Scribd
Upload
161 views5 pages

Unit 4 - Essay Questions

This document contains 3 essays with scenarios and questions about corporate finance topics. Essay 1 discusses corporate dividend policy given current economic conditions. Essay 2 involves a bond issuance to raise capital. Essay 3 examines the pros and cons of a preferred stock issuance compared to other financing alternatives. The essays require calculations to support any numerical answers.

Uploaded by

Jaiju
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
161 views5 pages

Unit 4 - Essay Questions

This document contains 3 essays with scenarios and questions about corporate finance topics. Essay 1 discusses corporate dividend policy given current economic conditions. Essay 2 involves a bond issuance to raise capital. Essay 3 examines the pros and cons of a preferred stock issuance compared to other financing alternatives. The essays require calculations to support any numerical answers.

Uploaded by

Jaiju
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

Essay 1 - Cost of Capital and Dividends

This study unit contains 3 essays, each with a unique scenario and multiple relevant
questions.

Suggested
Scenario Question
Time
1 1-3 30 minutes

All questions are required.

Calculations in support of numerical answers must be presented. Credit will not be


awarded for numerical answers for which there are no supporting calculations.

Many corporations are under persistent pressure from investors, especially institutional
investors, to increase cash dividends. On the average, corporations now pay out about
40 to 45% of reported earnings in cash dividends. This desire for increased cash
dividends is occurring at the same time that interest rates are rising. The prime interest
rate is up, and higher yields are being experienced on federal funds, treasury bills,
commercial paper, and utility and industrial bonds.

In addition, the growth in the economy has slowed, and there appears to be a threat of a
downturn. Some key indicators reflect the prospect that the economy may experience
difficult times. For instance, inflation is increasing again after a leveling-off period and is
at a higher than desired level. Retail sales are leveling off. Housing starts are down,
reflecting the higher interest rates on both construction loans and home mortgages. The
dollar has weakened on the foreign exchange market.

A. Many corporations attempt to maintain a sustained, rather than a


fluctuating, cash dividend per share payment. The payment is gradually
adjusted to changes in earnings over time. As a consequence,
corporations apparently establish a target payout ratio range. Explain
why corporation management’s desire sustained cash dividends per
share with an increasing trend and attempt to avoid fluctuating cash
dividend payments.
A. Based upon the current market and economic conditions and trends,
explain why it may be undesirable for a corporation to increase its
dividend payout ratio even if its earnings have increased.

A. Would distributing capital stock as stock dividends rather than


increasing cash dividends be a good alternative for a corporation under
pressure from its stockholders to increase its cash dividend payout
ratio? Explain your answer.
Essay 2 - Bond Issue

This study unit contains 3 essays, each with a unique scenario and multiple relevant
questions.

Suggested
Scenario Question
Time
1 1-4 30 minutes

All questions are required.

Calculations in support of numerical answers must be presented. Credit will not be


awarded for numerical answers for which there are no supporting calculations.

Henderson, Inc., needs to raise $15 million for its research and development program. Its
investment banker suggested raising the funds through the issuance of original issue discount
bonds. The bonds would be outstanding for 5 years and have a semi-annual coupon rate of 6%
as well as a maturity value of $1,000 each. The current market conditions require a yield of 8%,
given Henderson’s bond rating. Henderson’s marginal income tax rate is 40%. Ignore the issue
expense of the bonds and round all calculations to the nearest cent. Assume the bonds are
issued on the first day of the fiscal year.

A. What is the issue price of each bond? Show your calculations.

A. How many bonds will Henderson have to issue? Show your


calculations.

A. Determine the net after-tax cash flows per bond to Henderson relating
to the bonds at issuance (time = 0) and for each of the 5 years they are
outstanding. Show your calculations.

A. Assume that at the end of 3 years interest rates are 6% for bonds rated
the same as Henderson’s and maturing at the same time. What would a
rational investor be willing to pay for one of Henderson’s bonds? Show
your calculations.
Essay 3 - Preferred Stock vs. Its Alternatives

This study unit contains 3 essays, each with a unique scenario and multiple relevant
questions.

Suggested
Scenario Question
Time
1 1-2 30 minutes

All questions are required.

Calculations in support of numerical answers must be presented. Credit will not be


awarded for numerical answers for which there are no supporting calculations.

Venture Corporation is planning a large capital expenditure program to add plant


capacity and to modernize manufacturing equipment. The company’s projections of
fund flows reveal that available internal sources of funds will not be adequate to finance
the capital investment program.

A preferred stock issue has been suggested because the capital requirement is long-
term and Venture has never had a preferred stock issue in its capital structure. Top
management has asked the treasurer to investigate thoroughly the general attributes of
preferred stock. Major points to consider that came immediately to the mind of the
treasurer included cost, financial risk, and capital structure flexibility. The treasurer
plans to address these points as well as any other important issues in his analysis.

A. Identify and explain the principal provisions or features usually


associated with preferred stock.

A. From the viewpoint of a prospective industrial issuer, explain the


advantages and disadvantages of preferred stock with respect to the
financing alternatives of common stock and long-term debt.

You might also like