1. Which of the following statements concerning futures markets is false?
Futures markets allow investors to manage risk.
Futures markets can be used to hedge against changing commodity prices.
Interest rate futures can be used to hedge against the risk of rising interest rates.
All of the statements above are true.
2. All of the following are recognized as an important influences in the development of the banking crisis of 2008 and the resulting credit crisis EXCEPT:
Consumers, especially homeowners, took on too much debt.
Real estate prices collapsed.
The IMF bailed out Freddie Mac and Fannie Mae.
Too many subprime loans were repackaged and sold as securities.
3. Evidence of how global markets are linked was provided in 1997 and 1998 when international markets reacted to
the collapse of Asian currencies in Thailand, Indonesia, Malaysia and Korea.
Russia's default on its sovereign debt.
Japan's seven years of economic stagnation.
a and b are true.
4. The European Monetary Union (EMU) which came into effect in January of 1999 includes
Britain, France, Germany, Spain, Italy and 6 other European countries.
The establishment of a new European Central Bank to coordinate monetary policy for the Euro-zone countries.
A new currency called the Euro, which will be put into circulation in all EMU countries no later than 2009.
All of these.
5. During the next ten years, the major threat to the dominance of the U.S. money and capital markets will come from
Japan's prolonged recession and banking crisis.
Russia's difficulty in transforming its economy into a capitalistic one.
The huge Chinese economy and its billion plus people.
The Euro-zone countries comprising the European Monetary Union and a single currency.
6. Corporations prefer bonds over preferred stock for financing their operations because
preferred stocks require a dividend.
bond interest rates change with the economy while stock dividends remain constant.
the after-tax cost of debt is less than the cost of preferred stock.
none of these.
7. In general when interest rates are expected to rise, financial managers
accept more risk.
try to lock in long-term financing at low cost.
balance the company's debt structure with more short-term debt and less long-term debt.
rely more on internal sources of funds rather than external sources.
8. The major supplier of funds for investment in the whole economy is
households.
businesses.
government.
financial institutions.
9. Security markets are efficient when each of the following exist except
there is a continuous market where each successive trade is made at a price close to the previous trade.
prices adjust rapidly to new information.
security prices follow the leading indicators such as the DJIA very closely.
the markets can absorb large dollar amounts of stock without destabilizing the price.
10. The strong form of the efficient market hypothesis states that
past price data is positively correlated to future prices.
prices reflect all public information.
all information both public and private is immediately reflected in stock prices.
none of these
11. The Securities Act of 1933 is primarily concerned with
secondary trading of securities.
national securities market.
protecting customers of bankrupt securities firms.
original issues of securities.
12. The Securities Act of 1933 did not
set guidelines for insiders who trade in the securities of their own firm.
hold corporate officers liable for losses for those who were misled by false information in the prospectus.
require that all securities sold in more than one state be registered with the SEC.
require a prospectus for all new issues of securities which contains all information appearing in the registration statement.
13. The Securities Exchange Act of 1934 is primarily concerned with
protecting customers of bankrupt securities firms.
original issues of securities.
a central market system.
regulation of organized exchanges.
14. American Health Systems currently has 6,100,000 shares of stock outstanding and will report earnings of $14 million in the current year. The company is considering the issuance of 1,800,000 additional shares that will net $30 per share to the corporation.
(a) What is the immediate dilution potential for this new stock issue?
(b-1) Assume that American Health Systems can earn 7 percent on the proceeds of the stock issue in time to include them in the current year's results. Calculate earings per share.
(b-2) Should the new issue be undertaken based on earnings per share?
15. Assume Fisher Food Products is thinking about three different size offerings for the issuance of additional shares.
Size of offer Public price Net to corporation
|
Size of offer
|
Public price
|
Net to corporation
|
|
a.
|
$ 2.2
|
million
|
$ 45
|
$ 41.50
|
|
b.
|
7
|
million
|
45
|
42.00
|
|
c.
|
31
|
million
|
45
|
42.25
|
(a) What is the percentage underwriting spread for each size offer?
(b) What principle does this demonstrate?
Larger the offer size, the higher the percentage spread
Larger the offer size, the lower the percentage spread
Smaller the offer size, the lower the percentage spread
16. Walton and Company is the managing investment banker for a major new underwriting. The price of the stock to the investment banker is $23 per share. Other syndicate members may buy the stock for $25.25. The price to the selected dealers group is $26.80, with a price to brokers of $28.20. Finally, the price to the public is $29.95.
(a) If Walton and Company sells its shares to the dealers group, what will the percentage return be?
