THE INTERNATIONAL UNIVERSITY (IU)

FINAL EXAMINATION
CORPORATE FINANCE
Date: June 15, 2021
Đặng Thảo Vân Anh – BABAIU18016
Question 1:
a)
In the perfect market, where there are no taxes and other imperfect factors such as
bankruptcy fees, brokerage fees, dividend policy is irrelevant when considering a company's
value. This is the Dividend Irrelevant Theory proposed by Modigliani and Miller, which
argues that the dividend policy will have no effect on the capital structure or the price of the
stock.
For certain reasons, the company's managers may need to change the dividend policy (for
example by issuing more shares) to suit the requirements from the BoD. According to
M&M's Theory, when the periodical dividend being paid do not satisfy the investors, they
will have a way to adjust it to a different amount, using homemade dividends. Homemade
dividends is a method where investors will sell or buy a certain amount of shares to be able
to adjust the amount of dividends received in a period without affecting their own total profit.
If shareholders find that the dividend is too low than expected, they will sell part of their
shares and expand the current cash flow, while reducing the next period’s dividend to be
received. On the contrary, if they feel the dividend is high, they will choose to buy more
shares. The reason investors don't hesitate to do that is because they only care about returns,
so in a perfect market, money coming from dividends or selling stocks is not a big deal.
Afterall, the company's different policies will not change the total investment as well as the
amount of dividends that shareholders receive in the end.
To clarify this Theory, let’s look at an example. ABC inc. issue shares at $33 each, with a
dividend of $3 cash. Miss A is a holder of 120 shares and wants to receive a return equivalent
to $4 per share, which is $480. Miss A will sell her 4 shares ex-dividend immediately after
receiving the current period's dividend. Because the stock is sold on the ex-dividend date, the
price is only $30 and Miss A can receive the amount of $120 back. Thus, the total amount
she receives is:
Cash from dividend:.....................................$360
Cash from selling stocks:.............................$120
Total cash: ...................................................$480
Value of stock holding:................................$3480 ($30 x (120 – 4))
 Total wealth after adjusting:.........................$3960 ($3480 +$480)
Obviuosly, the total assets that Miss A has after using homemade dividends is equal to her
initial total assets 120 x $33 = $3960 and her return is $4 per share as desired.
To sum up, both changing dividend policy and using homemade dividends to adjust have
neither effect nor benefit for shareholders and the firm. Therefore, when companies develop new
projects, especially those with positive NPV for the purpose of increasing dividends, they can
ignore the effects of the new dividend policy on the company and its stakeholders.
b)
The 3 real-world factors considered as the reason for high dividends are preferred regardless
of personal taxes: Desire for current income, behavioral finance and agency costs.
Firstly, the people who will tend to look for a high dividend can be individuals who desire
current income, such as those who are retired, or those who cannot trade principal shares
because of trusts and endowments. In fact, homemade dividends is unreasonable because the
process of buying and selling shares is quite long and complicated, and the costs surrounding it
are also high. Compared to trying to adjust your return by buying and selling stocks, a high
dividend will be a better choice. In addition, intermediaries such as mutual funds can make it
easier for those in need to invest, possibly by allowing individual investors to participate in a
portion of large portfolios and bring high return.
Behavioural finance is a psychological factor that is very interested in financial investment.
This theory states that human behavior is the result of adaptation and learning after a series of
choices. When deciding to invest, a person will have to choose between having a higher return,
or investing in stocks with no dividends, and then selling the shares gradually to make a profit.
But reality shows that the second option takes a lot of time. At the same time, it can be seen that
not everyone will have the same stance on which stocks to choose, so the high dividend policy is
still offered by companies.
Regarding agency costs, there are 3 parties involved as follows: bondholders, stockholders,
managers who have conflicts. The bondholder wants the cash flow in the company to be
guaranteed so that the bond interest can be maintained under any circumstances, while the
stockholder wants to collect as much money as possible. In this conflict, managers act as
