Solution fundamentals of corporate finance brealy 4th chapter text solutions ch 13

After new issue; Book value of common stockholders’ equity figures in thousands Common Shares Retained Earnings $11030 Note: Authorized Shares Issued Shares 10030 2.. The total present v

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Solutions for Chapter 13

An Overview of Corporate Financing

1 a Authorized share capital = 100,000 Presently 20,000 shares are issued and

outstanding So 80,000 more shares can be issued without approval of

shareholders

b After new issue;

Book value of common stockholders’ equity (figures in thousands)

Common Shares

Retained Earnings

$11030

Note:

Authorized Shares

Issued Shares

10030

2 The cost of the share repurchase is $5 x 1000 = $5,000 If the average issue price

of these share was $ 5, the common shares account would be reduced by $5,000 The company’s accounts in the books would appear as follows:

Retained earnings 30,000

Net common equity 85,000

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6 a Under majority voting, the shareholder can cast 90 votes for a favorite

candidate

b Under cumulative voting with 10 candidates, the shareholder can cast

10 x 90 = 900 votes for a favorite candidate

7 a Under majority voting, each candidate is voted on in a separate election To

ensure that your candidate is elected, you need to own at least half the shares, which is 200,000 shares (or 200,001 shares to ensure a strict majority

of the votes)

b Under cumulative voting, all candidates will be voted on at once, and there will be 5 × 400,000 = 2,000,000 votes cast If your candidate receives one-fifth of the votes, he or she will place at least fifth in the balloting and will

be elected to the board Therefore, you would need to cast 400,000 votes for your candidate, which would require that you own 80,000 shares

8 a Common shares will go up by 10 million shares x $55 per share = $550

million The accounts will appear as follows:

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Book value of common stockholders’ equity of George Weston Limited (figures in millions)

Common Shares

Retained Earnings

Foreign Currency Translation Adjustments

$6704,046(192)

b The cost of the share repurchase to George Weston is $60 x 500,000 =

$30,000,000 If the average issue price of these shares is $30, common shares will be reduced by $30 x 500,000 = $15,000,000 The rest of the reduction is to retained earnings: $15 x 500,000 = $15,000,000 Common shareholders’ equity isnow arrived at as follows:

9 Lease obligations are like debt in that both legally obligate the firm to make a series of specified payments Bondholders would like the firm to limit lease obligations for the same reason that they desire limits on debt: to keep the firm’s financial burden at manageable levels and make the already existing debt safer

10 a A call provision gives the firm a valuable option It will require the firm to

compensate the investor by promising a higher yield to maturity

b A restriction on further borrowing protects bondholders They will therefore require a lower yield to maturity

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c Collateral also protects the bondholder and results in a lower yield to

12 In general, the fact that preferred stock has lower priority in the event of

bankruptcy reduces its price and increases its yield compared to bonds; on the other hand, the fact that the dividend payments are free of taxes to corporate holders increases the price and reduces the yield at which preferred stock trades For strong firms, the default premium will be small and the tax effect will

dominate, so the preferred will have a lower yield than the bonds For weaker firms the default premium will dominate

13

From Alcan’s Annual Report for 2003, we get the following:

• Redeemable preference shares

To answer the question, this site was accessed in August, 2005

• Book value of common equity 2004 – $ 16.781 billion (2004 Annual Report- Balance Sheet)

• Common shares outstanding for 2003 – 923,988,818 and 2004-925,935,682 (Note 21 of the 2004 Annual Report)

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• Bell Canada has raised money in a variety of ways, including plowing back earnings (through an increase in retained earnings) and issuing new common shares In 2004, the company raised money through retained earnings (2004 – increase by $55 million), than through the issue of common shares ($32 million) (See cash flow statement)

15 Alcan

• Long-term debt-to-equity (Book – in millions of US$)

2002 - 3,196/8,465 =0.38 2003 - 7,604/10,555= 0.72

Note: Equity =common shareholders’ equity.

