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Chapter 5: 1DQ (page 493)
In what way is an investment banker a risk taker?
An investment banker immediately acquires the securities and assumes all associated risk.
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Question: The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11戮 percent seven years ago. Interest rates have fallen to 10戮 percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the after-tax cost of new debt rounded up to the nearest whole number.
a. Compute the discount rate.
Question:Cox Media Corporation pays an 11 percent coupon rate on debentures that are due in 10 years. The current yield to maturity on bonds of similar risk is 8 percent. The bonds are currently callable at $1,110. The theoretical value of the bonds will be equal to the present value of the expected cash flow from the bonds.
a. Find the market value of the bonds using semiannual analysis.
b. Do you think the bonds will sell for the price you arrived at in part a? Why?
The Hastings Sugar Corporation has the following pattern of net income each year and associated capital expenditure projects. The firm can earn a higher return on the projects than the stockholders could earn if the funds were paid out in the form of dividends.
Year | Net income | Profitable capital expenditure |
1 | \(14 million | \)7 million |
2 | \(16 million | \)11 million |
3 | \(12 million | \)6 million |
4 | \(16 million | \)8 million |
5 | \(16 million | \)9 million |
The Hastings Corporation has 3 million shares outstanding. (The following questions are separate from each other.)
a. If the marginal principle of retained earnings is applied, how much in total cash dividends will be paid over the five years?
b. If the firm simply uses a payout ratio of 30 percent of net income, how much in total cash dividends will be paid?
c. If the firm pays a 10 percent stock dividend in years 2 through 5, and also pays a cash dividend of $3.40 per share for each of the five years, how much in total dividends will be paid?
d. Assume the payout ratio in each year is to be 20 percent of the net income and the firm will pay a 10 percent stock dividend in years 2 through 5, how much will dividends per share for each year be? (Assume the cash dividend is paid after the stock dividend.)
The Western Pipe Company has the following capital section in its balance sheet. Its stock is currently selling for \(6 per share.
Common stock (50,000 shares at \)2 par) | \(100,000 |
Capital in excess of par | \)100,000 |
Retained earnings | \(250,000 |
\)450,000 |
The firm intends to first declare a 15 percent stock dividend and then pay a 25-cent cash dividend (which also causes a reduction of retained earnings). Show the capital section of the balance sheet after the first transaction and then after the second transaction.
Question: The Robinson Corporation has $43 million of bonds outstanding that were issued at a coupon rate of 11戮 percent seven years ago. Interest rates have fallen to 10戮 percent. Mr. Brooks, the vice president of finance, does not expect rates to fall any further. The bonds have 17 years left to maturity, and Mr. Brooks would like to refund the bonds with a new issue of equal amount also having 17 years to maturity. The Robinson Corporation has a tax rate of 30 percent. The underwriting cost on the old issue was 2.4 percent of the total bond value. The underwriting cost on the new issue will be 1.7 percent of the total bond value. The original bond indenture contained a five-year protection against a call, with a 9 percent call premium starting in the sixth year and scheduled to decline by one-half percent each year thereafter. (Consider the bond to be seven years old for purposes of computing the premium.) Assume the discount rate is equal to the after-tax cost of new debt rounded up to the nearest whole number.
b. Calculate the present value of total outflows.
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