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Chapter 17: Common and Preferred Stock Financing
17-11
the board.
10. Cumulative voting (LO2) In problem 9, if nine directors were to be elected, and
Ms. Ramsey and her friends had 60,001 shares and Mr. Clark had 40,001 shares plus half
the uncommitted votes, how many directors could Mr. Clark elect?
17-10. Solution:
Midland Petroleum (Continued)
(40,001 9,999 1) (9 1) 49,999 10
120,000 120,000
+ − +
=
499,990 4.17 4 directors (rounded down)
120,000
= = =
11. Strategies under cumulative voting (LO2) Mr. Michaels controls proxies for 38,000 of the
70,000 outstanding shares of Northern Airlines. Mr. Baker heads a dissident group that controls
the remaining 32,000 shares. There are seven board members to be elected and cumulative
voting rules apply. Michaels does not understand cumulative voting and plans to cast 100,000
of his 266,000 (38,000 × 7) votes for his brother-in-law, Scott. His remaining votes will be
spread evenly for three other candidates.
How many directors can Baker elect if Michaels acts as described above? Use logical
numerical analysis rather than a set formula to answer the question. Baker has 224,000
votes (32,000 × 7).
17-11. Solution:
Northern Airlines
Chapter 17: Common and Preferred Stock Financing
that he favors.
Mr. Baker could elect 4 of 7 directors with less than one half of
the votes because of Mr. Michaels’s error in voting.
12. Different classes of voting stock (LO1) Rust Pipe Co. was established in 1994. Four years
later the company went public. At that time, Robert Rust, the original owner, decided to
establish two classes of stock. The first represents Class A founders’ stock and is entitled to
10 votes per share. The normally traded common stock, designated as Class B, is entitled to
one vote per share. In late 2010 Mr. Stone, an investor was considering purchasing shares
in Rust Pipe Co. While he knew the existence of founders’ shares were not often present in
other companies, he decided to buy the shares anyway because of a new technology Rust
Pipe had developed to improve the flow of liquids through pipes.
Of the 1,200,000 total shares currently outstanding, the original founder’s family owns
51,325 shares. What is the percentage of the founder’s family votes to Class B votes?
17-12. Solution:
Rust Pipe Company
Founder’s family votes = Shares owned × 10
Class B votes = total shares – founder’s family shares
Chapter 17: Common and Preferred Stock Financing
17-13
13. Rights offering (LO3) Prime Bankcorp has issued rights to its shareholders. The
subscription price is $50 and five rights are needed along with the subscription price to buy
one of the new shares. The stock is selling for $59 rights-on.
a. What would be the value of one right?
b. If the stock goes ex-rights, what would the new stock price be?
17-13. Solution:
Prime Bankcorp
a.
o
MS
R= N + 1
−
$59 $50 $9 $1.50
5 1 6
−
= = =
+
value.
14. Procedures associated with a rights offering (LO3) Computer Graphics has announced a
rights offering for its shareholders. Carol Stevens owns 1,200 shares of Computer Graphics
stock. Four rights plus $60 cash are needed to buy one of the new shares. The stock is
currently selling for $72 rights-on.
a. What is the value of a right?
b. How many of the new shares could Carol buy if she exercised all her rights? How
much cash would this require?
c. Carol doesn’t know if she wants to exercise her rights or sell them. Would either
alternative have a more positive effect on her wealth?
17-14. Solution:
Chapter 17: Common and Preferred Stock Financing
17-14
Computer Graphics
a.
MS
R= N + 1
o−
$72 $60 $12 $2.40 Value per right
4 1 5
−
= = =
+
1,200 rights/4 rights per share = 300 shares
15. Investing in rights (LO3) Todd Winningham IV has $4,000 to invest. He has been looking
at Gallagher Tennis Clubs, Inc., common stock. Gallagher has issued a rights offering to its
common stockholders. Six rights plus $38 cash will buy one new share. Gallagher’s stock
is selling for $50 ex-rights.
a. How many rights could Todd buy with his $4,000? Alternatively, how many shares
of stock could he buy with the same $4,000 at $50 per share?
b. If Todd invests his $4,000 in Gallagher rights and the price of Gallagher stock rises to
$59 per share ex-rights, what would his dollar profit on the rights be? (First compute
profit per right.)
c. If Todd invests his $4,000 in Gallagher stock and the price of the stock rises to $59
per share ex-rights, what would his total dollar profit be?
d. What would be the answer to part b if the price of Gallagher’s stock falls to $30 per
share ex-rights instead of rising to $59?
e. What would be the answer to part c if the price of Gallagher’s stock falls to $30 per
share ex-rights?
17-15. Solution:
Chapter 17: Common and Preferred Stock Financing
17-15
Gallagher Tennis Clubs, Inc.
