Corporate Finance
Professor Paola Sapienza
Finance II (441) Supplementary Problems

Most lecture outlines contain extra problems at the end. They also contain answers. This page contains supplementary problems that give you a chance to work through the concepts from class, but with different examples. In some cases, I make one assumption in class and a different assumption in the supplementary exercise. This is a good way to learn what the effect of different assumptions is. If I develop additional exercises during the term, I will post them here.

Lecture 2

Promised vs. expected return.
Risk and return of government bonds. Working through the enclosed numerical example will help you understand how the risk and return on government bonds and the risk free rate are related. These questions should also provide some practice for calculating discounted values and rates of return.
Bond pricing. This exercise works through an example of how to price bonds given the term structure of interest rates (similar to the supplementary exercise in Lecture 2).
Asset, debt, and equity betas. Asset, debt, and equity betas. As you lever up the firm, the debt and equity change. These exercises let you explore the mechanics of how this works. As you increase the leverage of the firm, you will see how the promised rate on debt, the expected rate on debt, as well as the debt and equity change. You will need the enclosed spreadsheet. Find the answer here.

Lecture 6

This exercise asks you to value the coffee cafe example from Lecture 6. However, as part of the valuation you need to estimate the project beta. If you are unclear on why we used different discount rates at different points of the valuation, this exercise should help. To complete it you will need the companion spreadsheet.

Lecture 7

Dividend announcements. This exercise lets you see how the stock price responds to dividend announcements. You can change how this year's earnings surprise is related to next year's earnings surprise and see how this changes the stock price reaction. You can use the enclosed spreadsheet to check your answers.

Lecture 8

In class we increase the firm's debt from 0 to $30. In the supplementary exercise, you can increase the leverage to $60. You should work through this assignment before Lecture 9. You can use the companion spreadsheet to check your answers.

Lecture 9

The value of the interest rate tax shield. This exercises changes my assumption of what happens when the firm defaults. In this exercise, I assume the firm is liquidated if it defaults.

Lecture 11

Capital budgeting and the cost of underpricing. If managers have information has information which the market does not, sometimes the equity will be mispriced. This means that sometimes managers will optimally choose not to issue securities and invest in positive NPV projects, because the losses on the equity sale swamp the gains on the investment project. We looked at one such example in Lecture 10. This exercise allows you to work through two additional examples. You will also need the companion spreadsheet to complete this assignment.

Capital budgeting for firms with a debt over hang. We have examined the effect on equity holders wealth from taking on a new project financed by new equity. In this exercise, I want you to look at a similar problem. The new project can be financed by equity or debt -- your choice. However, the firm currently has debt outstanding. This makes the problem more interesting.

Miscellaneous problems from textbook. Solution is attached

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If you have questions about this web page, send them to Paola-Sapienza@northwestern.edu