Question 1

Whereas commercial banks take deposits from some customers and make loans to other customers, the principal activities of investment banks are (1) to help firms issue new stock and bonds and (2) to give firms advice with regard to mergers and other financial matters. However, financial corporations often own and operate subsidiaries that operate as commercial banks and others that are investment banks. This was not true some years ago, when the two types of banks were required by law to be completely independent of one another.

Accepted Answer

A) True 
 B)False

Question 2

If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.

Accepted Answer

A) True 
 B)False

Question 3

Which of the following statements is most CORRECT?

Accepted Answer

A)   If new debt is used to refund old debt, the correct discount rate to use in the refunding analysis is the before-tax cost of new debt.
B)   The key benefits associated with refunding debt are the reduction in the firm's debt ratio and the creation of more reserve borrowing capacity.
C)   The mechanics of finding the NPV of a refunding decision are fairly straightforward. However, the decision of when to refund is not always clear because it requires a forecast of future interest rates.
D)   If a firm with a positive NPV refunding project delays refunding and interest rates rise, the firm can still obtain the entire NPV by locking in a low coupon rate when the rates are low, even though it actually refunds the debt after rates have risen.
E)   Suppose a firm is considering refunding and interest rates rise during time when the analysis is being done. The rise in rates would tend to lower the expected price of the new bonds, which would make them cheaper to the firm and thus increase the expected interest savings.F) B) and E)
G) B) and D)

Question 4

The term "leaving money on the table" refers to the situation where an investment banking house makes a very low bid for the right to underwrite a firm's new stock offering. The banker is, in effect, "buying the job" with the low bid and thus not getting all the money his firm would normally earn on the job.

Accepted Answer

A) True 
 B)False

Question 5

(The following data apply to Problems 24 through 26. The problems MUST be kept together.) 
New York Waste (NYW)  is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-The amortization of flotation costs reduces taxes and thus provides an annual cash flow. What will the net increase or decrease in the annual flotation cost tax savings be if refunding takes place?

Accepted Answer

A)   $6,480
B)   $7,200
C)   $8,000
D)   $8,800
E)   $9,680F) B) and D)
G) A) and C)

Question 6

Which of the following statements is NOT CORRECT?

Accepted Answer

A)   When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately, held."
B)   "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
C)   Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC.
D)   When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
E)   It is possible for a firm to go public and yet not raise any additional new capital.F) B) and C)
G) All of the above

Question 7

Which of the following is generally NOT true and an advantage of going public?

Accepted Answer

A)   Facilitates stockholder diversification.
B)   Increases the liquidity of the firm's stock.
C)   Makes it easier to obtain new equity capital.
D)   Establishes a market value for the firm.
E)   Makes it easier for owner-managers to engage in profitable self- dealings.F) C) and D)
G) All of the above

Question 8

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Accepted Answer

A)   $5,049,939
B)   $5,315,725
C)   $5,595,500
D)   $5,890,000
E)   $6,200,000F) C) and D)
G) B) and C)

Question 9

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

Accepted Answer

A) True 
 B)False  False

Question 10

The City of Charleston issued $3,000,000 of 8% coupon, 30-year, semiannual payment, tax-exempt muni bonds 10 years ago. The bonds had 10 years of call protection, but now the bonds can be called if the city chooses to do so. The call premium would be 6% of the face amount. New 20-year, 6%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2% of the amount of bonds sold. What is the net present value of the refunding? Note that cities pay no income taxes, hence taxes are not relevant.

Accepted Answer

A)   $453,443
B)   $476,115
C)   $499,921
D)   $524,917
E)   $551,163F) A) and E)
G) B) and D)

Question 11

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Accepted Answer

A) True 
 B)False

Question 12

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Accepted Answer

A) True 
 B)False

Question 13

Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

Accepted Answer

A)   $79,425
B)   $83,606
C)   $88,006
D)   $92,406
E)   $97,027F) A) and E)
G) A) and D)

Question 14

The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Accepted Answer

A)   The yield to maturity on the company's outstanding bonds increases due to a weakening of the firm's financial situation.
B)   A provision in the bond indenture lowers the call price on specific dates, and yesterday was one of those dates.
C)   The flotation costs associated with issuing new bonds rise.
D)   The firm's CFO believes that interest rates are likely to decline in the future.E) None of the above
F) A) and D)

Question 16

Rainier Bros. has 12.0% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?

