Chapter 5: 4DQ (page 524)
Discuss the relationship between the coupon rate (original interest rate at time of issue) on a bond and its security provisions. (LO16-1)
The greater protection is given to the bondholders' class, the lower the interest rate.
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What is shelf registration? How does it differ from the traditional requirements for security offerings?
The investment banking firm of Einstein & Co. will use a dividend valuation model to appraise the shares of the Modern Physics Corporation. Dividends (D1) at the end of the current year will be \(1.64. The growth rate (g) is 8 percent and the discount rate (Ke) is 13 percent.
a. What should be the price of the stock to the public?
b. If there is a 7 percent total underwriting spread on the stock, how much will the issuing corporation receive?
c. If the issuing corporation requires a net price of \)31.30 (proceeds to the corporation) and there is a 7 percent underwriting spread, what should be the price of the stock to the public? (Round to two places to the right of the decimal point.)
Question: The Bailey Corporation, a manufacturer of medical supplies and equipment, is planning to sell its shares to the general public for the first time. The firm’s investment banker, Robert Merrill and Company, is working with Bailey Corporation in determining a number of items. Information on the Bailey Corporation follows:
Bailey corporation | |
Income statement | |
For the year 20X1 | |
Sales (all on credit) | \(42,680,000 |
Cost of goods sold | \)32,240,000 |
Gross profit | \(10,440,000 |
Selling and administrative expenses | \)4,558,000 |
Operating profit | \(5,882,000 |
Interest expense | \)600,000 |
Net income before taxes | \(5,282,000 |
Taxes | \)2,120,000 |
Net income | \(3,162,000 |
Bailey corporation | |
Balance sheet | |
As of December 31, 20X1 | |
Assets | |
Current assets: | |
Cash | \)250,000 |
Marketable securities | \(130,000 |
Accounts receivables | \)6,000,000 |
Inventory | \(8,300,000 |
Total current assets | \)14,680,000 |
Net plant and equipment | \(13,970,000 |
Total assets | \)28,650,000 |
Liabilities and stockholders’ equity | |
Current liabilities: | |
Accounts payable | \(3,800,000 |
Notes payable | \)3,550,000 |
Total current liabilities | \(7,350,000 |
Long-term liabilities | \)5,620,000 |
Total liabilities | \(12,970,000 |
Stockholder’s equity: | |
Common stock (1,800,000 shares at \)1 par) | \(1,800,000 |
Capital in excess of par | \)6,300,000 |
Retained earnings | \(7,580,000 |
Total stockholder’s equity | \)15,680,000 |
Total liabilities and stockholder’s equity | $28,650,000 |
d. Now assume that, of the initial 800,000 share distribution, 400,000 belong to current stockholders and 400,000 are new shares, and the latter will be added to the 1,800,000 shares currently outstanding. What will earnings per share be immediately after the public offering? What will the initial market price of the stock be? Assume a price-earnings ratio of 12, and use earnings per share after the distribution in the calculation.
Richmond Rent-A-Car is about to go public. The investment banking firm of Tinkers, Evers & Chance is attempting to price the issue. The car rental industry generally trades at a 20 percent discount below the P/E ratio on the Standard & Poor’s 500 Stock Index. Assume that index currently has a P/E ratio of 25. The firm can be compared to the car rental industry as follows:
Richmond | Car Rental Industry | |
Growth rate in earnings per share..... | 15% | 10% |
Consistency of performance............. | Increased earnings 4 out of 5 years | Increased earnings 3 out of 5 years |
Debt to total assets..................... | 52% | 39% |
Turnover of product......................... | Slightly below average | Average |
Quality of management.................. | High | Average |
Assume, in assessing the initial P/E ratio, the investment banker will first determine the appropriate industry P/E based on the Standard & Poor’s 500 Index. Then a half point will be added to the P/E ratio for each case in which Richmond Rent-A-Car is superior to the industry norm, and a half point will be deducted for an inferior comparison. On this basis, what should the initial P/E be for the firm?
Question: The management of Mitchell Labs decided to go private in 2002 by buying in all 2.80 million of its outstanding shares at \(24.80 per share. By 2006, management had restructured the company by selling off the petroleum research division for \)10.75 million, the fiber technology division for \(8.45 million, and the synthetic products division for \)20 million. Because these divisions had been only marginally profitable, Mitchell Labs is a stronger company after the restructuring. Mitchell is now able to concentrate exclusively on contract research and will generate earnings per share of $1.10 this year. Investment bankers have contacted the firm and indicated that if it reentered the public market, the 2.80 million shares it purchased to go private could now be reissued to the public at a P/E ratio of 15 times earnings per share.
b. What is the total value to the company from (1) the proceeds of the divisions that were sold, as well as (2) the current value of the 2.80 million shares (based on current earnings and an anticipated P/E of 15)?
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