(b) If Walton and Company also performs the dealer's function and sells to brokers, what will the percentage return be?
(c) If Walton and Company fully integrates its operation and sells directly to the public, what will its percentage return be?
17. The Wrigley Corporation needs to raise $29 million. The investment banking firm of Tinkers, Evers, & Chance will handle the transaction.
(a) If stock is utilized, 1,800,000 shares will be sold to the public at $16.50 per share. The corporation will receive a net price of $16 per share. What is the percentage underwriting spread per share?
(b) If bonds are utilized, slightly over 28,800 bonds will be sold to the public at $1,008 per bond. The corporation will receive a net price of $996 per bond. What is the percentage of underwriting spread per bond? (Relate the dollar spread to the public price.)
(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?
18. Kevin's Bacon Company Inc. has earnings of $8 million with 2,400,000 shares outstanding before a public distribution. Seven hundred thousand shares will be included in the sale, of which 400,000 are new corporate shares, and 300,000 are shares currently owned by Ann Fry, the founder and CEO. The 300,000 shares that Ann is selling are referred to as a secondary offering and all proceeds will go to her.
The net price for the offering will be $16.50 and the corporate proceeds are expected to produce $1.5 million in corporate earnings.
(a) What were the corporation's earnings per share before the offering?
(b) What are the corporation's earnings per share expected to be after the offering?
19. Becker Brothers is the managing underwriter for a 1.35-million-share issue by Jay's Hamburger Heaven. Becker Brothers is "handling" 9 percent of the issue. Its price is $26 per share and the price to the public is $27.50.
Becker also provides the market stabilization function. During the issuance, the market for the stock turns soft, and Becker is forced to purchase 40,000 shares in the open market at an average price of $26.25. They later sell the shares at an average value of $26.15.
Compute Becker Brothers' overall gain or loss from managing the issue.
20. Winston Sporting Goods is considering a public offering of common stock. Its investment banker has informed the company that the retail price will be $17.25 per share for 620,000 shares. The company will receive $16.00 per share and will incur $140,000 in registration, accounting, and printing fees.
(a-1) What is the spread on this issue in percentage terms?
(a-2) What are the total expenses of the issue as a percentage of total value (at retail)?
(b) If the firm wanted to net $14.26 million from this issue, how many shares must be sold?
21. Rodgers Homebuilding is about to go public. The investment banking firm of Leland Webber and Company is attempting to price the issue. The homebuilding industry generally trades at a 18 percent discount below the P/E ratio on the Standard & Poor's 500 Stock Index. Assume that index currently has a P/E ratio of 20. Rodgers can be compared to the homebuilding industry as follows:
|
|
Rodgers
|
Homebuilding Industry
|
|
Growth rate in earnings per share
|
8%
|
10%
|
|
Consistency of performance
|
Increased earnings
4 out of 5 years
|
Increased earnings
3 out of 5 years
|
|
Debt to total assets
|
45%
|
40%
|
|
Turnover of product
|
Slightly below average
|
Average
|
|
Quality of management
|
Low
|
Average
|
Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor's 500 Index. Then 1/4 point will be added to the P/E ratio for each case in which Rodgers is superior to the industry norm, and 1/4 point will be deducted for an inferior comparison.
What should the initial P/E be for Rodgers Homebuilding?
22. 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 $1.80. The growth rate (g) is 8 percent and the discount rate (Ke) is 12 percent.
(a) What should be the price of the stock to the public?
(b) If there is a 6 percent total underwriting spread on the stock, how much will the issuing corporation receive?
(c) If the issuing corporation requires a net price of $ 43.50 (proceeds to the corporation) and there is a 6 percent underwriting spread, what should be the price of the stock to the public?
23. The Landers Corporation needs to raise $1.00 million of debt on a 20-year issue. If it places the bonds privately, the interest rate will be 10 percent. 30000 dollars in out-of-pocket costs will be incurred. For a public issue, the interest rate will be 9 percent, and the underwriting spread will be 2 percent. There will be $100,000 in out-of-pocket costs. Assume interest on the debt is paid semiannually, and the debt will be outstanding for the full 20-year period, at which time it will be repaid. Use AppendixB and Appendix D.
(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 13 percent annually. Use 6.50 percent semiannually throughout the analysis. (Disregard taxes.)
(b) Which plan offers the higher net present value?
