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Unformatted text preview: 4 To test your "IE mastery of this i“ . 4:4 material. take 3-5.. a quiz at www. , . mheducatl‘on. -_'._Inl asim‘olcfross Part IV Capital Structure and Dividend Policy WHICH ARE BEST: BOOK OR MARKET VALUES? Financial economists generally prefer market values when caiculatiiigPIdepéviiitittlifé since, as Chapter 14 indicates, market prices reflect current information. «mutimflel-S use of market values contrasts with the perspective of many celpoiate prise k “lugs Our conversations with corporate treasurers suggest to as that the pse {a- 1:; mil {he is popular because of the volatility of the stock market. It is f 1 eqltjlent y c till-glove “(Quad inherent volatility of the stock market makes market-based dc ‘t 1.1 to; , legged in too much. In addition, restrictions of debt in bond covenants are usu'a-dy 331)” ‘1S‘lnd book values rather than market values. Moreover, firms such asStandati _ eSS001 c Moody‘s use debt ratios expressed in book values to measure cregitwoit up; 1- U 5 non- A key fact is that whether we use book or market values. de t tapes I 11.1 imam financial firms generally have been well below 100 percent of tota equi y years; that is, firms generally use less debt than equity. unnnary and Conclusions The basic sources of long-term financing are long-term debt. preferred stock. and com- mon stock. This chapter described the essential features of each. 1. We emphasized that common shareholders have: a. Residual risk and return in a corporation. 2. giiildiidgshtiie not a business expense and firms cannot be forced into bankruptcy for non payment of adividend. . . ‘ _, , . 2. Long-term debt involves cont}r;;ctual obligattizn; {itwgpvtkintdicta:algofiilcilchunl; {111:1}: " ‘ ‘ ‘ 1 tia eature 15 1a e * t t t . '. ixdlljrtioililtijblll‘ili}tliit51:21:] debt are considered a business expense and are tax deductible]. 3. Preferred stock has some of the t’etpulres of deibt and Silillfigiii 5111:! LIslet1:11:13; :f 3:332:11 1 ' - ‘ ‘red stoet iave re erence t t . . hiltyliiiihii:iiiiiipaiidd Itibivlt’idlders of commonpequity, but often hold no voting rights.)- 1 4 Firms need financing for capital expenditures. working capital. and either long-tun ' uses. Most of the financing is provided from internally generated cash 1 on. ‘1 , _, 5. For many years. vs. firms have been retiring large amounts of equity. These s ltlll. buybacks have been financed with new debt. loncept Questions 1 Bond Features What are the main leaturcs ot a corporate bond that would be llhlLt in the indenture? 1 d .1 1., 2 Preferred Stock and Debt What are the differences between prelcrred stock and L 3 . 3 Preferred Stock Preferred stock doesn‘t offer a‘ corporate tax 51110139 on the . dividends paid. Why do we still observe some lirms issumg prclcrred stoc . 4 Preferred Stock and Bond Yields The yields on noneonvertible pgcferr-ed stocktapi: ' lower than the yields on corporate bonds. Why 18 there a dillercnce. Wine 1 lines t . are the primary holders of preferred stock? Why? Chapter 15 Long-Term Financing 501 5. Corporate Financing What are the main differences between corporate debt and equity? Why do some firms try to issue equity in the guise of debt? 6. Call Provisions A company is contemplating a long-term bond issue. It is debating whether to include a call provision. What are the benefits to the company from including a call provision? What are the costs? How do these answers change for a put provision? 7. Proxy What is a proxy? 8. Preferred Stock Do you think preferred stock is more like debt or equity? Why? 9. Long—Term Financing As was mentioned in the chapter. new equity issues are generally only a small portion of all new issues. At the same time. companies continue to issue new debt. Why do companies tend to issue little new equity but continue to issue new debt? 16. Internal versus External Financing What is the difference between internal financing and external financing? 11. Internal versus External Financing What factors influence a firm's choice of external versus internal equity timtncing? 12. Classes of Stock Several publicly traded companies have issued more than one class of stock. Why might a company issue more than one class of stock? 13. Caliahle Bonds Do you agree or disagree with the following statement: In an elticient market, callable and noncallable bonds will be priced in such a way that there wilE be no advantage or disadvantage to the cat] provision. Why? 14. Bond Prices If interest rates fall. will the price of noncallable bonds move up higher than that of caliable bonds? Why or why not? 15. Sinking Funds Sinking funds have both positive and negative characteristics for bondholders, Why? Questions and Probierns MSIC educations 1-6) Corporate Voting The shareholders of the Blue Ocean Company need to elect seven new directors. There are 850.001! shares outstanding currently trading at $43 per share. You would like to serve on the board of directors: unfortunately no one else will be voting for you. How much will it cost you to be certain that you can be elected if the company uses straight voting? How much will it cost you if the company uses cumulative voting? Cumulative Voting An election is being held to fill three seats on the board of directors of a firm in which you hold stock. The company has 7.601) shares outstanding. If the election is conducted under cumulative voting and you own 301) shares. how many more shares must you buy to be assured of earning a seat on the board? Cumulative Voting The shareholders of Star Power Corp. need to elect three new directors to the board. There are 8.0011111“) shares of common stock outstanding. and the current share price is $111.50. If the company uses cumulative voting procedures. how much will it cost to guarantee yourself one seat on the board of directors? Corporate Voting Candle box Inc. is going to elect six board members next month. Lucy Liu owns 17.4 percent of the total shares outstanding. How confident can she be of having one of her candidate friends elected under the cumulative voting ruie? Will her friend be elected for certain if the voting procedure is changed to the staggering rule. under which shareholders vote on two board members at a time? 302 JTERMEDIATE Questions 5—10) , Part IV Capital Structure and Dividend Policy 5. Valuing Caliable Bonds KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent and 30 years to maturity. The current market interest rates on these bonds are '1" percent. in one year, the interest rate on the bonds will be either it) percent or 6 percent with equal probability. Assume investors are risk~neutral. a. if the bonds are noncallable. what is the price of the bonds today‘? 