• Long term debt-to-equity (Market Value) = long-term debt/ (average price per share x average shares outstanding)

3 Market value of equity and long-term debt are quoted in U.S $

2002- Long-term debt (market value) = 3,196/ 10,750 = 0.30

2003- Long-term debt (market value) = 7,604/ 12,610 = 0.60

(Here, the numerator is comprised of the book value of long-term debt)

16 INCO LTD - For year ending December 31, 2004

•Common preferred shares issued

FALCONBRIDGE LTD-For year ending December 31, 2004

USES OF FUNDS

•Capital investment

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•Long term debt reduction

•Dividend paid

SOURCES OF FUNDS

•Long term debt

•Common and preferred shares issued

External source – debt financing

Anheuser-Busch’s primary use of funds during 2001 – 2003 include; capital expenditure and new business acquisitions (Cash Flow Statement 2003)

• Monthly closing price taken from Yahoo Finance

• Average shares outstanding at year end taken from Annual Report(in million) 2003=813.1, 2002=846.6, 2001= 879.1

• Average Stock Price 2003=US$50.05, 2002=US$50.89, 2001= US$43.03( monthly closing

price/12)

• Market value of equity and long-term debt are quoted in U.S $

• Long-term debt/common equity.

Using market value of equity the long-term debt-to-equity has improved

significantly for Anheuser-Busch This is due to higher market value of equity

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c i) For example, Big Rock Brewery’s internal source of financing includes

retained earnings and equity issues External source of financing – longterm debt

Big Rock Brewery’s primary use of funds – capital expenditure

ii) Long term debt –to- equity (Book - US$ million)

• Monthly closing price taken from Yahoo Finance

• Average shares outstanding at year end taken from Annual Report(in millions) 2003=5.542, 2002=5.242, 2001= 4.909

• Average Stock Price 2003=7.05, 2002=4.76, 2001= 5.08(monthly closing price/12)

• Market value of equity and long-term debt are quoted in U.S $

• Long-term debt/common equity.

Note: Big Rock Brewery’s fiscal year ended in March until 2003 when it switched to a calendar year The ratios for 2001 to 2003 use the March fiscal year-end

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Appendix 13A: Practice Problem Solutions

1 Before making the bond refunding decision, we calculate the present value of the net investment cost for E-Books.com by following the steps below:

Call premium = 0.05 x $1,000,000 = $50,000

The annual tax deduction on flotation cost of new issue = $25,000/5 =

$5,000

The annual tax savings over 5 years will be 0.25 x $5,000 = $1,250

After-tax cost of new debt = 9.0% (1- 0.25)

0675.1

11

250,1

5

= $5,160The net after-tax flotation cost on the new issue is calculated as follows:

Gross flotation costs on new issue $ 25,000

Present value of associated tax savings - 5,160

Net after-tax flotation cost on new issue $19,840

The additional interest cost on the old issue = 0.11 (1 0.25)

12

1000,000,

Since E-Books.com can invest the proceeds from the new issue in the money market for one month, we consider the after-tax interest E-Books.com would earn After-tax interest earned = 0.05 (1 0.25)

12

1000,000,

after-tax additional interest paid on the old issue $6,875

the after-tax interest earned on the new issue - 3,125

The net after-tax additional interest cost $3,750

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The total present value of the net investments costs associated with the refunding decision is provided below:

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Call premium $50,000

Net after-tax flotation cost on new issue 19,840

Net after-tax additional interest + 3,750

Total present value of net investment costs $73,590

We consider the net savings from refunding Therefore, we first compute the

The yearly interest saving from going forward with refunding is $82,500 - $67,500

= $15,000 To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue

The present value of the net savings from refunding:

0675.1

11

000,15

$

5

= $61,917

Finally, we calculate the net present value from bond refunding.

PV of net savings over 5 years $61,917

PV of net investment cost - 73,590

NPV of bond refunding ($11,673)

Since NPV is negative, E-Books.com should not refund the bond issue

Rate Time period

(years) Dollar amount ($)

Coupon interest rate on old issue 11%

Coupon interest rate on new issue 9.0%

After-tax coupon interest rate on new issue 6.8%

Short-term investment yield per annum 5.0%

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Present Value of Net Investment Costs

Interest earned on S-T investment of new

Net Savings from Refunding

PV of total interest cost savings over 5 years 0 61,917

Net Present Value (NPV) from bond

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The annual tax deduction on flotation cost of new issue = $150,000/5 =

0585.1

11

500,10

$

5

= $44,411

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The net after-tax flotation cost on the new issue is calculated as follows:

Gross flotation costs on new issue $ 150,000

Present value of associated tax savings - 44,411

Net after-tax flotation cost on new issue $105,589

The additional interest cost on the old issue:

