Ross5eChap15sm - Chapter 15 LongTerm Financing An...

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Chapter 15: Long–Term Financing: An Introduction 15.1 Assuming that the common shares have no par value: Before the issue After the issue Common shares 2,500,[email protected]$/share $4,000,000 Common shares Surplus $4,004,800 $133,200 Retained earnings $195,000,000 Retained earnings $195,000,000 Total $199,000,000 Total $199,138,000 New Book value per share is 199,138,000/2,503,000shares=$79.56/share New Market–to–Book ratio is $46/$79.56=0.578 15.2 Assuming that 100 shares are repurchased at $46 per share and cancelled: Before the purchase After the purchase Common shares 2,500,[email protected]$/share $4,000,000 Common shares 2’499’[email protected]$/share $3,999,840 Retained earnings $195,000,000 Retained earnings $194,995,560 Total $199,000,000 Total $198,995,400 Alternatively, if the shares are not cancelled and remain as Treasury Stock, the accounts would be as follows: After the purchase Common shares 2,500,[email protected]$/share $4,000,000 Treasury Stock (4,600) Retained earnings $195,000,000 Total $198,995,400 15.3 Corporate bonds yields are usually higher. Corporations may receive dividends on preferred stock tax free, so they are willing to accept a lower pretax yield. Other corporations and institutions are the big investors in preferred stock. 15.4 The following table summarizes the main difference between debt and equity. Debt Equity Repayment is an obligation of the firm Yes No Grants ownership of the firm No Yes Provides a tax shield Yes No Liquidation will result if not paid Yes No When corporations try to create a debt security that is really equity, they are trying to obtain the tax benefits of debt while eliminating its bankruptcy costs. Preferred stock is like an “equity bond” because: Answers to End–of–Chapter Problems B–209
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1. Preferred holders receive a stated dividend. 2. In case of liquidation, preferred holders are senior to common shareholders. 3. Often, preferreds carry credit ratings. 4. Preferreds are sometimes convertible into common shares. 5. Preferreds are often callable. 6. Preferreds may have a sinking fund. 7. Preferred may have an adjustable dividend. 15.5 Babel will finance initially with internal funds and if necessary, resort to external funds – first debt and lastly common stock. For example, suppose 80% could be generated internally: .80 ($14,000,000) = $11,200,000 internal funds .20 ($14,000,000) = 2,800,000, external funds, most likely debt.
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