Finance Final - Fall 2018

Frank Enstein is the CEO of a private medical equipment company that is proposing to sell 149,000 shares of its stock in an open auction. Suppose the company receives the bids in the following table. Shares Price 27,000 $ 94 17,000 92 22,000 87 32,000 84 17,000 83 15,000 81 21,000 80 22,000 79 37,000 75 What is the maximum price at which the company can sell its stock? (It's lying, find the price that will allow the company to sell all the shares for the most money).

$80.00 Ch. 15 Solution To achieve 149,000 shares issued, the firm would reach the $80 per share bid, (27,000 + 17,000 + 22,000 + 32,000 + 17,000 + 15,000 + 21,000)>149,000.

Mental Accounting

'house money' vs. income - more willing to take excessive risks with gambling winnings than with your own money - will clip a $2 coupon, but won't drive 3 mile away to save $37 on an item - paying with cash v. credit card; paying with cash feels like it costs more because you're physically watching the money go away - A penny saved is a penny earned? BF supplemental

What is behavioral real estate?

- a more inclusive definition of utility - is 'wealth maximization' all that matters? - it's NOT necessarily a test of rational versus irrational behavior, but more reflects what happens in the subconscious mind BF Supplemental

What are some research methods used in Behavioral/experimental RE?

- fMRI - layered voice analysis (LVA) - textural data mining - DNA sequencing/polymorphic markers - EEG, Eye tracking, GSR - FACET - graphic design/fly through tours BF Supplemental

What are some overlapping fields with behavioral and experimental real estate?

- finance/economics/game theory - psychology/marketing - mimetics - epidemiology - law - neuroscience/genetics - architecture BF Supplemental

What is experimental real estate?

A primary data collection method - using transactions data to reveal different aspects of a decision (ex. negotiations and pricing). - include many independent variables in hopes of holding all else constant through design of experiment. BF Supplemental

For each of the following pairs of issues, select the one that is most apt to have the lower proportionate underwriting and administrative costs: a) a large issue v. a small issue b) a bond issue v. a common stock issue c) a small general cash offer of bonds v. a small private placement of bonds

A) a large issue (proportionately lower costs due to economies of scale) B) a bond issue C) a small private placement of bonds (private placements are less expensive for small amounts) Ch. 15

What is anchoring, give an example.

Anchoring: providing a number immediately to p2 makes it very hard for p2 to get that number out of their head. ex. "i've heard this is 200 miles away. how far away is it actually?' answer will be more likely close if not exactly 200. even after being told to ignore anchoring, people still fall victim to it. - appraisal bias (smoothing); using an average of two numbers rather than giving each number to appear as a more happy median. - value of any asset - broker whisper price BF Supplemental

The following table presents information for Golden Fleece Financial. Long-term debt outstanding = $470,000 Current yield to maturity on debt = 9.00% Number of shares of common stock = 18,500 Price per share = $67 Book value per share = $42 Expected rate of return on stock = 18.00% Calculate the company cost of capital.

Cost of capital = 15.53 % Ch. 13 Solution: WACC=[D/V×rdebt] + [E/V×requity] WACCGFF = [470,000/470,000 + 1,239,500 × 9.00%] + [470,000/470,000 + 1,239,500 × 18.00%] = 15.53%

Reliable Electric is a regulated public utility, and it is expected to provide steady dividend growth of 4% per year for the indefinite future. Its last dividend was $6 per share; the stock sold for $60 per share just after the dividend was paid. What is the company's cost of equity? (%)

Cost of equity = 14.40% Ch. 13 Solution: Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. r = DIV1 / P0 + g = [DIV0 × (1 + g)] / P0 + g = [$6 × (1 + 0.04)] / $60 + 0.04 = 0.1440, or 14.40%

Pangbourne Whitchurch has preferred stock outstanding. The stock pays a dividend of $14 per share, and sells for $70. The corporate tax rate is 35%. What is the percentage cost of the preferred stock? (%)

Cost of preferred stock = 20% Ch. 13 Solution: Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. rPreferred = DIV / P0 = $14 / $70 = 0.20, or 20%

Disjunctive Thesis and how it relates to writing leases

Disjunctive thesis: is a contract a (1) promise to perform or (2) a promise to perform or pay damages? by specifying in your contract what happens in the event of a breach, it actually makes breech less of a moral issue and more of a business decision. ie. encouraging breach BF Supplemental

T or F: The vast majority of companies pay out cash each year in the form of a dividend or a stock repurchase.

