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8-1 Why is preferred stock referred to as a hybrid security? It is often said to combien the worst features of common stock and bonds. What is meant by this statement
Preferred stock is many times referred to as a hybrid security.  This is because preferred stock has many characteristics of both common stock and bonds.  It has characteristics of common stock: no fixed maturity date, the nonpayment of dividends does not force bankruptcy, and the nondeductibility of dividends for tax purposes.  But it is like bonds because the dividends are fixed in amount like interest payments.  From the point of view of the preferred stock shareholder, this is not the most delightful combination.  On one hand, the dividends are limited as with bonds, but the security of forced payment by the threat of bankruptcy is not there.  Thus, from the point of view of the investor, the worst features of common stock and bonds are combined.
8-2 Inasmuch as preferred stock dividends in arrears must be paid before common stock dividends, should they be considered a libility and appear on the right hand side of the balance sheet?
To a certain extent, preferred stock dividends can be thought of as a liability.  The major difference between preferred dividends in arrears and normal liabilities is that nonpayment of them cannot force the firm into bankruptcy.  However, since the goal of the firm is shareholder wealth maximization, which involves getting money to the shareholders (dividends), preferred arrearages do provide an effective block for the goal of the firm.
8-3 Why would a preferred stockholder want the stock to have a cumulative dividend feature and provtective provisions?
A cumulative feature requires all past unpaid preferred stock dividends be paid before any common stock dividends are declared.  A stockholder would like preferred stock to have a cumulative dividend feature because without it there would be no reason why preferred stock dividends would not be omitted or passed when common stock dividends were passed.  Since preferred stock does not have the dividend enforcement power of interest from bonds, the cumulative feature is necessary to protect the rights of preferred stockholders.
8-5 Compare valuing preferred stock and common stock
Both values are based on future cash flows to be received by stockholders.  Preferred stock typically has a predetermined constant dividend.  For common stock, the dividend is based on profitability of the firm and on management’s decision to pay dividends or to retain the profits for reinvestment purposes.  Thus, the growth of future dividends is a prime distinguishing feature of common stock
9-2 What are the criticisms of the use of the payback period as a capital budgget technique?
1. It ignores the timing of the flows that occur during the payback period.

2. It ignores all flows occurring after the payback period.
payback period as a capital budgget technique? what are the advantages?
1. It deals with cash flows rather than accounting profits and, therefore, focuses on the true timing of the project’s benefits and costs.

2. It is easy to calculate and understand.

3. It can be used as a rough screening device, eliminating projects whose returns do not materialize until later years.

These final two advantages are the major reasons why it is used frequently.
Briefly compare and contrast the NPV
The three discounted cash flow capital, budgeting criteria are the net present value, the profitability index, and the internal rate of return. The net present value method gives an absolute dollar value for a project by taking the present value of the benefits and subtracting the present value of the costs.
Briefly compare and contrast the PI
The profitability index compares these benefits and costs through division and comes up with a measure of the project’s relative value—a benefit/cost ratio.
Briefly compare and contrast the  IRR criteria.
On the other hand, the internal rate of return tells us the rate of return that the project earns. In the capital-budgeting area, these methods generally give us the same accept-reject decision on projects but many times rank them differently.
Briefly compare and contrast the NPV, PI, and IRR criteria.

What are the advantages and disadvantage of using each of these methods
As such, they have the same general advantages and disadvantages, although the calculations associated with the internal rate of return method can become quite tedious. The advantages associated with these discounted cash flow methods are:

1. They deal with cash flows rather than accounting profits.

2. They recognize the time value of money.

3. They are consistent with the firm’s goal of shareholder wealth maximization
9-7  How should manager compare two mutually exclusive projects of unequal size? Would your approach change if capital rationing existed?
When two mutually exclusive projects of unequal size are compared, the firm should select the project or set of projects with the largest net present value, whether there is capital rationing or not.
10-2 IF depreciation is not a cash flow expense, does it affect the level of cash flow from a project in any way? Why
Although depreciation is not a cash flow item, it does affect the level of the differential cash flows over the project’s life because of its effect on taxes. Depreciation is an expense item, and the more depreciation incurred, the larger are expenses. Thus, accounting profits become lower and, in turn, so do taxes which are a cash flow item.
10-3 If a project requires additional investment in working capital, how should this be treated in calculating cash flow?
If a project requires an increased investment in working capital, the amount of this investment should be considered as part of the initial outlay associated with the project’s acceptance. Since this investment in working capital is never "consumed," an offsetting inflow of the same size as the working capital’s initial outlay will occur at the termination of the project corresponding to the recapture of this working capital. In effect, only the time value of money associated with the working capital investment is lost.
10-4 How do sunk cost affect the determination of cash flows associated with an investment proposal?
When evaluating a capital-budgeting proposal, sunk costs are ignored. We are interested in only the incremental after-tax cash flows to the company as a whole. Regardless of the decision made on the investment at hand, the sunk costs will have already occurred, which means these are not incremental cash flows. Hence, they are irrelevant.
11-3 In computing the cost of capital, which sources of capital do we consider?
All types of capital, including debt, preferred stock, and common stock, should be incorporated into the cost of capital computation, with the relative importance of a particular source being based upon the percentage of financing to be provided.
11-4 How does a firm's tax rate affect its cost of capital? What is the effect of the flotation costs associated with a new security issue?
The effect of taxes on the firm’s cost of capital is observed in computing the cost of debt. Since interest is a tax-deductible expense, the use of debt indirectly decreases the firm’s taxes. Therefore, since we have computed the internal rate of return on an after-tax basis, we also compute the cost of debt on an after-tax basis. In completing a security offering, investment bankers and other involved individuals receive a commission for their services. As a result, the amount of capital net of these flotation costs is less than the funds invested by the individual purchasing the security. Consequently, the firm must earn more than the investors’ required rate of return to compensate for this leakage of capital.
12-1 Distinguish between business risk and financial risk? What gives rise to , or cause , each type of risk?
Business risk is the uncertainty that envelops the firm’s stream of earnings before interest and taxes (EBIT). One possible measure of business risk is the coefficient of variation in the firm’s expected level of EBIT. Business risk is the residual effect of the (1) company’s cost structure, (2) product demand characteristics, (3) intra-industry competitive position. The firm’s asset structure is the primary determinant of its business risk. Financial risk can be identified by its two key attributes: (1) the added risk of insolvency assumed by the common stockholder when the firm chooses to use financial leverage; (2) the increased variability in the stream of earnings available to the firm’s common stockholders.
12-6 Break even analysis assumes linear revenue and cost functions, In reality, these linear functions over large out put and sales level are highly improbably? Why
As the sales of a firm increase, two things occur that bias the cost and revenue functions toward a curvilinear shape. First, sales will increase at a decreasing rate. As the market approaches saturation, the firm must cut its price to generate sales revenue. Second, as production approaches capacity, inefficiencies occur that result in higher labor and material costs. Furthermore, the firm’s operating system may have to bear higher administrative and fixed costs. The result is higher per unit costs as production output increases.
Define the following terms: Financial structure:
Financial structure: the mix of all items that appear on the right-hand side of the company’s balance sheet.
Define the following terms:
Capital structure
Capital structure: the mix of long-term funds used by the firm.
Define the following terms:
Optimal capital structure
Optimal capital structure: the mix of long-term funds that will minimize the composite cost of capital for raising a given amount of funds.
Define the following terms:
Debt capacity
Debt capacity: the maximum proportion of debt that the firm can include in its capital structure and still maintain its lowest composite cost of capital.
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