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# Corporate Finance Problem Set

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(Bond valuation) A \$1,000 face value bond has a remaining maturity of 10 years and a required return of 9%. The bond's coupon rate is 7.4%. What is the fair value of this bond?
(Dividend discount model) Assume RHM is expected to pay a total cash dividend of \$5.60 next year and its dividends are expected to grow at a rate of 6% per year forever. Assuming annual dividend payments, what is the current market value of a share of RHM stock if the required return on RHM common stock is 10%?
(Required return for a preferred stock) James River \$3.38 preferred is selling for \$45.25. The preferred dividend is nongrowing. What is the required return on James River preferred stock?
(Stock valuation) Suppose Toyota has nonmaturing (perpetual) preferred stock outstanding that pays a \$1.00 quarterly dividend and has a required return of 12% APR (3% per quarter). What is the stock worth?
"(Interest-rate risk) Philadelphia Electric has many bonds trading on the New York Stock
Exchange. Suppose PhilEl's bonds have identical coupon rates of 9.125% but that one issue
matures in 1 year, one in 7 years, and the third in 15 years. Assume that a coupon payment
was made yesterday." (a-d)

"(Default risk) You buy a very risky bond that promises a 9.5% coupon and return of the
\$1,000 principal in 10 years. You pay only \$500 for the bond." (a-b)

(Constant growth model) Medtrans is a profitable firm that is not paying a dividend on its common stock. James Weber, an analyst for A. G. Edwards, believes that Medtrans will begin paying a \$1.00 per share dividend in two years and that the dividend will increase 6% annually thereafter. Bret Kimes, one of James' colleagues at the same firm, is less optimistic. Bret thinks that Medtrans will begin paying a dividend in four years, that the dividend will be \$1.00, and that it will grow at 4% annually. James and Bret agree that the required return for Medtrans is 13%.
(Beta and required return) The riskless return is currently 6%, and Chicago Gear has estimated the contingent returns given here.

Please see ** ATTACHED ** file(s) for complete details!!

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#### Solution Summary

Corporate finance problems are discussed. The solution is in an attached excel file.

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## Ethics article analysis: financial officers

Ethics Article Analysis
Need help in preparing an analysis of the attached article in which I address the following items:

a. Discuss how ethics affects the financial decision-making process.

b. Explain the ethics considerations involved in the financial decision-making outlined in your article.

c. Identify the financial management objectives of the organization in your article, and describe how these objectives may have influenced financial reporting decisions that were described in the article.

FINANCIAL OFFICERS' CODE OF ETHICS: HELP OR HINDERANCE?

Section: THE CPA IN INDUSTRY
The Sarbanes-Oxley Act of 2002 mandates new and improved governance infrastructure and controls to improve the accuracy and reliability of corporate financial reporting. The Act focuses on public accounting oversight, auditor independence, corporate responsibility, and analysts' conflicts of interest. The SEC is to improve its monitoring and stiffen its penalties. The section titled "code of ethics for senior financial officers" is somewhat ambivalent, and therefore should be explored by those potentially affected by it. It is a brief section and on the surface seems tame, but it may prove to be problematic to implement. There are four short paragraphs in the code of ethics section, each requiring deft handling to ensure that the final product is more than a maze of language that will have no impact on corporate governance. With only 180 days to produce the final rules to implement this section, it is possible that the resulting product may not be a control mechanism to ensure ethical performance.

The heart of the code of ethics section is a brief paragraph that defines the term "code of ethics" as the standards necessary to promote the following:
? "Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships"
? "Full, fair, accurate, timely, and understandable disclosure in the periodic reports"
? "Compliance with applicable government rules and regulations."
Translating such lofty goals into specific rules and instructions useful to companies will require consideration of many questions and issues. One of the most fundamental issues concerns the effectiveness of a code of ethics.

Historical Effectiveness
In addressing the effectiveness of codes of ethics, it is interesting to note the parallel between the description in Sarbanes' section 4.06 with Financial Executives International's (FEI) code of ethics. The first three points set out in FEI's code are almost identical to the wording in ruction 4.06:
? "Act with honesty and integrity, avoiding actual or apparent conflicts of interest in personal and professional relationships."
? "Provide constituents with information that is accurate, complete, objective, relevant, timely, and understandable."
? "Comply with rules and regulations of federal, state, provincial, and local governments, and other appropriate private and public regulatory agencies."

FEI's code of ethics represents an evolution of thoughts and input from their membership and leadership over 70 years. FEI was formed in 1931 as the Controllers Institute of America (CIA); the name Financial Executives Institute was adopted in 1962 and modified to Financial Executives International in 2001. The CIA was formed to address a need for quality of thought in management. In June 1933, CIA set out 17 duties of a corporate controller, and these remained in effect until 1949, when the Institute's Board of Directors approved four groupings of 18 duties and responsibilities. In 1962, when the organization broadened its scope to include the treasury function, a similar seven-point statement was developed to address it. Modifications continued through the years, and the current FEI code is a result of a study by the ethics and eligibility committee undertaken in 2001 and 2002, and subsequently approved by the executive committee and the national leadership board in early 2002.