False. 55% of all companies pay neither a cash dividend nor a stock repurchase. ch. 17

T or F: Most companies that distribute cash to investors do so either by paying dividends or by repurchase. It is very rare to find a company paying out cash by both methods.

False. Historically, few companies repurchased shares. Today the practice is more common among all types of firms. ch. 17

T or F: Companies undertaking substantial share repurchases usually finance them with an offsetting cut in cash dividends.

False. Shares repurchases typically do not replace dividends. ch 17

T or F: Managers often increase dividends temporarily when earnings are unexpectedly high for a year or two.

False. Since managers prefer to maintain stable dividends, unexpected profits are more likely to result in a stock repurchase. ch. 17

T or F: Stock dividends increase the number of shares that investors own and therefore increase shareholder wealth.

False. Stock dividends increase the number of shares, but cause dilution of value to existing shares. ch. 17

T or F: the most common method for repurchasing stock is by auction.

False. The most common method is via open-market repurchase. ch. 17

T or F: Companies decide each year's dividend by looking at their capital expenditure requirements and then distributing whatever cash is leftover.

False. The residual dividend policy is not practiced by most companies because of the signal it sends. ch. 17

T or F: By increasing the number of shares, stock dividends dilute each shareholder's interest in the company and therefore reduce wealth.

False. While the price per share declines, the number of shares owned increases; thus, shareholder wealth is unaffected. ch. 17

Venture Capital companies know that managers are more likely to work hard if they can be assured of a good steady salary - true or false?

False. venture capitalists believe managers need incentives and that a salary is inefficient motivation. Ch. 15

T or F: Underpricing in an IPO is a problem only when the original investors are selling part of their holdings.

False: Even when not divesting their ownership, original investors suffer when shares are sold below true value. When underpricing occurs, it represents a wealth transfer from existing investors to new investors. ch. 15

Venture capitalists typically provide first-stage financing sufficient to cover all development expenses. Second-stage financing is provided by stock issued with an IPO - True or False?

False: Venture capitalists will usually invest a portion of the operating costs and require managers to also invest. When second stage financing is required, they usually offer to provide this, under the condition they receive additional equity ownership. Ch. 15

T or F: The share price generally falls on the dividend payment date.

False: the share price will decline on the ex-dividend date, not the payment date. Ch. 17

T or F: venture capital companies are generally passive investors and are happy to let the companies in which they are invested get on with the job.

False: while venture capitalists generally do not merge the company, they remain active in monitoring and advising the company ch. 15

Familiarity Bias & endowment effect

Familiarity bias - familiar assets are deemed less risky/higher return - concentric circles around the asset Endowment effect - WTAccept > WTPay - sellers' decision bias - tendency for people to demand considerably more for a product they own versus what they are willing to pay if they don't yet own it. Result: status quo deviation aversion - The status quo bias will cause customers to use the status quo as the reference point to evaluate the attractiveness of the seller's product. From this perspective, any improvement is a gain and any shortcoming is a loss. BF Supplemental

Rights Issue

Further sale of an already publicly traded stock. The rights issue is offered to existing shareholders, thus not part of an IPO. ch. 15

Herding

Herding: mimicking the behavior of those around us - can be good for individual survival (possibly bad for the species) - informational v. mimetic (subconscious) herding - mavens (experts) - susceptibility to normative influence - concern for Group Think mentality BF Supplemental

What are heuristics? Why does our brain use them? How often do they help us? What is 'satisficing'?

