Stock and Flotation Expenses

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FI-516 – WEEK 4 – CHAPTER 20 - HOMEWORK PROBLEMS

Chapter 20 – Problem 20 – 1
(20–1) Profit or Loss on New Stock Issue
Security Brokers Inc. specializes in underwriting new issues by small firms. On a recent offering of Beedles Inc., the terms were as follows: Price to public| $5 per share|
Number of shares| 3 million|
Proceeds to Beedles| $14,000,000|
The out-of-pocket expenses incurred by Security Brokers in the design and distribution of the issue were $300,000. What profit or loss would Security Brokers incur if the issue were sold to the public at the following average price? a. $5 per share

b. $6 per share
c. $4 per share

Chapter 20 – Problem 20 – 2
(20–2) Underwriting and Flotation Expenses
The Beranek Company, whose stock price is now $25, needs to raise $20 million in common stock. Underwriters have informed the firm’s management that they must price the new issue to the public at $22 per share because of signaling effects. The underwriters’ compensation will be 5% of the issue price, so Beranek will net $20.90 per share. The firm will also incur expenses in the amount of $150,000. How many shares must the firm sell to net $20 million after underwriting and flotation expenses?

Bond Refunding Problem - Thompson Enterprises
Thompson Enterprises has $5,000,000 of bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%, and 15 years left to maturity. The bonds can be called at any time with a premium of $50 per bond.

If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations--assume that the firm's tax rate is zero.

The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?
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