Chapter 5: Q5DQ (page 594)
Explain the relationship between a company’s growth possibilities and its dividend policy?
The higher the number of growth possibilities, the lower the residual income distributed as dividends by the company. The dividend policy is related to the investment opportunities available to the company.
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Explain how the zero-coupon rate bond provides return to the investor. What are the advantages to the corporation? (LO16-2)
What is the difference between a bond agreement and a bond indenture? (LO16-1)
Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.
b. Compare the price in part a to the 8 percent call premium over par value. Which appears to be more attractive in terms of reacquiring the old bonds?
Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.
a. How many shares of stock must be sold to net $21,120,000? (Note: No out-of-pocket costs must be considered in this problem.)
Explain the role of financial intermediaries in the flow of funds through the three-sector economy.
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