2. The common stock and debt of Northern Sludge are valued at $65 million and $35 million (A+)

The common stock and debt of Northern Sludge are valued at $65 million and $35 million, respectively. Investors currently require a 15.9% return on the common stock and a 7.8% return on the debt. If Northern Sludge issues an additional $14 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.

Required:

New return on equity

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3. Establishment Industries borrows $1,040 million at an interest rate of 6.9% (A+)

Establishment Industries borrows $1,040 million at an interest rate of 6.9%. 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 37%.

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2. Pandora, Inc., makes a rights issue at a subscription price of $7 a share (A+)

Pandora, Inc., makes a rights issue at a subscription price of $7 a share. One new share can be purchased for every four shares held. Before the issue there were 12 million shares outstanding and the share price was $8.

Required:

a. What is the total amount of new money raised?

b. What is the expected stock price after the rights are issued?

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2. The market value of the marketing research firm Fax Facts is $850 million (A+)

The market value of the marketing research firm Fax Facts is $850 million. The firm issues an additional $100 million of stock, but as a result the stock price falls by 2%.

Required:

What is the cost of the price drop to existing shareholders as a fraction of the funds raised?

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2. When Microsoft went public, the company sold 3 million new shares (the primary issue) (A+)

When Microsoft went public, the company sold 3 million new shares (the primary issue). In addition, existing shareholders sold .5 million shares (the secondary issue) and kept 21.2 million shares. The new shares were offered to the public at $20, and the underwriters received a spread of $1.41 a share. At the end of the first day’s trading the market price was $34 a share.

Required:

a. How much money did the company receive before paying its portion of the direct costs?

b. How much did the existing shareholders receive from the sale before paying their portion of the direct costs?

c. If the issue had been sold to the underwriters for $29 a share, how many shares would the company have needed to sell to raise the same amount of cash?

d. How much better off would the existing shareholders have been?

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2. Moonscape has just completed an initial public offering (A+)

Moonscape has just completed an initial public offering. The firm sold 3 million shares at an offer price of $10 per share. The underwriting spread was $.7 a share. The price of the stock closed at $16 per share at the end of the first day of trading. The firm incurred $400,000 in legal, administrative, and other costs.

Required:

What were flotation costs as a fraction of funds raised?

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2. Having heard about IPO underpricing, I put in an order to my broker for 2,300 shares of every IPO he can get for me (A+)

Having heard about IPO underpricing, I put in an order to my broker for 2,300 shares of every IPO he can get for me. After 3 months, my investment record is as follows:

IPO Shares Allocated to Me Price per Share Initial Return

A 850 $10 7%

B 550 20 15

C 2,300 6 −4

D 0 10 26

Required:

a. What is the average underpricing of this sample of IPOs?

b. Calculate the average initial return, weighting by the amount of money invested in each issue.

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2. Common Products has just made its first issue of stock (A+)

Common Products has just made its first issue of stock. It raised $1.2 million by selling 150,000 shares of stock to the public. These are the only shares outstanding. The par value of each share was $3. Complete the following table:

Common shares (par value)

Additional paid-in capital

Retained earnings

Net common equity $ 1,600,000

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2. Book value of common stockholders’ equity of Dow Chemical, December 31, 2010 (figures in billions)Book value of common stockholders’ equity of Dow Chemical, December 31, 2010 (figures in billions) (A+)

Book value of common stockholders’ equity of Dow Chemical, December 31, 2010 (figures in billions).

Common shares ($1.5 par value per share) $2.934

Additional paid-in capital 2.289

Retained earnings 17.739

Treasury shares at cost (0.242)

Other (4.878)

Net common equity $17.842

Required:

a. Suppose that Dow Chemical issues 120 million shares at $25 share. Show the company’s equity after the issue.

b. Suppose that Dow subsequently repurchased 60 million shares at $45 a share. Rework part (a) to show the effect of the further change.

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2. The shareholders of the Pickwick Paper Company need to elect eight directors (A+)

The shareholders of the Pickwick Paper Company need to elect eight directors. There are 200,000 shares outstanding.

Required:

a. How many shares do you need to own to ensure that you can elect at least one director if the company has majority voting?

b. How many shares do you need to own to ensure that you can elect at least one director if the company has cumulative voting?

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