Chapter 17 Discussion Questions 17-1. Corporate management has become increasingly sensitive to the desires of large institutional investors because they fear these shareholders may side with corporate raiders in voting their shares in mergers or takeovers attempts. 17-2. There is no difference in dividend payments. The difference in trading values reflects a premium for being able to participate in electing a majority to the board of directors. 17-3. Usually corporations issue different classes of stock so that a controlling group can continue to control the board with a relatively small number of shares. 17-4. One disadvantage is that so-called non-voting shareholders generally contribute the bulk of the equity capital and get to elect only a minority of board members. Another is that in case of a takeover promising large premiums the non-voting shares can be ignored and therefore not get the same financial benefit as the voting shares. 17-5. The purpose of cumulative voting is to allow some minority representation on the board of directors. A possible disadvantage to management is that minority shareholders can challenge their actions. 17-6. Mainly because of the non-taxable nature of the dividends received by corporations and the dividend tax credit accorded individuals. 17-7. The preemptive right provides current shareholders with a first option to buy new shares. In this fashion, their voting right and claim to earnings cannot be diluted without their consent. 17-8. The actual owners have the last claim to any and all funds that remain. If the firm is profitable, this could represent a substantial amount. Thus, the residual claim may represent a privilege as well as a potential drawback. Generally, other providers of capital may only receive a fixed amount. 17-9. When a rights offering is announced, a stock initially trades rights-on, that is, if you buy the stock you will also acquire a right toward future purchase of the stock. After a certain period of time (say four weeks), the stock goes ex-rights; thus when you buy the stock you no longer get a right toward future purchase of stock. The significance to current and future shareholders is that they must decide if they wish to use or sell the right when the stock is trading rights-on. The stock will go down by the approximate value of the right when the stock moves to an ex-rights designation. 17-10. A poison pill may help management defend itself against a potential takeover attempt. When another company attempts to acquire the firm, the poison pill allows current shareholders to acquire additional shares at a very low price. This increases the shares outstanding and makes it more difficult for the potential acquiring company to successfully complete the merger. 17-11. Preferred stock is a ‘hybrid’ or intermediate form of security possessing some of the characteristics of debt and common stock. The fixed amount provision is similar to debt, but the non-contractual obligation is similar to common stock. Though the preferred shareholder does not have an ownership interest in the firm, the priority of claim is higher than that of the common shareholder. 17-12. Preferred stock may offer a slightly lower yield than bonds in spite of greater risk because corporate recipients of preferred stock dividends may receive them tax free while individuals can apply the dividend tax credit. 17-13. With the cumulative feature, if preferred stock dividends are not paid in any one year, they accumulate and must be paid in total before common shareholders can receive dividends. Even though preferred stock dividends are not a contractual obligation as is true of interest on debt, the cumulative feature tends to make corporations very aware of obligations to preferred shareholders. Preferred shareholders may even receive new securities for forgiveness of missed dividend payments. 17-14. The participation privileges of a few preferred stock issues mean that preferred shareholders may receive a payout over and above the quoted rate when the corporation enjoys a particularly good year. This is very similar to the situation with common stock and one can certainly say that common stock is a participation-type security. 17-15. There is less price volatility than with regular preferred stock. The corporation can issue floating-rate preferreds without trying to outguess the market in relation to future interest rates. 17-16. To the extent that shares on the NYSE are generally widely held while those on the TSX are more closely held, there should be more opportunities to buy control on the NYSE. Given the large size of many NYSE companies, however, many of those takeovers would require a great deal of capital. 