Principles of Corporate Finance 10ed Brealey Solutions

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w11m 发表于 2013-3-12 11:28
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dungcleaner 发表于 2013-3-30 01:39
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CHAPTER 16

Payout Policy

Answers to Problem Sets1.        a.         A1, B5; A2, B4; A3, B3; A4, B1; A5, B2

      b.         On August12, the ex-dividend date

      c.         (.35 X4)/52 = .027, or 2.7%

      d.         (.35 X 4)/4.56 =.31, or 3.1%

      e.         The price would fall to 52/1.10 = $41.27
 

2.                    a.         False. The dividend depends on pastdividends and current and
                       forecasted earnings.

               b.         True. Dividend changes conveyinformation to investors.

               c.         False. Dividends are “smoothed.”Managers rarely increase regular
                           dividends temporarily.They may pay a special dividend, however.

               d.         False. Dividends are rarely cut whenrepurchases are being made.
 

3.                    a.         Reinvest 1,000 X $.50 = $500 in thestock. If the ex-dividend price is $150
                        - $2.50, this should involve the purchase of500/147.50, or about 3.shares.


          T        r= 0.10 = 10.0%
Beginning at t = 2, each share in thecompany will enjoy a perpetual stream of growing dividends: $1.05 at t = 2, andincreasing by 5% in each subsequent year. Thus, the total value of the shares at t = 1 (after the t = 1dividend is paid and after N new shares have been issued) is given by:

If P1 is the price per share at t= 1, then:
V1= P1 ′(1,000,000 + N) = $21,000,000
and:
P1′ N =$1,000,000
From the first equation:
(1,000,000 ′ P1) + (N ′ P1) = $21,000,000
Substituting from the second equation:
(1,000,000 ′ P1) + $1,000,000 = $21,000,000
sothat P1 = $20.00
b.         With P1 equal to $20 thefirm will need to sell 50,000 new shares to raise $1,000,000.

c.         The expected dividends paid at t = 2are $1,050,000, increasing by 5% in each subsequent year.  With 1,050,000 shares outstanding, dividendsper share are: $1 at t = 2, increasing by 5% in each subsequent year.  Thus, total dividends paid to oldshareholders are: $1,000,000 at t = 2, increasing by 5% in each subsequentyear.

d.         For the current shareholders:


Substituting thesecond equation above for P0 in the first equation and then solving,we find that g = 4% and P0 = $50, so that the current stock price isunchanged.

24.       Assume that all taxpayers pay a 20% tax on dividend income and10% tax on capital gains.  Firm A pays nodividends but investors expect the price of Firm A stock to increase from $40to $50 per share.  Firm B pays a dividendof $5 per share and investors expect the price of Firm B stock to be $45 nextyear.  Results for Firm A are:

Before-tax rate of return	$10/$40 = 25.00%
Tax on dividend at 20%	$0.00
Tax on capital gains at 10%	0.10 ′ $10.00 = $1.00
Total after-tax income   (dividends plus capital gains less  taxes)	$0 + $10 - $1 = $9.00
After-tax rate of return	$9/$40 = 22.50%

The price of Firm B stock today must adjust soas to provide an after-tax return equal to that of Firm A.  Let X equal the current price of Firm Bstock.  Then, for Firm B:

Next year’s price	$45.00
Dividend	$5.00
Today’s stock price	X
Capital gain	$45 – X
Before-tax rate of return	[$5 + ($45 – X)]/X
Tax on dividend at 20%	0.20 ′ $5.00 = $1.00
Tax on capital gains at 10%	0.10 ′ ($45 – X)
Total after-tax income   (dividends plus capital gains less  taxes)	[$5 + ($45 – X)] – [$1 + 0.10 ′  ($45 – X)]

The price of Firm B stock adjusts so that theafter-tax rate of return for Firm B is equal to 22.5%, the after-tax rate ofreturn for Firm A.  To find today’s pricefor Firm A stock, solve the following for X:



25.       It is true that researchers have been consistent in finding apositive association between price-earnings multiples and payout ratios.  But simple tests like this one do not isolatethe effects of dividend policy, so the evidence is not convincing.
Suppose that KingCoal Company, which customarily distributes half its earnings, suffers a strikethat cuts earnings in half.  The setbackis regarded as temporary, however, so management maintains the normal dividend.  The payout ratio for that year turns out tobe 100 percent, not 50 percent.

