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CF - Questions and Practice Problems - Chapter 15

This document provides an overview of Chapter 15 from a corporate finance textbook. It includes sample concept questions about the differences between preferred stock and debt, as well as the benefits and costs of call and put provisions for bonds. Sample practice problems are also provided about determining the costs of securing board seats under different voting methods and calculating the likelihood of electing a candidate under cumulative voting rules.

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Kim Quyên
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111 views

CF - Questions and Practice Problems - Chapter 15

This document provides an overview of Chapter 15 from a corporate finance textbook. It includes sample concept questions about the differences between preferred stock and debt, as well as the benefits and costs of call and put provisions for bonds. Sample practice problems are also provided about determining the costs of securing board seats under different voting methods and calculating the likelihood of electing a candidate under cumulative voting rules.

Uploaded by

Kim Quyên
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Corporate Finance

Questions and Practice problems_Chapter 15

Chapter 15:
Concept questions (page 490 textbook): 2, 6, 12, 13
Question 2: What are the differences between preferred stock and debt?

Preferred stock Debt


- Preferred stock is considered as equity - Owner of debt would be the creditor
instruments which means investors would - Debt is company’s liability, the company
become partial owner of the firm has to pay interest of debt as legal
- Preferred stock is not company’s liability obligation.
and firms can choose to not pay out - Almost debts have maturity date
dividends (when dividend is declared then - Can use to deduct tax as interest expense
it will become company’s liability) part in the balance sheet.
- No maturity date - In term of liquidation when the company
- Can not use as taxable deduction purposes goes bankrupt, debt is senior to both
- In term of liquidation when company goes preferred stock and common stock
bankrupt, preferred stock is junior to debts
but is senior to common stocks

6. A company is contemplating a long-term bond issue. It is debating whether to include a call


provision. What are the benefits to the company from including a call provision? What are the
costs? How do these answers change for a put provision?
Pros and cons to the company from including a call provision
Pros Cons
- If the interest rate in the market - The issuer must pay the investors
decline, the issuer can call back the higher coupon rate to compensate for
bond before the maturity date and the risk of calling back and refinancing
later replacing it with a lower coupon -
payment rate.
- In addition, if the interest rate rises
significantly, the issues can benefit
from the bond’s lower interest rate

Pros and cons to the company from including a put provision


Pros Cons
- The interest rate on a putable bond is - When the market interest rate rises,
lower than the interest rate on a the bondholders usually exercise their
similar but not including this right. right and force the company to buy
back the bonds at an unappealing
price

12. Several publicly traded companies have issued more than one class of stock. Why might a
company issue more than one class of stock?

Multiple classes are issued with unequal voting rights which related with control of the firm. In
some cases, the founders and managers of the firm can issue a greater-per-sharing voting over
other classes of stock to ensure that they can maintain control other investors. These kinds of
stock are usually internally traded and limited at availability. Multi-classes of stock also allow
minority shareholders of the company remain their control while not holding major stock
outstanding.

13. Do you agree or disagree with the following statement: In an efficient market, callable and
noncallable bonds will be priced in such a way that there will be no advantage or disadvantage
to the call provision. Why?
The statement is true. To attract the investors, the issuer often sells their bonds at lower price
and offer at a higher coupon rate than the noncallable one. This is considered as a premium for
the investors to compensate for their risk of calling back when the market interest rate rises
which reflecting the disadvantages of the issuer as well as the advantages of the bondholders.

Questions and Problems (page 491 textbook): 1, 4

1. Corporate Voting The shareholders of the Stackhouse Company need to elect seven new
directors. There are 850,000 shares outstanding currently trading at $43 per share. You
would like to serve on the board of directors; unfortunately no one else will be voting
for you. How much will it cost you to be certain that you can be elected if the company
uses straight voting? How much will it cost you if the company uses cumulative voting?

- Straight voting: $43 x (50% x 850,000 +1) = $18,275,043


- Cumulative voting: $43x {[ 1/(7+1)] x 850,000 +1 } = $4,568,793

4. Corporate Voting Candle box Inc. is going to elect six board members next month. Betty
Brown owns 17.4 percent of the total shares outstanding. How confident can she be of
having one of her candidate friends elected under the cumulative voting rule? Will her
friend be elected for certain if the voting procedure is changed to the staggering rule,
under which shareholders vote on two board members at a time?

To have a seat of board members, candidate need at least = 1/N+1 = 1/7 = 14.3%
outstanding
Betty owns 17.4% which means she is guaranteed election
Under staggering rule which shareholders vote on 2 board members at a time, the shares
outstanding needed is 1/N+1 = 1/3 = 33.33%. At that time, her share’s percentage is not
guaranteed for the election.

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