Assignment 4

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Assiniboine Community College *

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0006

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Finance

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Jan 9, 2024

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1 CORPORATE FINANCE ASSIGNMENT Question 1 (10 marks) In 2018, National Utility issued $60,000,000 of 10%, 25-year bonds at par. The current market rate on bonds with the same rating is 8%. The bond contract will allow refunding of these bonds in 2023. Company officers have estimated the flotation costs (legal, printing, accounting, etc.) of a 20-year refunding bond issue to be $1,500,000. The underwriting costs on a best-efforts basis will be 3 percent of the issue price. The terms of the current bond contract require the payment of a 6% call premium. Short term money market rates are 6%, and a one-month overlap period is expected. Assuming that the utility firm’s tax rate is 40%, would a decision to refund the outstanding bonds be acceptable?

3 Question 2 (10 marks) RJ’s Chrome Rim Corporation is debating whether to acquire an asset through an operating lease arrangement or to borrow funds and purchase the asset. The purchase price of the asset, $125,000, can be financed with a five-year, 9% bank loan. If purchased, the asset will be placed in a CCA class of 20% with an expected salvage value of $12,000 at the end of its five year life. Alternatively, the firm can obtain the use of the asset with an operating lease of five years. The lease payments would be $30,000 at the beginning of each year. The firm’s tax rate is 35% and corporation cost of capital is 15%. Which alternative should be selected based on minimizing the present value of aftertax costs? PV of CCA Tax Shield: (C – S) x dT x 1 + 0.5 r r + d 1 + r

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5 Question 3 (6 marks) The Whipple Corporation currently has common stock selling for $25 per share on the Dominion Stock Exchange. Warrants are also available entitling the warrant holder the option of purchasing 1 share of common stock for every 3 warrants held. The exercise price is $19 per share. The warrants are currently selling for $4 per warrant. a) How much would you have to spend to buy one share of stock using warrants? Does this make sense? ________________________________________________________________________ ________________________________________________________________________ b) What is the intrinsic value of the warrant? ________________________________________________________________________ ________________________________________________________________________ c) What is the speculative premium on this warrant? ________________________________________________________________________ ________________________________________________________________________

6 Question 4 (10 marks) Dakota Corp. is considering a public offering of common stock. The firm will offer 500,000 shares of common stock for sale. The estimated selling price is $40 per share with Dakota Corp. receiving $36.20 per share after the offering. Registration fees are estimated at $375,000. Presently Dakota Corp. has earnings of $4 million and 1 million shares outstanding. a) What is the spread in dollars? In percent? ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ b) Compute the potential dilution from this new share issue. ________________________________________________________________________ ________________________________________________________________________ c) Compute the net proceeds to Dakota Corp. ________________________________________________________________________ ________________________________________________________________________ d) What rate of return must be earned on the net proceeds so that no dilution of earnings per share occurs? ________________________________________________________________________ ________________________________________________________________________ e) If Dakota Corp. needs to generate $25 million, how many shares will have to be sold? ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________

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