КФ / Лекции / Brealey Myers - Principles Of Corporate Finance 7th Ed (eBook)

3.(a) 40,000/.50 80,000 shares; (b) 78,000 shares;

(c) 2,000 shares are held as Treasury stock; (d) 20,000 shares.

4.(a) 80 votes; (b) 10 80 800 votes.

5.Similarities with debt: (a) Fixed income; (b) preferred stockholders have limited voting rights.

Similarities with equity: (a) Dividend is within discretion of directors; (b) no final repayment date;

(c)dividend is not an allowable deduction from taxable profits.

6.(a) subordinated; (b) floating rate; (c) convertible;

(d)warrant; (e) common stock; preferred stock.

7.(a) False; (b) true; (c) false.

8.A debt issue sold in international markets.

9.Support of the payment mechanism, facilitating borrowing and lending, pooling risk.

Chapter 15

1.(a) Further sale of an already publicly traded stock;

(b) U.S. bond issue by foreign corporation; (c) Bond issue by industrial company; (d) Bond issue by large industrial company.

2.(a) B; (b) A; (c) D; (d) C.

3.a. Financing of startup companies.

b. First sale of a security to public investors.

c.Trading of a security after it is issued.

d.Description of a security offering filed with the SEC.

e.Winning bidders for a new issue tend to overpay.

f.One or a few underwriters buy an entire issue.

4.(a) A large issue; (b) a bond issue; (c) subsequent issue of stock; (d) a small private placement of bonds.

5.(a) False; (b) true; (c) true.

6.(a) 135,000 shares; (b) primary: 500,000 shares; secondary: 400,000 shares; (c) $25 or 31%, which is higher than the average underpricing.

(d)

Note: Calculation ignores cost of shares sold under greenshoe option.

7.a. Net proceeds of public issue 10,000,000 150,000 80,000 $9,770,000; net proceeds of private placement $9,970,000.

b.PV of extra interest on private placement

a10 .005 10,000,000 $328,000, t 1 1.085t

i.e., extra cost of higher interest on private placement more than outweighs saving in issue costs. N.b. We ignore taxes.

c.Private placement debt can be custom-tailored and the terms more easily renegotiated.

8.An underwriter building a book solicits bids from investors, but the bids are not binding and are used only as a guide to set the issue price.

9.(a) Number of new shares, 50,000; (b) Amount of new investment, $500,000; (c) Total value of company after issue, $4,500,000; (d) Total number of shares after issue, 150,000; (e) Stock price after issue, $4,500,000/150,000 $30; (f) The opportunity to buy one share is worth $20.

Chapter 16

1.(a) A1, B5; A2, B4; A3, B3; A4, B1; A5, B2. (b) March 7 ex-dividend date; (c) (.34 4)/80.20 .017, or 1.7%; (d) (.34 4)/3.20 .43 or 43%; (e) The price would fall to 80.20/1.1 $72.91.

2.(a) .26; (b) .36.

3.(a) False; (b) true.

4.a. False. The dividend depends on past dividends and current and forecasted earnings.

b.True. This target does reflect growth opportunities and capital expenditure requirements.

c.False. Dividends are adjusted gradually to a target. The target is based on current or forecasted earnings multiplied by the target payout ratio.

d.True. Dividend changes convey information to investors.

e.False. Dividends are “smoothed.” Managers rarely increase regular dividends temporarily. They may pay a special dividend, however.

f.False. Dividends are rarely cut when repurchases are being made.

6.a. True, so long as the market value of “old” debt does not change.

b.False. MM’s Proposition I says only that overall firm value 1V D E 2 does not depend on capital structure.

c.False. Borrowing increases equity risk even if debt is default-risk-free.

d.False. Limited liability affects the relative values of debt and equity, not their sum.

e.True. Limited liability protects shareholders if the firm defaults.

f.True—but the required rate of return on equity and the firm’s assets are the same only if the firm

holds risk-free assets. In this case rA, rD, and rE all equal the risk-free rate of interest.

g.False. The shareholders could make the same debt issue on their own account.

h.True. To put it more precisely, it assumes that the expected rate of return to equity goes up, but stockholders’ required rate of return goes up proportionately. Therefore, stock price is unchanged.

i.False. The formula rE rA 1D/E 21rA rD 2 does not require rD a constant.

j.False. The clientele has to be willing to pay extra for the debt, which it will not do if plenty of corporate debt issues are already available.