The temporary earnings drop also affects KingCoal’s price-earnings ratio.  The stockprice may drop because of this year’s disappointing earnings, but it does notdrop to one-half its pre-strike value. Investors recognize the strike as temporary, and the ratio of price tothis year’s earnings increases.  Thus,King Coal’s labor troubles create both a high payout ratio and a highprice-earnings ratio.  In other words,they create a spurious association between dividend policy and marketvalue.  The same thing happens whenever afirm encounters temporary good fortune, or whenever reported earningsunderestimate or overestimate the true long-run earnings on which bothdividends and stock prices are based.
A second source of error is omission of otherfactors affecting both the firm’s dividend policy and its marketvaluation.  For example, we know thatfirms seek to maintain stable dividend rates. Companies whose prospects are uncertain therefore tend to beconservative in their dividend policies. Investors are also likely to be concerned about such uncertainty, sothat the stocks of such companies are likely to sell at low multiples.  Again, the result is an association betweenthe price of the stock and the payout ratio, but it stems from the commonassociation with risk and not from a market preference for dividends.
Another reason thatearnings multiples may be different for high-payout and low-payout stocks isthat the two groups may have different growth prospects.  Suppose, as has sometimes been suggested,that management is careless in the use of retained earnings but exercisesappropriately stringent criteria when spending external funds.  Under such circumstances, investors would becorrect to value stocks of high-payout firms more highly.  But the reason would be that the companieshave different investment policies.  Itwould not reflect a preference for high dividends as such, and no company couldachieve a lasting improvement in its market value simply by increasing itspayout ratio.


26.       a.         Themarginal investors are the institutions.

b.         Price of low-payout stock:              
Priceof medium-payout stock:      
Priceof high-payout stock:            

c.         For institutions, after-tax return is 12% for each type ofstock.
For individuals, after-tax returns are:
Forlow-payout stock:               
Formedium-payout stock:        
Forhigh-payout stock:              
For corporations, after-tax returns are:
Forlow-payout stock:               
Formedium-payout stock:        
Forhigh-payout stock:              
d.

	Low    Payout	Medium    Payout	High    Payout
Individuals	$80  billion
Corporations			$10  billion
Institutions	$20  billion	$50  billion	$110  billion

CHAPTER 17

Does Debt Policy Matter?

Answers to Problem Sets

% = 12.5%; = 20%

      b.         12.5%

      c.         E/P= 20%; P/E = 5

      d.         $50

      e.         .5X  + .5 X 0 = 1.0; = 2.0.
 

3.                    Expectedreturn on assets is rA= .08 X 30/80 + .16 X 50/80 = .13. The new return on equity will be rE = .13 +(20/60)(.13 - .08) = .147.

 

4.        a.
           

            .8 = (.25 x 0) + (.75 x βE)
            βE = 1.07
                     
                                
5.        a.         True

      b.         True (as long as the return earned bythe company is greater than the interest payment, earnings per share increase,but the PyE falls to reflect  the higherrisk).

      c.         False(the cost of equity increases with the ratio D/E).

      d.         False(the formula rE = rA + (D/E)(rA - rD) does notrequire rD to be
                  constant).

      e.         False(debt amplifies variations in equity income).

      f.          False (value increases only if clienteleis not satisfied).
 

6.        a.         rA = .15, rE = .175
           b.         βA= .6 (unchanged), βD=.3, βE= .9.
 

7.                    See Figure 17.3.
 


           





























15.       a.         UnderProposition I, the firm’s cost of capital (rA) is not affected bythe choice of capital structure.  Thereason the quoted statement seems to be true is that it does not account forthe changing proportions of the firm financed by debt and equity.  As the debt-equity ratio increases, it istrue that both the cost of equity and the cost of debt increase, but a smallerproportion of the firm is financed by equity. The overall effect is to leave the firm’s cost of capital unchanged.

b.         Moderate borrowing does notsignificantly affect the probability of financial distress, but it doesincrease the variability (and market risk) borne by stockholders.  This additional risk must be offset by a higheraverage return to stockholders.


16.       a.         Ifthe opportunity were the firm’s only asset, this would be a good deal.  Stockholders would put up no money and,therefore, would have nothing to lose. However, rational lenders will not advance 100% of the asset’s value foran 8% promised return unless other assets are put up as collateral.

Sometimes firms find it convenient to borrow all the cashrequired for a particular investment. Such investments do not support all of the additional debt; lenders areprotected by the firm’s other assets too.

