MINI CASE 5

Complete 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 6

Complete 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 250-500 word 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? Showthe operating break-even point if a company has fixed costs of $200, a sales priceof $15, and variable costs of $10.

MINI CASE 7

Complete Mini Case on pages 824-825 inFinancial 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 byanswering 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?