Part 7 Long-Term Financing
CHAPTER 19
EQUITY AND HYBRID INSTRUMENTS
CHAPTER LEARNING OBJECTIVES
19.1 Explain the basic rights associated with share ownership.
19.2 Describe the various classes of shares and the shareholders’ rights
19.3 Describe preferred shares and outline the various features associated with
19.4 Explain how combining warrants with debt issues, or issuing convertible
19.5 Describe the various hybrid financing options available to firms, and explain
how they are constructed.
Equity and Hybrid Instruments 19 – 2
MULTIPLE CHOICE QUESTIONS
1. When a corporation has only one class of shares, which of the following is NOT one of the
rights of shareholders?
a) To vote at any shareholder meeting of the corporation.
b) To vote at any director meeting of the corporation.
c) To receive any dividend declared by the corporation.
d) To receive any residual property of the corporation on dissolution.
2. The following may or may NOT be in a list of shareholders’ rights. Choose the letter that
corresponds to the correct list of rights:
1. Share in dividends 6. Examine the company records
2. Elect directors 7. Priority over unsecured junior
3. Appoint managers debt
4. Vote in general meetings 8. Issue new dividends
5. Vote in directors’ meetings 9. Declare a stock split
a) 1, 2, 3, 5, 8
b) 1, 2, 3, 5, 8, 9
c) 1, 2, 4, 6
d) 1, 2, 6, 9
3. Which of the following statements about family trusts is true?
a) Family trusts separate ownership and control.
b) Income flows to the trust beneficiaries.
c) The trustees retain the voting power.
d) All of the above statements are true.
4. You are given the following shareholders’ equity figures for Toronto Skaters Inc. (TS) for the
fiscal year ends of 2013, 2014, and 2015. What is TS’s book value per share for each of the
three years, beginning with 2013?
$ million 2013 2014 2015
Preferred stock 0 0 0
Capital stock 58,304 62,961 68,020
Retained earnings 194,442 227,601 102,770
Total shareholders’ equity 252,746 290,562 170,790
Total liabilities and equity 745,136 792,792 673,613
Total common equity 252,746 290,562 170,790
Shares outstanding year end (million) 101,027 101,358 101,784
Common dividend per share ($) 0.81 1.05 2.70*
* includes a special dividend of $1.50
a) $1.92, $2.25, and $1.01
b) $2.50, $2.87, and $1.68
c) $7.38, $7.82, and $6.62
d) $1.30, $1.28, and $1.66
5. The right of shareholders to receive new shares when new shares are issued is called:
a) a residual owner.
b) a general cash offer.
c) a private placement.
d) a pre-emptive right.
6. You are given the following shareholders’ equity figures for Toronto Skaters Inc. (TS) for the
fiscal year end of 2015. What is TS’s market to book ratio?
$ million 2015
Preferred stock 0
Capital stock 68,020
Retained earnings 102,770
Total shareholders’ equity 170,790
Total liabilities and equity 673,613
Total common equity 170,790
Shares outstanding year end (million) 101,784
Common dividend per share ($) 2.70*
Share Price $30.38
* includes a special dividend of $1.50
a) 4.59
b) 18.28
c) 30.09
d) 18.11
7. You are given the following shareholders’ equity figures for Toronto Skaters Inc. (TS) for the
fiscal year end of 2015. What is TS’s dividend yield, including and excluding the special
dividend?
$ million 2015
Preferred stock 0
Capital stock 68,021
Retained earnings 102,770
Total shareholders’ equity 170,790
Total liabilities and equity 673,613
Total common equity 170,790
Shares outstanding year end (million) 101,784
Common dividend per share ($) 2.70*
Share Price $30.38
* includes a special dividend of $1.50
a) 4.9%, 3.9%
b) 8.9%, 3.9%
c) 11.3%, 25.3%
19 – 5 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
d) 2.7%, 1.2%
8. The book value of the shareholders’ equity is represented by:
a) the total assets minus the current liabilities.
c) the sum of preferred stock, retained earnings, and common equity.
b) the sum of the par value of common stock and the accumulated retained earnings.
d) the total assets minus equity.