17-17. Income trusts were once attractive investments because of favourable tax treatment and they generally provide a claim on the “equity” cash flow from mature assets. Corporations set up trusts to provide additional capital funds for operations by providing an alternative investment for the marketplace. REITS survive and are well utilized by investors. 17-18. Common Stock a) b) c) d) e) f) g) h) Owners and control of the firm Obligation to provide return Claims to assets in bankruptcy Highest cost of distribution Highest return Highest risk Tax deductible of payment Payment to individual receives tax credit Preferred Stock Bonds X X X X X X X X X Internet Resources and Questions 1. www.tmx.com http://www.globeinvestor.com/servlet/Page/document/v5/data/bonds/ 2. http://www.sedar.com/new_docs/new_en.htm Problems 17-1. Folic Acid Inc. a. Earnings – Interest – Preferred stock dividends Common shareholders residual claim to earnings (in millions) $20.00 2.75 1.80 $15.45 b. Common shareholders have no legal, enforceable claims to dividends. 17-2. Text-Messaging Inc. a. The bondholders have a contractual claim of $8.35 and if this is not paid it is a violation of a covenant in the bond indenture that could force the company into bankruptcy proceedings. b. Preferred shareholders have no legal, enforceable claim to dividends but must be paid before any dividends can be paid to common shareholders. 17-3. Rapid Employment Company a. Votes = # of shares × # of directors to be elected = 21,000 × 11 = 231,000 b. Anita Job controls = 507 × 11 = 5,577 votes c. Anita’s percentage of total votes = 5,577/ 231,000 = 0.0241 = 2.41% 17-4. Austin Power Company (# of directors desired ) × Shares required = = (Total # of shares outstanding ) Total # of directors to be elected + 1 +1 5 × 150,000 750,000 +1 = + 1 = 50,001 shares 14 + 1 15 17-5. Softdrinks, Inc. (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding = (7,001 − 1) × (10 + 1) = 7,000 × 11 = 77,000 = 1 77,000 77,000 77,000 Yes, Mr. Cola can elect himself to the board. director 17-6. Beasley Corporation a. (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding (10,001 − 1) × (11 + 1) = 10,000 × 12 = 120,000 = 4 directors = 30,000 30,000 30,000 Four directors can be elected by the dissident shareholders under cumulative voting. None would be elected by the dissidents under majority rule because the existing board controls over 50 percent of the shares. b. (# of directors desired ) × (Total # of shares outstanding ) +1 Shares required = Total # of directors to be elected + 1 6 × 30,000 180,000 = +1 = + 1 = 15,001 shares 11 + 1 12 17-7. Midland Corporation a. (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding = (40,001 − 1) × (11 + 1) 40,001 + 60,001 + 19,998 = 40,000 × 12 480,000 = = 4 directors 120,000 120,000 Mr. Pickens can be assured of electing 4 directors. b. (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding = (60,001 − 1) × (11 + 1) = 60,000 × 12 = 720,000 = 6 120,000 120,000 120,000 directors Ms. Ramsey and his friends can be assured of electing 6 directors. c. Shares owned = shares owned and proxies of other voters: (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding (40,001 + 19,998 − 1) × (11 + 1) = 59,998 × 12 = 719,976 = 120,000 120,000 120,000 = 5.9998 = 5 directors (rounded down ) Mr. Pickens can elect 5 directors. Ms. Ramsey will control the board. 17-8. Midland Corporation (Continued) (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elected = Total # of shares outstanding = (40,001 + 9,999 − 1) × (9 + 1) = 49,999 × 10 = 499,990 120,000 120,000 = 4.17 = 4 directors (rounded down ) 120,000 17-9. Express Frozen Foods, Inc. Mr. Frost controls 224,000 votes (32,000 × 7 directors) Mr. Cooke controls 196,000 votes (28,000 × 7) If Mr. Frost casts 90,000 votes for Jack, this will leave 44,667 votes (134,000/ 3) for each of the other three candidates he favours. Mr. Cooke could elect 4 of 7 directors (196/ 4 = 49,000), with less than one half of the votes because of Mr. Frost’s error in voting. 17-10. Macho Iron Works Founder's family votes Class B votes Founders % = = Shares owned × 10 = 62,635 × 10 = 626,350 = Total shares – founder's family shares = 1,500,000 – 62,635 = 1,437,365 Founders family votes 626,350 = = 0.4358 = 43.58% Class B votes 1,437,365 17-11. Madonna Fashions, Inc. a. R = P0 - S $54 − $45 $9 = = = $1.50 N +1 5 +1 6 b. P e – R = $54 – $1.50 = $52.50 The share price will decrease by the amount of the right's value. 17-12. Redirect Energy Corporation a. R = P0 - S $30 − $25 $5 = = = $1.00 N +1 4 +1 5 b. P e – R = $30.00 – $1.00 = $29.00 The share price will decrease by the amount of the right's value. 