Suppose you own stock in a company. The current price per share is $25. Another company has just
announced that it wants to buy your company and will pay $35 per share to acquire all the outstanding
stock. Your company’s management immediately begins fighting off this hostile bid. Is management
acting in the shareholders’ best interests? Why or why not?
The goal of management should be to maximize the share price for the current shareholders. If
management believes that it can improve the profitability of the firm so that the share price will exceed
$35, then they should fight the offer from the outside company. If management believes that this bidder
or other unidentified bidders will actually pay more than $35 per share to acquire the company, then
they should still fight the offer. However, if the current management cannot increase the value of the
firm beyond the bid price, and no other higher bids come in, then management is not acting in the
interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the
corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in
situations such as this.
Braam Fire Prevention Corp. has a profit margin of 6.80 percent, total asset turnover of 1.95, and ROE
of 18.27 percent. What is this firm’s debt–equity ratio?
This question gives all of the necessary ratios for the DuPont Identity except the equity multiplier, so,
using the DuPont Identity:
ROE = (PM)(TAT)(EM)
ROE = .1827 = (.068)(1.95)(EM)
EM = .1827 / (.068)(1.95) = 1.38
D/E = EM – 1 = 1.38 – 1 =
Seaweed Mfg., Inc., is currently operating at only 95 percent of fixed asset capacity. Current sales are
$550,000. How fast can sales grow before any new fixed assets are needed?
To determine full capacity sales, we divide the current sales by the capacity the company is currently
Full capacity sales = $550,000 / .95
Full capacity sales = $578,947
The maximum sales growth is the full capacity sales divided by the current sales, so:
Maximum sales growth = ($578,947 / $550,000) – 1
Maximum sales growth = .0526 or
What happens to a future value if you increase the rate r? What happens to a present value?
The future value rises (assuming it’s positive); the present value falls.
Suppose the following bond quotes for IOU Corporation appear in the financial page of today’s
newspaper. Assume the bond has a face value of $1,000 and the current date is April 15, 2009. What is
the yield to maturity of the bond? What is the current yield?
The bond has 14 years to maturity, so the bond price equation is:
Apr 15, 2023