# Busi 320 Week 7 Assignment – Corporate Finance Problems

1.00 point

Which of the following is not a money market instrument?

Treasury bills

Commercial paper

Negotiable certificates of deposit

Treasury bonds

Learning Objective: 14-01 The

Multiple Choice capital markets; both domestic and

Difficulty: Basic foreign; are made up of securities

that have a life of one year or longer

(often much longer).

1.00 point

During the next several years, the major threat to the dominance of the U.S. money and capital markets is expected to come from

Russia’s difficulty in transforming its economy into a capitalistic one.

Japan’s prolonged recession and banking crisis.

the Eurozone countries comprising the European Monetary Union and a single currency. the huge Chinese economy and its billion-plus people.

Learning Objective: 14-02 The

primary participants raising funds in

Multiple Choice Difficulty: Intermediate domestic capital markets are the

U.S. Treasury; other agencies of the federal; state; and local governments; and corporations.

award:

1.00 point

Federally sponsored credit agencies include all but which of the following?

Securities Investor Protection Corporation (SIPC)

Federal Home Loan Banks (FHLB)

Student Loan Marketing Association (Sallie Mae)

Federal National Mortgage Association (Fannie Mae)

Learning Objective: 14-02 The

primary participants raising funds in

Multiple Choice Difficulty: Intermediate domestic capital markets are the

U.S. Treasury; other agencies of the

federal; state; and local

governments; and corporations.

award:

1.00 point

Which of the following is an internal source of funds?

Cash flow from depreciation (tax shield)

Net loss

Repurchase of debt securities

Bank loan

Learning Objective: 14-01 The

Multiple Choice capital markets; both domestic and

Difficulty: Basic foreign; are made up of securities

that have a life of one year or longer

(often much longer).

award:

1.00 point

Which of the following is not an example of indirect investment by a household?

Investment in a mutual fund’s shares

Investment in an original offering of corporate securities

Learning Objective: 14-03 The

United States is a three-sector

Multiple Choice Difficulty: Basic economy in which households;

Investment in life insurance

A savings deposit in a commercial bank

corporations; and governmental units allocate funds among themselves.

award:

1.00 point

Security markets provide liquidity

by allowing corporations to raise funds by selling new issues.

by creating a market in which owners may easily turn an investment into cash through its sale.

by allowing corporations to raise funds by selling new issues and by creating a market in which owners may easily turn an investment into cash through its sale.

None of these options are correct.

Multiple Choice Difficulty: Basic Learning Objective: 14-04 Securities

markets consist of physical and

electronic markets.

award:

1.00 point

Of the following efficient market hypotheses, which one has research generally indicated is not correct?

Weak

Semi-strong

Strong

Two of the options

Learning Objective: 14-05 Security

Multiple Choice Difficulty: Basic markets are considered to be

efficient when prices adjust rapidly

to new information.

award:

1.00 point

American Health Systems currently has 5,600,000 shares of stock outstanding and will report earnings of $17 million in the current year. The company is considering the issuance of 1,300,000 additional shares that will net $40 per share to the corporation.

a. What is the immediate dilution potential for this new stock issue? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Dilution $ per share

b-1. Assume that American Health Systems can earn 6 percent on the proceeds of the stock issue in time to include them in the current year’s results. Calculate earnings per share. (Do not round intermediate calculations and round your answer to 2 decimal places.)

Earnings per share $

b-2. Should the new issue be undertaken based on earnings per share?

No

Yes

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Learning Objective: 15-03

Worksheet Difficulty: Basic Distribution of new securities may

involve dilution in earnings per

share.

award:

9. 1.00 point

Assume Sybase Software is thinking about three different size offerings for issuance of additional shares.

Size of Offer Public Price Net to Corporation

a. $ 1.8 million $ 41 $ 38.60

b. 6.0 million 41 38.80

c. 29.0 million 41 39.50

What is the percentage underwriting spread for each size offer? (Do not round intermediate calculations.

Enter your answers as a percent rounded to 2 decimal places.)

