CORPORATE FINANCE (28C00100)

ASSIGNMENT 1: OCTOBER 2, 2009

LOGISTICS:
The weekly exercise report must be placed in the Corporate Finance box on the ground floor of Chydenia by 9:55 a.m. sharp on Friday, October 2, 2009. Please make sure that Aliases, Names and Student Numbers of all the group members are included on the work that is submitted.

STUDENT HONOR CODE:

Collaboration between groups is prohibited; this means that all work must be done within your own groups. Remember, three members is the maximum group size.

FORMATTING:
For all qualitative questions, the absolute maximum length for an answer is 1 page (font 12, 1.5 lines spaced). Use a .22-caliber rifle instead of a 10 gauge shotgun in your answers: be brief and to the point. In numerical problems, you must also show all relevant work, not just the final answers. The questions require you to think rather than copy text from the course material. The answers may be handwritten, but a computer printout is encouraged. Poor appearance will make your report difficult to understand and grade. Please highlight your final answer when possible.

PROBLEM 1 True or False? Briefly explain.

1p

a) For small issues of common stock, the issuing costs amount to about 10 percent of the proceeds. This means that the opportunity cost of external equity is about 10 percentage points higher than that of retained earnings. b) When a company announces an increase in its dividend, its stock price typically rises. Conversely, dividend decreases usually lead to stock price declines. This clearly contradicts the dividend irrelevance proposition.

CORPORATE FINANCE (28C00100)

ASSIGNMENT 1: OCTOBER 2, 2009

PROBLEM 2 VENTURE CAPITAL

1p

An entrepreneur seeks 10 million from a Venture Capital fund. The entrepreneur and fund managers have not come to terms about the present value of the firm. However, the VC feels that the company is likely to be ready to go public in five years. At that time, the company is expected to have net income of 15 million and comparable firms are expected to be selling at a price-to-earnings ratio of 30. Given the companys stage of development, the VC fund managers require a 40 percent compound annual return on their investment. a) What fraction of the firm will the Venture Capitalist request in exchange for its 10 million investment? b) Assume the entrepreneurs original investment amounted to 1 million. What (paper) return has the entrepreneur enjoyed by the first stage financing of the above-mentioned 10 million? c) Are the rates required by VCs exorbitant?

PROBLEM 3 IPO UNDERPRICING

1p

The EB Co. and the UKP Co. have both announced IPOs at 40 per share. One of these is undervalued by 10, and the other is overvalued by 5, but you have no way of knowing which is which. You plan on buying 1000 shares of each issue. If an issue is underpriced, it will be rationed, and only half your order will be filled. a) If you could get 1000 shares in EB and 1000 shares in UKP, what would your profit be? b) What profit do you actually expect? c) What principle have you illustrated?

PROBLEM 4 RIGHTS OFFER

1p

Money Machine Company is considering a rights offer. Its stock currently sells at 55 per share, and there are 15 million shares outstanding. The company determines that the exrights price would be 50. The rights offer would raise a total of 50 million. a) b) c) d) e) How many new shares will the company issue? What is the subscription price? How many rights will be needed to purchase one share? What is the value of each right? Suppose the right sell for only 4, what can you do to create an immediate profit?

CORPORATE FINANCE (28C00100)

ASSIGNMENT 1: OCTOBER 2, 2009

PROBLEM 5 PAYOUT POLICY

2p

The balance sheet of Tsing Hua Unisplendour Corporation Ltd. is given below. Assume that all balance sheet items are expressed in terms of market values. The company has decided to pay 8000 dividend to shareholders. There are four ways to do it: 1) Pay a cash dividend 2) Issue 8000 of new debt and equity in equal proportions (4000 each) and use the proceeds to pay a dividend 3) Issue 8000 of new equity and use the proceeds to pay the dividend. 4) Use the 8000 cash to repurchase equity.
Assets Property, plant, and equipment Inventory Cash Total assets Liabilities 24000 8000 8000 40000 20000 20000 40000 Equity Debt Total liabilities

What impact will each of the four policies have on the following? a) The total risk of the portfolio of assets held by the firm b) The market value of original bondholders wealth

PROBLEM 6 SHARE REPURCHASES

1p

AMC Corporation currently has a value of 400 million, of which 100 million is in cash. The firm has 10 million shares outstanding and no debt. Suppose AMC uses its cash to repurchase shares. After the share repurchase, news will come out that will change AMCs value to either 600 million or 200 million. a) What is AMCs share price prior to the share repurchase? b) What are AMCs share prices after the repurchase for both scenarios? c) Suppose AMC waits until after the news comes out to do the share repurchase. What are AMCs share prices after the repurchase for both scenarios? d) Suppose management expects good news to come out. If management desires to maximize AMCs ultimate share price, will they undertake the repurchase before or after the news comes out? When would management undertake the repurchase if they expect bad news to come out? e) Given your answer to part (d), what effect would you expect an announcement of a share repurchase to have on the stock price? Explain.