In any case,if firm value is independent of leverage, then any asset’s contribution to firmvalue must be independent of how it is financed.  Note also that the statement ignores theeffect on the stockholders of an increase in financial leverage.

b.         This is not an important reason forconservative debt levels.  So long asMM’s Proposition I holds, the company’s overall cost of capital is unchangeddespite increasing interest rates paid as the firm borrows more.  (However, the increasing interest rates maysignal an increasing probability of financial distress—and that can beimportant.)


17.       Examples of suchsecurities are given in the text and include unbundled stock units, preferredequity redemption cumulative stock and floating-rate notes.  Note that, in order to succeed, suchsecurities must both meet regulatory requirements and appeal to an unsatisfiedclientele.


18.       a.         As leverage isincreased, the cost of equity capital rises. This is the same as saying that, as leverage is increased, the ratio ofthe income after interest (which is the cash flow stockholders are entitled to)to the value of equity increases.  Thus,as leverage increases, the ratio of the market value of the equity to incomeafter interest decreases.

b.         (i)    AssumeMM are correct.  The market value of thefirm is determined by the income of the firm, not how it is divided among thefirm’s security holders.  Also, thefirm’s income before interest is independent of the firm’s financing.  Thus, both the value of the firm and thevalue of the firm’s income before interest remain constant as leverage isincreased.  Hence, the ratio is aconstant.

To solve for bA,use the following:

20.       We know from Proposition I that the valueof the firm will not change.  Also,because the expected operating income is unaffected by changes in leverage, thefirm’s overall cost of capital will not change. In other words, rA remains equal to 17% and bAremains equal to 0.875.  However, riskand, hence, the expected return for equity and for debt, will change.  We know that rD is 11%, so that,for debt:

rD = rf + bD (rm – rf)

0.11 = 0.10 + bD(0.18 – 0.10)

bD =0.125

For equity:

0.17 = (0.3 ′0.11) + (0.7 ′ rE)

rE = 0.196 = 19.6%
Also:
rE = rf + bE (rm – rf)

0.196 = 0.10 + bE(0.18 – 0.10)

bE= 1.20

21.       [Note: In the following solution, we haveassumed that $200 million of long-term bonds have been issued.]
a.         E = $55 ′ 10million = $550 million
V = D + E = $200 million + $550 million = $750 million




b.         The after-taxWACC would increase to the extent of the loss of the tax deductibility of theinterest on debt.  Therefore, theafter-tax WACC would equal the opportunity cost of capital, computed from theWACC formula without the tax-deductibility of interest:

dungcleaner1 发表于 2013-3-30 14:52
CHAPTER 17Does Debt Policy Matter?
Answers to Problem Sets

22.       We make use of the basic relationship:

Since overall beta (bA) is not affected by capital structure or taxes, then:
rA = rf + bA (rm – rf) = 0.06 + (1.5 × 0.08) = 0.18
The following table shows the value of rE for various values of D/E (and the corresponding values of D/V), derived from the above formula.  The graph is on the next page.
D/E
D/V
rA
rD
rE
0.00
0.00000
0.18
0.0600
0.1800
0.05
0.04762
0.18
0.0600
0.1871
0.10
0.09091
0.18
0.0600
0.1941
0.15
0.13043
0.18
0.0600
0.2012
0.20
0.16667
0.18
0.0600
0.2082
0.25
0.20000
0.18
0.0600
0.2153
0.30
0.23077
0.18
0.0610
0.2221
0.35
0.25926
0.18
0.0620
0.2289
0.40
0.28571
0.18
0.0630
0.2356
0.45
0.31034
0.18
0.0640
0.2423
0.50
0.33333
0.18
0.0650
0.2489
0.55
0.35484
0.18
0.0660
0.2554
0.60
0.37500
0.18
0.0670
0.2619
0.65
0.39394
0.18
0.0680
0.2683
0.70
0.41176
0.18
0.0690
0.2746
0.75
0.42857
0.18
0.0690
0.2814
0.80
0.44444
0.18
0.0700
0.2876
0.85
0.45946
0.18
0.0725
0.2929
0.90
0.47368
0.18
0.0750
0.2981
0.95
0.48718
0.18
0.0775
0.3031
1.00
0.50000
0.18
0.0800
0.3080





23.       Assume the election is near so that we can safely ignore the time value of
money.
Because one, and only one, of three events will occur, the guaranteed payoff from holding all three tickets is $10.  Thus, the three tickets, taken together, could never sell for less than $10.  This is true whether they are bundled into one composite security or unbundled into three separate securities.
However, unbundled they may sell for more than $10.  This will occur if the separate tickets fill a need for some currently unsatisfied clientele.  If this is indeed the case, then Proposition I fails.  The sum of the parts is worth more than the whole.


