Chapter 11—An Overview of Long-Term Financing
MULTIPLE CHOICE
1. The primary instruments used for long-term financing include all of the following except:
a.
commercial paper
b.
common stock
c.
preferred stock
d.
long term debt
e.
all of the above
2. Cumulative voting provisions:
a.
ensure that majority shareholder groups can maintain control
b.
improve minority stockholders’ chances of electing members of the Board of Directors
c.
hurt minority stockholders because large ownership groups can limit minority stockholder
influence
d.
are unrelated to corporate governance issues
e.
none of the above
3. Convertible bonds:
a.
allow the firm to convert existing bonds to common shares at some future date
b.
allow the investor to convert their bonds to common shares at some future date
c.
allow the firm to convert the bond interest to a new par basis
d.
allow the investor to convert their bond interest to a new par value basis
e.
none of the above
4. The order of priority for claims if a firm must be liquidated is:
a.
preferred stock, senior debt, subordinated debt, common stock
b.
preferred stock, common stock, senior debt, subordinated debt
c.
senior debt, preferred stock, subordinated debt, common stock
d.
senior debt, subordinated debt, preferred stock, common stock
e.
none of the above
5. The dominant source of financing for nonfinancial U.S. corporations is:
a.
external bond issues
b.
short term borrowing
c.
external common stock issues
d.
internally generated funds
e.
all of the above sources of funds are equally important
6. Jessica is a current stockholder in Have-it-all Inc. Recently, the firm announced a dividend increase of
$0.10 per share as well as a new security offering. A plausible explanation for Have-it-all’s actions
would be:
a.
The firm has not realized sufficient cash flow from operations and is in need of external
financing to meet its dividend policy.
b.
The firm is in need of capital to maximize current shareholder wealth through dividend
payments rather than retained earnings.
c.
The firm is in need of capital to fund positive NPV projects and would like to send a
signal to investors that future earnings will be increasing.
d.
The firm’s retained earnings have not been sufficient enough to finance all positive NPV
projects and external financing is now required in order to meet stated dividend
requirements.
e.
The firm requires external financing due to an increase in working capital stocks.
7. Banks that are allowed to hold equity claims of firms as well as provide loan offerings would be more
likely to:
a.
wield greater power as a corporate monitor
b.
continue to lend funds to firms in financial distress
c.
not notice a poorly performing loan
d.
a and b
e.
b and c
8. Lena is attempting to convince her boss that more common stock should be issued in order to raise
capital for an upcoming project. If Lena is successful, her firm:
a.
will be employing the worldwide dominant source of corporate funding
b.
will be employing the dominant source of corporate funding in the U.S.
c.
will be following the worldwide shift toward corporate reliance on retained earnings
d.
will raise capital through a secondary offering
e.
none of the above
9. In countries with legal systems based on English common law:
a.
greater protection is afforded to minority shareholders and public equity markets are larger
than in countries with other legal systems
b.
greater protection is afforded to shareholders and creditors, resulting in decreased
tendencies towards entrepreneurship
c.
public equity markets are larger than in countries with other legal systems but
entrepreneurial tendencies are relatively low
d.
entrepreneurship tendencies are higher due to low expected bankruptcy costs
e.
markets are characterized by atomistic ownership structures where a single investor or a
single block of shareholders is likely to control a majority of the voting stock in the typical
public company
10. Why do firms issue preferred stocks?
a.
the firm is a public utility, the most common issuer
b.
to acquire a firm in a merger transaction
c.
to attract corporate rather than individual investors
d.
b and c
e.
all of the above
11. Corporations that hold preferred stock can exclude from taxation __________ of the preferred
dividends they receive.
a.
none
b.
a small fraction
c.
all
d.
a large fraction
e.
none of the above
12. External funding needs tend to __________ at the end of economic expansion and __________ during
recessions.
a.
peak; bottom out
b.
bottom out; peak
c.
peak; peak
d.
bottom out; bottom out
e.
none of the above
13. A corporation’s choice between intermediated and security market financing significantly influences
__________.
a.
its post financing ownership structure
b.
its financial flexibility
c.
its repayment burden
d.
the key features of the corporate finance system that nations develop
e.
all of the above
14. The single largest category of foreign bond issues is __________.
a.
Heidi bonds
b.
Japanese (Samurai) bonds
c.
Swiss (Heidi) bonds
d.
Yankee bonds
e.
Eurobonds
15. Public utilities often issue preferred stock. The main factors influencing the decision to pursue
preferred stock are:
a.
to reduce their taxes by gaining the tax deduction from dividends
b.
to attract more individual investors rather than corporate investors
c.
to increase credit rating and debt capacity while avoiding required return of common stock
d.
all of the above
e.
none of the above
16. A bond issued by a Swiss corporation to U.S. investors and denominated in dollars is a:
a.