17-13. Skyway Airlines a. R = P0 - S $72 − $60 $12 = = = $2.40 N +1 4 +1 5 b. Harold owns 800 shares so she would receive 800 rights. 800 rights/ 4 rights per share = 200 shares 200 shares × $60 subscription price = $12,000 c. Neither exercising the rights nor selling them would have any effect on the shareholder's wealth (all things being equal). 17-14. Gallagher Tennis Clubs, Inc. a. R = Pe - S $50 − $38 = = $2.00 N 6 $4,000 investment/ $2.00per right = 2,000 rights $4,000 investment/ $50 per share = 80 shares b. R = Pe - S $59 − $38 = = $3.50 N 6 $3.50 per right value – $2.00 = $1.50 × 2,000 rights = c. ($59 – $50) = $9 × 80 shares = d. R = $1.50 profit per right $3,000 total profit (rights) $9 profit per share $720 total dollar profit (shares) Pe - S $30 − $38 = = −$1.33, value = $0 N 6 Todd would lose his entire $4,000 investment. e. ($30 – $50) = – $20 × 80 = – $20 loss per share – $1,600 Todd would lose $1,600 on his $4,000 investment. 17-15. Magic Tricks Corp.(The Andersons) a. R = P0 - S $60 − $48 $12 = = = $2.00 N +1 5 +1 6 b. Portfolio value: Stock 5 × $60 = Cash Total Portfolio Value $300 48 $348 c. First compute diluted value: Diluted value = Market value ex-rights P e – R = 60 – $2 = $58 OR: 5 old shares sold at $60 per share 1 new share will sell at $48 Total value of 6 shares $300 48 $348 Average value of 1 share (Market value ex-rights) = $348/ 6 = $58 Portfolio value: Shares 6 × $58 = Cash Total portfolio value $348 0 $348 d. Portfolio value: Shares 5 × $58 = $290 Proceeds from sale of 5 rights (5 × $2) 10 48 Cash = Total portfolio value $348 17-16. Owl Industries # of new share required to raise $30,000,000 = $30,000,000/ $50 = 600,000 new shares # of rights required to acquire 1 new share =4,200,000/ 600,000 = 7 rights R= 17-17. P0 - S $60 − $50 $10 = = = $1.25 N +1 7 +1 8 Delovely Productions # of new share required to raise $42,000,000 = $42,000,000/ $14 = 3,000,000 new shares # of rights required to acquire 1 new share =6,000,000/ 3,000,000 = 2 rights R= P0 - S $17 − $14 $3 = = = $1.00 N +1 2 +1 3 17-18. Walker Machine Tools a. Earnings per share = P/E ratio = $15 million = $3.00 per share 5 million shares Market price $42 = = 14 × Earnings per share $3 b. 5 million original shares + 500,000 new shares = 5,500,000 shares R= P0 - S $42 − $36.50 $5.50 = = = $0.50 N +1 10 + 1 11 P e – R = $42 – $0.50 = $41.50 Earnings per share = P/E ratio = $15 million = $2.73 per share 5,500,000 shares Market price $41.50 = = 15.20 × Earnings per share $2.73 17-19. Avery Corporation a. Government bond 9% × (1 – .36) = 9% × .64 = 5.76% b. Corporate bond 12% × (1 – .36) = 12% × .64 = 7.68% c. Preferred stock 10% Intercorporate dividends are tax free The preferred stock should be selected because it provides the highest aftertax return. It does however offer the greatest risk. 17-20. National Health Corporation a. $9 per share × 300,000 shares × 5 years = $13,500,000 dividends in arrears. b. $13,500,000 original dividends in arrears + ($9 × 300,000) next year's preferred dividends – $11,000,000 profit paid out in dividends. $13,500,000 + $2,700,000 – $11,000,000 = $5,200,000 amount still in arrears. c. No common stock dividends can be paid until all the preferred dividends are paid to the cumulative preferred shareholders. 17-21. Osmond Dental Products a. $6.50 per share × 850,000 shares × 4 years = $22,100,000 dividends in arrears $22,100,000 × 90% = $19,890,000 compensation b. Calculator: PV =? FV= 1,000 %i = 7% (14%/2) Compute: PV = $875.91 PMT = $60 ($120/ 2) N = 30 (15 × 2) c. Compensation $19,890,000 ÷ 875.91 Bond value Number of bonds to provide compensation 22,708 17-22. Enterprise Storage Company a. Enterprise is in arrears on the preferred shares 6 years × $4.75 × 400,000 shares = $11,400,000 b. Common share value Value of dividends and future price D 1 = $1.25 D 2 = $1.50 D 3 = $1.75 D 4 = $2.00 P 4 = $4.05 × 12 = $48.60 PV @ 10% $1.14 1.24 1.31 1.37 33.19 $38.25 c. To eliminate the deficit of $11,400,000 the number of common shares required for issue = This of course will not recover any of the original preferred share investment. 17-23. Harmon Bottling Company a. Preferred Stock Dividend yield Dividends $100,000 9% $ 9,000 b. Loan Interest expense Interest × (1 – T) Aftertax borrowing cost $100,000 11% 11,000 66% $ 7,260 (Aftertax income) c. Yes, the aftertax income exceeds the aftertax borrowing cost. Of course, other factors may be considered as well. d. The outcome could be quite unfavorable for two reasons. The increase in dividend yield would lower the value of the $100,000 portfolio. Also, interest rates generally are not fixed on a loan of this nature. Thus, the borrowing costs could go up. The dangers of these problems could be overcome by buying floating rate preferreds. The market value of the portfolio would be fixed and preferred share yields and interest rates would, in all likelihood, move up and down together. 