24.       Some shoppers may want only the chicken drumstick.  They could buy a whole chicken, cut it up, and sell off the other parts in the supermarket parking lot.  This is costly.  It is far more efficient for the store to cut up the chicken and sell the pieces separately.  But this also has some cost, hence the observation that supermarkets charge more for chickens after they have been cut.
The same considerations affect financial products, but:
a.    The proportionate costs to companies of repackaging the cash flow stream are generally small.
b.    Investors can also repackage cash flows cheaply for themselves.  In fact, specialist financial institutions can often do so more cheaply than the companies can do it themselves.


25.       Firms that are able to identify an ‘unsatisfied’ clientele and then design a financial service or instrument that satisfies the demands of this clientele can, in violation

of MM’s capital-structure irrelevance theory, enhance firm value.  However, if this is done successfully by one financial innovator, others will follow, eventually restoring the validity of the MM irrelevance theory.
If the financial innovation can be patented, the creator of the innovation can restrict the use of the innovation by other financial managers and thereby continue to use the innovation to create value.  Consequently, MM’s capital-structure irrelevance theory would potentially be violated during the life of the patent.

CHAPTER 13Efficient Markets and Behavioral Finance
Answers to Problem Sets

1.                    c
 
2.        Weak, semistrong, strong, strong, weak.
 
3.        a.         False

           b.         False

           c.         True

           d.         False

      e.         False

f.         True
 

4.        a.         False

           b.         False

           c.         True

           d.         False
 

5.                    6 - (-.2 + 1.45 X 5) = -1.05%.
 

6.                    a.         True

           b.         False

           c.         True

           d.         True
 

7.                    Decrease.The stock price already reflects an expected 25% increase. The 20% increaseconveys bad news relative to expectations.

8.                    a.         An investor should not buy or sellshares based on apparent trends or
                       cycles in returns.

               b.         A CFO should not speculate on changesin interest rates or foreign
          exchange rates. There is no reason to think that the CFO hassuperior information.

               c.         A financial manager evaluating thecreditworthiness of a large customer

               couldcheck the customer’s stock price and the yield on its debt. A fallingstock price or a high yield could indicate trouble ahead.

               d.         Don’t assume that accounting choicesthat increase or decrease earnings
                           will have any effect on stock price.

               e.         The company should not seekdiversification just to reduce risk. Investors
                           can diversify on their own.

f.          Stock issues do not depress price ifinvestors believe the issuer has no private information.


9.     a.         Evidence that two securities with identical cash flows (e.g.Royal Dutch

Shell and Shell Transport &Trading) can sell at different prices.

b.         Small-capstocks and high book-to-market stocks appear to have given above-averagereturns for their level of risk.

     c.         IPOs provide relatively low returns after their first fewdays of trading.

     d.         Stocks of firms that announce unexpectedly good earningsperform well

over the coming months.

In each case there appear to havebeen opportunities for earning superior profits.

10.       a.         Anindividual can do crazy things, butstill not affect the efficiency of markets. The price of the asset in an efficient market is a consensus price aswell as a marginal price.  A nutty personcan give assets away for free or offer to pay twice the market value.  However, when the person’s supply of assetsor money runs out, the price will adjust back to its prior level (assumingthere is no new, relevant information released by his action).  If you are lucky enough to know such aperson, you will receive a positivegain at the nutty investor’s expense. You had better not count on this happening very often, though.  Fortunately, an efficient market protectscrazy investors in cases less extreme than the above.  Even if

theytrade in the market in an “irrational” manner, they can be assured of getting afair price since the price reflects all information.

b.         Yes, and how many people have dropped abundle?  Or, more to the point, how manypeople have made a bundle only to lose it later?  People can be lucky and some people can bevery lucky; efficient markets do not preclude this possibility.

c.         Investor psychology is a slipperyconcept, more often than not used to explain price movements that theindividual invoking it cannot personally explain.  Even if it exists, is there any way to makemoney from it?  If investor psychologydrives up the price one day, will it do so the next day also?  Or will the price drop to a ‘true’level?  Almost no one can tell youbeforehand what ‘investor psychology’ will do. Theories based on it have no content.

d.         What good is a stable value when youcan’t buy or sell at that value because new conditions or information havedeveloped which make the stable price obsolete? It is the market price, the price at which you can buy or sell today,which determines value.