Heuristics are shortcuts the brain uses. bypasses: - cognitive limitations - time constraints - too many tasks - too many variables changing all at once. helps about 99% of the time satisficing - a 'good enough' solution BF Supplemental

Bookbuilding

Investors indicate to the underwriter how many shares they would like to buy in a new issue, and these indications are used to help set the price ch. 15

Binomial Tree Farm's financing includes $6.90 million of bank loans and $7.90 million book (face) value of 10-year bonds, which are selling at 80% of par value. Its common equity is shown in Binomial's Annual Report at $8.57. It has 690,000 shares of common stock outstanding which trade on the Wichita Stock Exchange at $35 per share. What debt ratio should Binomial use to calculate its WACC?

Market debt ratio = .35 Chapter 13 Solution: Binomial Tree Farm should make sure to use market values only when calculating the debt ratio on their securities: Market debt ratio = DV = 6.90 + 6.32/[6.90 + 6.32 + (35 × 0.69)] = 0.35

Prospect Theory - loss aversion - false reference points

Prospect theory says that losses hurt more than equivalent gain - false reference points; the price you paid and sunk costs (should be irrelevant, but aren't) result: winners sell too quickly, losers hold too long BF Supplemental

Pricing Strategies - name 2

Rounding v. Just Below v. Precise - rounding = $200,000 - Just below = $199,000 - Precise = $197,364 - customers prefer round numbers, but 'just below' pricing can help houses sell - signals a bargain to the brain. Even when people know the house is overpriced at 'just below', the house still sells at a higher price than others that used different price strategies. Signaling effect: - left most digit effect; the brain starts to store the number even before the whole thing is read, starting with the left most digits; - for ex. with $199,999 vs. $200,000, buyers tend to remember the 1 more than the 2 and are more inclined to buy the 'just under' priced house. - degree of surety in value; makes you more confident in your buy BF supplemental

Seasoned Issue

Sale of additional stock by a public company ch. 15

Secondary issue

Sale of securities to existing investors ch. 15

Primary Issue

Sale of stock by a company to raise new cash ch. 15

Blue-Sky Laws

State rules governing issues of securities ch. 15

How does the ultimatum game work and how does it relate to real estate finance?

The ultimatum game gives one person an amount of money and asks them to split it between themselves and their friend, any % split. ex. 50/50, 60/40, etc. - Relates to economic game theory, saying that if player 2 rejects the split, neither player gets any reward. - rational for p2 to accept any non-zero offer, but risks include inequality aversion, where p2 is likely to reject just to punish p1 for being unfair. BF Supplemental

T or F: A corporation cannot pay a dividend if its legal capital is impaired or if it is insolvent.

True Ch. 17

T or F: A company can keep repurchased stock in its treasury and reissue it later

True ch. 17

A company that declares a 10% stock dividend gives each shareholder 1 additional share for each 10 shares that he or she currently owns.

True. A stock dividend of 10% provides one new share for every 10 shares owned. ch 17

T or F: Managers and investors are more concerned with dividend changes than dividend levels.

True. Research shows changes in dividends are more relevant than the actual dividend amount. ch. 17

T or F: The effective tax rate on capital gains can be less than the stated rate

True. The effective rate can be less than the stated rate because the realization of gains can be deferred, which reduces the present value of the tax obligation. ch. 17

T or F: The future stock prices will be higher when a corporation distributes cash by repurchases rather than cash dividends.

True. The stock price remains constant when a firm repurchases shares but decreases by the amount of the dividend when a cash dividend is paid. Ch. 17

T or F: A greenmail transaction is one in which the target of a possible takeover buys back stock from the potential bidder.

True. This technique is commonly used by management to prevent a takeover. ch. 17

Venture capital companies generally advance the money in stages - True or false?

True. You will only get enough to reach the next key milestone or checkpoint. That gives the venture capitalist the opportunity to evaluate progress and decide whether investing in the next stage is worthwhile. ch. 15

T or F: Some young companies grow with the aid of equity investment provided by wealthy individuals known as angel investors.

True: Angel investors are highly speculative investors who specialize in funding companies in the earliest stages of their existence. Ch. 15

T or F: Stock price generally falls when the company announces a new issue of shares. This is attributable to the information released by the decision to issue.