7.See Figure 17.5.

8. (a) rA .15, rE .175; (b) A .6 (unchanged),D .3, E .9; (c) 18.3%.

9.(a) 10%; (b) 13.3%.

10.(a) Not affected; (b) 16 million; (c) $250 million;

(d)D/V 160/250 .64; (e) No one.

11.(a) It rises by $2 per share or $30 million; (b) 5 million;

(c)$250 million (unchanged); (d) 130/250 .52 (using market values); (e) Shareholders gain, investors in old debt lose.

c.PV tax shield TCD $350.

2.a. PV tax shield TCD $16.

b.TC 20 $8.

4.a. Direct costs of financial distress are the legal and administrative costs of bankruptcy. Indirect costs include possible delays in liquidation (Eastern Airlines) or poor investment or operating decisions while bankruptcy is being resolved. Also the threat of bankruptcy can lead to costs.

b.If financial distress increases odds of default, managers’ and shareholders’ incentives change. This can lead to poor investment or financing decisions.

c.See the answer to 4(b). Examples are the “games” described in Section 18.3.

5.Not necessarily. Announcement of bankruptcy can send a message of poor profits and prospects. Part of the share price drop can be attributed to anticipated bankruptcy costs, however.

6.A firm with no taxable income saves no taxes by borrowing and paying interest. The interest payments would simply add to its tax-loss carry-forwards. Such a firm would have little tax incentive to borrow.

7.a. Stockholders win. Bond value falls, since the value of assets securing the bond has fallen.

b.Bondholder wins if we assume the cash is left invested in Treasury bills. The bondholder is sure to get $26 plus interest. Stock value is zero, because there is no chance that firm value can rise above $50.

c.The bondholders lose. The firm adds assets worth $10 and debt worth $10. This would increase Circular’s debt ratio, leaving the old bondholders more exposed. The old bondholders’ loss is the stockholders’ gain.

d.Both bondholders and stockholders win. They share the (net) increase in firm value. The bondholders’ position is not eroded by the issue of a junior security. (We assume that the preferred does not lead to still more game playing and that the new investment does not make the firm’s assets safer or riskier.)

e.Bondholders lose because they are at risk for longer. Stockholders win.

8.Specialized, intangible assets such as growth opportunities are most likely to lose value in financial distress. Safe, tangible assets with good secondhand markets are least likely to lose value. Costs of financial distress are thus likely to be less for, say, real estate firms or trucking companies than for advertising firms or high-tech growth companies.

9.More profitable firms have more taxable income to shield and are less likely to incur the costs of distress. Therefore the trade-off theory predicts high (book) debt ratios. In practice the more profitable companies borrow least.

10.Firms have a pecking order for new financing. Internal finance is preferred, followed by debt and

then by external equity. Each firm’s observed debt ratio reflects its cumulative requirements for external finance. The more profitable companies borrow least because they have sufficient internal finance.

11.When a company issues securities, outside investors worry that management may have unfavorable information. If so the securities can be overpriced. This worry is much less with debt than equity. Debt securities are safer than equity, and their price is less affected if unfavorable news comes out later.

A company that can borrow (without incurring substantial costs of financial distress) usually does so. An issue of equity would be read as “bad news” by investors, and the new stock could be sold only at a discount to the previous market price.

12.Financial slack is most valuable to growth companies with good but uncertain investment opportunities. Slack means that financing can be raised quickly for positive-NPV investments. But too much financial slack can tempt mature companies to overinvest. Increased borrowing can force such firms to pay out cash to investors.

Chapter 19

1.Market values of debt and equity are D .9 75$67.5 million and E 42 2.5 $105 million. D/V .39.

WACC .0911 .35 2.39 .181.61 2 .1325, or 13.25%.

The key assumptions: stable capital structure (D/V constant); Federated will pay taxes at 35% marginal rate in all relevant future years; use WACC as discount rate for projects with same risk as average of firm’s assets.

