MINI CASE 5Complete Mini Case on page 586 inFinancial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a and b.Integrated Waveguide Technologies, Inc. (IWT) is a 6-year-old company founded by Hunt
Jackson and David Smithfield to exploit metamaterial plasmonic technology to develop and
manufacture miniature microwave frequency directional transmitters and receivers for use
in mobile Internet and communications applications. IWT’s technology, although highly
advanced, is relatively inexpensive to implement, and its patented manufacturing techniques
require little capital as compared to many electronics fabrication ventures. Because of the
low capital requirement, Jackson and Smithfield have been able to avoid issuing new stock
and thus own all of the shares. Because of the explosion in demand for its mobile Internet
applications, IWT must now access outside equity capital to fund its growth, and Jackson
and Smithfield have decided to take the company public. Until now, Jackson and Smithfield
have paid themselves reasonable salaries but routinely reinvested all after-tax earnings in the
firm, so dividend policy has not been an issue. However, before talking with potential
outside investors, they must decide on a dividend policy.
Your new boss at the consulting firm Flick and Associates, which has been retained to help
IWT prepare for its public offering, has asked you to make a presentation to Jackson and
Smithfield in which you review the theory of dividend policy and discuss the following issues.
a. (1) What is meant by the term “distribution policy”? How has the mix of dividend
payouts and stock repurchases changed over time?
(2) The terms “irrelevance,” “dividend preference,” or “bird-in-the-hand,” and “tax
effect” have been used to describe three major theories regarding the way
dividend payouts affect a firm’s value. Explain these terms, and briefly describe
each theory.
(3) What do the three theories indicate regarding the actions management should take
with respect to dividend payouts?
(4) What results have empirical studies of the dividend theories produced? How does
all this affect what we can tell managers about dividend payouts?
b. Discuss (1) the information content, or signaling, hypothesis, (2) the clientele effect, and (3) their effects on distribution policy.
MINI CASE 6Complete Mini Case on page 626 inFinancial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a and b.Using the mini case information, write a XXXXXXXXXXword recommendation of the financial decisions you propose for this company based on an analysis of its capital structure and capital budgeting techniques.
Assume 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 with all 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
estimated costs of debt for the firm at different capital structures:
If the company were to recapitalize, then debt would be issued and the funds received
would be used to repurchase stock. PizzaPalace is in the 40% state-plus-federal corporate
tax bracket, its beta is 1.0, the risk-free rate is 6%, and the market risk premium is 6%.
a. Using the free cash flow valuation model, show the only avenues by which capital
structure can affect value.
b.
(1) What is business risk? What factors influence a firm’s business risk?
(2) What is operating leverage, and how does it affect a firm’s business risk? Show the operating break-even point if a company has fixed costs of $200, a sales price of $15, and variable costs of $10.
MINI CASE 7Complete Mini Case on pages XXXXXXXXXXinFinancial Management: Theory and Practice. Using complete sentences and academic vocabulary, please answer questions a and b.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 questions.
a. 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?
b. How can knowledge of call options help a financial manager to better understand
warrants and convertibles?