Eurobond
b.
Foreign bond
c.
Samurai bond
d.
Debenture
e.
Securitized bond
17. According to a large stream of academic research, the single most important determinant of the size of
a country’s capital markets is:
a.
The degree of legal protection afforded to outside investors, which depends on whether a
country has a legal system based on English common law or another legal tradition.
b.
The state of the economy.
c.
The nation’s regulatory framework.
d.
The ability of a nation’s firms to attract investors which depends largely on the financial
strength of the majority of firms in a nation.
e.
The strength of a nation’s currency, which influences the desires of foreign investors to
move money into a nation’s financial markets.
18. Callable bonds allow the issuing entity the opportunity to retire the issue prior to maturity. When is a
bond most likely to be called?
a.
When the issuing entity has lower working capital.
b.
When market interest rates have decreased.
c.
When the issuing entity has excess cash.
d.
When the issuing entity has an excess of Treasury stock on the books that can be used to
replace the callable bonds.
e.
When the issuing entity’s bondholders are disgruntled with the firm after interest rate
increases.
19. The phrase “residual claimant” is often applied to
a.
debtholders
b.
common stockholders
c.
the lawyer representing creditors at a bankruptcy hearing
d.
a party that is able to purchase firm assets at cheap prices due to a hasty liquidation
20. Which of the following is not true of preferred stock
a.
It typically specifies a dividend per share to be received.
b.
It commonly includes a cumulative provision, whereby a missed dividend from a previous
period will be made up before any dividend payments are made to common stockholders.
c.
It generally comes with voting rights for the same decisions voted on by common
stockholders.
d.
All of these statements are true.
21. What is the largest sector of equity investors in today’s market based on dollars invested?
a.
Public and private pension funds
b.
Mutual funds
c.
Individual investors
d.
Foreign government entities
22. What does LIBOR stand for?
a.
London Institutional Borrowing Outstanding Return
b.
London Inter-Bank Offered Rate
c.
London International Banking Organizational Rule
d.
London Interest By Other Returns
23. Which of the following services would be provided by a merchant bank?
a.
Long-term loan for Microsoft
b.
Long-term loan to George Bush
c.
Checking account for a tire company
d.
Home mortgage
24. In the early 1990s who accounted for the majority of acquisition activity?
a.
The US
b.
Europe
c.
Japan
d.
Russia
25. What best describes the ownership concentration of firms in common law countries?
a.
Atomistic ownership structure
b.
Concentrated ownership structure
c.
Biased ownership structure
d.
Civil ownership structure
26. _____________ is calculated by multiplying the price per share times the number of shares
outstanding.
a.
Total equity
b.
Additional paid-in capital
c.
Treasury stock
d.
Market capitalization
27. Bonds issued and secured by transportation equipment is called
a.
Secured debt
b.
Equipment trust receipts
c.
Junior debt
d.
Mortgage bonds
28. The dominant source of financing in the United States is
a.
Internal cash from operations
b.
Bonds
c.
Preferred stock
d.
Common stock
29. Which of the following legal traditions offers the greatest protection to outside investors?
a.
German Law
b.
Scandinavian Law
c.
French Civil Law
d.
English Common Law
30. Which of the following legal traditions offers the weakest protection to outside investors?
a.
German Law
b.
Scandinavian Law
c.
French Civil Law
d.
English Common Law
31. When CFOs were asked to indicate the relative importance when making a financing decision, the
most important factor was
a.
Projected cash flow
b.
Corporate tax rate
c.
Voting control
d.
Market value of the stock
MATCHING
Match the terms to their best description:
a.
subordinated debt
b.
secured debt
c.
debenture
d.
long-term debt
e.
mortgage
1. loan backed by collateral
2. bond backed by general faith and credit of borrowing company
3. matures in more than 1 year
4. secured by real property
5. junior claims to senior debt
Match the acts with what they regulate:
a.
prohibited interstate banking
b.
mandated the separation of investment and commercial banking
c.
permitted credit unions in the U.S.
d.
repealed the McFadden Act
e.
repealed the Glass-Steagall Act
6. Gramm-Leach-Bliley Act
7. McFadden Act
8. Glass-Steagall Act
Match the term with the appropriate description:
a.
Commercial Paper
b.
Subordinated Debt
c.
Secured Debt
d.
Debenture
9. long-term debt instrument backed only by the general faith and credit of the borrowing company
10. debt instrument backed by collateral
11. debt instrument entitled to received payments after senior debt claims are paid in full
12. short-term debt instrument that is sold directly to corporate and individual investors and is usually held
to maturity
SHORT ANSWER
1. A company has total book value of common stock equal to $cs, a par value of $pv per share, s shares
issued and outstanding, and the market value of the common stock is $cs2 a share.
a.
