Corporate Finance - What Do You Think About the Rationale Behind Borrowing the Entire Amount What Is Your Company’s Weighted Average Flotation Cost, Assuming All Equity Is Raised Externally

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CORPORATE FINANCE

CASE STUDY : 1

Reliance company has a $ 1,000 face value convertible bond issue that is currently selling in the market for $ 950. Each bond is exchangeable at any time for 25 shares of the company’s stock. The convertible bond has a 7 percent coupon. Payable semi-annually. Similar non-convertible bonds are priced to yield 10 percent.

The bond matures in 10 years stock in Reliance sells for $ 36 per share.

Q1) What are the conversion ratio, conversion price, and conversion premium?

Q2) What is the straight bond value?

Q3) What is the conversion value?

Q4) What is the option value of the bond?

CASE STUDY : 2

Suppose your company needs $ 15 million to build a new assembly line. Your target debt equity ratio is 0.90. The flotation cost for new equity is 8 percent, but the flotation cost for debt is only 5%. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.

Q1) What do you think about the rationale behind borrowing the entire amount?

Q2) What is your company’s weighted average flotation cost, assuming all equity is raised externally?

Q3) What is the true cost of building the new assembly line after taking flotation costs into account?

Q4) Does it matter in this case that the entire amount is being raised from debt?

CASE STUDY : 3

ABC Co. & XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $ 800,000 in stock XYZ uses both stocks and perpetual debt, its stock is worth $ 400,000 and the interest rate on its debt is 10 per cent. Both firms expect EBIT to be $ 90000. Ignore taxes.

Q1) Rico owns $ 30,000 worth of XYZ’s stock. What rate of return is he expecting?

Q2) Show how Rico could generate exactly the same cash flows and...