Student’s Name

Supervisor’s Name

Institution Affiliation

11th April, 2018

Financial Management: Theory and Practice

Chapter 18

18-1: Define each of the following terms:

A.

 Going public: The act of selling stock to the public at large by a closely held corporation
or its principle stockholders.
 New issue market: The market for stock of companies that go public.
 Initial public offering (IPO): Occurs when a closely held corporation or its principal
stockholders sell stock to the public at large.

B.

 Public offering: An offer of new common stock to the general public.

 Private placement: The sale of stock to only one or a few investors, usually institutional
investors. The advantages of private placements are lower flotation coasts and greater
speed, since the shares issued are not subject to Securities and Exchange Commission
registration.

C.

 Venture capitalists: The manager of a venture capital fund. The fund raises most of its
capital from institutional investors and invests in start-up companies in exchange for
equity.
 Roadshow: Before an IPO, the senior management team and the investment banker make
presentations to potential investors. They make presentations in 10 to 20 cities, with three
to five presentations per day, over a 2-week period.
 Spread: The difference between the price at which an underwriter sells the stock in an
initial public offering and the proceeds that the underwriter passes on to the issuing firm;
the fee collected by the underwriter. It is often about 7% of the offering price.

D.

 Securities and Exchange Commission (SEC): A government agency which regulates the
sales of new securities and the operations of securities exchanges. The SEC, along with
other government agencies and self-regulation, helps ensure stable markets, sound
brokerage firms, and absence of stock manipulation.
 Registration statement: Required of companies by the Securities and Exchange
Commission before the securities can be offered t the public. This statement is used to
summarize various financial and legal information about the company.
 Shelf registration: Frequently, companies will file a master registration statement and
then update it with a short-form statement just before an offering. This procedure is
 termed shelf registration because companies put new securities “on the shelf” and then
later sell them when the market is right.
 Margin requirement: The margin is the percentage of a stock’s price that an investor has
borrowed in order to purchase the stock. The Securities and Exchange Commission sets
margin requirements, which is the maximum percentage of debt that can be used to
purchase a stock.
 Insiders: The officers, directors, and major stockholders of a firm.

E.

 Prospectus: Summarizes information about a new security issue and the issuing company.
 “Red herring” prospectus: A preliminary prospectus that may be distributed to potential
buyers prior to approval of the registration statement by the Securities and Exchange
Commission. After the registration has become effective, the securities, accompanied by
the prospectus, may be offered for sale.

F.

 National Association of Securities Dealers (NASD): An industry group primarily

concerned with the operation of the over-the-counter (OTC) market.

G.

 Best efforts arrangement: A type of contract with an investment banker when issuing
stock. In a best efforts sale, the investment banker is only committed to making every
effort to sell the stock at the offering price. In this case, the new issue will not be fully
subscribed.
 Underwritten arrangement: A type of contract with an investment banker when issuing
stock. An investment banker agrees to buy the entire issue at a set price and then resells
the stock at the offering price. Thus, the risk selling the issue rests with the investment
banker.

H.

 Refunding: Occurs when a company issues debt at current low rates and uses the
proceeds to repurchase one of its existing high coupon rate debt issues. Often these are
callable issues, which means the company can purchase the debt at a call price lower than
the market price.
 Project financing: Arrangements used to finance mainly large capital projects such as
energy explorations, oil tankers, refineries, utility power plants, and so on. Usually, one
or more firms (sponsors) will provide the equity capital required by the project, while the
rest of the project’s capital is supplied by lenders and lessors do not have recourse against
 the sponsors; they must be repaid from the project’s cash flows and the equity cushion
provided by the sponsors.
 Securitization: The process whereby financial instruments that were previously thinly
traded are converted to a form that creates greater liquidity. Securitization also applies to
the situation where specific assets are pledged as collateral for securities, and hence asset-
backed securities are created. One example of the former is junk bonds; an example of
the latter is mortgage-backed securities.
 Maturity matching: A policy that matches asset and liability maturities. It is also referred
to as the moderate, or self-liquidating, approach.

