Chapter 14 - Introduction to Corporate Financing

Solutions to Chapter 14

Introduction to Corporate Financing

1. a. Number of shares = par value of issued stock/par value per share

= $60,000/$1.00 = 60,000 shares

b. Outstanding shares = issued shares – Treasury stock

= 60,000 – 2,000 = 58,000 shares

c. The firm can issue up to a total of 100,000 shares. Because 60,000 shares
have been issued, another 40,000 shares can be issued without approval
from shareholders.

Est time: 01–05

2. a. The issue of 10,000 shares would increase the par value of common stock by:
10,000 shares  $1.00 = $10,000
Additional paid-in capital increases by:
10,000 shares  $3.00 per share = $30,000
The new accounts would be as follows:
Common stock $ 70,000
Additional paid-in capital 40,000
Retained earnings 30,000
Common equity 140,000
Treasury stock 5,000
Net common equity $135,000

b. If the company bought back 1,000 shares, Treasury stock would increase by the
amount spent on the stock: $4,000. The accounts would be:
Common stock $ 60,000
Additional paid-in capital 10,000
Retained earnings 30,000
Common equity 100,000
Treasury stock 9,000
Net common equity $ 91,000

Est time: 01–05

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Chapter 14 - Introduction to Corporate Financing

7. a. If the company has majority voting, each candidate is voted on in a separate

election. To ensure that your candidate is elected, you need to own at least half the shares, or
200,000 shares (or 200,001 shares, in order to ensure a strict majority of the votes).

b. If the company has cumulative voting, all candidates are voted on at once, and the
number of votes cast is 5  400,000 = 2,000,000 votes.
If your candidate receives one-fifth of the votes, that candidate will place at least
fifth in the balloting and will be elected to the board. Therefore, you need to cast
400,000 votes for your candidate, which requires that you own 80,000 shares.

Est time: 01–05

8. a. Par value of common shares will increase by:

100 million shares  $2.50 par value per share = $250 million
Additional paid-in capital will increase by:
($25.00 – $2.50)  100 million = $2.25 billion
Table 14-1 becomes:
Common shares ($2.50 par value per share) $ 3.181
Additional paid-in capital 4.536
Retained earnings 17.736
Treasury shares at cost (0.239)
Other (4.875)
Net common equity $20.339

b. Treasury shares will increase by 50,000,000  $40 = $2 billion.

Common shares ($2.50 par value per share) $ 3.181
Additional paid-in capital 4.536
Retained earnings 17.736
Treasury shares at cost (2.239)
Other (4.875)
Net common equity $18.339

Est time: 06–10

9. Common shares (par value) = 200,000  $2.00 = $400,000

Additional paid in capital = funds raised – par value = $2,000,000 – $400,000 = $1,600,000
Because net common equity of the firm is $2,500,000 and the book value of
outstanding stock is $2,000,000, then retained earnings equals $500,000.
3. a. funded
b. eurobond
c. subordinated
d. sinking fund

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Chapter 14 - Introduction to Corporate Financing

e. call
f. prime rate
g. floating rate
h. private placement, public issue
i. lease
j. convertible
k. warrant

5. Preferred stock is like long-term debt in that it commits the firm to paying the security
holder a fixed sum—either a specified interest payment in the case of bonds or a
specified dividend in the case of preferred stock. Like equity and unlike debt, however,
failure to pay the dividend on preferred stock does not set off bankruptcy.

10. Lease obligations are like debt in that both legally obligate the firm to make a series
of specified payments. Bondholders would like the firm to limit its lease obligations
for the same reason that bondholders desire limits on debt: to keep the firm’s
financial burden at manageable levels and to make the already existing debt safer.

11. a. A call provision gives the firm a valuable option. The call provision will require
the firm to compensate the investor by promising a higher yield to maturity.

b. A restriction on further borrowing protects bondholders. Bondholders will

therefore require a lower yield to maturity.

c. Collateral protects the bondholder and results in a lower yield to maturity.

d. The option to convert gives bondholders a valuable option. They will therefore
be satisfied with a lower promised yield to maturity.

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