The evolution of FEI's codes of ethics leaves no doubt that the time and effort devoted to the development of these codes, and the subsequent publicity given to them, have aided financial executives to better understand their responsibilities. It is clear that an organization's members must be held accountable for addressing the responsibilities set out in the code.
It is equally clear that problems such as those which have made headlines recently have continued to occur. The work expended by FEI's members and the fact that the breakdowns have continued to occur make it clear that: there are problems ensuring that codes of ethics will be followed. These problems are not restricted to the domain of business.
The most fundamental challenge to ensuring that codes of ethics are followed is human behavior. The history of political governance is one of monarchies and dictatorships, which political theorists have demonstrated are potentially the most efficient and effective forms of government. But monarchies and dictatorships are largely recognized as failed forms of political governance, because such all-powerful leaders fail to follow the code of ethics expected of them. While seemingly hindered by onerous, time-consuming checks and balances, democracy makes leaders accountable and has proved to be the most effective form of governance to date.

To be effective, the code of ethics for senior financial executives must be supported by a properly operating corporate governance process: a set of checks and balances involving the key players. These individuals, in their roles as members of the board, board committees, senior management, the internal or external audit function, and other involved parties, must understand their responsibilities, be accountable for them, and possess an attitude of service.

A properly functioning governance process must provide the framework for supporting the code of ethics for senior financial executives. A board whose directors understand, approve, and monitor the firm's business activities will have processes and procedures in place to support the senior financial executives. The interaction between all of the key players of the governance process will make the observance and enforcement of the code of ethics a natural, daily occurrence rather than a specialized event. The effective corporate governance process provides a continuing opportunity for key staff within the organization to address areas of concern before they take on catastrophic proportions. An effective system of checks and balances creates a natural forum for raising issues and concerns as they occur.

Individual Differences
The second fundamental issue concerns the development of an appropriate code of ethics for each company. The individual most clearly targeted is the CFO. There are vast differences in the CFO's responsibilities depending upon the company. In some large organizations, the CFO is equivalent to a COO, managing many aspects of a company's day-to-day businesses, both financial and nonfinancial. In other companies, a CFO is limited to financial matters, but these encompass a wide scope, including debt issuance, insurance, risk management, hedging, investing, and pension management, in addition to all of the traditional accounting and reporting functions. The CFO in a small company might be nothing more than a chief accountant with limited accounting duties. The legislation does not give much guidance on this point, so it will be up to each company to decide what shape its code takes. The scope of responsibility must set the parameters for ethical performance. Much more explicit direction will be necessary for a CFO who is more than just the chief accountant.

Ethical behavior can be very difficult to define. A CFO's access to information, relationships with external and internal auditors, and access to the board must all be taken into account. These factors have an impact on how much can be expected from the CFO when ethical problems surface. It would be foolish to draft a code of ethics mandating certain actions if the CFO doesn't have the information, support, and access to react to anti correct problems.

There are many issues that should be considered, and many apply to senior financial persons as well as the CFO. The legislation doesn't make it clear who is to be covered by the code of ethics, although a provision requires each issuer "to disclose whether or not... such issuer has adopted a code of ethics for senior financial officers, applicable to its principal financial officer and comptroller or principal accounting officer or persons performing similar functions." In some companies it might be appropriate to extend the code of ethics to the treasurer, the chief of internal audit, or the budget officer. The final rules should make it clear who is covered by this code of ethics requirement and who is excluded.

Questions arise all the time as to who senior financial officers serve. The obvious answer is the stockholders, the board, the CEO, the immediate supervisor, and the general public, but often there are conflicting interests to be sorted out. Given the circumstances, it may be difficult to uphold the code of ethics without retribution. It is important to consider penalties and protections covered by the code of ethics. This new requirement must be able to deal with those companies and individuals that violate either the letter or the spirit of the new code. Those whistleblowers who follow the code to their personal detriment must be protected from retribution and perhaps even be rewarded for their ethical performance.

Given the complexity of developing a code of ethics that addresses the many issues and differences in various companies, it makes sense to leave it to each company to write its own. The Act does not seem to require a review of the adequacy of the code by the SEC or any objective party. Will this be enough to rein in unethical behavior? There have been enough bad experiences in the past years to demonstrate that greed is a powerful motivator. Despite all of the safeguards that were intended to protect the U.S. capital markets, thousands of investors have lost billions to unethical corporate managers. The capital markets are still reeling from these actions. For them to regain positive momentum, the new code of ethics requirement must be one that helps rather than hinders.
~~~~~~~~
By H. Stephen Grace Jr., PhD and John E. Haupert
Edited by Robert H. Colson, CPA
H. Stephen Grace, Jr., PhD, is president, both of Grace & Co. Consultancy Inc. Grace is currently vice-chair of Financial Executives International.
John E. Haupert is a member of the board of advisors, both of Grace & Co. Consultancy Inc. Haupert, a consultant on corporate organizing and financing, was treasurer of the Port Authority of New York and New Jersey prior to retirement.

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