2. Step 1: r .091.39 2 .181.61 2 .145.

Step 2: rD .086, rE .145 (.145 .086)(15/85).155.

Step 3: WACC .086(1 .35).15 .155(.85) .14.

3.(a) False; (b) true; (c) true.

4.The method values the equity of a company by discounting cash flows to stockholders at the cost of equity. See Section 4.5 for more details. The method assumes that the debt-to-equity ratio will remain constant.

5.(a) True; (b) false, if interest tax shields are valued separately; (c) true; (d) true.

6.Rule 1 assumes that debt supported by a project is paid off on a fixed schedule regardless of project performance. Rule 2 assumes that debt is rebalanced to keep the ratio of debt to project value constant.

7.Acceptance of a project triggers financing costs or benefits. Examples: interest tax shields, issue costs, subsidized financing tied to the project. Other side effects are encountered in international investment.

8.APV base-case NPV PV financing side effects

(a) APV 0 .15(500,000) 75,000; (b) APV 0175,000 175,000; (c) APV 0 76,00076,000

9.a. 12%, of course.

b. rE .12 1.12 .075 2130/70 2 .139,

WACC .075(1 .35)(.30) .139(.70) .112, or 11.2%.

10.PV tax shield (.10/.35)576,000 $164,600; APV

170,000 164,600 $334,600.

11.a. Base-case NPV 1,000 1200/1.20 0.

b.PV tax shield (.35 .1 .3(1000))/1.1 9.55. APV 0 9.55 $9.55.

12.No. The more debt you use, the higher rate of return equity investors will require. (Lenders may demand more also.) Thus there is a hidden cost of the “cheap” debt: It makes equity more expensive.

13.The after-tax borrowing or lending rate. This assumes that the company can lend or borrow at a safe after-tax rate.

14.PV 16(1 .35)/(1 .055(1 .35)) $10.04 million.

Chapter 20

1.Call; exercise; put; European; call; assets; bondholders (lenders); assets; promised payment to bondholders.

2.Figure 20.13a represents a call seller; Figure 20.13b represents a call buyer.

3.a. The exercise price of the put option (i.e., you’d sell stock for the exercise price);

b.The value of the stock (i.e., you would throw away the put and keep the stock).

4.Value of call PV(exercise price) value of put

value of asset (e.g., share).

See table below.

Relationship holds only for European options with same exercise price.

5.Buy a call and lend the present value of the exercise price.

6.a. Keep gold stocks and buy 6-month puts with an exercise price equal to 83.3% of the current price.

8.

b.Sell gold stocks, invest £485,000 for 6 months at 6%. The remaining £115,000 can be used to buy calls on the gold stocks with the same exercise price.

7.(a) See Figure 4; (b) stock price PV(EX) 100 100/1.1 $9.09.

9.Stockholders have the option to walk away from their debts, in which case lender takes over assets. Default put is important for firms in distress (i.e., asset value low relative to amount of loan).

10.The lower bound is the option’s value if it expired immediately: either zero or the stock price less the exercise price, whichever is larger. If an (American) call option’s price were less than the lower bound, you could exercise immediately and make a sure profit. The upper bound is the stock price.

F I G U R E 4

Chapter 20, Quiz question 7.

11.Figure 20.13(b) doesn’t show the cost of purchasing the call. The profit from call purchase would be negative for all stock prices less than exercise price plus cost of call. Figure 20.13(a) doesn’t record the proceeds from selling the call.

12.(a) Zero; (b) Stock price less the present value of the exercise price.

13.The call price (a) increases; (b) decreases; (c) increases; (d) increases; (e) decreases; (f) decreases.

14.a. All investors, however risk-averse, should value more highly an option on a volatile stock. For both Exxon Mobil and AOL the option is valueless if stock price is below the exercise price, but the option on AOL has more upside potential.

b.Other things equal, stockholders lose and debtholders gain if the company shifts to safer assets. When the assets are risky, the default put is more valuable. Debtholders bear much of the losses if asset value declines, but shareholders get the gains if asset value increases.

Chapter 21

1.a. Using risk-neutral method, (p 20) (1 p) ( 16.7) 1, p .48.

