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proceeds. The dividend rate is 18 percent. What is the effective cost of the preferred stock?

1 . Knab Corporation expects to raise $2 million in a rights offering. Currently, there are 250,000 shares

2

outstanding. A subscription price of $40 a share is assigned. ( a ) How many shares must be sold?

(6) How many rights are required to purchase one share of stock?

13. Barnum Company stock sells at $70 a share with rights on. The subscription price is $55. Four rights

are needed to purchase a new share of stock. What is the value of each right?

14. Assume the same facts as in Problem 13. (a) What will be the market value of the stock trading

ex rights? ( 6 )What is the value of a right when the stock is selling ex rights?

Answers to Examination 1 1

1

1. (a) No entry is required, because the companyвЂ™s account balances remain the same. However, a

memorandum is required to the effect that there are now 40,000 shares having a par value of $2.50 per

share.

$16

-= $4

4

2. Net income $2,500,000

Percent of net income retained X0.6

Retained $1,500,000

$4,000,000

New assets

Percent financed by equity X0.45

Equity financing required $1,800,000

Retained earnings 1,500,000

External equity to be issued $ 300,000

$700,000 X 20% = $140,000

Dividend in 19x1 = $200,000 X 1.05 = $210,000

4.

-=

$60вЂ™ooo $11,503.07

5.216

397

EXAMINATION I11

$120,000 6*316

-=

5.

$19,000

Looking at the present value of annuity table in Appendix D and going across 16 years to a factor nearest to

6.316 find 6.2651 at a 14 percent interest rate.

6 (4

. $5,000 X 5.6603 = $28,301.50

Year Payment Interest Principal Balance

$28,301S O

0

$5,000 $3,962.21 $1,037.79 $27,263.71

1

2 $5,000 $3,816.92 $1,183.08 $26,080.63

7. ( a ) The before-tax times-interest-earned ratio is:

Income before tax and interest - $12,000,000+ $800,000"

- =3

$800,000 + 0.16X

Interest

$12,800,000 ˜

$800,000 + 0.16X -

$12,800,000 = $2,400,000 + 0.48X

X = $21,666,667

aInterest $5,000,000 X 0.16 = $800,000.

Book value of mortgaged assets - $60,000,000 + 0.2X

=4

$5,000,000 + X

Debt

$60,000,000 + 0.2X = $20,000,000 + 4X

X = $10,526,315

-- - $5,000,000 + X = 0.8

Debt

Equity $30,000,000

$5,000,000+ X = $24,000,000

X = $19,000,000

The second condition is controlling and thus restricts the amount of new debt to $10,526,315.

8. Old interest payments

$3,600,000

($30,000,000 X 0.12)

New interest payments

($30,000,000 X 0.10) 3,000,000

Annual savings $ 600,000

Call premium ($30,000,000 0.07) $2,100,000

X

Flotation cost 800,000

Total cost $2,900,000

Present Value

Calculations

-$2,900,000

-$2,900,000 x 1

Year 0

+$600,000 X 8.5136' +5,108,160

Years 1-20

Net present value +$2,208,160

OPresent value of annuity factor for i = 10%,n = 20.

A refunding of the bond issue should occur, since it results in a positive net present value.

EXAMINATION I11

398

$408,000

Call price

9.

400,000

Face value of bond

$ 8,000

Call premium

Preferred Common

10.

Stock

stock

Regular dividend

Preferred (12% X $150,000) $18,000

Common (10%x $200,000) $20,000

Excess dividend

Preferred

[($150,000/$350,000) $12,0001 5,143

X

Common

6,857

[($200,0001$350,000)X $12,000]

$23,143 $26,857

Total dividend

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