Size of Offer Underwriting Spread

a. $1.8 million %

b. $6.0 million %

c. $29.0 million %

View Hint #1

Learning Objective: 15-02

Investment bankers, rather than

Worksheet Difficulty: Basic corporations, normally take the risk

of successfully distributing corporate

securities and for this there are costs involved.

award:

10. 2.00 points

The Wrigley Corporation needs to raise $36 million. The investment banking firm of Tinkers, Evers, & Chance will handle the transaction.

a. If stock is utilized, 2,400,000 shares will be sold to the public at $16.80 per share. The corporation will receive a net price of $15 per share. What is the percentage underwriting spread per share? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Underwriting spread per share %

b. If bonds are utilized, slightly over 36,000 bonds will be sold to the public at $1,009 per bond. The corporation will receive a net price of $993 per bond. What is the percentage of underwriting spread per bond? (Relate the dollar spread to the public price.) (Do not round intermediate calculations.

Enter your answer as a percent rounded to 2 decimal places.)

Underwriting spread per bond %

c-1. Which alternative has the larger percentage of spread?

Stock

Bond

c-2. Is this the normal relationship between the two types of issues?

Yes

No

Learning Objective: 15-02

Investment bankers, rather than

Worksheet Difficulty: Basic corporations, normally take the risk

View Hint #1

of successfully distributing corporate securities and for this there are costs involved.

award:

11. 1.00 point

Kevin’s Bacon Company Inc. has earnings of $5 million with 2,200,000 shares outstanding before a public distribution. Six hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 200,000 are shares currently owned by Ann Fry, the founder and CEO. The 200,000 shares that Ann is selling are referred to as a secondary offering and all proceeds will go to her.

The net price from the offering will be $24.50 and the corporate proceeds are expected to produce $1.2 million in corporate earnings.

a. What were the corporation’s earnings per share before the offering? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Earnings per share $

b. What are the corporation’s earnings per share expected to be after the offering? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Earnings per share $

View Hint #1

Learning Objective: 15-02

Investment bankers, rather than

Worksheet Difficulty: Basic corporations, normally take the risk

of successfully distributing corporate securities and for this there are costs involved.

award:

12. 1.00 point

Becker Brothers is the managing underwriter for a 1.55-million-share issue by Jay’s Hamburger Heaven. Becker Brothers is “handling” 8 percent of the issue. Its price is $25 per share and the price to the public is $26.75.

Becker also provides the market stabilization function. During the issuance, the market for the stock turned soft, and Becker is forced to purchase 65,000 shares in the open market at an average price of

$25.70. They later sell the shares at an average value of $25.25.

Compute Becker Brothers’ overall gain or loss from managing the issue. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

(Click to select) $

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Learning Objective: 15-02

Investment bankers, rather than

Worksheet Difficulty: Basic corporations, normally take the risk

of successfully distributing corporate securities and for this there are costs involved.

award:

13. 2.00 points

The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D1) at the end of the current year will be $1.70. The growth

rate (g) is 7 percent and the discount rate (Ke) is 12 percent.

a. What should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Price of the stock $

b. If there is a 5 percent total underwriting spread on the stock, how much will the issuing corporation receive? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Net price to the corporation $

c. If the issuing corporation requires a net price of $32.50 (proceeds to the corporation) and there is a 5 percent underwriting spread, what should be the price of the stock to the public? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Necessary public price $

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Learning Objective: 15-01

Investment bankers are

Worksheet Difficulty: Intermediate intermediaries between corporations

in need of funds and the investing public. They also provide important advice.

award:

14. 3.00 points

The Landers Corporation needs to raise $1.90 million of debt on a 10-year issue. If it places the bonds privately, the interest rate will be 10 percent. Twenty five thousand dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 12 percent, and the underwriting spread will be 4 percent. There will be $110,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 10-year period, at which time it will be repaid. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. For each plan, compare the net amount of funds initially available—inflow—to the present value of future payments of interest and principal to determine net present value. Assume the stated discount rate is 16 percent annually. Use 8.00 percent semiannually throughout the analysis. (Disregard taxes.) (Assume the $1.90 million needed includes the underwriting costs. Input your present value of future payments answers as negative values. Do not round intermediate calculations and round your answers to 2 decimal places.)

