Sub:- CORPORATE FINANCE

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INDIAN SCHOOL OF BUSINESS

MANAGEMENT & ADMINISTRATION

AN ISO 9001 : 2008 CERTIFIED INSTITUTION

Sub:- CORPORATE FINANCE

CASE STUDY : 1

Q1) What are the conversion ratio, conversion price, and conversion premium?

Answer:Convertible bonds, often simply called converts, are usually debentures, which are unsecured bonds,that can be converted into common stock of the corporate issuer within a specified time period at the discretion of the investor. Either the number of shares or the share price is specified in the indenture. The number of shares of stock that each bond can be converted to is known as the conversion ratio. Thus, a bond that can be converted into 10 shares of stock has a conversion ratio of 10 to 1, or simply 10. If the share price is specified in the indenture instead of the number of shares, then the conversion ratio can be found by dividing the par value of the bond—$1,000—by the share price. Thus, if a share price of $

Q2) What is the straight bond value?

Answer:A straight bond is the most basic of debt investments. It is also knows as a plain vanilla bond because there are no additional features that other bonds might have. For example, some bonds can be converted into shares of common stock. As with all bonds there is default risk, which is the risk that the company could go bankrupt and no longer honor its debt obligations. It is a bond that pays interest at regular intervals, and at maturity pays back the principal that was originally invested. Straight bonds are debt instruments because they are essentially loaning money (creating debt) to an entity. The entity (government, municipality, or

Q3) What is the conversion value?

Answer:A convertible security that is trading at a price above its conversion value is said to have a conversion premium. This makes the security valuable and desirable. A convertible security is considered "busted" when it is trading at a price far below its conversion value. If the price of the underlying security falls too far below the conversion value, the convertible security is said to have reached its floor. The financial worth of the securities obtained by exchanging a convertible security for its underlying assets. Convertibles are a category of

Q4) What is the option value of the bond?

Answer:In finance, a bond option is an option to buy or sell a bond at a certain price on or before the option expiry date. These instruments are typically traded OTC.

·         A European bond option is an option to buy or sell a bond at a certain date in future for a predetermined price.

·         An American bond option is an option to buy or sell a bond on or before a certain date in future for a predetermined price.

Generally, one buys a call option on the bond if one believe

CASE STUDY : 2

Q1) What do you think about the rationale behind borrowing the entire amount?

Answer:There’s a pervasive myth that no debt is good debt. Whenever we’re talking about owing money these days, it’s almost always in a negative light. You hear it every day: homeowners are underwater, the national deficit is surging, consumers are saddled by shortsighted credit card spending, the nation’s graduates are buried under student loans.

For businesses, the truth about debt is far less ominous.

Q2) What is your company’s weighted average flotation cost, assuming all equity is raised externally?

Answer:This cost incurred by a publicly traded company when it issues new securities. Flotation costs are paid by the company that issues the new securities and includes expenses such as underwriting fees, legal fees and registration fees. Companies must consider the impact these fees will have on how much capital they can raise from a new issue. If a company sells its new shares for $50 each and its flotation costs are 5%, it will actually raise $47.50 for each share it sells (50 x 95 cents). Flotation costs, expected return on equity,

Q3) What is the true cost of building the new assembly line after taking flotation costs into account?

Answer:An assembly line is a manufacturing process (most of the time called a progressive assembly) in which parts (usually interchangeable parts) are added as the semi-finished assembly moves from work station to work station where the parts are added in sequence until the final assembly is produced. By mechanically moving the parts to the assembly work and moving the semi-finished assembly from work station to work station, a finished product can be assembled faster and with less labor than by having workers carry parts to a stationary piece for assembly.

Q4) Does it matter in this case that the entire amount is being raised from debt?

Answer:The terms "debt" and "equity" get tossed around so casually that it's worth reviewing their meanings. Debt financing refers to money raised through some sort of loan, usually for a single purpose over a defined period of time, and usually secured by some sort of collateral. Equity financing can be a founder's money invested in the business or cash from angel investors, venture capital firms, or, rarely, a government-backed community development agency—all in exchange for a portion of ownership, and therefore a share in any

CASE STUDY : 3

Q1) Rico owns $ 30,000 worth of XYZ’s stock. What rate of return is he expecting?

Answer:In the absence of taxes, the value of a leveraged firm is same as that of an unlevered firm. Thus value of XYX=Value of ABC=800,000

rLevered = runlevered +(runleverd -rdebt)*Debt/Equity

runlevered =(90000-0-0)/800000=11.25%

rdebt=10%

Q2) Show how Rico could generate exactly the same cash flows and rate of return by investing in ABC andusing homemade leverage?

Answer:ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed

Q3) What is the cost of equity for ABC? What is it for XYZ?

Answer:ABC is all-equity financed with $600,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $

Q4) What is the WACC for ABC? For XYZ? What principle have you illustrated?

Answer:Homemade Leverage and WACC [LO1] ABC Co. and XYZ Co. are identical firmsin all respects except for their capital structure. ABC is all equityfinanced with $650,000 in stock. XYZ uses both stock and perpetual debt;its

CASE STUDY : 4

Q1) How would be the new credit terms be quoted?

Answer:Credit (from Latin credere translation. "to believe") is the trust which allows one party to provide money or resources to another party where that second party does not reimburse the first party immediately (thereby generating a debt), but instead arranges either to repay or return those resources (or other materials of equal value) at a later date. The resources provided may be financial (e.g. granting a loan), or they may consist of goods or services (e.g. consumer credit). Credit encompasses any form of deferred payment.

Q2) What investment is receivables is required under the new policy?

Answer: The investment goal is to maximize investment earnings while maintaining adequate cash to meet the operating needs. Investments are made in accordance with applicable State statutes and policy. Both cash invested and cash in our bank accounts are analyzed daily and investments are purchased or sold according to our operating cash needs. Invested cash is kept in an interest bearing account. Earnings on investments will be distributed monthly as prescribed by State, and Federal Laws, Rules, and Procedures, depending on the source and type of invested funds.

Q3) Explain why the variable cost of manufacturing the shoes is not relevant here?

Answer:Variable costs can include direct material costs or direct labor costs necessary to complete a certain project. For example, a company may have variable costs associated with the packaging of one of its products. As the company moves more of this product, the costs for packaging will increase. Conversely, when fewer of these products are sold the costs for packaging will consequently decrease.A corporate expense that varies with production output. Variable costs are those costs that vary depending on a company's

Q4) If the default rate is anticipated to be 10 per cent, should the switch be made? What is the break evencredit price?

Answer:Having set its credit terms and developed a way to measure the risk of its customers, the company must next decide who should receive credit. In making this determination, the company must reconcile three contradictory objectives: (1) maximizing sales, (2) minimizing the cost of bad debts, and (3) minimizing the opportunity cost of funds tied up in accounts receivable. The solution to this dilemma is for the firm to apply the same criteria to the credit decision that it applies to any other investment decision. It must compare the incremental returns on relaxing credit standards with the incremental costs. If the difference is

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