Corporate Finance

Questions and Practice problems_Chapter 15

CF_Chapter 15:
Slide 4:
Straight voting: directors are elected one at a time; each time, the number of votes is
not cumulated.
Cumulative voting: all directors are elected at one time; the number of votes each
shareholder can cast can be cumulated: = number of shares the shareholder holds x
the number of directors up for election.
Staggered voting: only a fraction of directors is up for election at a particular time.
E.g. Peter has 20 shares, 4 directors are up for election.
With straight voting, Peter can cast the maximum of ? votes for each director.
With cumulative voting, Peter can cast the maximum of ? votes for one director because
all directors are elected at the same time and votes can be cumulated.

To guarantee that you get a seat on the Board of directors, you need to have at least:
- Straight voting: (50% x number of shares outstanding) + 1 share

- Cumulative voting: [1/(N+1)] x number of shares outstanding + 1 share

N: the number of directors up for election

E.g. A company has 10,000 shares outstanding; 3 directors are up for election. What’s
the minimum number of shares you need to have to guarantee that you get a seat on
the Board of directors?
Straight voting: = 0.5 x 10000 +1 = 5001
Cumulative voting: = 1/(3+1) x 10000 +1 = 2501

Slide 4:
- Proxy voting: When shareholders are absent at the meeting, they grant the right
to vote their shares to someone else.
- Classes of stock: Google has 2 classes of common stock:
Class A: 1 share has 1 vote; class A is held by the public.
Class B: 1 share has 10 votes; class B is held by founders and insiders  maintain
the control of the company.
- Preemptive right (Rights offering): issue the rights to buy new shares to existing
shareholders to help them avoid ownership dilution.

Slide 5:
Similarities between preferred stock and debt:
- Stated dividend
- Stated liquidating value
- Sometimes can be converted to common stock
Differences between preferred stock and debt:
- Preferred stock has no maturity date
- Dividends are not tax deductible
- Dividends are not the obligation of the company

Slide 7:
Sinking fund: an account managed by the bond trustee and used to repay the bonds.
Each year, the company transfers money to sinking fund to retire the bonds.
Call provision: allows the issuing company to repurchase (buy back) the bond any time
prior to maturity at a specified price.
- When r giảm, issuing firm wants to buy back the bond early
- Should have higher coupon rate when it is issued
Protective covenant:
- Negative covenant: prohibits some actions, e.g., limits the amount of dividends a
company can pay.
- Positive covenant: specifies an action that the company needs to take, e.g.,
requires the company to maintain a minimum level of working capital.

Slide 16:
Example: Which one of the following is the Eurobond, which one is the foreign bond?
1/ A French company issues a bond denominated in U.S. dollar to the U.S. bond market
2/ A Japanese company issues a bond denominated in Japanese yen to the bond
markets in China, Mexico, Brazil, Canada, the U.S., Korea, etc.
- Foreign Bond: A French company issuing a bond denominated in U.S. dollars to
the U.S. bond market is a foreign bond. This is because the bond is issued in a
foreign market (the U.S.) and denominated in the currency of that market (U.S.
dollars)
+ one market
+currency = country where the bond is issued/ sold foreign issuer
- Eurobond: A Japanese company issuing a bond denominated in Japanese yen to
bond markets in various countries (China, Mexico, Brazil, Canada, the U.S., Korea,
etc.) is a Eurobond. This is because the bond is issued outside the country whose
currency it is denominated in (Japan)
+ several markets
+ currency = country of issuer (issued/sold outside the country of issuer)
Chapter 15:

concept questions (page 490 textbook): 2, 6, 12, 13

2. Preferred Stock and Debt
What are the differences between preferred stock and debt?

Similarities between preferred stock and debt:

- Stated dividend
- Stated liquidating value
- Sometimes can be converted to common stock
Differences between preferred stock and debt:
- Preferred stock has no maturity date
- Dividends are not tax deductible
- Dividends are not the obligation of the company
Preferred Stock:
- Represents ownership in a company with a claim on assets and earnings.
- Dividends are paid out to preferred shareholders before common stockholders and can be fixed
or variable.
- Generally does not come with voting rights.
- In the event of liquidation, preferred shareholders are paid after debt holders but before common
stockholders.

Debt (Bonds):
- Represents a loan made by an investor to a borrower, typically corporate or governmental.
- Interest payments are made to bondholders at regular intervals.
- Priority over both preferred and common stockholders for asset claims in case of liquidation.
- Typically does not confer ownership or voting rights in the company.

 The differences between preferred stock and debt are:

a. The dividends on preferred stock cannot be deducted as interest expense when

determining taxable corporate income. From the individual investor’s point of view,
preferred dividends are ordinary income for tax purposes. For corporate investors,
70% of the amount they receive as dividends from preferred stock are exempt from
income taxes.

b. In case of liquidation (at bankruptcy), preferred stock is junior to debt and senior to
common stock.

c. There is no legal obligation for firms to pay out preferred dividends as opposed to
the obligated payment of interest on bonds. Therefore, firms cannot be forced into
default if a preferred stock dividend is not paid in a given year. Preferred dividends
can be cumulative or non-cumulative, and they can also be deferred indefinitely (of
course, indefinitely deferring the dividends might have an undesirable effect on the
market
value of the stock)

6. Call Provisions
A company is contemplating a long-term bond issue. It is debating whether to include
a call provision. What are the benefits to the company from including a call provision?
What are the costs? How do these answers change for a put provision?