Private placement
Public issue
Appendix D
PVA= A × PVIFA (n = 40, i = 6.5%)
PVA= $50,000 × 14.146
PVA= $707,300
Present value of lump-sum payment at maturity
Appendix B
PV = FV × PVIF (n = 40, i = 6.5%)
PV = $1,000,000 × .081
PV = $81,000
24. The Presley Corporation is about to go public. It currently has aftertax earnings of $6,900,000 and 3,200,000 shares are owned by the present stockholders (the Presley family). The new public issue will represent 500,000 new shares. The new shares will be priced to the public at $15 per share, with a 6 percent spread on the offering price. There will also be $270,000 in out-of-pocket costs to the corporation.
(a) Compute the net proceeds to the Presley Corporation.
(b) Compute the earnings per share immediately before the stock issue.
(c) Compute the earnings per share immediately after the stock issue.
(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.
(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.
25. The management of Mitchell Labs decided to go private in 2002 by buying in all 2.60 million of its outstanding shares at $23.50 per share. By 2006, management had restructured the company by selling off the petroleum research division for $11.50 million, the fiber technology division for $8.75 million, and the synthetic products division for $22 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 $1.60 this year. Investment bankers have contacted the firm and indicated that if it reentered the public market, the 2.60 million shares it purchased to go private could now be reissued to the public at a P/E ratio of 12 times earnings per share.
(a) What was the initial cost to Mitchell Labs to go private?
(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 2.60 million shares (based on current earnings and an anticipated P/E of 12)?
(c) What is the percentage return to the management of Mitchell Labs from the restructuring? Use answers from parts a andb to determine this value.
26. Preston Corporation has a bond outstanding with a $70 annual interest payment, a market price of $1,240, and a maturity date in ten years. Assume the par value of the bonds is $1,000.
Find the following:
(a) The coupon rate %
(b) The current rate %
(c) The approximate yield to maturity %
27. An investor must choose between two bonds:
Bond A pays $80 annual interest and has a market value of $855. It has 5 years to maturity.
Bond B pays $85 annual interest and has a market value of $750. It has ten years to maturity.
Assume the par value of the bonds is $1,000.
(a) Compute the current yield on both bonds.
Current yield
Bond A %
Bond B %
(b) Which bond should he select based on your answer to part a?
Bond B
Bond A
(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 A is 11.94 percent. What is the approximate yield to maturity on Bond B?
(d) Has your answer changed between parts b and c of this question in terms of which bond to select?
28. Match the security provisions with the yield to maturity.
|
(1)
|
(2)
|
|
Security provision
|
Yield to maturity
|
|
(a) Debenture
|
8.59 %
|
|
(b) Secured debt
|
10.67 %
|
|
(c) Subordinate debenture
|
9.79 %
|
(a) Debenture
(b) Secured debt
(c) Subordinate debenture
29. The Florida Investment Fund buys 52 bonds of the Gator Corporation through a broker. The bonds pay 7 percent annual interest. The yield to maturity (market rate of interest) is 12 percent. The bonds have a 10-year maturity. Use Appendix B and Appendix D. Using an assumption of semiannual interest payments:
(a) Compute the price of a bond.
(b) Compute the total value of the 52 bonds.
30. The yield to maturity for 15-year bonds is as follows for four different bond rating categories.
Use Appendix D and Appendix B.
|
Aaa
|
10.40%
|
|
Aa1
|
10.60%
|
|
Aa2
|
11.00%
|
|
Aa3
|
12.00%
|
The bonds of Falter Corporation were rated as Aa2 and issued at par a few weeks ago. The bonds have just been downgraded to Aa3. Determine the new price of the bonds, assuming a 15-year maturity and semiannual interest payments.
31. A 16-year, $1,000 par value, zero-coupon rate bond is to be issued to yield 6 percent. Use Appendix B.
(a) What should be the initial price of the bond?
(b) If immediately upon issue, interest rates dropped to 5 percent, what would be the value of the zero-coupon rate bond
(c) If immediately upon issue, interest rates increased to 10 percent, what would be the value of the zero-coupon rate bond?
32. Assume a zero-coupon bond that sells for $347 and will mature in 15 years at $1,100. Use Appendix B.
33. You buy a 7 percent, 20-year, $1,000 par value, floating rate bond in 2008. By the year 2011, rates on bonds of similar risk are up to 9 percent.
What is your one best guess as to the value of the bond?
34. Ten years ago, the Archer Corporation borrowed $6,100,000. Since then, cumulative inflation has been 63 percent (a compound rate of approximately 5 percent per year).
(a) When the firm repays the original $6,100,000 loan this year, what will be the effective purchasing power of the $6,100,000? (Hint: Divide the loan amount by one plus cumulative inflation.)
