Chapter 1 Practice Problems - Conceptual

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University of Alabama *

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Finance

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Apr 3, 2024

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FI 311 – Fall 2022 – Chapter 1 Practice Problems Conceptual: 1. Define Risk and Reward in the context of Finance. a. Risk is the possibility of losing money; Reward is what you hope to gain for putting your money at risk 2. Name 3 rights that shareholders have that have little or no value to shareholders of large corporations listed on a stock exchange. Would these rights be of more value in a small, unlisted corporation? a. Voting rights, proxy voting rights, right to share proportionately in assets following liquidation; Rights would have more value in a small unlisted corporation 3. Name 2 advantages of issuing stocks vs. bonds. a. Two advantages of issuing stocks vs. bonds: Stocks are easier to sell (ownership vs. lender) in addition, issuing stock does not make it closer to bankruptcy (no payments needed to shareholders) 4. Name 2 advantages of issuing bonds vs. stock. a. Two advantages of bonds vs. stock: Issuing bonds does not give up a piece of ownership in the company… coupon payments made on bonds are tax deductible unlike dividends 5. What ratings are the dividing line between Investment Grade and Non-Investment Grade Bonds (i.e. what is the lowest a bond can be rated and still be considered Investment Grade, and what is the highest a bond can be rated and not be considered Investment Grade)? Give two examples of why the distinction between the two classifications is important. a. BBB- & BB+ 6. Name 2 advantages of Preferred Stock over Common Stock. a. Two advantages of preferred stock > common stock: Preferred stockholders have the right to all missed dividends if resumed after stopping, and are slightly ahead of common stock in liquidation 7. True or False: When you buy a bond, you become part-owner of the issuing corporation. a. False; Bonds make you a lender, they do not come with ownership Calculating: COMPLETED IN EXCEL DOCUMENT CH. 1 PRACTICE PROBLEMS 8. You have formed a Corporation with 3 other friends, and each of you own an equal proportion of the company. You and your partners have decided to purchase a new piece of

equipment that costs $200,000, and to pay for it, you have decided to issue 10,000 new shares of stock at a price of $20 per share. According to the Corporation’s prospectus, you have pre-emptive rights. How many shares of the new issue do you have the right to buy? How much will it cost to maintain your proportional ownership of the company? 9. You own 55,000 shares of Company Y. The company has issued a total of 200,000 shares, and it has 100,000 shares outstanding. What is your percentage ownership of the company? 10. You have decided that, as soon as you graduate, you want to be on the board of directors of Dewitt Airlines, Inc. Unfortunately, nobody else will be voting for you, so you essentially will have to “buy” your way onto the board. The company has 1,000,000 shares of common stock outstanding, trading at a price of $26.50 per share. How much will this cost you? 11. What is the Coupon Rate of a bond that makes coupon payments of $27.50 semi-annually? 12. A bond has a Coupon Rate of 7%, and pays coupons semi-annually. How much is each coupon payment?

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