This website uses cookies to ensure you have the best experience. Learn more

Finance Essay

3188 words - 13 pages

-------------------------------------------------
MINI CASE –


Assume that you have just been hired as a business manager of PizzaPalace, a regional pizza restaurant chain. The company’s EBIT was $50 million last year and is not expected to grow. The firm is currently financed completely with equity, and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms’ owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firm’s investment banker the following ...view middle of the document...

Be sure to identify the ways in which capital structure can affect the weighted average cost of capital and free cash flows.

Answer: The basic definitions are:
(1) V = Value of firm
(2) FCF = Free cash flow
(3) WACC = Weighted average cost of capital
(4) rs and rd are costs of stock and debt
(5) ws and wd are percentages of the firm that are financed with stock and debt.

The impact of capital structure on value depends on the effect of debt upon: WACC and/or FCF.

Debt holders have a prior claim on cash flows relative to stockholders. Debt holders’ fixed claim increases risk of stockholders’ residual claim, so the cost of stock, rs, goes up.

Firms can deduct interest expenses. This reduces the taxes paid, frees up more cash for payments to investors, and reduces after-tax cost of debt.

Debt increases the risk of bankruptcy, causing pre-tax cost of debt, rd, to increase.

Adding debt increases the percent of firm financed with low-cost debt (wd) and decreases the percent financed with high-cost equity (wce).

The net effect on WACC is uncertain, since some of these effects tend to increase WACC and some tend to decrease WACC.

Additional debt can affect FCF. The additional debt increases the probability of bankruptcy. The direct costs of financial distress are legal fees, fire sales, and the like. The indirect costs are lost customers, reductions in productivity of managers and line workers, and reductions in credit (such as accounts payable) offered by suppliers. Indirect costs cause NOPAT to go down due to lost customers and drops in productivity, and they cause the investment in capital to go up due to increases in net operating working capital (accounts payable goes up as suppliers tighten credit).

Additional debt can affect the behavior of managers. It can cause reductions in agency costs, because debt pre-commits, or bonds, free cash flow for use in making interest payments. Thus, managers are less likely to waste FCF on perquisites or non-value adding acquisitions.

But it can cause increases in other agency costs. Debt can make managers too risk-averse, causing underinvestment in risky but positive NPV projects.

There are also effects due to asymmetric information and signaling. Managers know the firm’s future prospects better than investors do. Thus, managers would not issue additional equity if they thought the current stock price was less than the true value of the stock (given their inside information). Hence, investors often perceive an additional issuance of stock as a negative signal, and the stock price falls.

-------------------------------------------------
b. (1) What is business risk? What factors influence a firm's business risk?

Answer:...

Other assignments on Finance

Finance Essay

1171 words - 5 pages LYCEUM-NORTHHWESTERN UNIVERSITY Dagupan City GRADUATE SCHOOL CAUSES AND SYMPTOMS OF SEVERE ACUTE RESPIRATORY SYNDROME A Term Paper(Reaction Paper) Submitted In partial Fulfillment of the Requirements of business finance In the M.B.A Program Prepared

Finance Essay

707 words - 3 pages CAPM model. For beta, use the average beta of three selected competitors. You may obtain the betas from Yahoo Finance. Assume the risk free rate to be 3% and the market risk premium to be 4%. a. What is the cost of common equity? (5 pts) b. Explain the advantages and disadvantages to use the CAPM model as the method to compute the cost of common equity. Compare and contrast this method with the dividend growth model approach. (10 pts) 3

Finance

1743 words - 7 pages Bachelor of Business (Incorporating Graduate Diploma and Graduate Certificate in Business) Managerial Finance (ACCT 706) Semester Two, 2016 Assignment # 2 Due Date: Week 8, 03/05/16, 12.00 noon Weighting: 25% of the final grade Type: Individual Assignment Length: Approximately 2,000 – 3,000 words excluding appendices Submission: Students are expected to submit a hard copy of the assignment along with Arion

Finance - 3708 words

3708 words - 15 pages preference shares from the net profit earned during the accounting period in order to arrive at the earnings attributable to ordinary shareholders. Dividend on redeemable preference shares is already deducted from the income statement as interest expense (finance cost) and hence no further adjustment is required in its respect in the dividend cover calculation. Under task 7, the DCR is just over 1.5 i.e. 1.65 times which indicates that the company

