Bundle: Intermediate Financial Management, 13th + MindTap Finance, 1 term (6 months) Printed Access Card
13th Edition
ISBN: 9781337817332
Author: Brigham, Eugene F., Daves, Phillip R.
Publisher: Cengage Learning
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 20, Problem 1MC
Paul Duncan,
Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and the firm’s B rating means that interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to: (1)
As Duncan’s assistant, you have been asked to help in the decision process by answering the following questions.
How does preferred stock differ from both common equity and debt? Is preferred stock more risky than common stock? What is floating rate preferred stock?
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although EduSoft has done well, the firm’s founder believes an industry shakeout is imminent. To survive, EduSoft must grab market share now, and this will require a large infusion of new capital.
Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and the firm’s B rating means that interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to (1) preferred stock, (2) bonds with warrants, or (3) convertible bonds.
a) How does preferred stock differ from both common equity and debt? Is preferred stock more risky than common…
Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although EduSoft has done well, the firm's founder believes an industry shakeout is imminent. To survive, EduSoft must grab market share now, and this will require a large infusion of new capital.
Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and the firm's B rating means that interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to (1) preferred stock, (2) bonds with warrants, or (3) convertible bonds.
As Duncan's assistant, you have been asked to help in the decision process by answering the following question.…
The company you cofounded last year isgrowing rapidly and has strong prospects for an IPO inthe next year or two. The additional capital that an IPOcould raise would let you hire the brightest people inthe industry and continue to innovate with new productresearch. There is one potential glitch: You and therest of the executive team have been so focused onlaunching the business that you haven’t paid muchattention to financial control. You’ve had plenty offunds from venture capitalists and early sales, soworking capital hasn’t been a problem, but anexperienced CEO in your industry recently told youthat you’ll never have a successful IPO unless youclean up the financial side of the house. Yourcofounders say they are too busy chasing greatopportunities right now, and they want to wait untilright before the IPO to hire a seasoned financialexecutive to put things in order. What should you doand why?
Chapter 20 Solutions
Bundle: Intermediate Financial Management, 13th + MindTap Finance, 1 term (6 months) Printed Access Card
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.arrow_forwardIn a few sentences, answer the following question as completely as you can. Imagine you are the treasurer of a small manufacturing firm. Your firm is planning to go public (i.e., sell stock to investors for the first time). One unresolved question concerns the market’s required return on the stock. Given what you have learned, how do you think the required return will affect the market value of your firm’s stock? How would you go about estimating this rate?arrow_forwardYou heard about a company that is producing a product that you really believe in. You think you can scrape together some money to buy a couple of shares when you get paid next. First, you would like to make sure that the price seems fair so you will calculate its value. Analysts estimate that the price of the stock is likely to be $82.7 in one year. It is a young company, so they do not pay dividends yet. You estimated that the fair return on the stock is 11.2%. What is your best guess at the fair value of the stock given this information? Answer:arrow_forward
- You have a successful shop and feel that the demand for your shop has outpaced your capacity. You have decided to pitch your idea to a venture capitalist (VC). You brought in your income statement as you highlight that last year your gross profit was $500,000. the VC tells you that number is pointless. He asks you for your net profit. What information was the VC looking for? Why?arrow_forwardLarissa Warren and Dan Ervin have been discussing the future of East Coast Yachts. The companyhas been experiencing fast growth, and the future looks like clear sailing. However, the fast growthmeans that the company’s growth can no longer be funded by internal sources, so Larissa and Dan havedecided the time is right to take the company public. To this end, they have entered into discussionswith the investment bank of Crowe & Mallard. The company has a working relationship with Robin Perry,the underwriter who assisted with the company’s previous bond offering. Crowe & Mallard have helpednumerous small companies in the IPO process, so Larissa and Dan feel confident with this choice.Robin begins by telling Larissa and Dan about the process. Although Crowe & Mallard charged anunderwriter fee of 4 percent on the bond offering, the underwriter fee is 7 percent on all initial stockofferings of the size of East Coast Yachts’ initial offering. Robin tells Larissa and Dan that the…arrow_forwardYou work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is P400,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL − ROEU?arrow_forward