Accepted Answer

A)   9.29%
B)   9.78%
C)   10.29%
D)   10.81%
E)   11.35%F) A) and E)
G) C) and D) C

Question 17

(The following data apply to Problems 24 through 26. The problems MUST be kept together.) 
New York Waste (NYW)  is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-What is the NPV if NYW refunds its bonds today?

Accepted Answer

A)   $1,746,987
B)   $1,838,933
C)   $1,935,719
D)   $2,037,599
E)   $2,241,359F) A) and B)
G) A) and C)

Question 18

The State of Idaho issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds 5 years ago. The bonds had 5 years of call protection, but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding? Because these are tax-exempt bonds, taxes are not relevant.

Accepted Answer

A)   $278,606
B)   $292,536
C)   $307,163
D)   $322,521
E)   $338,647F) A) and B)
G) A) and D) A

Question 19

(The following data apply to Problems 24 through 26. The problems MUST be kept together.) 
New York Waste (NYW)  is considering refunding a $50,000,000, annual payment, 14% coupon, 30-year bond issue that was issued 5 years ago. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NYW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called.
-What will the after-tax annual interest savings for NYW be if the refunding takes place?

Accepted Answer

A)   $664,050
B)   $699,000
C)   $768,900
D)   $845,790
E)   $930,369F) B) and D)
G) All of the above

Question 20

Which of the following statements is most CORRECT?

Accepted Answer

A)   In a private placement, securities are sold to private (individual)  investors rather than to institutions.
B)   Private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
C)   Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
D)   The SEC requires that all private placements be handled by a registered investment banker.
E)   Private placements can generally bring in funds faster than is the case with public offerings.F) C) and D)
G) A) and C)

Exam 20: Initial Public Offerings, Investment Banking, and Financial Restructuring

Correct Answer
verified

If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.

Correct Answer
verified

Which of the following statements is most CORRECT?

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Which of the following statements is NOT CORRECT?

Correct Answer
verified

Which of the following is generally NOT true and an advantage of going public?

Correct Answer
verified

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Correct Answer
verified

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

Correct Answer
verified
False

Correct Answer
verified

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Correct Answer
verified

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Correct Answer
verified

Correct Answer
verified

The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

Correct Answer
verified

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Correct Answer
verified

Correct Answer
verified
C

Correct Answer
verified

Correct Answer
verified
A

Correct Answer
verified

Which of the following statements is most CORRECT?

Correct Answer
verified

Exam 20: Initial Public Offerings, Investment Banking, and Financial Restructuring

Correct AnswerverifiedShow Answer

If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is NOT CORRECT?

Correct AnswerverifiedShow Answer

Which of the following is generally NOT true and an advantage of going public?

Correct AnswerverifiedShow Answer

What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Correct AnswerverifiedShow Answer

Suppose a company issued 30-year bonds 4 years ago, when the yield curve was inverted. Since then long-term rates (10 years or longer) have remained constant, but the yield curve has resumed its normal upward slope. Under such conditions, a bond refunding would almost certainly be profitable.

Correct AnswerverifiedFalse

Correct AnswerverifiedShow Answer

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Correct AnswerverifiedShow Answer

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.

Correct AnswerverifiedShow Answer

Which of the following factors would increase the likelihood that a company would call its outstanding bonds at this time?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedC

Correct AnswerverifiedShow Answer

Correct AnswerverifiedA

Correct AnswerverifiedShow Answer

Which of the following statements is most CORRECT?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
False

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified
C

Correct Answer
verified

Correct Answer
verified
A

Correct Answer
verified

Correct Answer
verified