2.The period to expiration is subdivided into an indefinitely large number of subperiods (and when there is no incentive to early exercise).

3.(a) No. The maximum delta is 1.0 when the ratio of stock price to exercise price is very high. (b) No.

(c) Delta increases. (d) Delta increases.

4.Because option risk changes as time passes and the stock price changes.

Using the risk-neutral method, (p 33.3) (1 p) ( 25) 2, p .463.

The put price is 9.87.

c. 1p 100 2 11 p 21 50 2 10, p .4.

e.No. The true probability of a price rise is almost certainly higher than the risk-neutral probability, but it does not help to value the option.

8.a. Call value $3.44.

b.Put value call value PV(exercise price) stock price $1.67.

9.True; as the stock price rises, the risk of the option falls.

10.a. You would exercise early if the stock price was sufficiently low. There may be little opportunity for further gains in the option value and it would be better to invest the exercise price to earn interest.

b.Don’t exercise early. The interest savings from delaying payment of the exercise price is larger than the dividend foregone.

c.If the stock price and dividend are sufficiently high, it may pay to exercise early to capture the dividend.

Chapter 22

1.Expansion option; abandonment option; timing option (i.e., option to postpone investment); flexi-

ble production (i.e., option to exchange one asset for another).

2.a. Increase value (unless the cash flows from the Mark II needed to be discounted at a higher rate).

b.Increase value.

c.Reduce value.

3.a. Call (i.e., expansion option); (b) option to exchange one asset for another; (c) call on oil price; (d) timing option (Forest has an in-the- money call); (e) call (option to make subsequent investment in China); (f) put (i.e., abandonment option); (g) timing option (owner has an in-the-money call).

4.a. You can’t use any single discount rate for option payoffs. The risk of an option changes as asset price changes and time passes.

b.The risky asset may be worth less as a result, but option owner can capitalize from up moves while not losing from down moves.

c.Option value depends on value of underlying asset. DCF is needed to get this value.

5.a. You learn more about land prices and best use of the land.

b.By developing immediately, you capture rents immediately.

Chapter 23

1.a. (i) 0; (ii) 0; (iii) 0; (iv) $10; (v) $20. b.

Theoretical value of warrant (colored line)

c. Buy the warrant and exercise, then sell the stock.

Net gain 5 40 60 $15.

2.(a) No; (b) no; (c) 1/3 70 $23.33; (d) no, worse off; (e) zero; (f) more; (g) (i) less, (ii) less, (iii) more,

(iv)more, (v) more; (h) when the dividends on the stock outweigh the interest on the exercise price;

(i)more.

3.(a) $15,000; (b) $29,000.

4.(a) 1,000/47 21.28; (b) 1,000/50 $20.00; (c) 21.2841.50 $883.12, or 88.31%; (d) 650/21.28 $30.55;

(e) no (not if the investor is free to convert immediately); (f) $12.22, i.e., (910 650)/21.28; (g) (47/41.50)1 .13, or 13%; (h) when the price reaches 102.75% of par.

5.(a) $7.00; (b) $7.05.

6.(a) False; (b) true; (c) false; (d) false; (e) true; (f) true.

Chapter 24

1a. Figure 5 shows that an increase in the demand for capital increases investment and savings. The rate of interest also rises.

b.Figure 6 shows that an increase in the supply of capital also increases investment and savings. The rate of interest falls.

2.There are 20 coupon payments of 6.9375 plus a principal payment of 100. With a discount rate of 8.04/2 4.02%, PV is

3.a The Norwegian bond has the highest yield (5.6%) and the Finnish bond has the lowest (4.5%).

b.The Finnish bond has the longest duration (7.9 years) and the Norwegian has the shortest (7.1 years).

501,050

4.a. PV 1 r1 11 r2 22

501,050

b.PV 1 y 11 y 22

c.Less (it is between the 1-year and 2-year spot rates).

d.Yield to maturity; spot rate.

