Exam 18: Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

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?

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.

Which of the following statements about listing on a stock exchange is most CORRECT?

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?

Which of the following statements is most CORRECT?

Five years ago,the State of Oklahoma issued $2,000,000 of 7% coupon,20-year semiannual payment,tax-exempt bonds.The bonds had 5 years of call protection,but now the state can call the bonds if it chooses to do so.The call premium would be 5% of the face amount.Today 15-year,5%,semiannual payment bonds can be sold at par,but flotation costs on this issue would be 2%.What is the net present value of the refunding? Because these are tax-exempt bonds,taxes are not relevant.

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.

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.

Which of the following statements is most CORRECT?

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.

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.

Palmer Company has $5,000,000 of 15-year maturity bonds outstanding.Each bond has a maturity value of $1,000,an annual coupon of 12.0%.The bonds can be called at any time with a premium of $50 per bond.If the bonds are called,the company must pay flotation costs of $10 per new refunding bond.Ignore tax considerations-assume that the firm's tax rate is zero. The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds.What is the breakeven interest rate,the rate below which it would be profitable to call in the bonds?

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.

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.

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.

Which of the following statements is NOT CORRECT?

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.

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.

Which of the following is generally NOT true and an advantage of going public?