What is the company’s additional paid-in capital?
b.
What is the market capitalization?
market capitalization = $cs2 s shares outstanding = $mc million
2. What does $12.2 million in a company’s retained earnings represent?
3. What is the purpose of a cumulative voting system?
4. What does a firm consider when it determines how much capital it must raise each year?
5. Discuss the sources of financing for U.S., Western European, and Japanese corporations.
6. How do financial intermediaries (FIs) overcome the problem of assessing the true credit worthiness of
borrowers prior to lending them money and to monitor the subsequent use of the funds borrowed?
7. Explain the securitization of corporate finance.
8. What accounts for the increase in mergers and acquisitions in Europe and the U.S. during the 1990s?
9. What must be in place before a nation’s capital markets start to grow?
10. Discuss the effect of the legal traditions of the U.S., French, and German law on the size of a country’s
capital markets.
11. Carefully explain why common stockholders are considered residual claimants of a corporation.
12. Compare and contrast bondholder and preferred stockholder cash flows. In particular, discuss what
happens when promised payments are not made.
13. Critically evaluate the following claim regarding callable bonds:
“If you buy a callable bond and hold it to maturity, you will do as well as if the bond was not callable.
If the bond is called, you will make more given the bond’s call premium. Therefore, you can’t lose with
a callable bond.“
14. Discuss the incentive problem facing a large financial institution that offers both retail brokerage
services (offering buy and sell recommendations to individual investors) as well as investment banking
activities (assisting large corporations to raise debt and equity in primary market activities)
15. Var Eable Inc. has cash inflows that rise and fall with changes in short-term interest rates. Consider
what will happen to cash flows available for equity if the firm borrows funds at a floating rate or a
fixed rate.
16. Jamil owns s1 shares of stock in a firm that is preparing to hold elections for four board members.
Jamil wishes to gain a seat on the board. Jane, a current board member, and her associates hold the
remaining s2 shares. They would prefer to keep Jamil off the board of directors because he is asking
for changes that Jane and her associates don’t approve. Discuss Jamil’s chances of gaining a seat on the
board under the cumulative voting system and under the majority voting system.
17. Regular patterns have been observed for the internal/external funding patterns of U.S. corporations.
Characterize those patterns.
18. Compare the roles and services provided by financial intermediaries in the U.S. with those provided by
financial intermediaries outside the U.S.
19. Last year Hot Shots Exterminators, Inc. conducted an IPO, issuing cs0 million common shares with a
par value of $pv to investors at a price of $p per share. During its first year of operation, Hot Shots
earned a net income of $hs per share and paid a dividend of $pd per share. At the end of the year, the
company’s stock was selling for $cse per share. Construct the equity accounts for Hot Shots at the end
of its first year in business, and calculate the firm’s market capitalization.
20. Greener Side Fertilizer, Inc. estimates that its total financing needs for the coming year will be $etf
million. The firm’s required financing payments on its debt and equity financing during the coming
fiscal year will total $fd million. The firm’s financial manager estimates that operating cash flows
(OCFs) for the coming year will total $ocf million and that the following changes will occur in the
accounts noted.
Account
Forecast change
Gross fixed assets
+$gfa million
Change in current assets
+$cca million
Change in accounts payable
+$cap million
Change in accrued liabilities
+$cal million
a.
Estimate Greener Side’s free cash flow (FCF) for the coming year.
b.
How much of the free cash flow will the firm have available as a source of new internal
financing in the coming year?
c.
How much external financing will Greener Side need during the coming year to meet its total
forecast financing needs?
a.
FCF = $ocf0 million – $gfa million – ($cca million – $cap million – $cal million) = $a million
b.
$28.2 million – $fd0 million = $b million
$etf0 million – $b million = $c million
21. In the context of external financing, what are covenants?
22. Your firm has a b member board of directors, and all b positions are open. There are s million shares
of common stock outstanding. In order to ensure election of at least d desired directors, how many
shares are needed, assuming (answer each part)
a. majority voting or
b. cumulative voting
23. A firm has an b member board of directors. The firm has s million shares of stock outstanding. Of that
total, you and your allies have n million shares. How many directors can you elect in a
a. cumulative voting system?
b. majority voting system?
24. What accounts for the increase in takeover activity that began in the early 1990s?
ESSAY
1. Discuss the difference in services offered by the merchant bank system versus the security market–
based corporate finance system.
2. What is the relationship between a nation’s capital markets and the type of pension system covering
their citizens?
3. Provide at least one argument for and another against the separation of commercial banking activities
from traditional investment banking activities.
4. Discuss the changing regulatory treatment of U.S. commercial banks during the 20th century.