9. Residual owners are:
a) bond holders
b) equity holders
c) equity and preferred shareholders
d) all of the above
10. Which of the following statements about dividends is true?
a) Dividends are paid before interest is paid.
b) Dividends received by Canadian households are taxed at the marginal personal tax rate.
c) Dividends are tax deductible.
d) Dividends received by one Canadian corporation from another Canadian corporation are not
taxed.
11. Different classes of common shares are usually issued:
a) to give some shareholders control of the firm.
b) to pay more dividends to a specific class of common shares.
c) to vote at any director meeting of the corporation.
d) none of the above.
12. Use the following statements to answer this question:
I. Today, the pre-emptive right is always used by corporations to protect their investors from
dilution.
II. A common share has the characteristics of a call option because it has unlimited upside
potential.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
13. Which of the following statements is correct?
a) Family trusts ensure income flows to the people descended from the company founder.
b) Family trusts ensure all the votes are held by the trustees.
c) Family trusts nominate the managers of the corporation.
d) all of the above.
e) a and b
14. Preferred shares are ______ financing.
a) a form of debt
b) a form of equity
c) a combined form of debt and equity
d) different from debt and equity
15. In the event of liquidation, preferred shareholders rank ahead of:
a) subordinated debt holders.
b) secured debt.
c) common shareholders.
d) debenture holders.
16. Which one of the following is the reason for paying a different price for different classes of
shares in the case of a takeover?
a) Prices depend on the tax treatment of each class.
b) Prices depend on the dividend yield offered by the class.
c) Prices depend on the voting rights of the shares.
d) Prices depend on the floating of shares.
17. How would you price preferred shares?
a) As an annuity
b) As a growing annuity due
c) As a perpetuity
d) As a growing perpetuity
18. Use the following statements to answer this question:
I. A retractable preferred share can be sold back to the issuer.
II. Preferred shares provide a benefit for taxes given that dividend income receives preferential
tax treatment as compared to interest income.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
19. When dividends that have been in arrears are paid, the preferred shares have a ______
provision.
a) participating
b) cumulative
c) non-cumulative
d) retractable
20. The retraction feature:
a) protects the issuer from interest-rate risk.
b) allows the shareholder to sell it to the issuer at an early maturity date.
c) allows the issuer to buy it back from the shareholder at an early maturity date.
d) protects both the shareholder and the issuer regardless of interest rates.
21. Interest rates have gone up to 14 percent since you purchased your 10 percent preferred
shares. You would be best off if the shares had a(n) ______ feature.
a) call
b) extraction
c) redemption
d) retraction
22. Which of the following characteristics apply to straight preferred shares?
I. No maturity date
II. Pay a fixed dividend
III. Dividends are paid at regular intervals
IV. Have a positive yield spread over long Canada bonds
V. The right to sell them back to the issuer
a) I and II
b) I, II, and III
c) I, II, III, and IV
d) I, II, IV, and V
Equity and Hybrid Instruments 19 – 10
23. Which of the following statements is correct?
a) Companies issue preferred shares only to have better control of the firm.
b) Preferred shares pay a guaranteed dividend.
c) Preferred dividends are not tax deductible to the issuing firm.
c) None of the above
24. What is the tax value of money?
a) The difference between your before-tax and after-tax earnings.
b) The tax rate multiplied by the total income reported to the government.
c) Accounting for the fact that dividends are taxed more favourably than is interest income.
d) Accounting for the fact that dividends are not taxed while interest income is taxable.