18-2:
No. The general role of the investment banker is more important if the stock demand curve has a
steep slope and the negative signaling effect is substantial. Under such conditions, the investment
banker will have a harder time holding up the stock price
Chapter 22
22-1: Vandell’s free cash flow (FCF0) is $2M per year and is expected to grow at a constant rate
of 5% a year; its beta is 1.4. What is the current value of Vandell’s operations? If Vandell has
$10.82M in debt, what is the current value of Vandell’s stock? (Hint: Use the corporate
valuation model from Chapter 13.)

Solution

rs = rRF + RPM(b)
= 5% + 6% (1.4)
= 13.4%

WACC = wdrd(1-T) + wsrs

= 30 %(8%)(1-40%) + 70%(13.4%)
= 10.82%

Vop = FCF0 (1+g)/WACC-g

Vop = $2.1/ (10.82%-5%)
Vop = $36.08M

VS = Vop – Debt
VS = 36.08 – 10.82
= 25.26M

P0 = 25.26M/1M shares
P0 = $25.26 per share
22-2: Hastings estimates that if it acquires Vandell, interest payments will be $1,500,000 per
year for 3 years, after which the current target capital structure of 30% debt will be maintained.
Interest in the fourth year will be $1.472M, after which interest and the tax shield will grow at
5%. Synergies will cause the free cash flows to be $2.5M, $2.9M, $3.4M, and $3.57M in Years
1 through 4, respectively, after which the free cash flows will grow at a 5% rate. What is the
unlevered value of Vandell, and what is the value of its tax shields? What is the per share value
of Vandell to Hastings Corporation? Assume that Vandell now has $10.82M in debt.

Solution

rSU = wdrd + wsrsL

rSU =30%*8% + 70%*13.4%
rSU = 11.78%

Tax Shields 1-3 = Interest * Tax Rate

Tax Shields 1-3 = 1.5M * 40%
Tax Shields 1-3 = 600,000

Tax Shield 4 = $1,472,000 * 40%

Tax Shield 4 = $588,800

Tax Shield Horizon Value = (588,800*1.05)/(11.78%-5%)

= $9.12M

Tax Shield Value = 600K/(1+ rSU)+600K/(1+ rSU)^2+600K/(1+

rSU)^3+(588,800+9.12M)/(1+ rSU)^4
Tax Shield Value = $7.67M

Unlevered Vops = 2.5/(1+rSU) + 2.9/(1+rSU)^2 + 3.4/(1+rSU)^3 + (3.57 + 55.29)/(1+rSU)^4

Unlevered Vops = $44.69M

Vops = Unlevered Vops + Value of Tax Shields

Vops = $44.69 + $7.67
Vops = $52.36M

Equity Value = (Vops – Debt)/Number of Shares

= ($52.36 – 10.82)/1M
= $41.54M/1M
P0 = $41.54/share
Chapter 24

24-1
Southwestern Wear Inc. has the following balance sheet:
Current assets $1,875,000 Accounts payable $375,000
Fixed Assets 1,875,000 Notes Payable 750,000
Subordinated debentures 750,000
Total debt 1,875,000
Common Equity 1,875,000
Total Assets 3,750,000 Total liabilities and equity $3,750,000

The trustees cost total $281,250 and the firm has no accrued taxes or wages. The debentures are
subordinated only to the notes payable.

If the firm goes bankrupt and liquidates, how much will each class of investors receive if a total
of $2.5 million is received from sale of the assets?

Solution :

1. Proceeds from sale of assets $2,500,000

2. First mortgage, paid from sale of assets 0
3. Fees and expenses of administration of
Bankruptcy 281,250
4. Wages due workers earned within 3 months
prior to filing of bankruptcy petition 0
5. Taxes 0
6. Unfunded pension liabilities 0 281,250
7. Available to general creditors $2,218,750

Distribution to general creditors:

Percentage
After of Original
Application Subordination Claims
Claim of 75.56% Adjustment Received
Claims of general creditors (1) (2) (3) (4)
Notes payable $ 750,000 $ 750,000 $ 750,000 100%
Accounts payable 375,000 375,000 375,000 100
Subordinated debentures 750,000 750,000 750,000 100
$1,875,000 $1,875,000 $1,875,000

The remaining $2,218,750 – $1,875,000 = $343,750 will go to the common

stockholders. They will receive only $343,750/$1,875,000 = 18.33% of the amount
of equity on the balance sheet.