17-24. Harmon Bottling Company (Continued) Dividend Interest × (1 – T) Aftertax borrowing cost $9,000 $11,000 85% $ 9,350 No, the aftertax income is now less than the aftertax borrowing cost. 17-25. Hailey Transmission a. The floating rate preferred shares should be trading at very close to the par value of $100 since interest rates will adjust to current market conditions rather than price. b. Based on formula 10-3, the price of the straight preferred share will be (assuming dividend rate and yield were equal at time of issuance): D p $8.00 = = $72.73 Pp = 0.11 Kp Comprehensive Problems 17-26. Crandall Corp. (Rights Offering and the Impact on Shareholders) a. 10% discount-subscription price equals $45. # of new shares = $900,000 Required funds = = 20,000 Subscription price $45 # of rights to purchase 1 share = Old shares 100,000 = =5 New shares 20,000 20% discount-subscription price equals $40 # of new shares = Required funds $900,000 = = 22,500 Subscription price $40 # of rights to purchase 1 share = Old shares 100,000 = = 4.4 New shares 22,500 40% discount-subscription price equals $30 # of new shares = Required funds $900,000 = = 30,000 Subscription price $30 # of rights to purchase 1 share = Old shares 100,000 = = 3.3 New shares 30,000 b. R (10% ) = P0 - S $50 − $45 $5 = = = $0.83 N +1 5 +1 6 R (20% ) = P0 - S $50 − $40 $10 = = = $1.85 N +1 4.4 + 1 5.4 R (40% ) = P0 - S $50 − $30 $20 = = = $4.65 N +1 3.3 + 1 4.3 c. EPS (before rights offering) = EPS (after rights offering) = $500,000 = $5.00 per share 100,000 shares $500,000 = $4.17 per share 100,000 + 20,000 shares d. 20% increase in shares outstanding (100,000 to 120,000) e. Before After 100 shares × $5.00 = 120 shares × $4.17 = $500 $500 (rounded) f. No, he would expect greater earnings. He and others have put additional capital into the corporation so total claims to earnings should improve. Invested capital has increased from $5,000,000 to $5,900,000. He earned $500 before he put $900 more (20 shares × $45) of additional funds in the corporation. Over time, earnings should increase. 17-27. Hoffman Bike Parts a. Cumulative voting would make it easier for minority owners to obtain directors. b. Under majority vote, the majority could elect only one third of the directors each year so that staggered terms would make the takeover last for at least two years at which time the majority would have six of the nine positions. If cumulative voting along with staggered terms were used, Mr. Hoffman could elect one out of three directors each time and so it would take the majority at least three years before they could control six of the nine directors. c. With majority vote, it doesn’t matter how many directors there are: as long as you have a majority of votes, you control the whole company. If cumulative voting is used, the number of directors is possibly a concern. The fewer the number of directors, the greater the percentage of representation by minority interests. (Shares owned - 1) × # of directors (Total # of directors to be elected + 1) that can be elcted = Total # of shares outstanding = (700,000 − 1) × (11 + 1) = 699,999 × 12 = 4.20 = 4 directors 4 = 36.4% 11 = (700,000 − 1) × (10 + 1) = 699,999 × 11 = 3.84 = 3 directors 3 = 30% 10 = (700,000 − 1) × (8 + 1) = 699,999 × 9 = 3.15 = 3 directors 3 = 37.5% 8 = (700,000 − 1) × (7 + 1) = 699,999 × 8 = 2.80 = 2 directors 2 = 28.6% 7 = (700,000 − 1) × (5 + 1) = 699,999 × 9 = 2.10 = 2 directors 2 = 40.0% 5 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 17-28. Portable Laptop, Inc. (Poison Pill Strategy) a. If Rom owns 25 percent of the shares outstanding of PLI, the poison pill will go into effect. Since there are 1,700,000 shares outstanding, the trigger point is at 425,000 shares. This means Rom would have to buy 225,000 additional shares to go with its current ownership of 200,000. The cost of 225,000 additional shares of PLI common stock at its current price of $82 per share would be $18,450,000. b. To get a 50% + 1 share interest in PLI, Rom would need to own 850,000 (1/2 of 1,700,000) + 1 shares. The number is 850,001. Since Rom has already acquired 425,000 shares of PLI, it would need to buy 425,001 more shares. At a stock price of $82 per share, this would represent an additional cost of $34,850,082. 