12

1000,000,10

After-tax additional interest paid on the old issue $65,000

The after-tax interest earned on the new issue - 54,167

We can now arrive at the total present value of the net investments cost of

refunding

Net after-tax flotation cost on new issue 105,589

Total present value of net investment costs $816,422

Now, we must consider the net savings from refunding Therefore, we must first

calculate the following:

The annual after-tax interest cost on the old issue = $10,000,000 x 0.12 x (1- 0.35) = $780,000

The annual after-tax interest cost on the new issue = $10,000,000 x 0.09 x (1-0.35) = $585,000

Therefore, the yearly interest saving from going forward with refunding is

$780,000 - $585,000 = $195,000 To find the present value of this stream of yearly savings, we, once again, discount the annuity by the after-tax interest cost of the new issue

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0585.1

11

000,195

$

20

= $2,264,127

Finally, we calculate the net present value from bond refunding:

PV of net savings over 5 years $2,264,127

PV of net investment cost - 816,422

Short-term investment yield per annum 10%

Call premium on outstanding bond issue 7.0% 0 700,000

Flotation cost amortized for tax purposes 1-5 30,000

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Additional interest cost on old issue 0 65,000Interest earned on S-T investment of new

issue (after tax)

PV of total interest cost savings over 20 years 0 2,264,127

The present value of the tax savings on the flotation cost is computed as follows:

The present value of the tax savings =

065.1

11

000,350

$

5

= $1,454,488The net after-tax flotation cost on the new issue is calculated as follows:

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Present value of associated tax savings - 1,454,488

Net after-tax flotation cost on new issue $3,545,512

12

1000,000,100

We now arrive at the total present value of the net investments cost of refunding

Net after-tax flotation cost on new issue 3,545,512

Total present value of net investment costs $15,978,845

The annual after-tax interest cost on the old issue:

of the new issue

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11

000,600,2

20

= $28,648,119

Finally, we can now calculate the net present value from bond refunding by

taking the difference between the present value of the net savings and the present value of the net investment cost

PV of net savings over 5 years $28,648,119

PV of net investment cost - 15,978,845

Short-term investment yield per annum 6.0%

Call premium on outstanding bond issue 12% 0 12,000,000

Flotation cost amortized for tax purposes 1-5 1,000,000

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PV of tax savings on flotation cost 0 1,454,488Net after-tax flotation cost on new issue 0 3,545,512

Interest earned on S-T investment of new

Annual after tax interest on old issue 1-20 9,100,000Annual after tax interest on new issue 1-20 6,500,000

PV of total interest cost savings over 20 years 0 28,648,119

3 Coupon interest rate on old issue 0.14

5 Coupon interest rate on new issue 0.1

6 After-tax coupon interest rate on

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7 Short-term investment yield per

9 Present Value of Net Investment Costs

10 Call premium on outstanding bond

12 Flotation cost amortized for tax

14 PV of tax savings on flotation cost 0 =D13*(1-(1/(B6+1)^5))/B6

15 Net after-tax flotation cost on new

issue

16 Additional interest cost on old issue 0 =D2*(1/12*B3)*(1-B8)

17 Interest earned on S-T investment of

19 Total PV of after-tax investment

20 Net Savings from Refunding

21 Annual after tax interest on old

22 Annual after tax interest on new

23 Net annual savings in interest cost 1-20 =D21-D22

24 PV of total interest cost savings

over 20 years

0 =D23*(1-(1/

(B6+1)^20))/B6

25 Net Present Value (NPV) from bond refunding 0 =D24-D19

3 The present value of the net investment cost with Canada call feature is

computed as follows:

Price of a bond = 140(PVIFA 10%, 20) + {1000/ (1+r) 20

= 140(8.5136) + {1000/ (1.10) 20

= 1191.90 + 148.64 = $ 1,340.54Call premium per bond = price per bond – par value of bond

= 1,340.54 – 1000.00 = $ 340.54

Total Call Premium = 340.54 X 100,000 = $ 34,054,000The annual tax deduction on flotation cost of new issue = $5,000,000/5 =

$1,000,000

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The annual tax savings over 5 years will be 0.35 x $1,000,000 = $350,000 After-tax cost of new debt = 10% (1- 0.35)

= 6.5%