11.       a.         There is riskin almost everything you do in daily life. You could lose your job or your spouse, or suffer damage to your housefrom a storm.  That doesn’t necessarilymean you should quit your job, get a divorce, or sell your house.  If we accept that our world is risky, then wemust accept that asset values fluctuate as new information emerges.  Moreover, if capital markets are functioningproperly, then stock price changes will follow a random walk.  The random walk of values is the result of rational investors coping withan uncertain world.

b.         To make the example clearer, assumethat everyone believes in the same chart. What happens when the chart shows a downward movement?  Are investors going to be willing to hold thestock when it has an expected loss?  Ofcourse not.  They start selling, and theprice will decline until the stock is expected to give a positive return.  The trend will ‘self-destruct.’

c.         Random-walk theory as applied toefficient markets means that fluctuations from the expected outcome are random. Suppose there is an 80 percent chance of rain tomorrow (because it rainedtoday).  Then the local umbrella store’sstock price will respond today to theprospect of high sales tomorrow.  Thestore’s sales will not follow arandom walk, but its stock price will, because each day the stock pricereflects all that investors know about future weather and future sales.



12.       One of the ways to think about marketinefficiency is that it implies there is easy money to be made.  The following appear to suggest marketinefficiency:

(b)     strong form

(d)     weak form

(f)      semi-strong form

13.       The estimates are first substituted inthe market model.  Then the result fromthis expected return equation is subtracted from the actual return for themonth to obtain the abnormal return.
Abnormalreturn (Intel) = Actual return –[(−0.57) + (1.08 ′Market return)]
            Abnormalreturn (Conagra) = Actual return –[(-0.46) + (0.65 ′Market return)]


14.       The efficientmarket hypothesis does not imply that portfolio selection should be done with apin.  The manager still has threeimportant jobs to do.  First, she mustmake sure that the portfolio is well diversified.  It should be noted that a large number ofstocks is not enough to ensure diversification. Second, she must make sure that the risk of the diversified portfolio isappropriate for the manager’s clients. Third, she might want to tailor the portfolio to take advantage ofspecial tax laws for pension funds. These laws may make it possible to increase the expected return of theportfolio without increasing risk.


15.       They are bothunder the illusion that markets are predictable and they are wasting their timetrying to guess the market’s direction. Remember the first lesson of market efficiency: Markets have no memory.  The decision as to when to issue stock shouldbe made without reference to ‘market cycles.’


16.       The efficient-market hypothesis says thatthere is no easy way to make money. Thus, when such an opportunity seems to present itself, we should bevery skeptical.  For example:
§  Inthe case of short- versus long-term rates, and borrowing short-term versuslong-term, there are different risks involved. For example, suppose that we need the money long-term but we borrowshort-term.  When the short-term note isdue, we must somehow refinance.  However;this may not be possible, or may be possible only at a very high interest rate.
§ In the case of Japanese versus United Statesinterest rates, there is the risk that the Japanese yen - U.S. dollar exchangerate will change during the period of time for which we have borrowed.



17.       This doespresent some evidence against the efficient capital market hypothesis. One keyto market efficiency is the high level of competition among participants in themarket.  For small stocks, the level ofcompetition is relatively low because major market participants (e.g., mutualfunds and pension funds) are biased toward holding the securities of larger,well-known companies.  Thus, it isplausible that the market for small stocks is fundamentally different from themarket for larger stocks and, hence, that the small-firm effect is simply areflection of market inefficiency.

But there are at least two alternative possibilities. First, thisdifference might just be coincidental. In statistical inference, we never provean affirmative fact.  The best we can dois to accept or reject a specified hypothesis with a given degree ofconfidence.  Thus, no matter what theoutcome of a statistical test, there is always a possibility, however slight,that the small-firm effect is simply the result of statistical chance.

Second, firms with small market capitalization may contain some type ofadditional risk that is not measured in the studies. Given the informationavailable and the number of participants, it is hard to believe that anysecurities market in the U.S is not very efficient. Thus, the most likelyexplanation for the small-firm effect is that the model used to estimateexpected returns is incorrect, and that there is some as-yet-unidentified riskfactor.

