Problems and Questions

1. You have been asked for your advice by a XYTEL Inc, a small software firm that is planning to make an equity issue in November as to whether they should wait until January to make the issue. What would you advise be? Would you advice be any different if the firm were planning to make the issue in June? Why or why not?

2. Interest rates are rising because of a surge in inflation. FinBank, a large financial service firm, that had been planning on making a bond issue, asks you whether the bond issue should be delayed until rates come down. Assuming that the delay will cost the firm in terms of lost projects, what would you advise?

3. You have been approached by FutureFin, an investment bank that claims to have a model that predicts stock and bond market movements. The bank offers its services to help in timing your security issues. Would you accept? Why or why not?

4. DownSize Inc, a large auto parts manufacturing firm announces that it will be closing an unprofitable plant and taking a charge against earnings, causing a big drop in earnings per share. Based upon the empirical evidence surveyed in this chapter, what would you expect the stock price response to be?

5. Mintel, a firm that manufactures semi-conductor chips for computers has just uncovered a flaw with one of its most widely used products. You have been asked to advise it on whether it should announce this bad news to financial markets or suppress it for as long as it can. What would you advise? Why?

6. A firm makes a very negative earnings announcement, and, as a result, stock prices plummet. The managers of the firm feel that the market response is much too negative, given the report. Given the historical evidence, are they likely to be right?

7. NeedCap, a small a fast-growing firm decides to raise new equity by making a rights offering and is surprised to see its stock price go down upon the announcement. How would you explain the market reaction? Can you counter the reaction?

8. A well-known equity research analyst has issued a sell recommendation on your company but has based it upon faulty data. What would you expect to happen to your stock price when the sell recommendation comes out? What would you expect the price to be six months later?

9. A firm come up with a security, with fixed life, fixed dollar dividend payments that are tax deductible and no voting rights (and therefore has all of the characteristics of debt), but it is classified as equity by ratings agencies in calculating leverage. The firm believes it is pulling off a coup because it is getting all of the benefits of leverage without increasing its leverage. Is it right? Why or why not?

10. Daimler Benz reported a loss of $ 4.2 billion in January 1996, for the 1995 fiscal year. Much of the loss was attributed to the write off of the Fokker Aircraft division that it owned. The stock price increased by 1.25 DM. How would you explain the reaction? Under what conditions would you expect the stock price to react negatively?

11. The Gap, a specialty retailing firm, announces that it will be splitting its stock 2-for-1, while increasing its cash dividend by 25%. How would you expect the stock price to react? Why?

12. You a small software company that is planning to make an initial public offering. The value of the company is estimated to be 25 million, and there will be 2.5 million shares outstanding. The investment banker proposed to price the issue at $ 9.00 per share. How would you react to the pricing? Would your response by any different if you planned to offer only 10% of the stock on the initial offering date, and the remaining stock 6 months later?

13. You are the manager of Telefax Inc, a company that manufactures fax modems for computers. You need to raise fresh equity for your firm, which is publicly traded. Your investment banker argues against doing so now, suggesting that your stock which has gone up 75% in the last six months is likely to keep going up because of price momentum. Would you go along with her advice? Why or why not?

14. You are a manager at a large manufacturing company and you have information that your next earnings reports is going to come in well below analyst expectations. Should you try to reveal the information to financial markets? Why or why not?

15. Swimmees Inc., a company that manufacturers swimming wear, makes almost 65% of its operating income in the summer months. It needs to raise fresh equity to finance its projects, and is considering delaying the issue until the summer when its sales will be greatest because it assumes that its stock price will also be highest in those months. What would your advice be? Under what conditions will the stock price increase during the summer months?