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FINA3313-005 Homework 4 Fall 2015 Chapter 14 Introduction to Corporate Financing True / False Questions (True A, False B) 1. Shares of stock that have been issued and subsequently repurchased by the issuer are known as treasury stock. 2. The price at which new shares are sold to investors almost always exceeds par value. The difference is entered into the company's accounts as additional paid-in capital, or capital surplus. 3. The gap between internally generated cash and the cash that the company needs is called the financial deficit. 4. Suppose a firm needs fresh capital, but its management does not want to give up its controlling interest. The existing shares could be labeled Class A, and then Class B shares with limited voting rights could be issued to outside investors. 5. Differences in classes of stock often appear in their voting rights. 6. If shareholders do not like the policies that management pursues, their easiest solution is to vote in a different board of directors. 7. When firms retain cash, they are generating funds internally thereby decreasing the amount of external funds needed. 8. A capital surplus is obtained when the selling price of new shares is greater than the par value. Multiple Choice Questions 9. A stock's par value is represented by the: A. maturity value of the stock. B. price at which each share is recorded. C. price at which an investor could sell the stock. D. price received by the firm when the stock was issued. 10. Which one of the following equity concepts would you expect to be least important to a financial analyst? A. Par value per share B. Additional paid-in capital C. Retained earnings D. Net common equity 11. If a corporation issues 1,000 shares of $1 par value stock for $10 per share, then retained earnings will: A. increase by $1,000. B. increase by $9,000. C. decrease by $9,000. D. remain unchanged. 12. A proxy contest is typically one in which: A. the Board attempts to gain control from the shareholders. B. management attempts to gain control from the Directors. C. outsiders attempt to gain control from management. D. the Board attempts to gain control from the Directors. 1 FINA3313-005 Homework 4 Fall 2015 13. Preferred stock dividends: A. have preference over bond interest payments. B. are guaranteed to be paid at least annually. C. are excluded from the taxable income of their recipients. D. have priority over common stock dividends. 14. Which one of the following statements about floating-rate preferred stock is correct? A. Its dividends increase as interest rates increase. B. Its market price increases at a set rate annually. C. It is the only stock issued without a par value. D. Its dividends are deductible for tax purposes by the paying corporation. 15. Funded debt refers to those liabilities that: A. have established a sinking fund for repayment. B. are not callable at the option of the firm. C. are secured by specific collateral. D. have a maturity of more than one year remaining. 16. Bonds that have been sold only to a limited number of institutional investors are considered: A. secured bonds. B. convertible bonds. C. private placements. D. indexed bonds. 17. A corporation with funded fixed-rate debt might prefer floating-rate debt if it thought that: A. interest rates would be declining. B. interest rates would be increasing. C. its bond rating might be lowered. D. its bonds were going to be converted into equity. 18. When new shares of stock are sold at a price greater than par value, the excess over par is recorded as: A. capital surplus. B. retained earnings. C. treasury stock. D. authorized capital. 19. A firm just issued 15,000 new shares of stock with a market price of $14 per share and par value of $2 per share. Which one of these correctly states the resulting change in the equity accounts? A. Capital surplus will increase by $180,000. B. Retained earnings will decrease by $210,000. C. Common stock will increase by $15,000. D. Common stock will increase by $210,000. 20. Which one of the following statements is correct concerning stock dividends? A. Common stock dividends cannot be paid if preferred stock dividends are in arrears. B. Preferred stock dividends cannot be paid if common stock dividends are in arrears. C. Common and preferred dividends must be paid simultaneously. D. No stock dividends can be paid without specific shareholder approval. 2 FINA3313-005 Homework 4 Fall 2015 Chapter 15 How Corporations Raise Venture Capital and Issue Securities True / False Questions 21. Equity capital in young businesses is known as venture capital and it is provided by venture capital firms, wealthy individuals, and investment institutions such as pension funds. 22. Underwriters usually play a triple rolefirst providing the company with procedural and financial advice, then buying the stock, and finally reselling it to the public. 23. When a public company makes a general cash offer of debt or equity, it essentially follows the same procedure used when it first went public. 24. The SEC requires the sale of a private placement to be limited to a small number of knowledgeable investors. 