True: The adage "buy low, sell high" rings true. The signal sent to the market is that the share price must be too high. Thus, the perceived reason for the sale is an overvalued security. If the company declines to sell shares, the market perceives the price to be too low. ch. 15

Best Efforts

Underwriters' agreement to sell as much of an issue as possible. An initial agreement where the underwriter accepts responsibility only to TRY to sell the issue ch. 15

Here is some information about Stokenchurch Inc.: Beta of common stock = 2.2 Treasury bill rate = 4% Market risk premium = 8.5% Yield to maturity on long-term debt = 8% Book value of equity = $540 million Market value of equity = $1,080 million Long-term debt outstanding = $1,080 million Corporate tax rate = 35% What is the company's WACC? Answer in %

WACC - 13.95% Chapter 13 Solution: rEquity = rf + β(rm - rf) = 0.04 + 2.2(0.085) = 0.2270, or 22.70% WACC = (D / V) × (1 - Tc)rDebt + (E / V) × rEquity = [$1,080 / ($1,080 + 1,080)] × (1 - 0.35)(0.08) + [$1,080 / ($1,080 + 1,080)] × 0.227 = 0.1395, or 13.95%

Ethelbert.com is a young software company owned by two entrepreneurs. It currently needs to raise $580,000 to support its expansion plans. A venture capitalist is prepared to provide the cash in return for a 20% holding in the company. Under the plans for the investment, the VC will hold 19,000 shares in the company and the two entrepreneurs will have combined holdings of 24,000 shares. a. What is the total after-the-money valuation of the firm? b. What value is the venture capitalist placing on each share?

a) $2,900,000 b) $67.44 CH. 15 Solution: a. The VC is buying 20% of the firm for $580,000, so the new valuation of the equity is: 580,000/0.20 = 2,900,000 b. The value per share is the market capitalization divided by the number of shares outstanding, $2,900,000/(19,000 +24,000) =$67.44

For each of the following U.S. investors, state whether the investor has a tax reason to: (1) prefer the company's payout to be in the form of dividends (2) prefer payout to be in the form of repurchases, or (3) have no preference. a) A pension fund b) an individual investor in the top income bracket c) a corporation d) an endowment for a charity or university

a) 3 - no preference b) 3 - no preference c) 1 - prefer dividends d) 3 - no preference Corporate investors will prefer dividends while other investors have no preference. Corporations only pay income tax on 30 percent of their dividend income which lowers the effective corporate tax rate on dividends. ch. 17

Universal Foods has a debt-to-value ratio of 47%, its debt is currently selling on a yield of 5%, and its cost of equity is 9%. The corporate tax rate is 40%. The company is now evaluating a new venture into home computer systems. The internal rate of return on this venture is estimated at 13.4%. WACCs of firms in the personal computer industry tend to average around 14%. a. What is Universal's WACC? b. Will Universal make the correct decision if it discounts cash flows on the proposed venture at the firm's WACC? c. Should the new project be pursued?

a) 6.18% b) no c) no Chapter 13 Solution: a. rEquity = (D / V) × (1 - Tc)rDebt + (E / V) × rEquity = 0.47 × (1 - 0.40)(0.05) + (1 - 0.47) × 0.09 = 0.0618, or 6.18% b. No. The IRR is above the company WACC, so the project appears attractive. In fact, the project is not attractive since the proper discount rate is 14%. c. No. Since the IRR is below the required discount rate of 14%, it produces a negative NPV.

Which term applies to the following? a.) The underwriter agrees to buy the issue from the company at a fixed price b) the company offers to sell stock only to existing stockholders c) sales of securities to a limited number of investors without a public offering options: - private placement - firm commitment - rights issue

a) Firm commitment b) rights issue c) private placement ch. 15

Geothermal's WACC is 10.4%. Executive Fruit's WACC is 11.3%. Now Executive Fruit is considering an investment in geothermal power production. a) Should it discount project cashflows at 11.3%? - yes - no b) What would be a better discount rate for this investment? - find better discount rate in %

a) no b) 10.4% chapter 13 Solution: a. The risk of the project determines the discount rate, and in this case Geothermal's WACC is more reflective of the risk of the project in question. The proper discount rate, therefore, is not 11.3%. b. Executive Fruit should use the WACC of Geothermal, not its own WACC, when evaluating an investment in geothermal power production. The proper WACC to use is 10.4%.