Gcu Finance

255 words - 2 pages Stephen A. Ross, Franco Modigliani Professor of Finance and Economics, Sloan School of Management, Massachusetts Institute of Technology, Consulting Editor Financial Management Adair Excel Applications for Corporate Finance First Edition Block and Hirt Foundations of Financial Management Thirteenth Edition Brealey, Myers, and Allen Principles of Corporate Finance Ninth Edition Brealey, Myers, and Allen Principles of Corporate Finance, Concise

Global Finance

3346 words - 14 pages Global Finance, Inc. is an international organization with expansions in many states. In every state, the company has a number of sites and each site has several workers and customers. Offices are interconnected to each other and to the host organization. As an international organization, Global Finance, Inc. requires a robust network that can support its daily operations, a secure network system and efficient network management strategies

Multinational Finance

565 words - 3 pages International finance Final Exam: Essay questions Fall 2015 Instructions: Choose five questions from the list of the questions below and give it a thoughtful answer. Please formulate your answers in your own words and give references when needed. You may look up in textbooks in the library or check relevant websites to answer. Each question is to be answered fully but concisely, each answer should not be exceeding 200 words per question

Corporate Finance

4966 words - 20 pages Corporate Finance, 9/e Stephen A. Ross, Massachussetts Institute of Technology Randolph W. Westerfield, University of Southern California Jeffrey F. Jaffe, University of Pennsylvania ISBN: 0073382337 Copyright year: 2010 Table of Contents PART I: Overview 1 Introduction to Corporate Finance 1 1.1 | What Is Corporate Finance? | 1 | | The Balance Sheet Model of the Firm | 1 | | The Financial Manager | 3 | 1.2 | The Corporate

Personal Finance

358 words - 2 pages Associate Level Material Appendix B Personal Financial Planning Worksheet Directions: Based on your readings and discussions in class this week, answer the following questions completely. The process of creating a detailed plan to meet your financial needs and prepare for the future is called: Developing goals. Personal financial planning. Collecting financial information. Personal finance. Which of the following is not one of

International Finance

876 words - 4 pages International Finance May 10, 2015 U.S International Debt Please look at the International part of the U.S. Government debt and discuss, 1) why the country has had to rely on International lenders, 2) why the situation with the International lenders may have caused the U.S. Federal Reserve System to initiate Quantitative Easing, and 3) give your opinion of the possible future state of the U.S. economy as it relies on International lenders

Managerial Finance

1382 words - 6 pages Managerial Finance FIN515 Homework1 Mini case (a) Corporate Finance Investors provide enough funding for corporations to make quality goods and services that are highly valued by costumers and enables growth of the corporation. So managers’ primary goal is to generate enough cash to distribute compensation to investors. Understanding corporate finance allows managers to make monetary decisions that achieve the goal of adding value for

Similar Documents

Finance Essay 2359 Words

2359 words - 10 pages include Chinese language, Japanese Language among others. It is one of the largest companies in the Internet Information providers industry of the NASDAQ with a market capitalization of $42.55 billion as at 14th May 2012. The company was founded in the year 2000 and is headquartered in Beijing China (Yahoo finance, 2012a) Dendreon Corporation; this is accompany that is listed under the Biotechnology industry of the NASDAQ Stock Exchange whose

Finance Essay 265 Words

265 words - 2 pages Uttara University Department of Business Administration Program – MBA Semester –Autumn 2013 Course Title: Investment Analysis and portfolio Mgt. Course Teacher: Md. Azizur Rahman (Assistant Professor of Finance) Lesson Plan for Midterm |CHAPTER| |Investment, The Importance of Financial Investments, Investment Management Process, Measures of | |1

Finance Essay 856 Words

856 words - 4 pages The main purpose of studying finance is to gain an understanding of the financial performance of a company, corporation or industry. By looking at a company's financial performance, decisions can be made about many things by many different players. Corporations are rated by different agencies that examine financial records and potential for growth. Fitch ratings are a good example of this. My employer has an A++ Fitch rating. This high rating

Finance Essay 499 Words

499 words - 2 pages Finance FIN 1103 Week 3 Individual Work Perform Time Value Money Calculations Assignment Instructions | To complete this assignment: 1. Answer all of the questions below in the space provided. 2. Reflect on the information presented in this week’s lesson and provide an insightful response to each question writing no more than two paragraphs. | Save and Submit to Dropbox | 1. Save your work as a Microsoft Word 2010 (.docx