lower effective tax since one can defer the tax until the gains are realized but taxes are due when dividends are paid.
· Why don't all firms use stock repurchases?
When there is no tax disadvantage of dividend, or there is signaling value in dividend distribution, firms would like to pay out dividends rather than repurchase their own stocks.
18.6hWhat is the relationship between expected returns and dividend elds? Theory implies a direct relationship between expected returns and dividend elds. Empirical results are not consistent regarding this relationship.
18.7 · What are the real-world factors favoring a high-dividend policy? 1. Desire for current income 2. Resolution of uncertainty
3. Brokerage and other transactions costs 4. Fear of consumption out of principal
18.8 · Do dividends have information content?
Often. An increase in dividend payouts may signal that future earnings are expected to rise enough so that dividends will not likely be reduced later on.
· What are tax clienteles?
Different types of shareholders that prefer one kind of dividend policy due to difference in tax brackets.
CONCEPT QUESTIONS - Appendix to Chapter 18
· What is a stock dividend? A stock split?
Stock dividend is a dividend in the form of stocks. In a stock split, each shareholder receives additional shares of stock for each one held originally.
· What is the value of a stock dividend and a stock split?
It can be positive, zero or negative. The possible benefits are lowered commission in stock trades within the proper trading range. The costs are related to the financial procedures. CONCEPT QUESTIONS - CHAPTER 19
19.1 · Describe the basic procedures in a new issue. 1. Obtain approval of the Board of Directors. 2. File registration statement with the SEC 3. Distribute prospectus 4. Determine offer price
5. Place tombstone advertisements.
· What is a registration statement?
A document filed with the SEC containing information relevant to the offering.
19.3 · Describe a firm commitment underwriting and a best-efforts underwriting.
In a firm commitment underwriting, the underwriter buys the entire issue and then resells it. In a best efforts underwriting, the underwriter is only legally bound to use \sell the securities at the agreed upon offering price.
· Suppose that a stockholder calls you up out of the blue and offers to sell you some shares of a new issue. Do you think the issue will do better or worse than average?
It will probably do worse because otherwise it would have been oversold and there would be no need for the broker to try to sell it to you.
19.4 · What are some reasons that the price of stock drops on the announcement of a new equity issue?
1. Managers are disinclined to issue stock when the share price is below their estimate of intrinsic value. Equity offerings signal that management considers the share price high. 2. Equity offerings are more likely when the firm is over-levered.
19.5 · Describe the costs of a new issue of common stock.
1. Spread: The difference between the offering price and what the underwriter pays the issuing company.
2. Other direct expenses: Filing fees, legal fees and taxes.
3. Indirect expenses: Management time spent analyzing the issuance.
4. Abnormal returns: The drop in the current stock price by 1% to 2% in a seasoned new issue of stock.
5. Underpricing: Setting the offering price below the correct value in an initial new issue of stock.
6. Green shoe option: The underwriter's right to buy additional shares at the offer price to cover overallotments.
· What conclusions emerge from an analysis of Table 19.5? 1. There are substantial financial economies of scale. CONCEPT QUESTIONS - CHAPTER 19
19.1 · Describe the basic procedures in a new issue. 1. Obtain approval of the Board of Directors. 2. File registration statement with the SEC 3. Distribute prospectus 4. Determine offer price
5. Place tombstone advertisements.
· What is a registration statement?
A document filed with the SEC containing information relevant to the offering.
19.3 · Describe a firm commitment underwriting and a best-efforts underwriting.
In a firm commitment underwriting, the underwriter buys the entire issue and then resells it. In a best efforts underwriting, the underwriter is only legally bound to use \sell the securities at the agreed upon offering price.
· Suppose that a stockholder calls you up out of the blue and offers to sell you some shares of a new issue. Do you think the issue will do better or worse than average?
It will probably do worse because otherwise it would have been oversold and there would be no need for the broker to try to sell it to you.
19.4 · What are some reasons that the price of stock drops on the announcement of a new equity issue?
1. Managers are disinclined to issue stock when the share price is below their estimate of intrinsic value. Equity offerings signal that management considers the share price high. 2. Equity offerings are more likely when the firm is over-levered.