Một công ty đang cân nhắc phát hành trái phiếu dài hạn. Công ty đang cân nhắc có
nên đưa điều khoản mua lại vào hay không. Lợi ích của việc đưa điều khoản mua lại
vào công ty là gì? Chi phí là bao nhiêu? Những câu trả lời này thay đổi như thế nào
đối với điều khoản bán lại?

 There are two benefits. First, the company can take advantage of interest rate declines by
calling in an issue and replacing it with a lower coupon issue. Second, a company might
wish to eliminate a covenant for some reason. Calling the issue does this. The cost to the
company is a higher coupon. A put provision is desirable from an investor’s standpoint, so
it helps the company by reducing the coupon rate on the bond. The cost to the company is
that it may have to buy back the bond at an unattractive price.

when the interest rate declines, the company can call back the current bond and then issue a lower
coupon rate – bond
bonds with a call provision pay investors a higher interest rate
The company could offer lower coupon rate for the bond with put provisionthe cost is that the company
don't have right to call back to bond when they want
bondholders can force the company to buy the bond back prior to maturity

(Call provision: allows the issuing company to repurchase (buy back) the bond any time prior to maturity at a
specified price.)

- Điều khoản mua lại cho phép công ty phát hành trái phiếu có quyền mua lại trái phiếu trước ngày đáo hạn.
- Lợi ích:
- Công ty có thể tái cấp vốn với lãi suất thấp hơn khi lãi suất thị trường giảm.
- Giảm gánh nặng nợ nếu điều kiện tài chính của công ty cải thiện.
- Chi phí:
- Trái phiếu có điều khoản mua lại thường phải trả lãi suất cao hơn để bù đắp rủi ro cho nhà đầu tư.
- Có thể phải trả một khoản phí nếu sử dụng điều khoản mua lại.

- Điều khoản bán lại cho phép nhà đầu tư có quyền bán lại trái phiếu cho công ty phát hành trước ngày đáo hạn.
- Thay đổi so với điều khoản mua lại:
- Bảo vệ nhà đầu tư khỏi rủi ro tái đầu tư và rủi ro mặc định của công ty phát hành.
 - Trái phiếu có điều khoản bán lại thường được bán với giá cao hơn so với trái phiếu không có điều khoản này do
cung cấp thêm an toàn cho nhà đầu tư.
12. Classes of Stock
Several publicly traded companies have issued more than one class of stock. Why
might a company issue more than one class of stock?

Having dual class stock means that there is a difference in voting rights. Dual share
classes allow minority shareholders to retain control even though they do not own the
majority of the total shares.

 When a company has dual class stock, the difference in the share classes are the
voting
rights. Dual share classes allow minority shareholders to retain control of the
company
even though they do not own a majority of the total shares outstanding. Often, dual
share companies were started by a family, and then taken public, but the founders
want to retain control of the company.

13. Callable Bonds

Do you agree or disagree with the following statement: In an efficient market, callable
and noncallable bonds will be priced in such a way that there will be no advantage or
disadvantage to the call provision. Why?

 The statement is true. In an efficient market, the callable bonds will be sold at a lower
price than that of the non-callable bonds, other things being equal. This is because the
holder of callable bonds effectively sold a call option to the bond issuer. Since the
issuer holds the right to call the bonds, the price of the bonds will reflect the
disadvantage to the bondholders and the advantage to the bond issuer (i.e., the
bondholder has the obligation to surrender their bonds when the call option is
exercised by the bond issuer.)

TRUE
- In an efficient market, callable bonds typically offer a higher interest rate to
compensate for call risk, which is the risk that the bond may be redeemed by the issuer
before its maturity date.
- Noncallable bonds do not have this risk  usually have a lower interest rate, reflecting
their more predictable income stream.
- The pricing of callable and noncallable bonds reflects the balance of these risks and
rewards. Investors may perceive callable bonds as having a disadvantage due to call risk,
while others may view the higher interest rate as an advantage.
- Ultimately, whether there is an advantage or disadvantage to the call provision
depends on future market conditions, which are uncertain. If interest rates fall, issuers
are more likely to call the bonds, which can be disadvantageous for investors looking for
long-term, stable income.
- However, if the market expects interest rates to rise, callable bonds may be less likely
to be called, and the higher interest rate can be advantageous for investors.

