Corporate Finance

Answer all the following questions. They are equally weighted. Scan any diagrams you have drawn by hand and incorporate them into the Word document. You may want to name the document firstname-lastname.doc substituting your name for firstname-lastname to make it different from the other students’ exams. You can ask me to acknowledge receipt of your exam if you like. All the best!



Question 1

Identify two large U.S. public corporations with different types of assets and begin by describing them briefly so your reader is familiar with each company.


  1. What operating problems would each encounter in the event of financial distress and why?
  2. How well would the assets keep their value?
  3. What are some firm characteristics that affect how much debt firms issue? Describe the two companies in terms of these characteristics. Do these characteristics suggest that these firms should issue a lot of debt? Little debt? No debt? Compare what these characteristics suggest that the firms should do to how much debt they have really issued. How can you explain the differences (if any)?





Question 2

(a)        On January 10, 1985, the following announcement was made: “Early today the Justice Department reached a decision in the Universal Product Care (UPC) case.  UPC has been found guilty of discriminatory practices in hiring.  For the next five years, UPC must pay $2 million each year to a fund representing victims of UPC’s policies.”  Should investors not buy UPC stock after the announcement because the litigation will cause an abnormally low rate of return?  Why?


(b)        Here’s an excerpt from an article that appeared in The Wall Street Journal dated March 19, 2011:


“BMI Corp. adopted yesterday a new accounting rule on post-retirement health benefits, resulting in a first-quarter charge of $2.3 billion, or about $4 a share…

The accounting charge doesn’t affect the company’s operating results, but will result in a historical curiosity: BMI’s first ever quarterly loss…

In composite trading on the New York Stock Exchange yesterday, BMI shares closed at $113.875 a share, up $3.”


Why did BMI’s stock price increase given that the previous day was a mundane day in terms of news about the company, the industry, and the economy?



(c)        Shown on below is an “event study” chart that plots the average stock price of 300 oil companies that announced a significant oil find. On the x-axis is the month relative to the oil find announcement date, i.e., month 0 is the month in which the oil find announcement was made, month -1 is one month before, etc. Is the diagram consistent with market efficiency? Why or why not?







Question 3

(a)       A political advisory committee recently recommended wage and price controls to prevent the spiraling inflation that was experienced in the 1970s.  Members of the investment community and several labor unions have sent the committee reports that discuss whether or not dividends should be under the controls.


The reports from the investment community demonstrated that the value of a share of stock is equal to the discounted value of its expected dividend stream.  Thus, they argued that any legislation that caps dividends will also hold down share prices.


The union reports conceded that dividends are important to shareholders, but only because the dividend is the shareholders’ wage.  In order to be fair, the unions argued, if the government controls labor’s wage, it should also control dividends.


Discuss these arguments and explain the fallacy in them.






  • Comment briefly on each of the following statements:

(i)         “Unlike new capital, which needs a stream of new dividends to service it, retained earnings are essentially free capital.”

(ii)        “If a company repurchases stock instead of paying a dividend, the number of shares falls and earnings per share rise. Thus stock repurchase must always be preferred to paying dividends.”



Question 4

  1. Are the following hypothetical mergers horizontal, vertical, or conglomerate?
  2. Apple acquires Blackberry


  1. Dell Computer acquires Best Buy


iii. Best Buy acquires Kraft Foods.


  1. Pizza Hut acquires Esh’s Flour Mills.



  1. Which of the following motives for mergers make economic sense?


  1. Merging to achieve economics of scale


  1. Merging to reduce risk by diversification


iii. Merging to redeploy cash generated by a firm with ample profits but limited growth opportunities


  1. Merging to combine complementary resources


  1. Merging just to increase earnings per share


  1. True or False


  1. Sellers almost always gain in mergers


  1. Buyers usually gain more than sellers


iii. Firms that do unusually well tend to be acquisition targets


  1. Merger activity in the U.S. tends to vary dramatically year to year