1. Santa’s Shoes is a retailer that has just begun having financial difficulty. Santa’s suppliers are aware of the increased possibility of bankruptcy. What might Santa’s suppliers do based

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2. A few years ago, a friend of yours started a small business that develops gaming software. The company is doing well and is valued at $1.5 million based on multiples for comparable public companies after adjustments for their lack of marketability. With 300,000 shares outstanding, each share is estimated to be worth $5. Your friend, who has been serving as CEO and CTO (chief technology officer), has decided that he lacks sufficient managerial skills to continue to build the company. He wants to sell his 160,000 shares and invest the money in an MBA education. You believe you have the appropriate managerial skills to run the company. Would you pay $5 each for these shares? What are some of the factors you should consider in making this decision?

 

3. A friend of yours is trying to value the equity of a company and, knowing that you have read this book, has asked for your help. So far she has tried to use the FCFE approach. She estimated the cash flows to equity to be as follows:

Sales

$800.0

-CGS

-450.0

-Depreciation

-80.0

-Interest

-24.0

Earnings before taxes (EBT)

246.0

-Taxes (0.35 x EBT)

-86.1

= Cash Flow to Equity

$159.9

She also computed the cost of equity using CAPM as follows:

kE = kF + βE(Risk premium) = 0.06 + (1.25 x 0.084) = 0.165, or 16.5%

where the beta is estimated for a comparable publicly traded company. Using this cost of equity, she estimates the discount rate as

WACC = xDebtkDebtpretax(1 – t) + xcskcs

= [0.20 x 0.06 x (1-0.35)]+(0.80 x 0.165) = 0.14, or 14%

Based on this analysis, she concludes that the value of equity is $159.9 million/0.14 = $1,142 million.

Assuming that the numbers used in this analysis are all correct, what advice would you give your friend regarding her analysis?

 

4. A firm plans to issue $700,000 worth of debt at a YTM of 7.5%. The debt is trading at par. The firm’s marginal corporate tax rate is 30%. What is the present value of the tax savings in perpetuity?

 

$210,000

 

 

 

$490,000

 

 

 

$280,000

 

 

 

$ 15,750

 

5. Besides providing an interest tax shield, the inclusion of debt in a firm’s capital structure provides it with all of the following advantages, except

 

less likelihood of managers wasting shareholders’ money due to better oversight by debt-holders.

 

 

 

lower agency costs.

 

 

 

lower transactions costs.

 

 

 

better focus on the maximization of the firm’s cash flows.

 

6. Under which of the following forms of business organization are the owners faced with double taxation?

 

Limited partnership.

 

 

 

Sole proprietorship.

 

 

 

Limited liability Corporation (LLC.)

 

 

 

C Corporation.

 

7. Which of the following factors does not directly affect the value of a business?

 

All of these directly affect the value of a business.

 

 

 

The magnitude of the expected cash flows that the business is likely to produce.

 

 

 

The timing of the expected cash flows that the business is likely to produce.

 

 

 

The riskiness of the expected cash flows that the business is likely to produce.

 

8. Tiptop Corp. has debt of $150 million and generated a net income of $88 million in the last fiscal year. In attempting to determine the total value of the firm, an investor identified a similar firm in Mammoth, Inc., an all-equity firm. This firm had 100 million shares outstanding, a share price of $17.50, and net income of $225 million. What is the total value of Tiptop Corp.? Round to the nearest million dollars.

 

$ 685 million

 

 

 

$ 1,750 million

 

 

 

$ 835 million

 

 

 

$ 535 million

 

9. Valuations differ between young and mature companies because of all of the following except:

 

Young companies have less certain futures.

 

 

 

Many young companies are not yet profitable.

 

 

 

Young companies must invest a considerable amount and that makes it hard to use a cost approach.

 

 

 

All of these are reasons valuations differ between young and mature companies.

 

Go to http://www.economist.com/index.html. Open the Economics tab. Scroll down until you see “Markets and Data” on the left hand side menu. Underneath that heading, click on the link for “Big Mac Index,” then review some of the articles under the heading “The Big Mac index.”

Be prepared to discuss your findings in the Discussion area.

 

10. What might explain why the currency of some countries is undervalued or overvalued relative to the American dollar?

 

11.  This question is based on your Web Field Trip.

 

What does the Big Mac Index tell you that managers should be aware of when they make decisions to invest internationally?

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