 Callable bond higher coupon rate, lower bond price to compensate investor,
disadvanatge of call provision. The issuer can buy back before maturity date
 Noncallable bond lower coupon rate, higher bond price

Questions and Problems (page 491 textbook): 1, 4

1. Corporate Voting
The shareholders of the Stackhouse Company need to elect seven new directors. There
are 850,000 shares outstanding currently trading at $43 per share. You would like to
serve on the board of directors; unfortunately no one else will be voting for you. How
much will it cost you to be certain that you can be elected if the company uses straight
voting? How much will it cost you if the company uses cumulative voting?
Straight Voting  Each shareholder may vote their shares for each director position.
- To be certain of election, you need more than 50% of the votes - 1 director seat.
 With 850,000 shares outstanding, you need: 50%*850,000= 425,001 shares.
- Total Cost = 425,001 shares * $43/share = $18,275,043.

Cumulative Voting  Each shareholder may concentrate all their votes on one
candidate.
- Total votes = number of shares * number of director seats.
= 850,000 shares * 7 directors = 5,950,000 votes.
- Votes needed for election = total votes / (number of directors + 1) + 1.
5,950,000
= + 1 = 743,751 votes.
(7+1)
- Shares needed = 743,751 votes / 7 votes per share = 106,250 shares (rounded up).
- Cost = 106,250 shares * $43 per share = $4,568,750.

The formula to determine the minimum number of shares needed to guarantee a seat
( Number of Directors you want ¿ elect∗Total Shares Outstanding)
is: +1
(Number of Directors¿be elected +1)

4. Corporate Voting
Candle box Inc. is going to elect six board members next month. Betty Brown owns 17.4
percent of the total shares outstanding. How confident can she be of having one of her
candidate friends elected under the cumulative voting rule? Will her friend be elected
for certain if the voting procedure is changed to the staggering rule, under which
shareholders vote on two board members at a time?

Formula: To determine the minimum shares needed to guarantee a seat, we use the
( Number of Directors you want ¿ elect∗Total Shares Outstanding)
formula: +1
(Number of Directors¿be elected +1)
Percent of stock/shares needed
Number of Directors you want ¿ elect ¿
(Number of Directors¿be elected +1)

Betty wants to elect 1 director out of 6.

She owns 17.4% of the total shares
1 X
To guarantee a seat, she needs: = = 0.1429=14.29%
(6+ 1) 7
 Betty needs to own more than 14.29% of total shares to guarantee a seat.
 She owns 17.4% of the total shares
 She is likely to secure a seat.

If the elections are staggered, the percentage of the company's stock needed is:
 Percent of stock needed = 1 / (2 + 1) = 0 .3333, or 33.33%
 Her candidate friend is no longer guaranteed election.

Percent of stock needed = 14.29%. Her nominee is guaranteed election.

If the elections are staggered, the percentage of the company’s stock needed is 33.33%. Her
nominee is no longer guaranteed election.

https://quizlet.com/vn/609021728/chapter-15-flash-cards/

1. What is the most popular kind of stock that represents shares of ownership in a firm?
o A) Preferred stock
o B) Common stock
o C) Convertible bonds
o D) Debentures

Answer: B) Common stock

2. Which type of voting increases the likelihood of minority shareholders getting a seat on
the board?
o A) Straight voting
o B) Cumulative voting
o C) Staggered voting
 o D) Proxy voting

Answer: B) Cumulative voting

3. What is the minimum number of shares needed to guarantee a seat on the Board of
Directors with cumulative voting if a company has 10,000 shares outstanding and 3
directors are up for election?
o A) 2,501 shares
o B) 2,001 shares
o C) 3,334 shares
o D) 1,001 shares

Answer: D) 1,001 shares

4. Which of the following is NOT a characteristic of preferred stock?

o A) Preference in dividend payments
o B) Voting rights
o C) Stated liquidating value
o D) Cumulative dividends

Answer: B) Voting rights

5. What is the main difference between debt and equity from a financial point of view?
o A) Debt is an ownership interest in the firm
o B) Equity holders have no voting power
o C) Interest on debt is tax-deductible
o D) Unpaid debt is not a liability of the firm

Answer: C) Interest on debt is tax-deductible

6. Which type of bond allows the issuing company to repurchase the bond any time prior
to maturity at a specified price?
o A) Convertible bond
o B) Put bond
o C) Callable bond
o D) Income bond

Answer: C) Callable bond

7. What is the main benefit of a sinking fund for bonds?

o A) Higher coupon rate
o B) Lower default risk
o C) Increased volatility
o D) Higher required return
 Answer: B) Lower default risk

8. Which of the following is true about dividends?

o A) They are a liability of the corporation once declared
o B) They are tax-deductible for the corporation
o C) They must be paid even if not declared
o D) They are paid out of the corporation’s pre-tax cash flow

Answer: A) They are a liability of the corporation once declared

9. What is the effect of financial leverage on EPS and ROE during good times?
o A) Decreases both EPS and ROE
o B) Increases both EPS and ROE
o C) No effect on EPS and ROE
o D) Increases EPS but decreases ROE

Answer: B) Increases both EPS and ROE

10. According to M&M Proposition I (with taxes), what happens to the value of a levered
firm?
o A) It decreases
o B) It remains the same
o C) It increases
o D) It becomes zero

Answer: C) It increases