representatives of shareholders, so will try to push the dividend up. At the same time, one of the
main agency costs is managers not working properly, choosing negative or unproductive NPV
projects. Set high dividend is a measure proposed by researchers, with the argument that if the
dividend equals the excess cash flow, management will not be able to waste sources.
c)
Both cash dividends and stock repurchases provide returns for individual investors, and both
require tax payments based on the law. But the reality shows that stock repurchasing not only
outweigh purchasing financial assets but also the best choice when considering the appearance of
personal income tax. Assume that the tax on dividends and selling stocks is the same, and is set
at 20%. If a person chooses to buy shares and receive $50 in periodic dividends, that person will
have to pay $10 in taxes. However, it is different when we consider share buybacks. Tax is
charged only on the actual profit on the resale of assets. The actual profit, in this case, would be
around $20, assuming the original purchase price was $30, so the actual tax payable is only $4, a
much lower number.
In general, the tax rate on stock repurchasing is lower than on dividends from assets, even if
the tax imposed on the two cases are the same. However, the competent authorities have
implemented many control methods to make sure companies don't repurchase too much just to
evade taxes.
Question 2:
a)
1. Fully underwriting:
Advantages:
+ Underwriters increase the stock price: Because of the nature of the middleman's
commission and the effort to sell off the entire shares, underwriters will contribute to an
increase in the stock price.
+ No risk: All shares are bought back by syndicates and they are now the who resell assets in
the market. Therefore, if the shares cannot be sold, they will be the ones who suffer, not the
company. However, since stock prices are often set within the day, underwriters can gauge
the market and change accordingly.
+ Certify the price to the market: Underwriters have the ability to access the company
situation and need to ensure their credibility when selling so they will set the right price of
the stock. Therefore, this method partly reflects the company's situation through the stock
price, partly helping investors to buy stocks more easily.
Disadvantages:
+ Dilution of proportionate ownership: An underwriting option is a method of extending the
buying option to a large number of people, so the more people buy the stock, the more
diluted the company's shareholder ratio becomes.
+ Slow progress: Underwriting often takes longer than a rights offering, and furthermore
requires shareholder approval and approval.
+ High cost: this is simply because the company will have to pay the middleman, or the
underwriter will pay the company a lower price per share.
2. Rights offering:
Advantages:
 + Speed: Offering rights is considered a convenient and fast method because it does not
require too many regulations, nor does it take time to attract new shareholders.
+ Low cost: the company does not need to bear advertising costs, attracting new investors,
nor does it need to pay underwriting fees, but only needs to notify the old shareholders directly.
+ Guaranteed Ownership: Unlike underwriting, rights issues are offered directly to existing
owners, so their ownership will not be diluted. They also feel respected and protected when a
new series of issues are launched for them instead of being made public.
Disadvantages:
+ Share price decreases: when a new quantity is issued, the subscription price will naturally
be lower than the original price. Therefore, it leads to a decrease in stock prices in the market.
+ Negative impact on firm image: using a rights offering is a sign that the company is in a
financial crisis, or lacks the capital to carry out good projects. Stockholders will assume that the
firm is having a hard time managing its finances or running smoothly and may choose to sell its
shares, causing the asset price to fall even further. This is detrimental when applying for a listing
on a national exchange for Microsystems.
+ Right issue limit: exchanges set rules that each company can only issue rights within a
certain limit, and usually determined by the company's current capital. In particular, the company
cannot issue more than the IPO. So, if a company values its stock too low, it takes on a high risk.
b)
Subscription price per share:$35+($0.5x6) = $38
Number of new share = $3,500,000 / $38 = 92105.26 shares
Number of rights needed to purchase a share:
N = Number of share outstanding / number of new share = 3.26
Right’s value = (Right on price – Subscription price) / (N+1)
= ($42 - $38) / (3.26+1) = $0.94
Question 3:
a) Price of new machine: $30,000+($500x6) = $30,300
Buy (1) Year 0 Year 1-5
Cost of new machine ($303,00)
After tax saving $12,500 x (1 – 0.34) = $8,250