33. if the bonds are callable one year from today at $1,080, will their price be greater or less than the price you computed in (a)? Why? 6. Valuing Callable Bonds New Business Ventures, inc. has an outstanding perpetual bond with a it} percent coupon rate that can be ‘alled in one year. The bond makes annual coupon payments. The call premium is set at $150 over par value. There is a 60 percent chance that the interest rate in one year will be 12 percent. and a - ~40 percent chance that the interest rate will be 7 percent. If the current interest rate is} 10 percent. what is the current market price of the bond? ’1'. Y’aluing Callabie Bonds Penang Manufacturing intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at $1.175. Oneuyear interest rates are 9 percent. There is a 60 percent probability that long-term interest rates one year from today will be 10 percent. and a 40 percent probability that they will be 8 percent. Assume that if interest rates fall the bonds will be called. What coupon rate should the bonds have in order to sell at par value? 8. Valuing Callable Bonds Canton Industries has decided to borrow money by issuing. perpetual bonds with a coupon rate of 7 percent, payable annually: The one-year interest rate is 7 percent. Next year. there is a 35 percent probability that interest rates will increase to 9 percent. and there is a 65 percent probability that they will fall to 6 percent. a. What wiil the market value of these bonds be if they are noncailable? 1). If the company decides instead to make the bonds callable in one year, what couw pon will be demanded by the bondholders bribe bonds to sell at par? Assume that the bonds will be called if interest ratesmgise and that the call premium is / equal to the annual coupon. " ‘31“ .isii " sic. What will be the value of the call provision to the company? i 9. iBond Refunding An outstanding issue of Public Express Airlines debentures has a call provision attached. The total principal value of the bonds is $250 million. and ’/ the bonds have an annual coupon rate of 9 percent. The company is considering refunding the bond issue. Refunding means that the company would issue new bonds and use the proceeds from the new bond issuance to repurchase the outstanding bonds. The total cost of refunding would be it) percent of the principal amount raised. The appropriate tax rate for the company is 35 percent. How low does the iborrowing cost need to drop to justify refunding with a new bond issue? 10. fBond Refunding Charles River Associates is considering whether to cali either of the two perpetual bond issues the company currently has outstanding. If the bond is called, '/ it will be refunded, that is, a new bond issue will he made with a lower coupon rate. The proceeds from the new bond issue will be used to repurchase one of the existing bond issues. The information about the two currently outstanding bond issues is: illsiiirentrrn CHALLENGE (Questions 1 I—E2) Chapter 15 Long-Term Financing 503 The corporate tax rate is 35 percent. What is the NPV of the refunding for each bond;J Winch. it either, bond should the company refinance? Assume the call premium is tax deductible. ll. Valuing the Call Feature Consider the prices of the following three Treasury issues as of February 24. 2012: . uses May l6 l06.3t250 10637500 «M13 5.28 j. 8.250 May-16- l03.43750 103.5000 W3 5.24 12.900 May 15 13418125 13436875 «as 5.32 The bond in the middle is callable in February 20! 3. What is the implied value of the cal] feature? (Him: Is there a way to combine the two noncallablc issues to create an issue that has the same coupon as the callable bond?) 12. Treasury Bonds The following Treasury bond quote appeared in The Wall Street Journal on May 11. 2004: . 9.125 ' May 09 [00.09375 JOOJZSOO . . . m2.l5 Why would anyone buy this Treasury bond with a negative yield to maturity? How 15 this possible? CORPQRATE DEBTS Singapore has one of the most developed bond markets in Asia. According to the Monetary Authority of Singapore‘s corporate debt market review. the market capitaliza- tion was more than $53357 billion in year '20} 1. The SGD bond market includes Singapore Government Securities (SGS). quasi-govermncnt bonds, corporate bonds and structured securities. The SGS is one of the major components of SGD bond market with more than $388.5 billion outstanding. Generally speaking, there are three types of $65: treasury bills. bonds and non—marketable SGS bonds. Treasury bills are shortnterm marketable government securities that mature in one year or less. The nominal value of treasury bills is $351,000. which are issued at discount. On maturity date. the treasury bill holders will receive the full face value of the treasury bill. SGS bonds are long-term marketable government debt securities with maturities more thanone year (2, 5, 10, 15. 20 and 30 years). Each SGS bond has a unique issue code. The nominal value of SOS bonds is S$l,000 with fixed interest payments to bondholders semi- annually over the life of the security and face value at maturity. Non~1narketable SGS bonds are issued for the Central Provident Fund (CPF) Board. There is no quoted market value and the interest rate for these bonds and the advance deposits are bolted to the CPF interest rate. . Besides SGS, corporate bond is another major component of the SGD bond market with more than $394 billion outstanding in year 201 1. In general. there are four types of corporate debts: corporate debentures (captures 71 percent of the corporate bond market). medium~term notes (captures 16 percent of the corporate bond market). hybrid securities (captures 11 percent of the corporate bond market). and securitized debt securities (cap- tures 2 percent of the corporate bond market). ...
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