5.a. Fall (e.g., 1-year 10% bond is worth 110/1.1 100 if r 10% and is worth 110/1.15 95.65 if r 15%).

b.Less (e.g., see 5(a)).

c.Less (e.g., with r 5%, 1-year 10% bond is worth 110/1.05 104.76).

d.Higher (e.g., if r 10%, 1-year 10% bond is worth 110/1.1 100, while 1-year 8% bond is worth 108/1.1 98.18).

e.No, low-coupon bonds have longer durations (unless there is only one period to maturity) and are therefore more volatile (e.g., if r falls from 10% to 5%, the value of a 2-year 10% bond rises from 100 to 109.3 (a rise of 9.3%). The value of a 2-year 5% bond rises from 91.3 to 100 (a rise of 9.5%).

6.a. (100/90.826)(1/2) 1 .0493, or 4.93%; (100/73.565)(1/7) 1 .0448, or 4.48%; (100/70.201)(1/8) 1 .0452, or 4.52%;

(100/67.787)(1/9) 1 .0441, or 4.41%; (100/29.334)(1/30) 1 .0417, or 4.17%.

b.Downward.

c.Higher (the yield is a complicated average of the different spot rates).

d.73.565/70.201 1 .0479, or 4.79%; 70.201/ 67.787 1 .0356, or 3.56%.

7.a. Price today is 108.425; price after 1 year is 106.930.

b.Return (106.930 8)/108.425 1 .06, or 6%.

c.If a bond’s yield to maturity is unchanged, the return to the bondholder is equal to the yield.

8.a. False. Duration depends on the coupon as well as the maturity.

b.False. Given the yield to maturity, volatility is proportional to duration.

c.True. A lower coupon rate means longer duration and therefore higher volatility.

d.False. A higher interest rate reduces the relative present value of (distant) principal repayments.

10. a. 11 r2 22 11 r1 211 f2 2

1.032 1.01 11 f2 2 f2 .05, or 5%.

b.The expected 1-year spot rate at time 1 equals the forward rate f2.

c.Against (unless one believes that investors have generally expected interest rates to rise).

d.The forward rate equals the expected spot rate plus a liquidity premium.

e.Long-term bonds.

f.Short-term bonds.

11.a. Aaa, Aa, A, and Baa

b.(i) Increase; (ii) increase; (iii) increase; (iv) increase.

12.Option to put (i.e., sell) company assets to the bondholders for the face value of the debt.

13.Value an option to put (i.e., sell) the company’s assets to the government for the amount of the loan.

Chapter 25

1. (a) High-grade utility bonds; (b) industrial holding companies; (c) industrial bonds; (d) railroads;

(e)asset-backed security.

2.• Indenture or trust deeds—agreement between the borrower and a trust company representing bondholders.

•Debentures—long-term unsecured bonds.

•Mortgage bonds—debt secured by property.

•Call provision—company has right to call and pay off debt.

•Sinking fund—provision for repayment of part or most of principal prior to maturity.

•Foreign bond—bond sold in another country’s market.

•Negative pledge clause—if secured debt is issued, existing debt will also become secured.

3.(a) Decreases; (b) impossible to say; (c) impossible to say. For example, if the bond has a high coupon and is sold at a premium at issue, the prospect of drawings at par could decrease value. For an originalissue discount bond, the effect could be reversed.

4.a. You would like an issue of junior debt.

b.You prefer it not to do so (unless it is also junior debt). The existing property may not be sufficient to pay off your debt.

5.(a) First Boston, Goldman Sachs, Shearson Lehman, Stifel Nicholaus; (b) Continental Bank; (c) $967.25;

(d) registered; (e) 104.26 (percent of par); (f) no.

6.a. Issue price approximately 1 month’s interest976.00 95/12 $983.92.

b.December 1, 1986; $47.50.

c.2016. The sinking fund was designed to pay off all but $8.64 million of principal by that date. The company must pay off the remaining $8.64 million.

d.2002.

7.The 7.8 percent rate is actually 3.9 percent semiannually. The effective annual rate is 1.0392 1.0795, slightly higher than the London quote. International bonds pay interest annually.

8.Private placements: typically have simpler loan agreements—which may nevertheless contain “custom” features; have more stringent covenants; are more easily renegotiated.

9.a. False. Lenders usually retain some recourse; e.g., they may demand a completion guarantee.

b.True, but some new securities (e.g., zero-coupon bonds) survive even when the original motive for issuing them disappears.