18.       There are several ways to approach thisproblem, but all (when done correctly!) should give approximately the sameanswer.  We have chosen to use theregression analysis function of an electronic spreadsheet program to calculatethe alpha and beta for each security. The regressions are in the following form:
Security return = alpha + (beta ′ market return) + error term
The results are:

	Alpha	Beta
Executive Cheese	0.803	0.956
Paddington Beer	-0.834	0.730

Theabnormal return for Executive Cheese in February 2007 was:

–2.1 – [0.803 + 0.956 ′ (–7.7)] = 4.31%

For Paddington Beer, theabnormal return was:

–9.4 – [-0.834+ 0.73 ′ (–7.7)] = –2.95%

Thus, the average abnormal return of the two stocks during the month ofthe earnings announcement was –0.68%.

19.       The market ismost likely efficient.  The government ofKuwait is not likely to have non-public information about the BP shares.  Goldman Sachs is providing an

intermediary service for which they should be remunerated.  Stocks are bought by investors at (higher)ask prices and sold at (lower) bid prices. The spread between the two ($0.11) is revenue for the broker.  In the U.S., at that time, a bid-ask spreadof 1/8 ($0.125) was not uncommon.  The‘profit’ of $15 million reflects the size of the order more than anymispricing.

cleanerdung2 发表于 2013-3-30 15:04
CHAPTER 13Efficient Markets and Behavioral Finance
Answers to Problem Sets

20.       Any time there is a separation of ownership and control, it is possible that the resulting agency costs will lead to market distortions. Many people hire others (explicitly or implicitly) to manage their money, and these managers may not have the same incentives to push for the best price. Over large markets, we might expect many of these distortions to have less impact, but some imperfections may remain.

As described in the text, one example of this is mortgage securitization market. Because banks were paid a fee for packaging the securities and did not retain the risks of ownership, they may not have pushed for adequate underwriting. This may have lead to easy credit terms and a housing market bubble.


21.       Opinion question; answers will vary. Some of the blame may indeed rest with borrowers who held overly-optimistic views of housing market appreciation and of their ability to repay mortgages. Similarly, purchasers of mortgage backed securities may have unwisely believed that these instruments offered an adequate return. Alternative explanations include inaccurate ratings, agency cost problems (where loan originators lacked incentives to underwrite the loans effectively, the purchase activity and implicit government backing of Fannie Mae and Freddie Mac, and other information asymmetry problems.


22.       a.         The probability that mutual fund X achieved superior performance in any one year is 0.50.  The probability that mutual fund X achieved superior performance in each of the past ten years is:
0.510 = 0.00097656
b.         The probability that, out of 10,000 mutual funds, none of them obtained ten successive years of superior performance is:
(1 – 0.00097656)10,000 = 0.00005712
Therefore, the probability that at least one of the 10,000 mutual funds obtained ten successive years of superior performance is:
1 – 0.00005712 = 0.99994288


23.       It is difficult to define ex ante rules for identifying bubbles where prices differ from some measure of intrinsic value. Research in this area focuses on excessive
liquidity, inflationary pressures, a rigorous analysis of “underlying fundamentals,” and other factors that may cause prices to exceed intrinsic value (whatever that means). But since we expect prices to move in a random walk—and since this random walk might sometimes move rapidly upwards—the process of identifying bubbles is vexing.

CHAPTER 14An Overview of Corporate Financing

Answers to Problem Sets

1.         a.         False

            b.         True

            c.         True

 

2.         a.         40,000/.50= 80,000 shares

            b.         78,000shares

            c.         2,000shares are held as Treasury stock

            d.         20,000shares

      

            e.         See tablebelow

            f.          Seetable below

      

         

 

3.         a.         80 votes

            b.         10X 80 = 800 votes.

 

4.         a.         subordinated

            b.         floatingrate

            c.         convertible

            d.         warrant

            e.         commonstock; preferred stock.