Suppose that you own 1,300 shares of Nocash Corp. and the company is about to pay a 25% stock dividend. The stock currently sells at $100 per share. a. What will be the number of shares that you hold after the stock dividend is paid? b. What will be the total value of your equity position after the stock dividend is paid? c. What will be the number of shares that you hold if the firm splits five-for-four instead of paying the stock dividend?

a) number of shares = 1,625 b) total value = $130,000 c) number of shares hold = 1,625 Ch. 17 Solution: a. Post-dividend number of shares = 1,300 × 1.25 = 1,625 shares b. Price per share will fall to $100 / 1.25 = $80. Initial value of equity is 1,300 × $100 = $130,000. The value of the equity position remains at 1,625 × $80 = $130,000. c. A 5-for-4 split will have precisely the same effect on price per share, shares held, and the value of your equity position, as would the 25% stock dividend. In both cases, the number of shares held increases by 25% to 1,625 shares.

The expected pretax return on three stocks is divided between dividends and capital gains in the following way: Stock A: - Expected dividend: $0 - Expected Capital Gain: $10 Stock B: - Expected dividend: $5 - Expected Capital Gain: $5 Stock C: - Expected dividend: $10 - Expected Capital Gain: $0 a. If each stock is priced at $155, what are the expected net percentage returns on each stock to (i) a pension fund that does not pay taxes, (ii) a corporation paying tax at 45% (the effective tax rate on dividends received by corporations is 10.5%), and (iii) an individual with an effective tax rate of 10% on dividends and 5% on capital gains? b. Suppose that investors pay 40% tax on dividends and 10% tax on capital gains. If stocks are priced to yield an after-tax return of 10%, what would A, B, and C each sell for? Assume the expected dividend is a level perpetuity.

a. Stock A: - Pension: 6.45% - Investor Corporation: 3.55% - Individual: 6.13% Stock B: - Pension: 6.45% - Investor Corporation: 4.66% - Individual: 5.97% Stock C: - Pension: 6.45% - Investor Corporation: 5.77% - Individual: 5.81% b. Stock A Price: $90 Stock B Price: $75 Stock C Price: $60 Ch. 17 Solution: a. (i) Pension fund: rA = ($0 + 10) / $155 = 0.0645, or 6.45% rB = ($5 + 5) / $155 = 0.0645, or 6.45% rC = ($10 + 0) / $155 = 0.0645, or 6.45% (ii) Corporation: rA = [($0 × (1 - 0.105) + ($10 × (1 - 0.45)] / $155 = 0.0355, or 3.55% rB = [($5 × (1 - 0.105) + ($5 × (1 - 0.45)] / $155 = 0.0466, or 4.66% rC = [($10 × (1 - 0.105) + ($0 × (1 - 0.45)] / $155 = 0.0577, or 5.77% (iii) Individual: rA = [($0 × (1 - 0.10) + ($10 × (1 - 0.05)] / $155 = 0.0613, or 6.13% rB = [($5 × (1 - 0.10) + ($5 × (1 - 0.05)] / $155 = 0.0597, or 5.97% rC = [($10 × (1 - 0.10) + ($0 × (1 - 0.05)] / $155 = 0.0581, or 5.81% b. PriceA = [($0 × (1 - 0.40) + $10.00 × (1 - 0.10)] / 0.10 = $90.00 PriceB = [($5 × (1 - 0.40) + $5.00 × (1 - 0.10)] / 0.10 = $75.00 PriceC = [($10 × (1 - 0.40) + $0 × (1 - 0.10)] / 0.10 = $60.00

In 2015, Caterpillar Inc. had about 657 million shares outstanding. Their book value was $36.3 per share, and the market price was $76.00 per share. The company's balance sheet shows that the company had $16.20 billion of long-term debt, which was currently selling near par value. a. What was Caterpillar's book debt-to-value ratio? b. What was its market debt-to-value ratio? c. Which measure should you use to calculate the company's cost of capital? Book value or Market value?

a. .ratio = .4 b. ratio = .24 c. market value Chapter 13 Solution: a. Book debt-to-value ratio = Debt / (Debt + Equity) = $16.2b / [$16.2b + (0.657b × $36.3)] = 0.40 b. Market debt-to-value ratio = Debt / (Debt + Equity) = $16.2b / [$16.2b + (0.657b × $76.00)] = 0.24 c. Market value is the proper measure, as it is determined by cash flows and forecasts, rather than accounting rules.

