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Common Stock Essay

Question 1.1. (TCO D) Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?

(a) The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.

(b) If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.

(c) Listing a large firm’s stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.

(d) Stockholders have the right to elect the firm’s directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management’s performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.

(e) The announcement of a large issue of new stock could cause the stock price to fall. This loss is called “market pressure,” and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue. (Points : 20)

Answer d.

Question 2.2. (TCO D) The City of Charleston issued $3,000,000 of eight percent coupon, 30-year, semiannual payment, tax-exempt muni bonds 10 years ago. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be six percent of the face amount. New 20-year, six percent, semiannual payment bonds can be sold at par, but flotation costs on this issue would be two percent of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

Answer a

Question 3.3. (TCO D) New York Waste (NYW) is considering refunding a $50,000,000, annual payment, 14 percent coupon, 30-year bond issue that was issued five years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67 percent in today’s market. A call premium of 14 percent would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW’s marginal tax rate is 40 percent. The new bonds would be issued when
the old bonds are called.

The amortization of flotation costs reduces taxes, and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

Answer c

(a) $6,480
(b) $7,200
(c) $8,000
(d) $8,800
(e) $9,680 (Points : 20)


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