25. When securities are issued under a firm commitment, the underwriter bears the risk of low sales. 26. In a rights offering, the shares are priced at a substantial discount to current market value, which ensures that the shareholders will either exercise the rights themselves or sell them to other investors. 27. Issue costs for debt are considerably lower than issue costs for equity securities. 28. A rights issue is one in which a public company offers shares only to existing shareholders in order to raise additional cash. Multiple Choice Questions 29. An investor exercises the right to buy one additional share at $20 for every five shares held. How much should each share be worth after the rights issue if they previously sold for $50 each? A. $35.00 B. $41.67 C. $45.00 D. $46.00 30. A secondary offering IPO occurs when: A. new shares are sold to provide the company with additional funds. B. the second public issue of equity becomes available. C. the company's founders or venture capitalists market a portion of their shares. D. not all of the shares in a primary IPO were sold. 31. The most important function of an underwriter is to: A. assess the firm's capital needs. B. approve the prospectus before distribution to the public. C. provide private placement of the firm's debt. D. buy the securities issue from the firm and resell the securities to the public. 32. When underwriters issue securities on a best efforts basis, they: A. sell as much of the stock as possible, but with no guarantee. B. submit a bid for purchase, which the issuer compares to other bids. C. buy the entire issue from the firm. D. guarantee that the issuer will be charged the minimum spread. 33. A major purpose of the prospectus is to: 3 FINA3313-005 Homework 4 Fall 2015 A. inform investors of the security's rate of return. B. advise investors of the security's potential risks. C. distribute stock warrants to prospective investors. D. list the security's dividend payment dates. 34. The most likely reason that underpricing of new issues occurs more frequently than overpricing is that: A. underwriters want to reduce the risk of a firm commitment. B. the demand for a new issue is typically too high. C. underwriters earn low rates of return. D. issuing firms demand that equity be underpriced. 35. How much will a firm receive in net funding from a firm commitment underwriting of 250,000 shares priced to the public at $40 if a 10% underwriting spread has been added to the price paid by the underwriter? Additionally, the firm pays $600,000 in legal fees. A. $8,400,000 B. $8,460,025 C. $8,490,909 D. $8,545,455 36. When securities are issued under a rights issue: A. existing shareholders have the opportunity to expand their holdings. B. shares are offered to the public at a discount. C. the existing shares will increase in price. D. current shareholders have the right to resell their stock to the issuer. 37. Which one of these terms applies to a public company offering new shares to the general public? A. Rights offer B. Initial public offering C. Venture capital offer D. General cash offer 38. Issue costs for equity are higher than those for debt for all of the following reasons except: A. equity issues have higher administrative costs. B. underwriting stock is riskier than underwriting bonds. C. equity issues involve significantly more time to sell. D. equity issues have no economies of scale. 39. A firm has just issued $250 million of equity which caused its stock price to drop by 3%. Calculate the loss in value of the firm's equity given that its market value of equity was $1 billion before the new issue. A. $7.5 million B. $30.0 million C. $33.3 million D. $37.5 million 40. In return for providing funds, venture capitalists generally require: A. collateral equal in value to the funds provided. B. first right to all of the firm's assets. 4 FINA3313-005 Homework 4 Fall 2015 C. D. an equity position in the firm. ownership of the entire firm. Chapter 16 Debt Policy True / False Questions 41. When there are no taxes and capital markets function well, the market value of a company does not depend on its capital structure. 42. When asked about key factors of debt policy, financial managers commonly mention the tax advantage of debt and the importance of maintaining their credit rating. 43 Debt finance does not affect the operating risk but it does add financial risk. 44. MM's proposition I states that the required rate of return on equity increases as the firm's debtequity ratio increases. 45. Once you recognize the fact that debt also increases financial risk and causes shareholders to demand a higher return on their investment, debt is no cheaper than equity. 46. Financial leverage describes debt financing's amplification of the effects of changes in operating income on the returns to stockholders. 47. The benefit of an interest tax shield is captured by the equity holders. 48. Costs of financial distress are costs arising from bankruptcy or distorted business decisions before bankruptcy. 