CH20-Capital Structure Decision and Management

Question 1

Why is debt cheaper than equity?

Answer 1

because Debt holders get paid first and therefore have less risk.

Question 2

Advantages of going public

Answer 2

1. Diversification of owners
2. Increased liquidity
3. Increased transparency
4. Improved ability to spin off divisions

Question 3

Disadvantages of going public

Answer 3

1. Regulatory disclosure
2. Managerial flexibility
3. Surrender some control, even if majority ownership is retained
4. Exposure to market conditions

Question 4

Shareholder Rights

Answer 4

1. Control
2. Cumulative voting
3. Proxy=assign voting to another individual
4. Staggered election of directors=make it difficult to take over the BOD
5. Preemptive right=first right to purchase new stock issued

Question 5

Types of Acquisition (in detail)

Answer 5

1. Friendly acquisition = cooperative BOD, due diligence.
2. Hostile takeover = 3 ways
   2a) creeping tender offer = Quietly buy sufficient stock on open market
   2b) Tender offer = Directly contact shareholders and offer to purchase stock
   2c) Proxy fight = contact investors that didn’t sell on open market and have them assign their votes to him

Question 6

If a firm financed entirely with equity substitutes a small amount of debt for equity, what happens to WACC, the debt ratio, and the coverage ratio?

Answer 6

WACC decreases b/c debt is cheaper than equity.
Debt ratio is still low.
Coverage ratio (e.g. times interest earned) would be very high

Question 7

Define At The Money (ATM) program

Answer 7

(an alternative to issuing a fixed amount of stock at a fixed price, all at once)
allows for issuance of stock up to a specific amount over time that is sold into the existing secondary market at the current market price on an as-needed basis