CHAPTER 13

SECURITY STRUCTURES AND DETERIMINING ENTERPRISE VALUES

TrueFalse Questi!s
F. 1. Preferred stock is the equity claim senior to common stock providing
preference on dividends but not liquidation proceeds.
F. 2. For preferred noncumulative stock, all previously unpaid preferred
dividends must be paid before any common stock dividend is paid.
F. 3. Convertible preferred stockholders have the right to convert a preferred
share into a specified number of common shares at any time after the
epiration date.
!. ". #f a share of preferred stock has a $1% par value, and the stock has a 2&1
conversion ratio, then the conversion price 'ould be $(.
!. (. )y issuing preferred stock, and thus forfeiting bankruptcy rights from the
use of debt, the venture and its investors can benefit by committing to an
internal reorgani*ation as opposed to bankruptcy reorgani*ation.
!. +. For ,merican and )ermudan embedded options, the eercise price can
change over time as specified in the security agreement.
F. -. , 'arrant is a call option issued by a company granting the holder the right
to buy common stock at a specific price at a specific time.
!. .. #f a call option can be bought for $12 and the stock/s market value is $12,
it/s said to be 0at the money1.
F. 2. ,s the underlying stock price increases in value, a put option to sell it
becomes more valuable.
!. 1%. !he value of a 'arrant can be directly derived from the value of a call
option.
!. 11. , preemptive right is a right for eisting o'ners to buy sufficient shares to
preserve their o'nership share.
F. 12. Convertible debt is debt that converts into preferred stock.
!. 13. ,n option is a right to buy or sell additional shares of stock.
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F. 1". ,n ,merican3style option is an option that can be eercised only at the
epiration date
!. 1(. ,n option not currently 'orth eercising is said to be an out of the money
option.
F. 1+. 4'ning a put option on a stock is the same as selling a call option on that
same stock.
!. 1-. !he enterprise method of valuation can be eecuted 'ith either an after3ta
or before3ta 'eighted cost of capital as long as the rate is applied to the
appropriate enterprise cash flo's.
!. 1.. 5ntity valuation allo's us to ans'er the question of ho' much debt a
venture needs to issue to achieve a target capital structure 6789:.
F. 12. 4ptions generally have no effect on the value of a venture capital
investment.
!. 2%. !he concept of an enterprise value is that it is the combined value of all of
venture/s financing, typically equity plus all of the debt.
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!. 21. ;arrant valuation 6as presented in this tet: is similar to option valuation
ecept that one applies a dilution factor to the option value to arrive at a
'arrant value.
F. 22. !he unad<usted )lack and =choles model is a model for determining the
value of a 'arrant to buy a ne' share.
!. 23. !he )lack and =choles model requires the stock price as an input.
F. 2". !he )lack and =choles model requires the inflation rate as an input.
!. 2(. !he )lack and =choles model requires an eercise price as an input.
