 + 20,000,000) = $10,981,250 d. NPV of cash offer = $11,375,000 - 11,000,000 = $375,000 NPV of stock offer = $11,375,000 - 10,981,250 = $393,750 e. The acquirer should make the stock offer since its NPV is greater.

Fly-By-Night Couriers is analyzing the possible acquisition of Flash-in-the-Pan Restaurants. Neither firm has debt. The forecasts of Fly-By-Night show that the purchase would increase its annual aftertax cash flow by $400,000 indefinitely. The current market value of Flash-in-the-Pan is $8 million. The current market value of Fly-By-Night is $20 million. The appropriate discount rate for the incremental cash flows is 10 percent. Fly-By-Night is trying to decide whether it would offer 45 percent of its stock or $11 million in cash to Flash-in-the-Pan. a) What is the synergy from the merger? b) What is the value of Flash-in-the-Pan to Fly-By-Night? c) What is the cost to Fly-By-Night of each alternative? d) What is the NPV to Fly-By-Night of each alternative? e) What alternative should Fly-By-Night use?

a. Synergy value = $400,000 / .10 = 4,000,000 b. The value of Flash-in-the-Pan to Fly-by-Night Value = $4,000,000 + 8,000,000 = $12M c. Cash costs= $11 million Stock cost= .45($12,000,000 + 20,000,000)= $14,400,000 d. NPV of cash offer = $12,000,000 - 11,000,000= $1M NPV of stock offer = $12,000,000 - $14,400,000 e. The acquirer should make the cash offer since its NPV is greater (and positive).

Stock splits are often used to:

adjust the market price of a stock such that it falls within a preferred trading range

The market's reaction to the announcement of a change in the firm's dividend payout is likely the:

clientele effect

A merger in which an entirely new firm is created and both the acquired and acquiring firms cease to exist is called a:

consolidation

The date by which a stockholder must be registered on the firm's roll as having share ownership in order to receive a declared dividend is called the:

date of record

The date on which the board of directors passes a resolution authorizing payment of a dividend to the shareholders is the _____ date.

declaration

In an efficient market, ignoring taxes and time value, the price of stock should:

decrease by the amount of the dividend immediately on the ex-dividend date

The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs.

direct bankruptcy

The date before which a new purchaser of stock is entitled to receive a declared dividend, but on or after which she does not receive the dividend, is called the _____ date.

ex-dividend

All else equal, the market value of a stock will tend to decrease by roughly the amount of the dividend on the:

ex-dividend date

In a merger or acquisition, an asset should be acquired if it:

generates a positive net present value to the shareholders of an acquiring firm

Generous compensation packages paid to a firm's top management in the event of a takeover are referred to as:

golden parachutes

The ability of shareholders to undo the dividend policy of the firm and create an alternative dividend payment policy via reinvesting dividends or selling shares of stock is called (a):

homemade dividends

All else equal, a stock dividend will _____ the number of shares outstanding and _____ the value per share.

increase; decrease

Directors who are employees, former employees, or family members of employees are called ________.

inside directors

Studies have found that firms with high proportions of intangible assets are likely to use ____________ debt compared with firms with low proportions of intangible assets.

less

The optimal capital structure will tend to include more debt for firms with:

lower probability of financial distress

The fact that flotation costs can be significant is justification for:

maintaining a low dividend policy and rarely issuing extra dividends

The information content of a dividend increase generally signals that:

management believes that the future earnings of the firm will be strong

Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to:

meet interest and principal payments which, if not met, can put the company into financial distress

An attempt to gain control of a firm by soliciting a sufficient number of stockholder votes to replace the current board of directors is called a:

proxy contest

A _____ is an alternative method to cash dividends which is used to pay out a firm's earnings to shareholders.

share repurchase

A contract wherein the bidding firm agrees to limit its holdings in the target firm is called a:

standstill agreement

The positive incremental net gain associated with the combination of two firms through a merger or acquisition is called:

synergy

In a reverse stock split:

the number of shares outstanding decreases but owners' equity is unchanged