49. The "trade-off theory" of capital structure suggests that firms have an optimal level of debt. 50. The pecking-order theory of capital structure depicts the fact that firms prefer internal financing to avoid sending out adverse signals that may lower the stock price. Multiple Choice Questions 51. An increase in a firm's financial leverage will: A. increase the variability in earnings per share. B. always reduce the operating risk of the firm. C. increase the value of the firm in a non-MM world. D. increase the WACC. 52. Financial risk refers to the: A. risk of owning equity securities. B. risk faced by equityholders of firms with debt. C. general business risk of the firm. D. possibility that interest rates will increase. 53. What is the proportion of debt financing for a firm that expects a 24% return on equity, a 16% return on assets, and a 12% return on debt? Ignore taxes. A. 54.0% B. 60.0% C. 66.7% D. 75.0% 5 FINA3313-005 Homework 4 Fall 2015 54. Assume a firm is financed with 30% debt on which it pays 9%. What is the expected return on equity if the expected return on assets is 14%? A. 16.14% B. 17.86% C. 14.92% D. 15.50% 55. According to MM II, as a firm's debt-equity ratio decreases: A. its financial risk increases. B. its operating risk increases. C. the required rate of return on equity increases. D. the required rate of return on equity decreases. 56. A firm has perpetual debt of $10 million at an interest rate of 7%. What is the present value of the interest tax shield if the tax rate is 35%? A. $245,000 B. $700,000 C. $3,500,000 D. $10,000,000 57. Calculate the WACC for a firm that pays 10% on its debt, requires an 18% rate of return on its equity, finances 45% of assets with debt, and has a tax rate of 35%. A. 12.83% B. 14.00% C. 14.40% D. 18.20% 58. The trade-off theory of capital structure describes the optimal capital structure for any firm as being the level of debt that: A. minimizes the financial distress costs. B. maximizes the present value of the interest tax shield. C. equates the present values of the interest tax shield and the financial distress costs. D. maximizes the after-tax cash flows that are internally generated. 59. According to pecking-order theory, managers will often choose to finance with: A. new equity rather than debt, due to bankruptcy costs. B. debt rather than new equity, to avoid reduced share price. C. debt rather than retained earnings, to lower the WACC. D. new equity rather than debt, to strengthen EPS. 60. MM's proposition II without taxes states that the: A. expected return on equity increases as financial leverage increases. B. expected return on assets decreases as expected return on debt decreases. C. firm's capital structure is irrelevant to the firm's overall value. D. greater the proportion of equity, the higher the expected return on debt. 61. Which one of the following lists presents the order of financing from most preferred to least preferred according to the pecking-order theory? A. Debt issue, stock issue, internally generated funds 6 FINA3313-005 Homework 4 Fall 2015 B. Internally generated funds, debt issue, stock issue C. Stock issue, internally generated funds, debt issue D. Internally generated funds, stock issue, debt issue 62. Debt may be the preferred form of external financing for many firms because: A. most firms already have too much equity. B. tax rates on equity are lower. C. debt will not adversely affect the firm's financial ratios. D. equity issuance is considered by investors to be a negative sign. 63. Leverage will _____ shareholders' expected return and ______ their risk. A. increase; decrease B. decrease; increase C. increase; increase D. increase; do nothing to 64. Those who benefit from the interest tax shield are: A. debtholders. B. equityholders. C. both debtholders and equityholders. D. only the firm's customers. 65. When corporate taxes are considered, how does leverage affect the WACC? A. An increase in leverage will be offset by a decrease in equity financing, thus leaving WACC unchanged. B. Changes in leverage will affect the WACC only if the interest rate on debt changes. C. Increased leverage will increase the WACC. D. Increased leverage will decrease the WACC. Chapter 17 Payout Policy True / False Questions 66. Anyone holding a stock before its ex-dividend date is entitled to the dividend. 67. Companies can pay out cash to their shareholders in two ways. They can pay a dividend or they can buy back some of their outstanding shares. 68. In a three-for-two stock split, each investor would receive one additional share for each two shares already held. 69. A 100% stock dividend results in a doubling of the number of outstanding shares, but it does not affect the company's assets, profits, or total value. 70. Investors often interpret a stock split announcement as a signal of management's confidence in the future. 71. A stock split will affect the stock's price, while a stock dividend will not. 72. Corporate dividends are less volatile than corporate earnings. 73. MM's dividend irrelevance proposition is based on an efficient market system with no taxes or issue costs. 74. According to the MM dividend irrelevance proposition, since investors do not need dividends to convert their shares to cash, they will not pay higher prices for firms with higher dividend payouts. 