ch 8 solutions


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CHAPTER 8 COMMON STOCK: CHARACTERISTICS, VALUATION AND ISSUANCE ANSWERS TO QUESTIONS: 1.a. Nonvoting stock - common stock that is issued when the firm wishes to raise additional equity capital but does not want to give up voting power. b. Stock split - the issuance of a number of new shares in exchange for each old share held by a stockholder in order to lower the stock price to a more desirable trading level. c. Reverse stock split - the issuance of one new share in exchange for a number of old shares held by a stockholder in order to raise the stock price to a more desirable trading level. d. Stock dividend - a dividend to stockholders in the form of additional shares of stock instead of cash. e. Book value - total common stockholders' equity divided by the number of shares outstanding. f. Treasury stock - shares of common stock that have been repurchased by the company. 2. No, the retained earnings figure on the balance sheet is simply the cumulative amount of earnings that have been retained over time. At the time when income is retained, these dollars may be used to purchase additional long-term assets. As a result, the retained earnings amount is not available for current dividends. Current dividends are paid out of cash (or earnings) and not out of retained earnings. 3. Reasons for stock repurchases: tax considerations – Under current tax laws, capital gains income is taxed at lower rates than dividend income for individual taxpayers. Also, there is a tax advantage to share repurchases because taxes on capital gains income can be deferred into the future when the stock is sold. (See Chapter 14 for additional discussion of this point.) financial restructuring - the firm can gain the benefits of increased financial leverage through the issuance of debt and using the proceeds to repurchase its common stock. future corporate needs - repurchased stock can be used in future acquisitions of other companies, executive stock options, exercise of warrants, and conversion of convertible 93
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Chapter 8 Common Stock: Characteristics, Valuation and Issuance securities. disposition of excess cash - funds that the company does not feel can be profitably invested in the foreseeable future can be used to repurchase stock. reduction of takeover risk - by increasing the price of the firm's stock and concentrating ownership in the hands of a smaller number of investors, share repurchases can be used to reduce the returns to investors who might be considering acquisition of the firm. 4. For common stock, par value typically is a low figure of little significance. Book value is common stockholders’ equity divided by the number of common shares issued and outstanding. The market value of a common stock depends in general on the outlook for the firm and the economy (i.e. future earnings and dividends and their risk) and normally bears little relationship to book value and no relationship to par value. 5.
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This note was uploaded on 04/08/2008 for the course FINANCE 311 taught by Professor Bradley during the Spring '08 term at Clemson.

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