25. Which of the following characteristics apply to retractable preferred shares?
I. No maturity date
II. Pay a fixed dividend at regular intervals
III. Have a positive yield spread (before tax) over mid-term Canada bonds
IV. The right to sell them back to the issuer
a) I and II
b) I, II, and III
c) I, II, III, and IV
19 – 11 Test Bank for Introduction to Corporate Finance, Fourth Canadian Edition
d) II, III, and IV
26. Which of the following characteristics apply to floating rate preferred shares?
I. Long maturity date
II. Pay a fixed dividend
III. Dividends are paid at regular intervals
IV. Have a positive yield spread (after tax) over bankers’ acceptances
V. The right to sell them back to the issuer
a) I and II
b) I, II, and III
c) III, IV, and V
d) I, III, and IV
27. In which of the following ways are some preferred shares similar to bonds?
I. Call provisions
II. Convertible features
III. Retraction provisions
IV. Rated by rating agencies
a) I, II, and III
b) I, II, and IV
c) II and III
d) I, II, III, and IV
28. Evaluate the following statement:
The cost of preferred stock is the rate of return shareholders require on the firm’s preferred
stock.
a) False.
b) True.
29. In which of the following ways do warrants differ from call options?
I. Warrants impact the firm while call options do not.
II. Call options generally have shorter maturities than warrants.
III. Any profit received from call options is taxable while that from warrants is not taxable.
IV. Volatility increases the value of call options but makes warrants less valuable.
V. The longer maturities of warrants make them less valuable.
a) I, II, and III
b) I, III, and V
c) II, IV, and V
d) I and II
30. A company has 20 million shares outstanding that are trading at $30 per share. The
company has 2 million warrants outstanding that have an exercise price of $28 per share. What
is the payoff to the warrant holders exercising them, rounded to the nearest dollar?
a) $3,636,364
b) $ 2,800,000
c) – $3,636,364
d) $6,000,000
31. Issuing bonds plus warrants is similar to issuing:
a) Retractable bonds.
b) Convertible bonds.
c) Floating rate bonds.
d) Preferred shares.
32. Punta Oil Company has 600,000 shares outstanding and has just issued 640,000 warrants.
Each warrant entitles its owner to buy one share anytime in the next quarter at a price of $40.
The common stock price is current $50. What is the payoff to the warrant holders exercising
them, rounded to the nearest dollar?
a) $774.193.54
b) $3,096,774.19
c) $3,577,684.67
d)$3,844,599.16
33. Warrants are similar to call options on stocks. What’s the equivalent of the strike price?
a) The initial price of the warrant
b) The market price of the warrant
c) The price of exercise of the warrant
d) None of the above
34. Use the following statements to answer this question:
I. A warrant’s value is due, in part, to its long-term maturity.
II. The intrinsic value of a warrant does not depend on the volatility of the stock.
a) I and II are correct.
b) I and II are incorrect.
c) I is correct and II is incorrect.
d) I is incorrect and II is correct.
35. Warrants attached to a bond:
a) are used as sweeteners to make bond issues less attractive.
b) always increase the risk of the bond.
c) always decrease the risk of the bond.
d) all of the above.
36. Which of the following support the rationale for issuing convertible bonds?
a) To reduce underwriting costs
b) To permit cheaper initial financing
c) To minimize dilution
d) All of the above are good reasons for issuing convertible bonds.
37. The ______ specifies the number of shares received for each convertible bond.
a) conversion price
b) subscription price
c) conversion ratio
d) subscription ratio
38. Which of the following is true regarding convertible bonds?
a) The convertible bond value is unrelated to the value of the stock.
b) The value of convertible debt is a function of the risk of default.
c) The conversion factor can be separated from the bond and sold separately to other investors.
d) When a bond is converted into shares, the company receives additional funds as part of the
conversion.
39. Hudson Bay Fishing Corporation has issued bonds that can be converted into common
shares when the share price is $50. The current market price of the stock is $35. The bond has
a face value of $1,000 and currently sells for $975. What is the conversion ratio for this bond?
a) 20
b) 28.6
c) 24.4
d) 27.9