425,001 × $82 $34,850,082 additional shares stock price additional cost c. One more share than Rom would necessitate an ownership of 1,250,001 shares. Since “friendly” interests to PLI already own 350,000 shares, they would need to acquire 900,001 additional shares. Because under the poison pill provision, they can buy at 80% of current market value, the total cost of the 900,001 shares would be $59,040,065. 900,001 × $ 65.60 $59,040,066 additional shares cost per share* total cost *$82 × 80% (poison pill provision) = $65.60 d. Yes, the poison pill is an effective deterrent in this case. With 1,700,000 shares outstanding and the “friendly” interests already owning 350,000 shares, the most that Rom can acquire is 1,350,000. Since the poison pill provision allows up to 1,100,000 additional shares to be purchased by “friendly” interests, the “friendly” interests are assured of always owning more than 1,350,000 shares. Their total potential is 1,450,000 shares (350,000 shares currently owned plus 1,100,000 under the poison pill plan). Quite likely, the poison pill is not in the best interest of the general shareholders. Without the poison pill, PLI is more likely to be a merger takeover candidate. Often a price is offered well in excess of current market value for a takeover candidate. For example, PLI, with a current price of $82, might be offered $100 per share in a takeover tender offer. General shareholders would certainly benefit from such an offer. MINI CASE Alpha Biogenetics (Poison Pill) This case gives the student exposure to the poison pill and the entire issue of anti-takeover amendments. Through running the numbers in the case, the student is able to view how poison pills can protect the current position of management. There is also dialogue in the case in which the virtues and drawbacks of poison pills are discussed. The student begins to get a feel for the issues of management entrenchment versus stockholder rights. Because there is also a venture capital investment and an IPO, the student is exposed to other areas of corporate finance as well. a. Values for 2008 Earnings $1,600,000 = = $0.32 Shares 5,000,000 Share price $9.60 P/E = = = 30 EPS $0.32 Earnings per share = b. Public price – Underwriting spread (5%) Net price × Shares (new shares sold) Total proceeds – Out-of-pocket expense Net proceeds $ 9.60 0.48 $ 9.12 2,000,000 $18,240,000 120,000 $18,120,000 c. Profit on sell of shares Sales price × Shares Total proceeds – purchase price Profit $ 9.60* 1,200,000 11,520,000 4,000,000 $ 7,520,000 *This assumes no underwriting spread on the secondary offerings of the venture capitalist shares. If the spread is included, the net sales price is $9.12 and the profit is $6,944,000. We are assuming the underwriter waives the spread. Rate of return = Profit $7,520,000 = = 188% Investment $4,000,000 Given the risk that a venture capitalist takes in early stage financing, it is probably a reasonable return. Also, keep in mind that the venture capitalist had its funds tied up for a number of years to achieve the 188% total return. d. Values for 2012 Earnings 4,800,000 = = $.96 Shares 5,000,000 Share price $33.60 P/E = = = 35 EPS $.96 Earnings per share = e. Shares outstanding × Percent ownership Number of Shares × Price per share Total cost 5,000,000 25% 1,250,000 $33.60 $42,000,000 f. The inside control group owns 1.8 million shares. An unfriendly, outside party could acquire the remaining 3.2 million shares out of the 5 million shares outstanding. In order to maintain their majority position, the inside control group would need to buy 1,400,001 shares. This would give them a total of 3,200,001 shares. Old shares New shares 1,800,000 1,400,001 3,200,001 This represents one more share than the unfriendly, outside party owns. The total dollar cost would be: Share price $33.60 × Percent of price at which shares may be purchased 70% Net share price $23.52 × Number of shares 1,400,001 Total cost $32,928,024 g. In many cases, it appears that poison pills are intended to provide management with job security rather than maximize shareholder wealth. In fact, research indicates that poison pill announcements are often met with a slightly negative response in the stock market. Of course, the counter argument is that poison pills allow management to take a long-term perspective without fear of being ousted and also puts the firm in a strong bargaining position in the event of a potential tender offer. Although there is no one correct answer to this question and either side of the issue can be justified, most large institutional investors do not like poison pill provisions. Solution Manual for Foundations of Financial Management Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen, Doug Short, Michael Perretta 9780071320566, 9781259268892, 9781259261015
Download
Close
Close