(Todd winningham IV)
a.
e
MS
R= N
−
$50 $38 $2 per right
6
−
==
$4,000 investment/$2 per right = 2,000 rights
$4,000 investment/$50 per share = 80 shares
b. ($59 – $38)/6 = $3.50 per right value
17-15. (Continued)
Chapter 17: Common and Preferred Stock Financing
17-16
16. Effect of rights on stockholder position (LO3) Mr. and Mrs. Anderson own five shares of
Magic Tricks Corporation’s common stock. The market value of the stock is $60. The
Andersons also have $48 in cash. They have just received word of a rights offering. One
new share of stock can be purchased at $48 for each five shares currently owned (based on
five rights).
a. What is the value of a right?
b. What is the value of the Andersons’ portfolio before the rights offering? (Portfolio in
this question represents stock plus cash.)
c. If the Andersons participate in the rights offering, what will be the value of their
portfolio, based on the diluted value (ex-rights) of the stock?
d. If they sell their five rights but keep their stock at its diluted value and hold on to their
cash, what will be the value of their portfolio?
17-16. Solution:
Magic Tricks Corp.
(The Andersons)
a.
oMS
R= N + 1
−
$60 $48 $12 $2
5 1 $6
−
= = =
+
b. Portfolio value
17-16. (Continued)
c. First compute diluted value:
Diluted value = Market value ex-rights
or
Chapter 17: Common and Preferred Stock Financing
17-17
5 old shares sold at $60 per share $300
1 new share will sell at $48 48
17. Relation of rights to EPS and the price-earnings ratio (LO3) Walker Machine Tools has
5 million shares of common stock outstanding. The current market price of Walker
common stock is $42 per share rights-on. The company’s net income this year is $15
million. A rights offering has been announced in which 500,000 new shares will be sold at
$36.50 per share. The subscription price plus 10 rights is needed to buy one of the new
shares.
a. What are the earnings per share and price-earnings ratio before the new shares are
sold via the rights offering?
b. What would the earnings per share be immediately after the rights offering? What
would the price-earnings ratio be immediately after the rights offering? (Assume
there is no change in the market value of the stock, except for the change when the
stock begins trading ex-rights.) Round all answers to two places after the decimal
point.
17-17. Solution:
Chapter 17: Common and Preferred Stock Financing
17-18
Walter Machine Tools
a. $15 million earnings/5 million shares = $3 earnings per
share
ratio
b. 5 million original shares + 500,000 new shares = 5,500,000
shares
$15 million earnings $2.73 earnings per share
5,500,000 shares =
o
MS
$42 $36.50 $5.50
R = $.50
N + 1 10 1 11
−−
= = =
+
$42 per share – $.50 = $41.50
$41.50 market price per share 15.20 price-earnings ratio
$2.73 earnings per share =
18. Aftertax comparison of preferred stock and other investments (LO5) The Omega
Corporation has some excess cash that it would like to invest in marketable securities for
a long-term hold. Its vice-president of finance is considering three investments (Omega
Corporation is in a 35 percent tax bracket and the tax rate on dividends is 15 percent).
Which one should she select based on aftertax return: (a) Treasury bonds at a 9 percent
yield; (b) corporate bonds at a 12 percent yield; or (c) preferred stock at a 10 percent yield?
17-18. Solution:
Chapter 17: Common and Preferred Stock Financing
17-19
Omega Corporation
a. Treasury bonds 9% × (1 – .35) = 9% × .65 = 5.85%
19. Preferred stock dividends in arrears (LO5) National Health Corporation (NHC) has a
cumulative preferred stock issue outstanding, which has a stated annual dividend of $9 per
share. The company has been losing money and has not paid preferred dividends for the
last five years. There are 300,000 shares of preferred stock outstanding and 600,000 shares
of common stock.
a. How much is the company behind in preferred dividends?
b. If NHC earns $11,000,000 in the coming year after taxes but before dividends, and
this is all paid out to the preferred stockholders, how much will the company be in
arrears (behind in payments)? Keep in mind that the coming year would represent the
sixth year.
c. How much, if any, would be available in common stock dividends in the coming year
if $11,000,000 is earned as explained in part b?
17-19. Solution:
Chapter 17: Common and Preferred Stock Financing
17-20
National Health Corp.
a. $9 per share × 300,000 shares × 5 years = $13,500,000
dividends in arrears.
20. Preferred stock dividends in arrears (LO5) Robbins Petroleum Company is four years in
arrears on cumulative preferred stock dividends. There are 850,000 preferred shares
outstanding, and the annual dividend is $6.50 per share. The vice-president of finance sees
no real hope of paying the dividends in arrears. She is devising a plan to compensate the
preferred stockholders for 90 percent of the dividends in arrears.
a. How much should the compensation be?
b. Robbins will compensate the preferred stockholders in the form of bonds paying
12 percent interest in a market environment in which the going rate of interest is
14 percent for similar bonds. The bonds will have a 15-year maturity. Using the bond
valuation table in Chapter 16 (Table 16–3), indicate the market value of a $1,000 par
value bond.
c. Based on market value, how many bonds must be issued to provide the compensation
determined in part a? (Round to the nearest whole number.)
17-20. Solution:
