Questions and Answers of Corporate Finance 5th Edition

As discussed in the text, in the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the equity goes ex dividend.
Miller and Rock (1985) put forward a signalling model of corporate payout policy. Critically evaluate this model, with specific reference to the theoretical and empirical literature that supports or
After completing its capital spending for the year, Carlson Manufacturing has £1,000 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 8 per cent
1 You have been asked by a client to forecast the dividend per share of Clouds plc over the next 3 years. From initial investigation, you find out that the company paid a dividend of £1.00 per share
Review the steps involved in the public issue of equity. Do a search on Google for a public equity issue in your country, download all relevant news stories and track the issue process for the
What is the difference between a public offering and a private placement? What might explain a company’s decision to favour one over the other? Your discussion should make reference to the
Announcement Effects Why do you think the share price tends to go down when an equity issue is announced?
Why would shareholders not be keen on shelf registration? What steps could they take to avoid shelf registration?
Provide an overview of the private equity market. Why would firms wish to go private once they have listed on a stock exchange? In April 2015, Rangers International Football Club plc delisted from
What is meant by underpricing? Why are most IPOs underpriced?Drawing on the academic evidence, explain the main theories behind this phenomenon. Is this is a sign of market inefficiency? Explain.
Unicredit, a multinational bank, had a rights issue in January 2012. Assisted by a consortium of banks including BofA Merrill Lynch and Mediobanca, Unicredit sold 3.86 billion shares at €1.943
Outline the advantages and disadvantages for a company undertaking an IPO.
IPO underpricing is a worldwide phenomenon. In the United States, IPOs are on average underpriced by around 17 per cent, and in the United Kingdom they are underpriced by around 16 per cent. Most
ThyssenKrup AG is an industrial component manufacturer based in Germany. Assume that it is considering opening a new plant in Poland. It has two choices to fund the investment: issue equity via a
The following material represents the cover page and summary of the prospectus for the initial public offering of the Pest Investigation Control Corporation SA (PICC), which is going public tomorrow
Assume you have been hired by the Spanisphage 534 food exporter, Distribuidora Internacional de Alimentacion SA to help progress a seasoned equity offering it plans to undertake in the autumn. You
Assume you have been hired by the Spanish food exporter, Distribuidora Internacional de Alimentacion SA to help progress a seasoned equity offering it plans to undertake in the autumn. You have been
For the same firm in Question 14, you have been approached by a major shareholder who has asked you to consider either an underwritten cash offer or a rights issue(not underwritten) to current
Explain why shelf registration has been used by many firms instead of syndication. Why is it controversial?
Balmorals plc is a well-established company that has run into difficulty in recent years. Its management has recently undertaken a review of its activities and has decided to proceed with a radical
Faff plc has announced a rights issue to raise £50 million for a new journal, the Journal of Financial Excess. This journal will review potential articles after the author pays a non-refundable
Glasauge AB concluded that additional equity financing will be needed to expand operations and that the needed funds will be best obtained through a rights issue. It has correctly determined that as
Carlyle plc and Mullan plc have both announced IPOs at £40 per share. One of these is undervalued by £11, and the other is overvalued by £6, but you have no way of knowing which is which. You plan
Groene Heuvels NV has just gone public. Under a firm commitment agreement, Groene Heuvels received €19.75 for each of the 5 million shares sold. The initial offering price was €21 per share, and
Raggio SpA has 100,000 shares of equity outstanding. Each share is worth €90, so the company’s market value of equity is €9,000,000. Suppose the firm issues 20,000 new shares at the following
The Newton Company has 10,000 shares of equity that each sell for £40.Suppose the company issues 5,000 shares of the new equity at the following prices: £40, £20 and £10. What is the effect of
What are the five methods through which a company can raise seasoned equity? What might explain a company’s decision to favour one over the other?Your discussion should define each and make
Larme SA wishes to expand its facilities. The company currently has 10 million shares outstanding and no debt. The equity sells for €50 per share, but the book value per share is €40. Net income
Elvis Heavy Metal Mining (EHMM) plc wants to diversify its operations. Some recent financial information for the company is shown here:EHMM is considering an investment that has the same PE ratio as
A company’s equity currently sells for £45 per share. Last week the firm issued rights to raise new equity. To purchase a new share, a shareholder must remit £10 and three rights.(a) What is the
Gipfel equity is currently selling at €13 per share. There are 1 million shares outstanding. The firm is planning to raise €2 million to finance a new project. What are the ex-rights share price,
Hoobastink Mfg. is considering a rights offer. The company has determined that the ex-rights price would be €52. The current price is €55 per share, and there are 5 million shares outstanding.
