Deck 18: Ipos, Invsmt Banking

Question 1

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.

Answer 1

True

Question 2

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.

Answer 2

False

Question 3

Which of the following statements is most CORRECT?

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.
B) 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.
C) 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.
D) 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.
E) 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.

Answer 3

B

Question 4

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.

Question 5

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.

Question 6

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.

Question 7

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

A) Any firm can be listed on the NYSE as long as it pays the listing fee.
B) Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
C) Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.
D) The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.
E) Listing is a decision of more significance to a firm than going public.

Question 8

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

A) Increases the liquidity of the firm's stock.
B) Makes it easier to obtain new equity capital.
C) Establishes a market value for the firm.
D) Makes it easier for owner-managers to engage in profitable self-dealings.
E) Facilitates stockholder diversification.

Question 9

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.

Question 10

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?

A) 9.57%
B) 10.07%
C) 10.60%
D) 11.16%
E) 11.72%

Question 11

Which of the following statements is most CORRECT?

A) Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
B) Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
C) The SEC requires that all private placements be handled by a registered investment banker.
D) Private placements can generally bring in funds faster than is the case with public offerings.
E) In a private placement, securities are sold to private (individual) investors rather than to institutions.

Question 12

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.

Question 13

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.

Question 14

its managers make a tender offer and buy all shares that were not held by the management team, this is called a private placement.

Question 15

years ago, the State of Oklahoma issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bondsThe 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.

A) $278,606
B) $292,536
C) $307,163
D) $322,521
E) $338,647

Question 16

will the after-tax annual interest savings for NWW be if the refunding takes place?

A) $664,050
B) $699,000
C) $768,900
D) $845,790
E) $930,369

Question 17

finance its ongoing construction project, Bowen-Roth Incwill 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?

A) $79,425
B) $83,606
C) $88,006
D) $92,406
E) $97,027

Question 18

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.

A) $453,443
B) $476,115
C) $499,921
D) $524,917
E) $551,163

Question 19

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 sharePatton 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.

A) $1,235,925
B) $1,300,973
C) $1,369,446
D) $1,441,522
E) $1,517,391

Question 20

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.

Question 21

amortization of flotation costs reduces taxes and thus provides an annual cash flow What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

A) $6,480
B) $7,200
C) $8,000
D) $8,800
E) $9,680

Question 22

is the NPV if NWW refunds its bonds today?

A) $1,746,987
B) $1,838,933
C) $1,935,719
D) $2,037,599
E) $2,241,359