- Consider the following thoughts of a manager at the end of the companys third quarter: If I can increase my reported profit by 2 million, the actual earnings per share will exceed analysts expectations, and stock prices will increase. The stock options that I am holding will become more valuable. The extra income will also make me eligible to receive a significant bonus. With a son headed to college, it would be good if I could cash in some of these options to help pay his expenses. However, my vice president of finance indicates that such an increase is unlikely. The projected profit for the fourth quarter will just about meet the expected earnings per share. There may be ways, though, that I can achieve the desired outcome. First, I can instruct all divisional managers that their preventive maintenance budgets are reduced by 25 percent for the fourth quarter. That should reduce maintenance expenses by approximately 1 million. Second, I can increase the estimated life of the existing equipment, producing a reduction of depreciation by another 500,000. Third, I can reduce the salary increases for those being promoted by 50 percent. And that should easily put us over the needed increase of 2 million. Required: Comment on the ethical content of the earnings management being considered by the manager. Is there an ethical dilemma? What is the right choice for the manager to make? Is there any way to redesign the accounting reporting system to discourage the type of behavior the manager is contemplating?arrow_forwardDavid Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: d. Suppose that Firms U and L have the same input values as in Part c except for debt of 980,000. Also, both firms have total net operating capital of 2,000,000 and both firms are expected to grow at a constant rate of 7%. (Assume that the EBIT in part c is expected at t = 1.) Use the compressed adjusted present value (APV) model to estimate the value of U and L. Also estimate the levered cost of equity and the weighted average cost of capital.arrow_forwardThe Boulder Brass Works Company (BBWC) is a small-capitalization machine shop that has found a rapidly growing niche market for its custom-machined brass parts. Its business is growing so fast that it has decided not to pay a dividend next year. However, in year 2 it expects its growth to decelerate and so plans to begin paying dividends at that time. At the end of year 2 it plans to pay a dividend of $5.00. At the end of year 3 it plays to pay a dividend of $15.00. Beginning in year 4, BBWC's management believes that the company will have entered its middle age. Management anticipates being able to sustain a dividend growth rate of 3% per year in year 4 and every year thereafter. Firms with similar growth and risk characteristics return 18% per year to their equity investors. What is BBWC's intrinsic value?arrow_forward
- You have invested in a business that proudly reports that it is profitable. Your investment of $5,000 has produced a profit of $300. The managers think that if you leave your $5,000 invested with them, they should be able to generate $300 per year in profits for you in perpetuity. Evaluating other investment opportunities, you note that other long-term investments of similar risk offer an expected return of 8%. Should you remain invested in this firm? The expected return of your investment is %. (Round to one decimal place.) (Select from the drop-down menus.) If projects that are similar in horizon and risk are offering an expected return of 8%, then this business earning your opportunity cost of capital, and you should remain invested invest elsewherearrow_forwardYou work for the CEO of a new company that plans to manufacture and sell a new type of laptop computer. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $810,000. Other data for the firm are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i. e., what is EPSL - EPSU? 0% Debt, U 60% Debt, L Oper. income (EBIT) $810,000 $810,000 Required investment $ 2,500,000 $2,500,000 % Debt 0.0% 60.0% $ of Debt $0.00 $1,500,000 $ of Common equity $2,500,000 $ 1,000,000 Shares issued, $10/share 250,000 100, 000 Interest rate NA 10.00% Tax rate 25% 25% a. $0.75 b. $ 2.52 c. $3.36 d. $4.10 e. $2.90arrow_forwardRead the article. Whats the author point of view? How does this relate to financing a business? What would be a solution for this pronblem? The role of finance is undergoing a significant shift. As businesses strive for growth and competitiveness in an increasingly complex and dynamic market, finance leaders are being challenged to add more value beyond their traditional responsibilities.Insights from Microsoft’s Economic Guardians of the Future report show finance teams are going through an evolution and must strike the right balance between strategic innovation and protecting the long-term health of their company. Eighty percent of finance leaders believe that they and their teams are being challenged more than ever to add value beyond their standard roles and responsibilities. This shift has been driven in part by the uncertain economic climate, marked by factors such as inflation, recession, and international conflicts.Finance teams are being asked to provide insight into the…arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning
Financial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage Learning
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Cornerstones of Cost Management (Cornerstones Ser...
Accounting
ISBN:9781305970663
Author:Don R. Hansen, Maryanne M. Mowen
Publisher:Cengage Learning
Financial Reporting, Financial Statement Analysis...
Finance
ISBN:9781285190907
Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher:Cengage Learning
Accounting for Derivatives Comprehensive Guide; Author: WallStreetMojo;https://www.youtube.com/watch?v=9D-0LoM4dy4;License: Standard YouTube License, CC-BY
Option Trading Basics-Simplest Explanation; Author: Sky View Trading;https://www.youtube.com/watch?v=joJ8mbwuYW8;License: Standard YouTube License, CC-BY