Show that the value of a right can be written aswhere PRO, PS, and PX stand for the ‘rights-on’ price, the subscription price and the ex-rights price, respectively, and N is the number of rights
Wuttke plc wants to raise £3.65 million via a rights issue. The company currently has 490,000 ordinary shares outstanding that sell for £30 per share. Its underwriter has set a subscription price
Mitsi Inventory Systems has announced a rights offer. The company has announced that it will take four rights to buy a new share in the offering at a subscription price of €40. At the close of
Consider the following experiment: you submit a purchase order for every firm commitment initial public offering of oil and gas exploration companies. There are 22 of these offerings, and you submit
Larissa Warren and Dan Ervin have been discussing the future of West Coast Yachts. The company has been experiencing fast growth, and the future looks like clear sailing. However, the fast growth
1 ‘In a public share issue, the probability of receiving an allocation of an underpriced security is less than or equal to the probability of receiving an allocation of an overpriced issue.’
Review the characteristics of a bond. Why do you think short-term debt is known as unfunded debt and long-term debt as funded debt?
Explain what is meant by a bond covenant and provide examples of the different forms of covenant you may see in a bond indenture. What are the costs and benefits of bond covenants to the shareholders
Why would a firm choose to issue callable bonds? Are there any disadvantages to issuing callable bonds? Explain.
Explain what is meant by a sukuk. Why do you think it is called a bond? Global sukuk issuance has rapidly expanded over the last number of years. Why do you think this is? What is the unique nature
What are the benefits of a private placement over a public issue of bonds?
Loans What are the main agency issues involved in a syndicated loan? Do you think syndicated loans should be priced differently from public debt issues? Explain.
Since 2007 credit rating agencies have come under a lot of criticism for their role in the subprime mortgage crisis. To what extent do you think credit rating agencies were responsible for the
Assume you work for Sacyr Vallehermoso SA, a Spanish company that offers construction services. The management has decided to have a long-term bond issue to fund investment in China. It is debating
How would Sacyr Vallehermoso decide on an appropriate coupon rate to set on its bonds given that the investment is in China? Is the coupon rate the same as the required rate of return on the bond?
Empirically, share prices and bond prices have been shown to react only to a small degree to credit rating changes, if at all. Why do you think this is?
As the Eurozone crisis deepened, most of the countries in the area had their credit ratings downgraded. What impact do you think a government’s credit rating has on a company that operates in that
Assume that Sacyr Vallehermoso had a bond issue and a credit rating from Moody’s and S&P. However, Moody’s have given a rating of Aaa and S&P have given a rating of BBB. What does this mean and
Why might we expect firms with credit ratings in the middle of the spectrum to issue debt privately rather than publicly?
Why do bonds have indentures? What, in your opinion, is the most important indenture for a bond? Are indentures more or less important for junk bond issues?Explain.
A controversy erupted regarding bond rating agencies when some agencies began to provide unsolicited bond ratings. Why do you think this is controversial?
What is a sinking fund covenant? Sinking funds have both positive and negative characteristics for bondholders. Why?
Which is riskier to a prospective creditor – an open-end mortgage or closed-end mortgage? Why?
In general, why don’t bond prices change when bond ratings change?
You purchase an Asian Paints Ltd bond on the Bombay Stock Exchange with an invoice price of R9,342. The bond has a coupon rate of 6.45 per cent, and there are 5 months to the next semi-annual coupon
You purchase a bond with a coupon rate of 5.2 per cent and a clean price of £865. If the next semi-annual coupon payment is due in 2 months, what is the invoice price?
Infineon AG plans to issue €500 million of bonds with a face value of€100,000, coupon rate of 3.5 per cent and 10 years to maturity. The current market interest rate on these bonds is 6 per cent.
Parto SpA has an outstanding perpetual bond with a 4 per cent coupon rate that can be called in one year. The bonds make annual coupon payments.The call premium is set at 120 per cent of par value.
Mobistar intends to issue callable, perpetual bonds with annual coupon payments. The bonds are callable at €12,500. One-year interest rates are 6 per cent. There is a 60 per cent probability that
Heineken NV has decided to borrow money by issuing perpetual bonds with a coupon rate of 6 per cent, payable annually. The one-year interest rate is 6 per cent.Next year, there is a 35 per cent
An outstanding issue of Jeronimo Martins bonds has a call provision attached. The total principal value of the bonds is €120 million, and the bonds have an annual coupon rate of 6.6 per cent. The
Charles River Associates is considering whether to refinance either of the two perpetual bond issues the company currently has outstanding. Here is information about the two bond issues: Coupon rate
Following the banking crisis European regulators have been encouraging banks to issue CoCo bonds, which have a bail-in structure should it get into financial difficulty. For instance, if the bank’s
As of February 2015, the total stock of government bonds trading at a negative yield was $3.6 trillion. Why do you think investors are willing to buy bonds with a negative yield?
