Corporate Financial Policy (Raising Capital)

All else constant, which one of the following will increase a firm's cost of equity if the
firm computes that cost using the security market line (CAPM) approach? Assume the
firm currently pays an annual dividend of $2.10 a share and has a beta of 1.1.
a. a reduction in the dividend amount
b. an increase in the dividend amount
c. a reduction in the market risk premium
d. a reduction in the firm's beta
e. an increase in the market rate of return

Hilltop, Inc. has a capital structure which is based on 30 percent debt, 10 percent
preferred stock, and 60 percent common stock. The pre-tax cost of debt is 8 percent, the
cost of preferred is 9 percent, and the cost of common stock is 11 percent. The company's
tax rate is 34 percent. The company is considering a project that is equally as risky as the
overall firm. This project has initial costs of $250,000 and cash inflows of $94,000 a year
for three years. What is the projected net present value of this project?
a. $-15,823.76
b. $-12,414.07
c. $-9,127.53
d. $1,083.19
e. None of the above

When calculating the weighted average cost of capital (WACC) an adjustment is made
for taxes because:
A) the interest on debt is tax deductible.
B) equity earns higher return than debt.
C) equity is risky

10. Which of the following choices best describes the role of taxes on the after-tax cost of
capital in the U.S. from the different capital sources?
Common equity Preferred equity Debt
A) No effect No effect Decrease
B) No effect Decrease Decrease
C) Decrease Decrease No effect

Assume that a company has equal amounts of debt, common stock, and preferred
stock. An increase in the corporate tax rate of a firm will cause its weighted average cost
of capital (WACC) to:
A) fall.
B) rise.
C) more information is needed

Which of the following choices best describes the role of taxes on the after-tax cost of
capital in the U.S. from the different capital sources?
Common equity Preferred equity Debt
A) No effect No effect Decrease
B) No effect Decrease Decrease
C) Decrease Decrease No effect

In the U.S., interest paid on corporate debt is tax deductible, so the after-tax cost of debt
capital is less than the before-tax cost of debt capital. Dividend payments are not tax
deductible, so taxes do not decrease the cost of common or preferred equity.

Which one of the following is an underlying assumption of the dividend growth
model?
A. A stock has the same value to every investor.
B. A stock's value is equal to the discounted present value of the future cash flows which
it generates.
C. A stock's value changes in direct relation to the required return.
D. Stocks that pay the same annual dividend have equal market values.
E. The dividend growth rate is inversely related to a stock's market price.

Answer this question based on the dividend growth model. If you expect the market
rate of return to increase across the board on all equity securities, then you should also
expect:
A. an increase in all stock values.
B. all stock values to remain constant.
C. a decrease in all stock values.
D. dividend-paying stocks to maintain a constant price while non-dividend paying stocks
decrease in value.
E. dividend-paying stocks to increase in price while non-dividend paying stocks decrease
in value

What is venture capital?
a. equity funds from internal sources used to finance high-risk projects
b. capital raised from issuing equity securities in order to retire debt securities
c. financing for new firms which generally entails high levels of risk
d. bank loans used to pay the start-up costs of a new firm
e. the use of supplier credit as a means of financing the initial inventory purchases of a new firm

What is a red herring?
a. newspaper listing of a security offering
b. negative comments by the SEC on a proposed security offering
c. a debt issue that matures in less than nine months
d. a preliminary prospectus
e. a preliminary assumption that the small-issues exemption applies to an offering

Advertisements in a financial newspaper announcing a public offering of securities, along
with a list of the investment banks handling the offering, are called:
a. red herrings.
b. tombstones.
c. Green Shoes.
d. registration statements.
e. letters of comment.

What is a seasoned equity offering?
a. shares of stock that have been available for public purchase but remain unsold
b. shares of stock purchased by an underwriter that can be resold to the general public after six
months
c. equity securities held by a firm's founder that will be offered to the general public once all the
IPO shares are sold
d. sale of newly issued equity shares by a firm that is currently publicly owned
e. a set number of equity shares that are offered to the public once a year

Underwriter buys shares from the issuer (issuing firm)

Underwriter sells the shares to the public on the first day of the IPO 

Risky for the underwriting Syndicate- if some shares are not sold underwriting syndicate is stuck with the shares

Early stage financing consists of these 3 parts: friends & family, angel investors, venture capital

Angel investors- wealthy, affluent individuals, invest in high risk profile firms, expect an average return

Venture capital- private financing for relatively new businesses in exchange for stock, VC firms are formed from a group of investors that pool capital and then have partners in the firm decide which companies will receive financing

Venture Capitalist- choose VC that has a management style that is compatible with your own

Selling Securities to the Public- Management must obtain permission from the Board of Directors, firm must file with the SEC, price determined on date of registration

Underwriters- formulate method used to issue securities, price the securities, conduct road shows and the ‘book building’ process, sell the securities, price stabilization by lead underwriter

syndicate- group of investment bankers that market the securities and share the risk associated with selling the issue

Spread- difference between what the syndicate pays the company and what the security sells for initially in the market

Firm Commitment Underwriting- The issuer sells the issue to a syndicate, which resells it to the public, making a profit on the price difference and assuming the risk of unsold shares. This is the most common underwriting method in the U.S.

Shelf Registration- permits a corporation to register a large issue with the SEC
and sell it in small portions within two years, reduces the flotation costs of registration, allows, the company more flexibility to raise money quickly

Direct listings- company is public, no new shares issued, proceeds go to stockholders selling their shares

Advantages of Direct listings: cost effective, fast process, liquidity to owners who wish to cash out, no dilution of existing stockholders

Disadvantages of direct listings: no research analysts, no road shows, no investment banks to help price the stock-less transparency for investors

Types of Long-term Debt- Bonds, Private issues

2 types of private issues- Term loans, private placements

Term loans- direct business loans from commercial banks, insurance companies, maturities

Private placements- similar to term loans with longer maturity

New Equity Issues & Price- stock prices tend to decline in the longer run, signaling and managerial info, debt usage

Types of Issuance Costs- spread, other direct expenses (legal fees, filing fees), indirect expenses, green shoe option (cost of more shares syndicate can purchase after its gone to market)

Green Shoe provision– Allows the syndicate to purchase an additional 15% of
the issue from the issuer (oversubscription), Provides some protection for the underwriters as they perform their price stabilization function: the underwriter has the ability to increase supply and smooth out price fluctuations if demand surges

Lockup agreements– Restriction on insiders that prevents them from selling
their shares of an IPO for a specified time period

Types of Underwriting- firm commitment underwriting, best efforts underwriting, dutch auction underwriting

best efforts underwriting- underwriter must make their “best effort” to sell the securities at an agreed-upon offering price

why does underpricing exist- underpricing is used to induce more investors to participate in the IPO

Signal company quality- although costly, may allow the issuer to return to market to sell equity on better terms at a later date

lawsuit avoidance- some companies purposefully sell their stock at a discount rate to reduce the likelihood of future lawsuits from shareholders disappointed with the post IPO performance of their shares