7 FINA3313-005 Homework 4 Fall 2015 75. Dividend policy may be defined as the trade-off between retaining earnings on the one hand and paying out cash and issuing shares on the other. Multiple Choice Questions 76. You currently own 200 shares of stock valued at $6 per share. If the firm declares a 1-for-4 reverse stock dividend you will own ____ shares valued at ___ per share. A. 800; $6 B. 800; $1.50 C. 50; $6 D. 50; $24 77. A stock goes ex-dividend: A. two business days prior to the record date. B. two business days after the declaration date. C. three business days prior to the record date. D. three business days prior to the payment date. 78. Boards of directors may be legally restricted in their declaration of dividends if: A. cash must be borrowed for the dividend payment. B. dividends have increased substantially over a short period of time. C. the dividend would create a situation of insolvency. D. the stock is selling at a low relative price. 79. ABC Corp. stock is selling for $30 per share when a 10% stock dividend is declared. If you own 100 shares of ABC Corp. then you will receive: A. shares valued at $3 each. B. $3 times 100 shares = $300 cash. C. $300 plus 10 shares of ABC Corp. D. 10 shares of ABC Corp. 80. XYZ Corp. has 1,000 shares outstanding and retained earnings of $25,000. Theoretically, what would you expect to happen to the price of their stock, currently selling for $30 per share, if a 25% stock dividend is declared? A. Price should increase to $44.00 per share. B. Price should increase to $37.50 per share. C. Price should decrease to $24.00 per share. D. Nothing; price should remain at $30.00. 81. A stock is currently selling for $40 a share. If the firm declares a 3-for-2 stock dividend there will be: A. two-thirds as many shares outstanding priced at $60 each. B. three times as many shares outstanding priced at $26.67 each. C. 50% more shares outstanding priced at $26.67 each. D. one-and-one-half times as many shares outstanding price at $60 each. 82. Which one of these statements is correct? A. Dividends tend to fluctuate in direct relation to changes in annual earnings. 8 FINA3313-005 Homework 4 Fall 2015 B. Managers are less concerned with the change in the dividend than with the actual amount of the dividend. C. Managers tend to avoid smooth dividends as they don't signal the firm's most recent successes. D. Managers tend to only increase dividends when they believe the increased amount can be sustained. 83. Stock repurchases are most commonly interpreted by investors as a signal that: A. future repurchases will be forthcoming. B. the firm's shares are underpriced. C. the firm has an increasing number of positive-NPV opportunities. D. stock repurchases will gradually replace the stock dividends. 84. How are investors most apt to interpret a reduction in a firm's regular dividend payment? A. Earnings are expected to decline. B. New investments are expected to increase. C. Stock repurchases are expected to increase. D. Share price is expected to increase. 85. Based on the dividend growth model, the price of a stock will remain constant if the dividend is cut, provided that the: A. required return on the stock is proportionately increased. B. growth rate in dividends remains constant. C. reduction is offset by an increase in the growth rate. D. growth rate is decreased by the percent decrease in the dividend. 86. Which statement is true concerning the one-year after-tax return on the following stocks, assuming a 40% tax rate on dividends and a 20% tax rate on capital gains: Stock A is purchased for $50, offers a 5% dividend yield, and is sold for $56; stock B is purchased for $60, offers no dividend yield, but is sold after one year for $70. A. Stock A's after-tax return is higher by 1.27%. B. Stock B's after-tax return is higher by .73%. C. Stock A's after-tax return is higher by .27%. D. Stock B's after-tax return is higher by .58%. 87. If the total assets of a firm are unaffected by a stock dividend, then: A. the stock should retain the same price per share. B. stock dividends should be preferred by corporations over cash dividends. C. an investor's wealth should not be changed by the dividend. D. only bondholders benefit from stock dividends. 88. An investor owns 300 shares of stock currently selling for $70 per share. After a 3-for-2 stock split, the investor will have: A. 200 shares selling for $93.10 each. B. 200 shares selling for $105.00 each. C. 450 shares selling for $46.67 each. D. 450 shares selling for $93.10 each. 89. Which one of the following is correct for a firm with $400,000 in net earnings, 50,000 shares, and a 30% payout ratio? 9 FINA3313-005 Homework 4 Fall 2015 A. Retained earnings will increase by $120,000. B. Each share will receive a $1.20 dividend. C. $120,000 will be spent on new investments. D. The dividend per share will be $2.40. 90. When a firm announces a two-for-one stock split (in the absence of other new information), investors should expect that: A. the earnings per share will decrease by 50% but the stock price will remain constant. B. the stock price will decrease by 50% but earnings per share will remain constant. C. both the earnings per share and the stock price will remain the same. D. both earnings per share and the stock price will decrease by 50%. 10