FIN 540 Week 5 Midterm Exam – Strayer NEW
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Midterm Exam Chapter 18 Through
23
CHAPTER
18—PUBLIC AND PRIVATE FINANCING: INITIAL OFFERINGS, SEASONED OFFERINGS, AND
INVESTMENT BANKS
TRUE/FALSE
1. If
its managers make a tender offer and buy all shares that were not held by the
management team, this is called a private placement.
2. Going
public establishes a market value for the firm's stock, and it also ensures
that a liquid market will continue to exist for the firm's shares. This is
especially true for small firms that are not widely followed by security
analysts.
3. The
cost of meeting SEC and possibly additional state reporting requirements
regarding disclosure of financial information, the danger of losing control,
and the possibility of an inactive market and an attendant low stock price are
potential disadvantages of going public.
4. The
term "leaving money on the table" refers to the situation where an
investment banking house makes a very low bid for the right to underwrite a
firm's new stock offering. The banker is, in effect, "buying the job"
with the low bid and thus not getting all the money his firm would normally
earn on the job.
5. Whereas
commercial banks take deposits from some customers and make loans to other
customers, the principal activities of investment banks are (1) to help firms
issue new stock and bonds and (2) to give firms advice with regard to mergers
and other financial matters. However, financial corporations often own and
operate subsidiaries that operate as commercial banks and others that are
investment banks. This was not true some years ago, when the two types of banks
were required by law to be completely independent of one another.
6. The
term "equity carve-out" refers to the situation where a firm's
managers give themselves the right to purchase new stock at a price far below
the going market price. Since this dilutes the value of the public
stockholders, it "carves out" some of their value.
7. Suppose
a company issued 30-year bonds 4 years ago, when the yield curve was inverted.
Since then long-term rates (10 years or longer) have remained constant, but the
yield curve has resumed its normal upward slope. Under such conditions, a bond
refunding would almost certainly be profitable.
8. The
appropriate discount rate to use when analyzing a refunding decision is the
after-tax cost of new debt, in part because there is relatively little risk of
not realizing the interest savings.
9. If
the firm uses the after-tax cost of new debt as the discount rate when
analyzing a refunding decision, and if the NPV of refunding is positive, then
the value of the firm will be maximized if it immediately calls the outstanding
debt and replaces it with an issue that has a lower coupon rate.
10. When
a firm refunds a debt issue, the firm's stockholders gain and its bondholders
lose. This points out the risk of a call provision to bondholders and explains
why a non-callable bond will typically command a higher price than an otherwise
similar callable bond.
MULTIPLE
CHOICE
11. Which
of the following is generally NOT true and an advantage of going
public?
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a.
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Increases the liquidity of the firm's stock.
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b.
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Makes it easier to obtain new equity capital.
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c.
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Establishes a market value for the firm.
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d.
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Makes it easier for owner-managers to engage in
profitable self-dealings.
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e.
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Facilitates stockholder diversification.
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12. Which
of the following statements about listing on a stock exchange is most CORRECT?
|
a.
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Any firm can be listed on the NYSE as long as it
pays the listing fee.
|
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b.
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Listing provides a company with some
"free" advertising, and it may enhance the firm's prestige and help
it do more business.
|
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c.
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Listing reduces the reporting requirements for
firms, because listed firms file reports with the exchange rather than with
the SEC.
|
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d.
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The OTC is the second largest market for listed
stock, and it is exceeded only by the NYSE.
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e.
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Listing is a decision of more significance to a
firm than going public.
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13. Which
of the following statements is most CORRECT?
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a.
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Private placements occur most frequently with
stocks, but bonds can also be sold in a private placement.
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b.
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Private placements are convenient for issuers, but
the convenience is offset by higher flotation costs.
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c.
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The SEC requires that all private placements be
handled by a registered investment banker.
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d.
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Private placements can generally bring in funds
faster than is the case with public offerings.
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e.
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In a private placement, securities are sold to private
(individual) investors rather than to institutions.
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14. Which
of the following statements is most CORRECT?
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a.
|
The key benefits associated with refunding debt
are the reduction in the firm's debt ratio and the creation of more reserve borrowing
capacity.
|
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b.
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The mechanics of finding the NPV of a refunding
decision are fairly straightforward. However, the decision of when to refund
is not always clear because it requires a forecast of future interest rates.
|
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c.
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If a firm with a positive NPV refunding project
delays refunding and interest rates rise, the firm can still obtain the
entire NPV by locking in a low coupon rate when the rates are low, even
though it actually refunds the debt after rates have risen.