Match Group went public in November 2015. The company sold 16,833,333 shares at $15.8 per share. The underwriting spread was $2.56 a share, and the direct expenses were $0.40 a share. a. What was the percentage underwriting spread? b. How much did the company raise after all expenses? c. On its first day of trading the stock closed at $20.44. Calculate the dollar cost of underpricing.

a. 16.2% b. $216,139,996 c. $78,106,665 CH. 15 Solution: a. The underwriting spread percentage was: 2.5615.8=0.162 or 16.2% b. The company raised: ($15.8 - $2.56 - $0.40) × 16,833,333 = $216,139,996 c. The cost of the underpricing is: ($20.44 - $15.80) × 16,833,333 = $78,106,665

The market value of the research firm Fax Facts is $450 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?

a. 6% Ch. 15 Solution: Announcement cost as a percent of funds raised = (Market value of stock × Percentage change in price) / Funds raised = ($450 million × .02)/$150 million = 0.06, or 6%

Bunkhouse Electronics is a recently incorporated firm that makes electronic entertainment systems. Its earnings and dividends have been growing at a rate of 30.5%, and the current dividend yield is 2.50%. Its beta is 1.21, the market risk premium is 8.50%, and the risk-free rate is 3.90%. a. Use the CAPM to estimate the firm's cost of equity. (%) b. Now use the constant growth model to estimate the cost of equity. (%) c. Which of the two estimates is more reasonable?

a. Cost of equity = 14.19% b. Cost of equity = 33% c. CAPM Ch. 13 Solution a. Based on the CAPM, cost of equity would be: r = rf + β(rm - rf) = 3.90% + (1.21 × 8.50%) = 14.20% b. Using the recent growth rate of 30.5% and the dividend yield of 30.5%, one estimate would be: DIV1/P0 + g = 0.03 + 0.31 = 0.33 = 33% c. The estimate of 33% seems far less reasonable.It is based on a historic growth rate that is impossible to sustain.The DIV1/P0 + g rule requires that the growth rate of dividends per share must be viewed as highly stable over the foreseeable future.In other words, it requires the use of the sustainable growth rate.

The stock of Payout Corp. will go ex-dividend tomorrow. The dividend will be $0.50 per share, and there are 25,000 shares of stock outstanding. The market-value balance sheet for Payout is shown below. Ignore taxes. Assets - Cash: $150,000 - Fixed Assets: $950,000 Liabilities - Equity: $1,100,000 a. What price is Payout stock selling for today? b. What price will it sell for tomorrow?

a. Price = $44.00 b. Price = $43.50 Ch. 17 Solution: a) P = $1,100,000/25,000 = $44 b) the price tomorrow will be $0.50 per share lower, so $43.50

Big Industries has the following market-value balance sheet. The stock currently sells for $20 a share, and there are 1,020 shares outstanding. The firm will either pay a dividend of $1 per share or repurchase $1,020 worth of stock. Ignore taxes. Assets - Cash: $2,400 - Fixed Assets: $28,100 Liabilities - Debt: $10,100 - Equity: $20,400 a. What will be the subsequent price per share if the firm pays a dividend? b. What will be the subsequent price per share if the firm repurchases stock? c. If total earnings of the firm are $3,000/yr, find earnings per share if the firm pays a dividend. d. Now find earnings per share if the firm repurchases stock e. Find the price-earnings ratio if the firm pays a dividend. f. Find the price-earnings ratio if the firm repurchases stock. g. Adherents of the "dividends-are-good" school sometimes point to the fact that stocks with high dividend payout ratios tend to sell at above-average price-earnings multiples. Is Big Industries' P/E ratio higher if it pays a dividend?