19.5 · Describe the costs of a new issue of common stock.
1. Spread: The difference between the offering price and what the underwriter pays the issuing company.
2. Other direct expenses: Filing fees, legal fees and taxes.
3. Indirect expenses: Management time spent analyzing the issuance.
4. Abnormal returns: The drop in the current stock price by 1% to 2% in a seasoned new issue of stock.
5. Underpricing: Setting the offering price below the correct value in an initial new issue of stock.
6. Green shoe option: The underwriter's right to buy additional shares at the offer price to cover overallotments.
· What conclusions emerge from an analysis of Table 19.5? 1. There are substantial financial economies of scale. 2. Direct costs are somewhat greater than indirect ones. 3. Higher costs for best efforts offers.
4. More underpricing for firm commitment than for best efforts offers.
5. Both direct and indirect costs are higher for initial offerings than for seasoned ones.
19.6 · Describe the details of a rights offering.
In a rights offering, each shareholder is issued an option to buy a specified number of shares from the firm at a specified price within a certain time frame. These rights are often traded on securities exchanges or over the counter.
· What are the questions that financial management must answer in a rights offerings?
1. What price should existing shareholders pay for a share of new stock? 2. How many rights will be required to purchase one share of stock?
3. What effect will the rights offering have on the price of the existing stock?
· How is the value of a right determined? Value of one right
= Rights-on stock price - ex-rights stock price
= (Ex-rights price - Subscription price) / (rights/share) = (Rights-on price - Subscription price) / (rights/share+1)
19.7 · What are the several kinds of dilution? 1. Dilution of ownership 2. Dilution of market value 3. Dilution of book value
· Is dilution important?
True dilution, of ownership or market value, is very important because it is an economic loss to current shareholders. Book value dilution, on the other hand, is irrelevant.
· Why might a firm prefer a general cash offering to a rights offering?
1. Underwriters provide insurance regarding the amount raised by the firm regardless of true stock value.
2. Proceeds are available sooner.
3. Underwriters will provide wider distribution of ownership 4. Underwriters provide consulting advice.
19.8 · Describe shelf registration.
It is registration allowed by Rule 415 of the SEC whereby a corporation registers stock that will be sold within two years of registration.
· What are the arguments against shelf registration?
1. The costs of new issues might go up because underwriters may be unable to provide as much information to potential investors as would be true otherwise. 2. It may cause \
19.9 · What are the different sources of venture-capital financing?
Private partnerships and corporations, large industrial or financial corporation, and wealthy families and individuals.
· What are the different stages for companies seeking venture capital financing?
Seed money, start-up, and then first through fourth round financing as the company gets off
the ground.
· What is the private equity market?
The private equity market involves the issuance of securities to a small number of private investors or certain qualified institutional investors.
· What is Rule 144A?
Rule 144A establishes a legal framework for the issuance of private securities to qualified institutional investors.
CONCEPT QUESTIONS - CHAPTER 20
20.2 · Do bearer bonds have any advantage? Why might Mr. \Private\They have the advantage of secrecy.
· What advantages and what disadvantages do bondholders derive from provisions of sinking funds?
They provide additional security as an early warning system if sinking fund payments are not made. But if interest rates are high, the company will buy the bonds from the market, and if rates are low, it will use the lottery, exercising an option that makes sinking fund bonds less attractive to bondholders.
· What is a call provision? What is the difference between the call price and the stated price? It is an option that allows the company after a certain number of years to repurchase the bonds at the call price. This option will only be exercised if interest rates drop. The difference between the call price and the stated price is the call premium.
20.3 · What the advantages to a firm of having a call provision?
If interest rates go down and the market bond prices are higher than the call price, the firm can exercise its call option and buy the bonds at less than the market price.
· What are the disadvantages to bondholders of having a call provision?
If the firm decides to exercise its option, bondholders will have to sell their bonds to the firm at less than the market price.
20.4 · List and describe the different bond rating classes.
1. Investment grade |AAA/Aaa to BBB/Baa: extremely strong to adequate capacity to pay interest and principal.
2. Speculative BB/Ba to CC/Ca: slightly to extremely speculative capacity to pay interest and
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