1. (TCO D) Which of the following statements is NOT CORRECT? (a) When a corporat
ID: 2684368 • Letter: 1
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1. (TCO D) Which of the following statements is NOT CORRECT? (a) When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately, held." (b) "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. (c) Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC. (d) When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market. (e) It is possible for a firm to go public and yet not raise any additional new capital. 2. (TCO D) Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000 of new capital during each of the next three years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40 percent debt and 60 percent equity, and it wants to be at that structure in three years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6 percent of the gross debt proceeds. Yearly flotation costs for three separate issues of debt would be 3.0 percent of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in three separate issues? (a) $79,425 (b) $83,606 (c) $88,006 (d) $92,406 (e) $97,027Explanation / Answer
1. b. Going public establishes a firms true intrinsic value and ensures that a liquid market will always exist for the firms shares.
2. Explanation : Single Debt Issue = $15Million x 40% Debt to Equity Ratio = $6Million
Total Debt costs needed would be $6Million / (1-Flotation costs)
=6,000,000/(1-0.016)= 6,000,000/0.984)= 6,097,561
Multiple Debt -- $6Million in total still needed for debt proceeds
Here, total debt proceeds needed would be $6Million / (1-Flotation costs)
=6,000,000/(1-0.03)= 6,000,000/0.97)= 6,185,567
Therefore, Net savings would be 6,185,567-6,097,561 = $88,006
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