Private Placement Public Issue

Net amount to Landers $ $

Present value of future payments

Net present value $ $

b. Which plan offers the higher net present value?

Private placement

Public issue

Learning Objective: 15-01

Investment bankers are

Worksheet Difficulty: Intermediate intermediaries between corporations

View Hint #1

in need of funds and the investing public. They also provide important advice.

award:

15. 2.00 points

The Presley Corporation is about to go public. It currently has aftertax earnings of $7,100,000, and 3,200,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 900,000 new shares. The new shares will be priced to the public at $25 per share, with a 5 percent spread on the offering price. There will also be $250,000 in out-of-pocket costs to the corporation.

a. Compute the net proceeds to the Presley Corporation. (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Net proceeds $

b. Compute the earnings per share immediately before the stock issue. (Do not round intermediate

calculations and round your answer to 2 decimal places.)

Earnings per share $

c. Compute the earnings per share immediately after the stock issue. (Do not round intermediate calculations and round your answer to 2 decimal places.)

Earnings per share $

d. Determine what rate of return must be earned on the net proceeds to the corporation so there will not be a dilution in earnings per share during the year of going public. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Rate of return %

e. Determine what rate of return must be earned on the proceeds to the corporation so there will be a 5 percent increase in earnings per share during the year of going public. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Rate of return %

View Hint #1

Learning Objective: 15-03

Worksheet Difficulty: Challenge Distribution of new securities may

involve dilution in earnings per

share.

award:

16. 2.00 points

The management of Mitchell Labs decided to go private in 2002 by buying all 3.50 million of its outstanding shares at $18.40 per share. By 2006, management had restructured the company by selling off the petroleum research division for $13.50 million, the fiber technology division for $ 7.90 million, and the synthetic products division for $23 million. Because these divisions had been only marginally profitable, Mitchell Labs is a stronger company after the restructuring. Mitchell is now able to concentrate exclusively on contract research and will generate earnings per share of $1.45 this year. Investment bankers have contacted the firm and indicated that if it reentered the public market, the 3.50 million shares it purchased to go private could now be reissued to the public at a P/E ratio of 13 times earnings per share.

a. What was the initial cost to Mitchell Labs to go private? (Do not round intermediate calculations.

Round your answer to 2 decimal places. Enter your answer in millions, not dollars (e.g., $1,230,000 should be entered as “1.23”).)

Initial cost $ million

b. What is the total value to the company from (1) the proceeds of the divisions that were sold, as well as

(2) the current value of the 3.50 million shares (based on current earnings and an anticipated P/E of 13)? (Do not round intermediate calculations. Round your answer to 2 decimal places. Enter your answer in millions, not dollars (e.g., $1,230,000 should be entered as “1.23”).)

Total value to the company $ million

c. What is the percentage return to the management of Mitchell Labs from the restructuring? Use answers from parts a and b to determine this value. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Percentage return %

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Learning Objective: 15-05

Worksheet Difficulty: Challenge Leveraged buyouts rely heavily on

debt in the restructuring of a

corporation.

award:

17. 2.00 points

Preston Corporation has a bond outstanding with an annual interest payment of $80, a market price of $1,230, and a maturity date in 5 years. Assume the par value of the bond is $1,000.

Find the following: (Use the approximation formula to compute the approximate yield to maturity and use the calculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

a. Coupon rate %

b. Current yield

%

c-1. Approximate yield to maturity %

c-2. Exact yield to maturity %

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Learning Objective: 16-02 Bond

Worksheet yield are important to bond analysis

Difficulty: Basic and are influenced by how bonds

are rated by major bond rating

agencies.

award:

18. 2.00 points

Harold Reese must choose between two bonds:

Bond X pays $70 annual interest and has a market value of $800. It has 13 years to maturity. Bond Z pays $80 annual interest and has a market value of $850. It has four years to maturity.

Assume the par value of the bonds is $1,000.

a. Compute the current yield on both bonds. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Current Yield

Bond X %

Bond Z %

b. Which bond should he select based on your answers to part a?

