25 or 25 her nominee is no longer guaranteed election

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Unformatted text preview: y maintains the bankruptcy and ownership advantages of equity, the firm has the best of both worlds. 6. There are two benefits. First, the company can take advantage of interest rate declines by calling in an issue and replacing it with a lower coupon issue. Second, a company might wish to eliminate a covenant for some reason. Calling the issue does this. The cost to the company is a higher coupon. A put provision is desirable from an investor’s standpoint, so it helps the company by reducing the coupon rate on the bond. The cost to the company is that it may have to buy back the bond at an unattractive price. It is the grant of authority by a shareholder to someone else to vote his or her shares. Preferred stock is similar to both debt and common equity. Preferred shareholders receive a stated dividend only, and if the corporation is liquidated, preferred stockholders get a stated value. However, unpaid preferred dividends are not debts of a company and preferred dividends are not a tax deductible business expense. A company has to issue more debt to replace the old debt that comes due if the company wants to maintain its capital structure. There is also the possibility that the market value of a company continues to increase (we hope). This also means that to maintain a specific capital structure on a market value basis the company has to issue new debt, since the market value of existing debt generally does not increase as the value of the company increases (at least by not as much). 7. 8. 9. 10. Internal financing comes from internally generated cash flows and does not require issuing securities. In contrast, external financing requires the firm to issue new securities. 11. The three basic factors that affect the decision to issue external equity are: 1) The general economic environment, specifically, business cycles. 2) The level of stock prices, and 3) The availability of positive NPV projects. 12. When a company has dual class stock, the difference in the share classes are the voting rights. Dual share classes allow minority shareholders to retain control of the company even though they do not own a majority of the total shares outstanding. Often, dual share companies were started by a family, taken public, but the founders want to retain control of the company. 13. The statement is true. In an efficient market, the callable bonds will be sold at a lower price than that of the non-callable bonds, other things being equal. This is because the holder of callable bonds effectively sold a call option to the bond issuer. Since the issuer holds the right to call the bonds, the price of the bonds will reflect the disadvantage to the bondholders and the advantage to the bond issuer (i.e., the bondholder has the obligation to surrender their bonds when the call option is exercised by the bond issuer.) 331 14. As the interest rate falls, the call option on the callable bonds is more likely to be exercised by the bond issuer. Since the non-callable bonds do not have such a drawback, the value of the bond will go up to reflect the decrease in the market rate of interest. Thus, the price of non-callable bonds will move higher than that of the callable bonds. 15. Sinking funds provide additional security to bonds. If a firm is experiencing financial difficulty, it is likely to have trouble making its sinking fund payments. Thus, the sinking fund provides an early warning system to the bondholders about the quality of the bonds. A drawback to sinking funds is that they give the firm an option that the bondholders may find distasteful. If bond prices are low, the firm may satisfy its sinking fund obligation by buying bonds in the open market. If bond prices are high though, the firm may satisfy its obligation by purchasing bonds at face value (or other fixed price, depending on the specific terms). Those bonds being repurchased are chosen through a lottery. Solutions to Questions and Problems NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability constraints, when these intermediate steps are included in this solutions manual, rounding may appear to have occurred. However, the final answer for each problem is found without rounding during any step in the problem. Basic 1. If the company uses straight voting, the board of directors is elected one at a time. You will need to own one-half of the shares, plus one share, in order to guarantee enough votes to win the election. So, the number of shares needed to guarantee election under straight voting will be: Shares needed = (600,000 shares / 2) + 1 Shares needed = 300,001 And the total cost to you will be the shares needed times the price per share, or: Total cost = 300,001 × $39 Total cost = $11,700,039 If the company uses cumulative voting, the board of directors are all elected at once. You will need 1/(N + 1) percent of the stock (plus one share) to guarantee election, where N is the number of seats up for election. So, the percentage of the c...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of Texas-Tyler.

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