 

5.         a.         False

            b.         True

            c.         False

6.         a.         Par value is$0.05 per share, which is computed as follows:

$443 million/8,863million shares

b.         The shares were sold at an average price of:

[$443 million +$70,283 million]/8,863 million shares = $7.98

c.         The company has repurchased:

8,863 million – 6,746 million = 2,117 millionshares

d.         Averagerepurchase price:

$57,391million/2,117 million shares = $27.11 per share.

e.         The value of the net common equity is:

$443 million + $70,283 million + $44,148million – $57,391 million

= $57,483 million

7.         a.         The dayafter the founding of Inbox:

Common shares ($0.10 par value)	$	50,000
Additional paid-in capital		1,950,000
Retained earnings		0
Treasury shares		0
Net  common equity	$	2,000,000

b.         After 2 years of operation:

Common shares ($0.10 par value)	$	50,000
Additional paid-in capital		1,950,000
Retained earnings		120,000
Treasury shares		0
Net  common equity	$	2,120,000

c.         After 3 years of operation:

Common shares ($0.10 par value)	$	150,000
Additional paid-in capital		6,850,000
Retained earnings		370,000
Treasury shares		0
Net  common equity	$	7,370,000

8.         a.

Common shares ($1.00 par value)	$1,008
Additional paid-in capital	5,444
Retained earnings	16,250
Treasury shares	(14,015)
Net common equity	$8,687

b.

Common shares ($1.00 par value)	$1,008
Additional paid-in capital	5,444
Retained earnings	16,250
Treasury shares	(14,715)
Net  common equity	$7,987

9.         One would expect that the voting shareshave a higher price because they have an added benefit/responsibility that hasvalue.

10.       a.

Gross profits	$	760,000
Interest		100,000
EBT	$	660,000
Tax (at 35%)		231,000
Funds available to common  shareholders	$	429,000

b.

Gross profits (EBT)	$	760,000
Tax (at 35%)		266,000
Net income	$	494,000
Preferred dividend		80,000
Funds available to common  shareholders	$	414,000

11.       Internet exercise; answers will vary.

12.       a.         Lessvaluable

b.           More valuable

c.           More valuable

d.           Less valuable

13.      Answers may differ. Some key eventsof the financial crisis through the end of 2008 include:

June 2007:    Bear Stearns pledges $3.2 billion to aid oneof its ailing hedge funds

Sept. 2007:    Northern Rock receives emergency fundingfrom the Bank of England

Oct. 2007:      Citigroup begins a string of writedownsbased on mortgage losses

Dec. 2007:     Fed establishes Term Auction Facility lines

Jan. 2008:     Ratings agenciesthreaten to downgrade Ambac and MBIA (major bond issuers)

Feb. 2008:     Economic stimuluspackage signed into law

Mar. 2008:     JPMorgan purchasesBear Stearns with support from the Fed

Mar. 2008:     SEC proposes ban onnaked short selling

July 2008:      FDIC takes overIndyMac Bank

Sept. 2008:    Lehman forced intobankruptcy

                        B of Apurchases Merrill Lynch

                        10 bankscreate $70 billion liquidity fund

                        AIG debtdowngraded

                        RMC moneymarket fund “breaks the buck”

                        Treasurybailout plan voted down in the House

Oct. 2008:      9 large banks agreeto capital injection from Treasury

                        Revisedbailout plan passes in House

                        Consumerconfidence hits lowest point on record

                        

The NY Fed has an excellent timeline of events at:

www.ny.frb.org/research/global_economy/Crisis_Timeline.pdf

14.       Answerswill differ. Some purported causes of the financial crisis include:

·        Long periods of very low interest rates leadingto easy credit conditions

·        High leverage ratios

·        The bursting of the US housing market bubble

·        High rates of default on subprime mortgages

·        Massive losses on investments in mortgage backedsecurities

·        Opaque derivative markets and amplified lossesthrough credit default swaps

·        High rates of unemployment and job losses

15.       a.         Formajority voting, you must own or otherwise control the votes of a simplemajority of the shares outstanding, i.e., one-half of the shares outstandingplus one.  Here, with 200,000 sharesoutstanding, you must control the votes of 100,001 shares.

b.           With cumulative voting, the directors areelected in order of the total number of votes each receives.  With 200,000 shares outstanding and fivedirectors to be elected, there will be a total of 1,000,000 votes cast.  To ensure you can elect at least onedirector, you must ensure that someone else can elect at most fourdirectors.  That is, you must have enoughvotes so that, even if the others split their votes evenly among five othercandidates, the number of votes your candidate gets would be higher by one.

Let x be the numberof votes controlled by you, so that others control (1,000,000 - x) votes.  To elect one director:

Solving, we find x= 166,666.8 votes, or 33,333.4 shares. Because there are no fractional shares, we need 33,334 shares.