Bond Z

Bond X

c. A drawback of current yield is that it does not consider the total life of the bond. For example, the approximate yield to maturity on Bond X is 9.70 percent. What is the approximate yield to maturity on Bond Z? The exact yield to maturity? (Use the approximation formula to compute the approximate yield to maturity and use the calculator method to compute the exact yield to maturity. Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)

Approximate yield to maturity %

Exact yield to maturity %

d. Has your answer changed between parts b and c of this question?

Yes

No

View Hint #1

Learning Objective: 16-02 Bond

Worksheet yield are important to bond analysis

Difficulty: Basic and are influenced by how bonds

are rated by major bond rating

agencies.

award:

19. 2.00 points

A 15-year, $1,000 par value zero-coupon rate bond is to be issued to yield 8 percent. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. What should be the initial price of the bond? (Assume annual compounding. Do not round intermediate calculations and round your answer to 2 decimal places.)

Bond price $

b. If immediately upon issue, interest rates dropped to 7 percent, what would be the value of the zero-

coupon rate bond? (Assume annual compounding. Do not round intermediate calculations and round your answer to 2 decimal places.)

Bond price $

c. If immediately upon issue, interest rates increased to 11 percent, what would be the value of the zero-coupon rate bond? (Assume annual compounding. Do not round intermediate calculations and round your answer to 2 decimal places.)

Bond price $

View Hint #1

Learning Objective: 16-02 Bond

Worksheet yield are important to bond analysis

Difficulty: Basic and are influenced by how bonds

are rated by major bond rating

agencies.

award:

20. 2.00 points

Assume a zero-coupon bond that sells for $413 will mature in 15 years at $1,500. Use Appendix B for an approximate answer but calculate your final answer using the formula and financial calculator methods.

What is the effective yield to maturity? (Assume annual compounding. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Effective yield to maturity %

View Hint #1

Worksheet yield are important to bond analysis

Difficulty: Basic and are influenced by how bonds

are rated by major bond rating

agencies.

award:

21. 1.00 point

You buy an 11 percent, 15-year, $1,000 par value floating rate bond in 1999. By the year 2014, rates on bonds of similar risk are up to 13 percent.

What is your one best guess as to the value of the bond?

Value of the bond $

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Learning Objective: 16-02 Bond yield are important to bond analysis

Worksheet Difficulty: Basic and are influenced by how bonds

are rated by major bond rating

agencies.

award:

22. 1.00 point

Thirteen years ago, the Archer Corporation borrowed $7,000,000. Since then, cumulative inflation has been 67 percent (a compound rate of approximately 4 percent per year).

a. When the firm repays the original $7,000,000 loan this year, what will be the effective purchasing power of the $7,000,000? (Hint: Divide the loan amount by one plus cumulative inflation.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Effective purchasing power $

b. To maintain the original $7,000,000 purchasing power, how much should the lender be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.) (Do not round intermediate calculations and round your answer to the nearest whole dollar.)

Loan repayment $

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Learning Objective: 16-02 Bond

Worksheet yield are important to bond analysis

Difficulty: Intermediate and are influenced by how bonds

are rated by major bond rating

agencies.

award:

23. 2.00 points

A $1,000 par value bond was issued 25 years ago at a 12 percent coupon rate. It currently has 15 years remaining to maturity. Interest rates on similar obligations are now 10 percent. Assume Ms. Bright bought the bond three years ago when it had a price of $1,080. Further assume Ms. Bright paid 30 percent of the purchase price in cash and borrowed the rest (known as buying on margin). She used the interest payments from the bond to cover the interest costs on the loan.

a. What is the current price of the bond? Use Table 16-2. (Input your answer to 2 decimal places.)

Price of the bond $

b. What is her dollar profit based on the bond’s current price? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Dollar profit $

c. How much of the purchase price of $1,080 did Ms. Bright pay in cash? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Purchase price paid in cash $

d. What is Ms. Bright’s percentage return on her cash investment? Divide the answer to part b by the answer to part c. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Percentage return %

View Hint #1

Learning Objective: 16-02 Bond

Worksheet yield are important to bond analysis

Difficulty: Intermediate and are influenced by how bonds

are rated by major bond rating

agencies.

award:

24. 3.00 points

A $1,000 par value bond was issued five years ago at a coupon rate of 10 percent. It currently has 20 years remaining to maturity. Interest rates on similar debt obligations are now 12 percent. Use Appendix B and Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. Compute the current price of the bond using an assumption of semiannual payments. (Do not round intermediate calculations and round your answer to 2 decimal places.)

