Fin 400 Final Exam Review

Topics: Stock, Corporate finance, Futures contract Pages: 27 (7070 words) Published: May 31, 2013
Term Final Exam Preparation
(Note: This document includes practice examples from chapters covered only after the mid term. Your term final exam will be a comprehensive one and will include all chapters both before and after mid term exam.)

FIN 300 Review: Basic Capital Budgeting
Ch. 14:Calculating WACC
Calculating the growth rate of dividends
Ch. 15:Value of a right (including flotation)
Dilution (three types)
IPO underpricing (Winner’s Curse)
Ch. 16:Indifference EBIT
M&M Propositions and the Static Theory
Homemade Leverage
Ch. 17:Mechanics of a Dividend (price impacts of cash and stock dividends/splits)
Homemade Dividends
Strict Residual Dividends
Ch 22:Net Advantage of Leasing (NAL)
Break-even Lease
Range of Lease Payments
Ch. 23M&A with cash
M&A with stock swap
Ch. 24Read a futures quote
Read an option quote
Create a simple hedge
Ch. 25Types of options and payoffs
Intrinsic and time value
Factors influencing option value
Convertible bonds

Chapter 15

Probably one of the easier chapters. Make sure you read it over because there is a lot of detail there that might show up in M/C questions. Off the top of my head, there is Venture Capital, the types (firm commitment, best efforts, bought deal) and costs (direct and indirect) of underwriting, the mechanics of equity issues and issuing long-term debt. But, since the focus of this review is the problems, the main types of problem concern dilution, direct and indirect costs, the winner’s curse and the value of a right. The value of a right is covered in the book and there are several formulae, but I find it easier to attack these things with another “recipe”. If I always do them the same way, after a while, they start to look pretty easy. Here is an example:

Big Al’s Cajun Grill Inc. (BACG) wants to raise some money with a new equity issue. It decides on a rights issue because Big Al’s biggest shareholder is his mom, and he doesn’t want to make her angry by diluting her proportionate ownership. BACG has one million shares outstanding and the current share price is $15 per share. Big Al hopes to raise $5 million, and the underwriter has set the subscription price at $10 per share. Calculate the value of a right and the ex-rights price.

You can do these using the formulae in the book, but I showed it to you this way. First, calculate the # of new shares required.

1. # of new shares required
$5,000,000/$10 = 500,000
Make sure you are comfortable with the spread. If the underwriter charges a spread, it is handled in this step. It is in the book, and I provided examples.

2. # of rights needed to buy one new share
1,000,000/500,000 = 2

3. Ex rights Price
[2(15) +1(10)]/ 3 = $13.33

4. Value of a Right
$15- $13.33 = $1.67

That’s it. There is nothing else (that I can think of) that you can’t figure out if you have all of these numbers. Just be sure to watch out for underwriting spreads, I’ll cover that in a minute…

The “winner’s curse” was presented as a reason for IPO underpricing. (Remember the underpricing is one of the indirect costs of raising equity. The direct and indirect costs are summarized in Section 15.7 of your text.) The story is that some investors are “informed” and others are “uninformed”. The informed investors can tell good IPOs from bad ones, and only buy the good ones. Uninformed investors know some IPOs are good (underpriced) and some are bad (overpriced) but cannot tell which is which. So, they subscribe to equal amounts of all IPOs. Inevitably, they have to share the good ones with the informed investors, but they get all of the bad ones. So, they get low IPO returns. In order to compensate them for the knowledge differential, they demand that all IPOs be underpriced on average. That way, even though they get all of the bad ones but only a portion of the good...
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