The market value of the marketing research firm Fax Facts is $900 million. The firm issues an

The market value of the marketing research firm Fax Facts is $900 million. The firm issues an additional $150 million of stock, but as a result the stock price falls by 2%. What is the cost of the price drop to existing shareholders as a fraction of the funds raised? (Enter your answer in millions.)

Cost of the price drop

$ million

Explanation:

The lost value to the original shareholders is 0.02 × $900 million = $18 million.

This is 12% of the value of the funds raised.

You need to choose between the following types of issues:

  

•	A public issue of $10 million face value of 10-year debt. The interest rate on the debt would be 8.0%, and the debt would be issued at face value. The underwriting spread would be 1.9%, and other expenses would be $83,000.

  

•	A private placement of $10 million face value of 10-year debt. The interest rate on the private placement would be 8.5%, but the total issuing expenses would be only $39,000.

  

a-1.	Calculate the net proceeds of public issue. (Enter your answer in dollars not in millions.)

  

Net proceeds of public issue

$

  

a-2.	Calculate the net proceeds of private placement. (Enter your answer in dollars not in millions.)

  

Net proceeds of private placement

$

  

b.	Other things equal, which is the better deal?
	Public issue

rev: 05_11_2012


Explanation:

a.

Net proceeds of public issue = $10,000,000 − $190,000 − $83,000 = $9,727,000

Net proceeds of private placement = $9,961,000

b.

The extra interest paid on the private placement is:

0.005 × $10 million = $50,000 per year

The present value is:

$50,000 × annuity factor (8.0%,10 years) =

This exceeds the savings in direct issue costs ($234,000), so the public issue appears to be the better deal.

(Note that we use a discount rate of 8.0%, rather than 8%, because 8.0% is the yield to maturity at which public investors are willing to invest in the bond when the company pays the cost of the issue directly to the underwriters. In the private placement, part of the 8% coupon rate should be considered compensation for issuance costs that are not charged for explicitly.)

Pandora, Inc., makes a rights issue at a subscription price of $5 a share. One new share can be purchased for every five shares held. Before the issue there were 16 million shares outstanding and the share price was $8.

a.	What is the total amount of new money raised? (Enter your answer in millions rounded to 1 decimal place.)

New money raised

$ million

b.	What is the expected stock price after the rights are issued? (Round your answer to 2 decimal places.)

New share price

$

Explanation:

a.

The number of new shares is $16 million/5 = 3.2 million.

Each share is sold for $5, so new money raised is $16.0 million.

b.

After the issue, there are 16.0 million shares. The total value of the firm is:

$128 million (the original value of the firm) + $19.2 million

The new share price is $144.0 million/19.2 million shares = $7.50 per share.

Establishment Industries borrows $900 million at an interest rate of 7.9%. It expects to maintain this debt level into the far future. What is the present value of interest tax shields? Establishment will pay tax at an effective rate of 29%. (Do not round intermediate calculations. Enter your answer in millions rounded to 1 decimal place.)

PV(tax shield)

$ million

Explanation:

PV(tax shield)	=	0.29 × (0.079 × $900)	=	0.29 × $900	=	$261.0 million
		0.079

The common stock and debt of Northern Sludge are valued at $68 million and $32 million, respectively. Investors currently require a 16.2% return on the common stock and a 7.8% return on the debt. If Northern Sludge issues an additional $12 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

New return on equity

%

Explanation:

Some values below may show as rounded for display purposes, though unrounded numbers should be used for the actual calculations.

Expected return on assets is:

rassets = (0.078 × 32/100) + (0.162 × 68/100) = 0.1351 = 13.51%

The new return on equity is:

requity = rassets + [D/E × (rassets − rdebt)]

= 0.1351 + [20/80 × (0.1351 − 0.078)] = 0.1494 = 14.94%