Current bond price $

b. If Mr. Robinson initially bought the bond at par value, what is his percentage capital gain or loss?

(Ignore any interest income received. Do not round intermediate calculations and input the amount as a positive percent rounded to 2 decimal places.)

Percentage (Click to select) %

c. Now assume Mrs. Pinson buys the bond at its current market value and holds it to maturity, what will be her percentage capital gain or loss? (Ignore any interest income received. Do not round intermediate calculations and input the amount as a positive percent rounded to 2 decimal places.)

Percentage (Click to select) %

d. Why is the percentage gain larger than the percentage loss when the same dollar amounts are involved in parts b and c?

The percentage gain is larger than the percentage loss because the investment is larger. The percentage gain is larger than the percentage loss because the investment is smaller.

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Learning Objective: 16-02 Bond

yield are important to bond analysis

Worksheet Difficulty: Intermediate and are influenced by how bonds

are rated by major bond rating agencies.

award:

25. 4.00 points

The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it merely footnoted lease obligations in the balance sheet, which appeared as follows: Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

In $ millions

Current assets $ 85

Fixed assets 85

Total assets $ 170

In $ millions

Current liabilities $ 25

Long-term liabilities 50

Total liabilities $ 75

Stockholders’ equity 95

Total liabilities and

stockholders’ equity $ 170

The footnotes stated that the company had $35 million in annual capital lease obligations for the next 10 years.

a. Discount these annual lease obligations back to the present at a 10 percent discount rate. (Do not round intermediate calculations. Round your answer to the nearest million. Input your answer in millions of dollars (e.g., $6,100,000 should be input as “6”).)

PV of lease obligations $ million

b. Construct a revised balance sheet that includes lease obligations. (Do not round intermediate calculations. Round your answers to the nearest million. Input your answer in millions of dollars (e.g., $6,100,000 should be input as “6”).)

Balance Sheet (In $ millions)

Current assets $ Current liabilities $

Fixed assets Long-term liabilities

Leased property Obligations under

under capital lease capital lease

Total liabilities $

Stockholders’ equity

Total liabilities and

Total assets $ Stockholders’ equity $

c. Compute the total debt to total asset ratio for the original and revised balance sheets. (Input your answers as a percent rounded to 2 decimal places.)

Original %

Revised %

d. Compute the total debt to total equity ratio for the original and revised balance sheets. (Input your answers as a percent rounded to 2 decimal places.)

Original %

Revised %

e. In an efficient capital market environment, should the consequences of SFAS No. 13, as viewed in the answers to parts c and d, change stock prices and credit ratings?

Yes

No

View Hint #1

Learning Objective: 16-04 Long-

Worksheet term lease obligations have many

Difficulty: Challenge characteristics similar to debt and

are recognized as a form of indirect

debt by the accounting profession.

award:

26. 4.00 points

The Hardaway Corporation plans to lease a $840,000 asset to the O’Neil Corporation. The lease will be for 16 years. Use Appendix D for an approximate answer but calculate your final answer using the formula and financial calculator methods.

a. If the Hardaway Corporation desires a return of 12 percent on its investment, how much should the lease payments be? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Lease payment $

b. If the Hardaway Corporation is able to take a 10 percent deduction from the purchase price of $840,000 and will pass the benefits along to the O’Neil Corporation in the form of lower lease payments (related to the Hardaway Corporation in the form of lower initial net cost), how much should the revised lease payments be? The Hardaway Corporation desires a return of 12 percent on the 16-year lease. (Do not round intermediate calculations and round your answer to 2 decimal places.)

Revised lease payment $

View Hint #1

Learning Objective: 16-04 Long-

Worksheet term lease obligations have many

Difficulty: Challenge characteristics similar to debt and

are recognized as a form of indirect

debt by the accounting profession.