Depreciation tax shield $2,500 x 0.34 = $850

Net CF ($30,300) $9,100
Lease (2) Year 0 Year 1-5
Lease payment - $6,400 (1 – 0.34) = - $4,224
After tax saving $12,500 x (1 – 0.34) = $8,250
Net CF 0 $4,026
Leasing instead of buying (2) – (1) $30,300 ($5,074)

−$ 5,074 1
NPV (leasing instead of buying) = $30,300 + ( 0.1 (
× 1−
( 1+0.1 )5)=$ 11,065.55

Therefore, Rubber Manufacturing Company should lease.

b)
Rubber Manufacturing Company: Year 0 Year 1–5
Cost of new machine: $30,300
After tax lease payment: - Lmax (1 – 0.34)
Forgone Depreciation tax shield: - $2,500 x 0.34 = - $850
⇨ NPV= $30,300 - Lmax (1 – 0.34) - $850
−Lmax(1 – 0.34)−$ 850 1
NPV = 0  $30,300 + ( 0.1
× 1−
(
( 1+ 0.1 )5 )
= 0⇨ Lmax = $10,822.82

⇨ Maximum payment = $10,822.82

Question 4:
Advantages of leasing:
+ Tax advantages: Leasing can lead to tax shield, especially when companies are in different
tax brackets. The lessee will receive tax amortization and interest deductions. Furthermore,
lessors will also consider to set prices low to ease the burden of income tax on them. So
sometimes there will be a conflict of interest between the lessee and the lessor, and that's when
the two parties come to an agreement and determine the appropriate rent for mutual benefits.
+ Reduction of uncertainty: Leasing makes lessee does not need to own properties, and as
such will not need to be responsible for depreciation, damage and risk of use.
+ Transaction costs: The cost of performing a lease is usually less than the cost of entering in
to a contract of sale. However, there is some concern that lessee will raise agency costs. In that
case, the lessor will take measures to monitor, or set a high leasing price, but anyway, lessee is
still profitable.
 + Quality properties: with a limited capital, leasing will give the company the right to use
higher quality machinery or assets for the required time instead of spending large amounts of
money to buy it outright.
Disadvantages of leasing:
+ Lease expenses: leasing are not counted as equity payment towards assets but as expenses.
+ Debt: lease payments do not appear on balance sheet, but investors will assume them as
debt.
+ Limit ownership: or rather no ownership. After using, the company is required to return the
property regardless of its condition of use, and the rental is only utilized for a meager rental
period.
+ In some cases, assets take a long time to function properly, or will increase in value over
time (like real estate). At that time, renting will be a waste and pointless.
Question 5:
Part 1)
The merger or acquisition of one or more companies can yield greater returns than the value
of the other.
The first source of synergy is revenue enhancement. The combined firm will improve
marketing inefficiencies, weak communication channels, and unbalanced product mixes.
Furthermore, when two companies are combined, strategic elements are also organized more
effectively (for example, company A will be the output or input for company B). M&A also
offers the opportunity to capture a larger market share, gain more market power and possibly
become a monopoly in that industry.
Another factor that brings benefits to synergy is cost reduction. Two companies that
combine well will have a more streamlined production process than if they were separate.
Especially for horizontal mergers, the average production costs will be greatly reduced thanks to
the production support and offset and bring about the economy of scale. As for vertical
integration, cost-effectiveness can come from mutual sourcing. In addition, other factors that are
equally important are technology transfer, complementary resources, and elimination of
inefficient management. In particular, the review and change of management, work processes,
and worksflow often bring great value to the company.
M&A brings a huge benefit, which is tax reduction, which comes from 3 main factors: use of
tax losses, use of unused debt capacity, use of surplus funds. The use of tax losses is the benefit
when the company has a profitable division. In terms of debt capacity, there are two cases where
mergers lead to increased debt and tax shield: , the target has too little debt, and the acquirer can
infuse the target with the missing debt, or both the target and acquirer have optimal debt levels.
 Finally, the M&A will reduce the capital requirement, because the two parties can support,
supply, and find outputs and inputs for each other without having to buy, hire or outsource. A
merger permits these economies of scale to be realized, a reduction in working capital.
Part 2)
Sweet Shoppe (A): Number of shares outstanding: 85,000+(100x6) = 85600
Candy Land (B): Number of shares outstanding: 59,000+(100xA) = 59,600
After-tax annual cash flow: $60,000+($500x6) = $63,000
a) NPV = (VB + ΔV) – cash paid = (59,600 x $27 + $63,000) - $1,650,000 = $22,200
New share price = (85600 x $36 + (59,600 x $27 + $63,000) -
$1,650,000)/( 85600+59,600) = $21.38