Medhat International is a manufacturing firm operated along Islamic principles. They wish to raise 20 billion Bahrain dinars and pay this back in equal instalments over 6 years.Comparable Western
Stature Technologies plans to issue £100 million of bonds with a face value of £100,000, coupon rate of 4.125 per cent and 10 years to maturity. The current yield to maturity of these bonds is 4
1 Andrew and Gilstad (2005) write that ‘business schools typically teach that leasing is a zerosum game. However, the economic assumptions that lead to this belief often are not true. These
Warf Computers has decided to proceed with the manufacture and distribution of the virtual keyboard (VK) the company has developed. To undertake this venture, the company needs to obtain equipment
Many laypeople find the whole concept of options difficult to understand. Use a non-financial example to explain how options work and why they are so important for flexible decision-making. What are
What is the difference between an American and European option? Is an American call option on a dividend-paying stock always worth at least as much as its intrinsic value? How about for a European
Why is it that an American option is always worth the same as a European option? If it were not, what strategy could an arbitrageur use to profit?
Suppose that UK government bond yields unexpectedly rise.Ceteris paribus, what would happen to the value of call options and put options?
Look at Table 22.1. Normally the settlement price falls as the strike price increases for call options. Conversely, the settlement price generally increases as the strike price gets higher for put
Why would a corporation wish to combine put and call options on a commodity? Provide an example of a case where this might happen.
Review the factors that affect the value of call and put options.
Why can’t you just value an option using discounted cash flows, as in net present value?
What are the Greeks? Why are they important to a corporation?
Show how a share of equity can be viewed as an option.Why is this perspective helpful?
In many countries, governments have encouraged bank mergers to reduce their risk. Use option analysis to show why this may be bad news for the bank’s shareholders. Does this mean that you should
The Pirelli & C. SpA share price is €8.895. A call option with an exercise price of €9 sells for €0.35 and a put option with the same exercise price sells for €0.65. Does this make sense?
T-bills currently yield 2.1 per cent and the Man Group plc share price is £0.97. There is no possibility that the equity will be worth less than £0.50 per share in one year.(a) What is the value of
Use the option quote information from Euronext Liffe shown here for Xstrata plc to answer the questions that follow. The equity is currently selling for £11.025.(a) Are the call options in the
Use the option quote information on Ageas from Euronext Liffe shown here to answer the questions that follow.(a) Suppose you buy 20 contracts of the June €1.50 call option. How much will you pay,
The share price of ABC plc will be either £2 or £1.5 at the end of the year. Call options are available with one year to expiration. UK government bond yields are currently at 3 per cent.(a)
The price of National Bank of Greece shares will be either €1.74 or €1.43 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 7 per cent.(a)
BP plc shares are currently selling for £4.29 per share. A put option with an exercise price of £4.40 sells for £0.25 and expires in 3 months. If the risk-free rate of interest is 2.6 per cent per
Alcatel-Lucent put option and a call option with an exercise price of €1 and 3 months to expiration sell for €0.28 and €0.11, respectively. If the risk-free rate is 2.5 per cent per year,
Arcellormittal call and put options with an exercise price of €17 expire in 4 months and sell for €2.07 and €2.03, respectively. If the equity is currently priced at€17.03, what is the annual
Coal mining is becoming more popular because of the demand for energy in Asia. Assume that you have the rights to a coal mine and the most recent valuation of the mine was £6.7 million. Because of
The spot price of XYZ plc is 394.5p, with a standard deviation of 20 per cent. A call option on the stock expires in 219 days, and it has a strike price of 400p, with a quoted price of 18p. The
Xstrata plc is currently priced at £10.52. A call option with an expiration of 6 months has an exercise price of £9.00. The risk-free rate is 3 per cent per year, compounded continuously, and the
Shire plc has a zero coupon bond issue outstanding with £12 billion face value that matures in 5 years. The current market value of the firm’s assets is £20 billion.The standard deviation of the
Suppose Shire plc (see Question 25) is considering two mutually exclusive investments. Project A has an NPV of £700 million, and project B has an NPV of £1.2 billion. As the result of taking
Suppose Shire plc (Question 25) decides to reorient its operations and, as a result, the return on assets now has a standard deviation of 30 per cent per year.(a) What is the value of Shire plc
A company has a single zero coupon bond outstanding that matures in 10 years with a face value of £30 million. The current value of the company’s assets is £22 million, and the standard deviation
Ken is interested in buying a European call option written on Southeastern Airlines plc, a non-dividend-paying equity, with a strike price of£110 and one year until expiration. Currently,
Maverick Manufacturing plc must purchase gold in 3 months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $875 per ounce, the firm would
An investor is said to take a position in a ‘collar’ if she buys the asset, buys an out-of-the-money put option on the asset, and sells an out-of-the-money call option on the asset. The two

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