a. Stock price = $19/share b. Stock price = $20/share c. EPS = $2.941 d. EPS = $3.096 e. Price-earnings ratio = 6.46 f. price - earnings ratio = 6.46 g. no ch. 17 Solution: a. If the firm pays a dividend, the stock price will fall to $19 per share. b. If the firm repurchases stock, the market value of equity will fall to $19,380 and the number of shares will fall by $1,020 / $20 = 51 shares. The stock price will remain at $19,380 / 969 = $20 per share. c. If the firm pays a dividend, earnings per share will be $3,000 / 1,020 = $2.941. d. If the firm repurchases stock, then EPS = $3,000 / 969 = $3.096. e. If the dividend is paid, the price-earnings ratio will be $19 / $2.941 = 6.46. f. If the stock is repurchased, the price-earnings ratio will be $20 / $3.096 = 6.46. The price-earnings ratio is the same whether the dividend is paid or the stock is repurchased. g. We have just shown that dividends per se do not have an effect on the price-earnings ratio. The stock sells at the same P/E multiple regardless of whether the firm pays a dividend or repurchases shares.

Good Values Inc. is all-equity-financed. The total market value of the firm currently is $125,000, and there are 2,500 shares outstanding. Ignore taxes. a. The firm has declared a $6 per share dividend. The stock will go ex-dividend tomorrow. At what price will the stock sell today? b. At what price will the stock sell tomorrow? c. Now assume that the tax rate on all dividend income is 30% and the tax rate on capital gains is zero. At what price will the stock sell today, taking account of the taxation of dividends? d. Now suppose that instead of paying a dividend, Good Values plans to repurchase $15,000 worth of stock. What will be the stock price before the repurchase? e. What will it be after the repurchase? f. Does the existence of taxes tend to favor dividends or repurchases? i) Dividends ii) Repurchases iii) Depends on the dividend and capital gain tax rates

a. Stock price = $50 b. stock price = $44 c. stock price = $48.20 d. stock price = $50 e. stock price = $50 f. iii - depends on the dividend and capital gain tax rates Ch. 17 solution: a. Price = $125,000 / 2,500 = $50 per share b. After the dividend is paid, total market value of the firm will be $110,000, representing $44 per share. In addition, the investor will receive $6 per share. c. If the dividend is taxed at 30%, then the investor will receive an after-tax cash flow of $6 × (1 - 0.30 ) = $4.20. The price today will be $44 + $4.20 = $48.20. This is less than the value in part (a) by the amount of taxes investors pay on the dividend. d. The repurchase will have no tax implications. Because the repurchase does not create a tax obligation for the shareholders, the value of the firm today is the value of the firm's assets ($125,000) divided by 2,500 shares, or $50 per share. e. The firm will repurchase 300 shares for $15,000. After the repurchase, the stock will sell at a price of $110,000/2,200 = $50 per share. f. It depends on the tax rate. Whichever payout is taxed lower will be preferred.

You have purchased 1 million shares in a restaurant chain venture. At this zero-stage investment, your company's assets are $110,000 plus the idea for your new product. Look back at your restaurant chain venture. Suppose that when you first approach your friendly VC, he decides that your shares are worth only $1.00 each. a. How many shares will you need to sell to raise the additional $1,370,000? b. What fraction of the firm will you own after the VC investment?

a.) 1,370,000 b.) 42.2% Ch. 15 Solution: A) at $1.00/share, it will take (100/1,370,000.00 = 42) to raise the additional funding B) You own 1,000,000 shares, and the VC owns 1,370,000 shares, so you own: 1,000,000/(1,000,000+1,370,000) = 42.4% of the enterprise.