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d.
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Suppose a firm is considering refunding and
interest rates rise during time when the analysis is being done. The rise in
rates would tend to lower the expected price of the new bonds, which would
make them cheaper to the firm and thus increase the expected interest savings.
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e.
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If new debt is used to refund old debt, the
correct discount rate to use in the refunding analysis is the before-tax cost
of new debt.
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15. Which
of the following factors would increase the likelihood that a company
would call its outstanding bonds at this time?
|
a.
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A provision in the bond indenture lowers the call
price on specific dates, and yesterday was one of those dates.
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b.
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The flotation costs associated with issuing new
bonds rise.
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c.
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The firm's CFO believes that interest rates are
likely to decline in the future.
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d.
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The firm's CFO believes that corporate tax rates
are likely to be increased in the future.
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e.
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The yield to maturity on the company's outstanding
bonds increases due to a weakening of the firm's financial situation.
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16. Which
of the following statements concerning common stock and the investment banking
process is NOT CORRECT?
|
a.
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If a firm sells 1,000,000 new shares of Class B
stock, the transaction occurs in the primary market.
|
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b.
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Listing a large firm's stock is often considered
to be beneficial to stockholders because the increases in liquidity and
reputation probably outweigh the additional costs to the firm.
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c.
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Stockholders have the right to elect the firm's
directors, who in turn select the officers who manage the business. If
stockholders are dissatisfied with management's performance, an outside group
may ask the stockholders to vote for it in an effort to take control of the
business. This action is called a tender offer.
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d.
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The announcement of a large issue of new stock
could cause the stock price to fall. This loss is called "market
pressure," and it is treated as a flotation cost because it is a cost to
stockholders that is associated with the new issue.
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e.
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The preemptive right gives each existing common
stockholder the right to purchase his or her proportionate share of a new
stock issue.
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17. Which
of the following statements is NOTCORRECT?
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a.
|
"Going public" establishes a firm's true
intrinsic value and ensures that a liquid market will always exist for the
firm's shares.
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b.
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Publicly owned companies have sold shares to
investors who are not associated with management, and they must register with
and report to a regulatory agency such as the SEC.
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c.
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When stock in a closely held corporation is
offered to the public for the first time, the transaction is called
"going public," and the market for such stock is called the new
issue market.
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d.
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It is possible for a firm to go public and yet not
raise any additional new capital.
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e.
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When a corporation's shares are owned by a few
individuals who own most of the stock or are part of the firm's management,
we say that the firm is "closely, or privately, held."
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18. In
its negotiations with its investment bankers, Patton Electronics has reached an
agreement whereby the investment bankers receive a smaller fee now (6% of gross
proceeds versus their normal 10%) but also receive a 1-year option to purchase
an additional 200,000 shares at $5.00 per share. Patton will go public by
selling $5,000,000 of new common stock. The investment bankers expect to
exercise the option and purchase the 200,000 shares in exactly one year, when
the stock price is forecasted to be $6.50 per share. However, there is a chance
that the stock price will actually be $12.00 per share one year from now. If
the $12 price occurs, what would the present value of the entire underwriting
compensation be? Assume that the investment banker's required return on such
arrangements is 15%, and ignore taxes.
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a.
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$1,235,925
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b.
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$1,300,973
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c.
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$1,369,446
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d.
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$1,441,522
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e.
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$1,517,391
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19. To
finance its ongoing construction project, Bowen-Roth Inc. will need $5,000,000
of new capital during each of the next 3 years. The firm has a choice of
issuing new debt or equity each year as the funds are needed, or issue only
debt now and equity later. Its target capital structure is 40% debt and 60%
equity, and it wants to be at that structure in 3 years, when the project has
been completed. Debt flotation costs for a single debt issue would be 1.6% of
the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt
would be 3.0% of the gross amount. Ignoring time value effects, how much would
the firm save by raising all of the debt now, in a single issue, rather than in
3 separate issues?
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a.
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$79,425
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b.
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$83,606
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c.
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$88,006
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d.
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$92,406
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e.
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$97,027
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20. 10
years ago, the City of Melrose issued $3,000,000 of 8% coupon, 30-year,
semiannual payment, tax-exempt muni bonds. The bonds had 10 years of call
protection, but now the bonds can be called if the city chooses to do so. The
call premium would be 6% of the face amount. New 20-year, 6%, semiannual
payment bonds can be sold at par, but flotation costs on this issue would be 2%
of the amount of bonds sold. What is the net present value of the refunding?
Note that cities pay no income taxes, hence taxes are not relevant.
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