Concept Questions
1. Bond features: What are the main features of a corporate bond that would be listed in the
indenture?
2. What are the differences between preferred stock and debt?
3. Preferred stock doesn't offer a corporate tax shield on the dividends paid. Why do we still
observe some firms issuing preferred stock?
4. Preferred Stock & Bond Yields: The yields on noncovertible preferred stock are lower than
the yields on corp. bonds. Why is there a difference? Which investors are the primary holders of
preferred stocks?
5. Corporate Financing: What are the main differences between corp. debt and equity? Why do
some firms try to issue equity in the guise of debt?
6. Call provisions: A company is contemplating a LT bond issue. It is debating whether to
include a call provision. What are the costs? How do these answers change for a put provision?
7. What is a Proxy?
8. Do you think Preferred Stock is more like debt or equity? Why?
9. Long Term Financing: As mentioned in Ch. 15, new equity issues are generally only a small
portion of all new issues. At the same time, companies continue to issue new debt. Why do
companies tend to issue little new equity but continue to issue new debt.
10. Internal vs. External Financing: What is the difference between internal financing and
external financing?
11. Internal vs. External Financing: What factors influence a firm's choice of external versus
internal equity financing?
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?
13. Callable Bonds: Do you agree or disagree - 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.
14. Bond Prices: If interest rates fall, will the price of noncallable bonds move up higher than
that of callable bonds?
15. Sinking Funds: Sinking funds have both a positive and negative characteristics for
bondholders. Why?
Questions and Problems
Basic
1. Corporate Voting: The shareholders of the Stackhouse Company need to elect seven new directors.
There are 960,000 shares outstanding currently trading at $48 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?
2. Cumulative Voting: An election is being held to fill three seats on the board of directors of a firm in
which you hold stock. The company has 17,400 shares outstanding. If the election is conducted under
cumulative voting and you own 300 shares, how many more shares must you buy to be assured of
earning a seat on the board?
3. Cumulative Voting: The shareholders of Bryant Power Corp. need to elect three new directors to the
board. There are 16,500,000 shares of common stock outstanding, and the current share price is $13.75.
If the company uses cumulative voting procedures, how much will it cost to guarantee yourself one seat
on the board of directors?
4. Corporate Voting: Beasley, Inc. is going to elect nine board members next month. Betty Brown
owns 12.4 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 three board
members at a time?
5. Financial Leverage: Kiedis, Corp., has interest-bearing debt with a market value of $65 million. The
company also has 2 million shares that sell for $25 per share.What is the debt–equity ratio for this
company based on market values?
6. Financial Leverage: Frusciante, Inc., has 290,000 bonds outstanding. The bonds have a par value of
$1,000, a coupon rate of 7 percent paid semiannually, and 8 years to maturity. The current YTM
on the bonds is 7.5 percent. The company also has 10 million shares of stock outstanding, with a market
price of $23 per share. What is the company’s market value debt–equity ratio?
7. Financial Leverage: Harrison, Inc., has the following book value balance sheet:
a. What is the debt–equity ratio based on book values?
b. Suppose the market value of the company’s debt is $225 million and the market value of equity is
$670 million. What is the debt–equity ratio based on market values?
c. Which is more relevant, the debt–equity ratio based on book values or market values? Why?
8. Valuing Callable Bonds: KIC, Inc., plans to issue $5 million of bonds with a coupon rate of 8 percent
and 30 years to maturity. The current market interest rates on these bonds are 7 percent. In one year, the
interest rate on the bonds will be either 10 percent or 6 percent with equal probability. Assume investors
are risk-neutral.
a. If the bonds are noncallable, what is the price of the bonds today?
b. If the bonds are callable one year from today at $1,080, will their price be greater or less than the price
you computed in (a)? Why?
9. Valuing Callable Bonds: New Business Ventures, Inc., has an outstanding perpetual bond with a 10
percent coupon rate that can be called in one year. The bond makes annual coupon payments. The call
premium is set at $150 over par value. There is a 60 percent chance that the interest rate in one year will
be 12 percent, and a 40 percent chance that the interest rate will be 7 percent. If the current interest rate is
10 percent, what is the current market price of the bond?
10. Valuing Callable Bonds: Bowdeen Manufacturing intends to issue callable, perpetual bonds with
annual coupon payments. The bonds are callable at $1,175. One-year interest rates are 9 percent. There is
a 60 percent probability that long-term interest rates one year from today will be 10 percent, and a 40
percent probability that they will be 8 percent. Assume that if interest rates fall the bonds will be called.
What coupon rate should the bonds have in order to sell at par value?
11. Valuing Callable Bonds: Williams Industries has decided to borrow money by issuing perpetual
bonds with a coupon rate of 6.5 percent, payable annually. The one-year interest rate is 6.5
percent. Next year, there is a 35 percent probability that interest rates will increase to 8 percent, and
there is a 65 percent probability that they will fall to 5 percent.
a. What will the market value of these bonds be if they are noncallable?
b. If the company decides instead to make the bonds callable in one year, what coupon will be demanded
by the bondholders for the bonds to sell at par? Assume that the bonds will be called if interest rates fall
and that the call premium is equal to the annual coupon.
c. What will be the value of the call provision to the company?
12. Treasury Bonds: The following Treasury bond quote appeared in The Wall Street Journal on
May 11, 2004:
Why would anyone buy this Treasury bond with a negative yield to maturity? How is this possible?