Explain the decoy effect

adding in an additional option to encourage a specific answer. - Ex. if the orignial question is girl brunette A or girl blonde B, then you introduce a slightly less attractive blonde C, people are now only comparing the two blondes, and are more likely to choose blonde B and completely discount blonde A. - ex. sizes of popcorn and their prices. - the brain makes choices through pairwise comparisons, not through independent evaluations. BF Supplemental

Private Placement

bond issued by an industrial company The lack of SEC paperwork associated with a private placement is attractive to companies borrowing money. Existing stock already registered with the SEC would have no advantage to being sold via private placement. ch. 15

Micro Spinoffs Inc. issued 20-year debt a year ago at par value with a coupon rate of 5%, paid annually. Today, the debt is selling at $1,380. If the firm's tax bracket is 20%, what is its percentage cost of debt? Assume a face value of $1,000. (%)

cost of debt = 1.98% Ch. 13 Solution: Some values below may show as rounded for display purposes, though unrounded numbers should be used for actual calculations. PV = $1,380 = [(0.05 × $1,000) × ((1 / r) - {1 / [r(1 + r)(20 - 1)]})] + $1,000 / (1 + r)(20 - 1) Using trial-and-error, a financial calculator, or a computer, we find that: r = 2.470% After-tax cost of debt = Before-tax cost of debt × (1 - Tc) = 2.470% × (1 - 0.20) = 1.98%

Moonscape has just completed an initial public offering. The firm sold 2 million shares at an offer price of $10 per share. The underwriting spread was $0.40 a share. The price of the stock closed at $14.00 per share at the end of the first day of trading. The firm incurred $200,000 in legal, administrative, and other costs. What were flotation costs as a fraction of funds raised?

costs as percent of funds raised = 45% ch. 15 Solution: Funds raised = shares issued x offer price per share = $2 million * $10 = $20 Million Cost percentage = (underwriting cost + underpricing + other direct costs) / (funds raised) = [($2M*$0.40) + ($2M*($14-$10)) + $200,000]/$20M = $9M/$20M = 45%

Correctly order the dates below: Record Date Last with-dividend date payment date declaration date ex-dividend date b) on which date is the stock price likley to fall by about the amount of the dividend? c) Cash Cow International pays a regular quarterly dividend of $0.075 a share. The stock price at the beginning of the month was $27. What was the prospective dividend yeld? d) The annual earnings per share were forecast at around $1.90. What was the percentage payout ratio?

declaration date last with-dividend date ex-dividend date record date payment date b) ex-dividend date c) 1.11% d) 15.79% Ch. 17 solution: c) the annual dividend is $0.075*4 = $0.30. the dividend yield is $0.30/$27 = 1.11% d) the percentage payout rate was $0.30/$1.90 = 15.79%

Registration statement

document filled with SEC providing details of a new issue ch. 15

Legal v. psychological contracts

legal contract vs. when people feel like they're in a contract. - once 'in a contract', people let their guard down - less likely to scrutinize all information (due diligence) - less likely to buy insurance once 'in a contract' - more likely to suffer (dis-) confirmation bias (tendancy to interpret new evidence as confirmation of previously held beliefs) BF Supplemental

Shelf registration

several issues of the same security may be sold under the same registration several tranches (batch, fraction of larger issue) of the same security may be sold under the same registration IPO - The first step in doing an IPO is registering the security with the SEC. It then becomes a shelf registration, awaiting sale. ch 15

Underwriters' Spread

the difference between the issue price and the price paid by the underwriters. ch. 15

Framing Bias

the tendency of decision makers to be influenced by the way a situation or problem is presented to them - Ex. Trolley Dilemma BF supplemental

Money Illusion

the tendency to think in nominal as opposed to real terms; people have an illusory picture of their wealth and income based on nominal dollar terms, rather than real terms. Real prices and income take into account the level of inflation in an economy. - ignores inflation - has not historically been a problem in the US - not a S-T issue (because less inflation in the S-T) - it could be an issue as interest rates rise system I (happier) v. system II (economically better off) - rephrasing the question can remind us to focus on real terms BF supplemental

Informational Uncertainty

transparency v. opacity - when it comes to downside risk, is it better to keep people in the dark or tell them exactly what to expect? depends on fear levels, morality, etc. interpersonal considerations - local v. on-line lenders - reputation (egregious lenders) - is bad behavior commonplace? experiments might include: - real time facial expressions - voice analysis - FACET and LVA - skype or virtual meetings

Confidence intervals; men v. women

want 90% confidence intervals; 90% chance that the correct answer falls between that range. - men are 3 times more likely to suffer from over-confidence than women BF Supplemental