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Multi#le&C"i'e Questi!s
a. 1. ;hich of the follo'ing have the least senior claim on a venture/s asset>
a. common =tock
b. preferred stock
c. convertible preferred stock
d. convertible debt
e. ,merican3style option
c. 2. !he right for eisting o'ners to maintain their o'nership share by
purchasing sufficient shares to keep their percentage share of the firm is
called>
a. stock option
b. stock 'arrant
c. preemptive right
d. participating stock
e. paid3in3kind preferred stock
c. 3. ;hich of the follo'ing stock can be structured to assure the shareholder
that they 'ill share in the payment of any dividends to common stockholders>
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non3cumulative preferred stock
d. ". ;hich of the follo'ing provides the option to echange into common
stock>
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non3cumulative preferred stock
a. (. ;hich of the follo'ing offers the option 'here the dividend obligation can
be satisfied in cash or by issuing additional par amounts of the preferred
security>
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non3cumulative preferred stock
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b. +. ;hich of the follo'ing requires that all previously unpaid preferred
dividends must be paid prior to any common dividend>
a. paid in kind preferred stock
b. cumulative preferred stock
c. participating preferred stock
d. convertible preferred stock
e. non3cumulative preferred stock
b. -. Convertible debt has all of the follo'ing ecept&
a. bankruptcy rights
b. regular dividend payments
c. it can be structured to provide senior interest in specific assets
d. a ta shield due to interest epense
e. a security interest in the firms/ assets
a. .. !he right, not the obligation, to purchase a specified asset at a specified
price is called a&
a. call option
b. put option
c. ,merican3=tyle option
d. 5uropean3=tyle option
e. )ermuda3=tyle option
b. 2. !he right, not the obligation, to sell a specified asset at a specified price is
called a&
a. call option
b. put option
c. ,merican3=tyle option
d. 5uropean3=tyle option
e. )ermuda3=tyle option
c. 1%. ,n option that can be eercised at any time until epiration is called a&
a. call option
b. put option
c. ,merican3=tyle option
d. 5uropean3=tyle option
e. )ermuda3=tyle option
d. 11. ,n option that can be eercised only at the epiration date is called a&
a. call option
b. put option
c. ,merican3=tyle option
d. 5uropean3=tyle option
e. )ermuda3=tyle option
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e. 12. ,n option that can be eercised only at a specific set of dates is called a&
a. call option
b. put option
c. ,merican3=tyle option
d. 5uropean3=tyle option
e. )ermuda3=tyle option
b. 13. ;hich of the follo'ing is an eample of a call option 'hich is out of the
money>
a. !he option to sell at $11, the stock is 'orth $12.
b. !he option to buy at $13, the stock is 'orth $12.
c. !he option to buy at $12, the stock is 'orth $12.
d. !he option to sell at $13, the stock is 'orth $12.
e. !he option to buy at $11, the stock is 'orth $12.
e. 1". ;hich of the follo'ing is an eample of a call option 'hich is in the
money>
a. !he option to sell at $11, the stock is 'orth $12.
b. !he option to buy at $13, the stock is 'orth $12.
c. !he option to buy at $12, the stock is 'orth $12.
d. !he option to sell at $13, the stock is 'orth $12.
e. !he option to buy at $11, the stock is 'orth $12.
a. 1(. ;hich of the follo'ing is an eample of a put option 'hich is out of the
money>
a. !he option to sell at $11, the stock is 'orth $12.
b. !he option to buy at $13, the stock is 'orth $12.
c. !he option to buy at $12, the stock is 'orth $12.
d. !he option to sell at $13, the stock is 'orth $12.
e. !he option to buy at $11, the stock is 'orth $12.
d. 1+. ;hich of the follo'ing is an eample of a put option 'hich is in the
money>
a. !he option to sell at $11, the stock is 'orth $12.
b. !he option to buy at $13, the stock is 'orth $12.
c. !he option to buy at $12, the stock is 'orth $12.
d. !he option to sell at $13, the stock is 'orth $12.
e. !he option to buy at $11, the stock is 'orth $12.
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c. 1-. !o calculate the enterprise valuation cash flo', one begins 'ith 'hich of
the follo'ing information from the income statement>
a. net sales
b. operating profit
c. earnings before interest and taes times one minus the enterprise ta
rate
d. net income
e. net income times the enterprise ta rate
a. 1.. ;hen consistent assumptions are used, 'e
a. get the same value for equity under the enterprise and equity methods
of valuation
b. 'e get a higher value of equity under the equity method of valuation
c. 'e get a lo'er value of equity under the equity method of valuation
d. 'e get equity values that cannot be compared across the equity and
enterprise methods of valuation
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c. 12. !he )lack and =choles model is intended to be used to value
a. stocks
b. bonds
c. options
d. futures contracts
a. 2%. ;hich of the follo'ing is not an input to the )lack and =choles model>
a. earnings per share
b. stock price
c. risk free rate
d. volatility
c. 21. ?6h: in the )lack and =choles model involves the use of
a. the number of shares issued
b. the net time that a venture capitalist 'ill invest money
c. the normal distribution cumulative density function
d. the number of times that the venture 'ill have to raise money
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