(b) To maintain the original $6,100,000 purchasing power, how much should the lender be repaid? (Hint: Multiply the loan amount by one plus cumulative inflation.)
35. A $1,000 par value bond was issued 20 years ago at a 11.00 percent coupon rate. It currently has 10 years remaining to maturity. Interest rates on similar debt obligations are now 7.00 percent.
(a) What is the current price of the bond?
(b) Assume Ms. Russell bought the bond three years ago when it had a price of $1,000. What is her dollar profit based on the bond's current price?
(c) Further assume Ms. Russell 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. How much of the purchase price of $1,000 did Ms. Russell pay in cash?
(d) What is Ms. Russell's percentage return on her cash investment?
36. A $1,000 par value bond was issued 20 years ago at a 8 percent coupon rate. It currently has 5 years remaining to maturity. Interest rates on similar debt obligations are now 10 percent. Use Appendix D and Appendix B.
(a) Compute the current price of the bond using an assumption of semiannual payments.
(b) If Mr. Robinson initially bought the bond at par value, what is his percentage loss (or gain)?
(c) Now assume Mrs. Pinson buys the bond at its current market value and holds it to maturity, what will her percentage return be?
(d) Although the same dollar amounts are involved in part b and c, why the percentage gain is larger than the percentage loss.
Investment is larger
Investment is smaller
37. The Bowman Corporation has a $21 million bond obligation outstanding, which it is considering refunding. Though the bonds were initially issued at 10 percent, the interest rates on similar issues have declined to 8.5 percent. The bonds were originally issued for 20 years and have 5 years remaining. The new issue would be for 5 years. There is an 10 percent call premium on the old issue. The underwriting cost on the new $21,000,000 issue is $670,000, and the underwriting cost on the old issue was $520,000. The company is in a 34 percent tax bracket, and it will use a 7 percent discount rate (rounded after-tax cost of debt) to analyze the refunding decision. Use Appendix D.
(a) Calculate the present value of total outflows.
(b) Calculate the present value of total inflows.
(c) Calculate the net present value.
(d) Should the old issue be refunded with new debt?
38. The Robinson Corporation has $51 million of bonds outstanding that were issued at a coupon rate of 8 1/2 percent seven years ago. Interest rates have fallen to 7 1/2 percent. Mr. Brooks, the vice-president of finance, does not expect rates to fall any further. The bonds have 15 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 15 years to maturity. The Robinson Corporation has a tax rate of 34 percent. The underwriting cost on the old issue was 2.3 percent of the total bond value. The underwriting cost on the new issue will be 1.6 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 8 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be 7 years old for purposes of computing the premium). Assume the discount rate is equal to the aftertax cost of new debt rounded to the nearest whole number.
What would be the aftertax cost of the call premium at the end of year 12 (in dollar value)?
39. The Deluxe Corporation has just signed a 120-month lease on an asset with a 18-year life. The minimum lease payments are $2,600 per month ($31,200 per year) and are to be discounted back to the present at a 12 percent annual discount rate. The estimated fair value of the property is $230,000. Use Appendix D.
(a) Calculate the lease period as a percentage to the estimated life of the leased property.
(b) Calculate the present value of lease payments as a percentage to the fair value of the property.
(c) Should the lease be recorded as a capital lease or an operating lease?
Operating lease
Capital lease
40. 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.
|
In $ millions
|
In $ millions
|
|
Current assets
|
$
|
50
|
Current liabilities
|
$
|
15
|
|
Fixed assets
|
|
50
|
Long-term liabilities
|
|
25
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
$
|
40
|
|
|
|
|
Stockholders' equity
|
|
60
|
|
|
|
|
|
|
|
|
Total assets
|
$
|
100
|
Total liabilities and
stockholders' equity
|
$
|
100
|
|
|
|
|
|
|
|
|
The footnotes stated that the company had $20 million in annual capital lease obligations for the next 15 years.
(a) Discount these annual lease obligations back to the present at a 9 percent discount rate.
(b) Construct a revised balance sheet that includes lease obligations.
(c) Compute total debt to total assets on the original and revised balance sheets.
(d) Compute total debt to equity on the original and revised balance sheets.
41. The Hardaway Corporation plans to lease a $860,000 asset to the O'Neil Corporation. The lease will be for 12 years. Use Appendix D.
(a) If the Hardaway Corporation desires a 13 percent return on its investment, how much should the lease payments be?
(b) The Hardaway Corporation is able to take a 10 percent deduction from the purchase price of $860,000 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 13 percent return on the 12-year lease.