9-Q1 The interest held by ordinary shareholders is a residual claim.

Explain the meaning and significance

of this statement.

Residual claim: claim to profit or assets that remain after the payments of all other interested parties
have been met
In other words, ordinary shareholders are entitled to the profit (if any) that remains after all other
claimants (suppliers, employees, lenders, government bodies)
The statement means that ordinary shareholders are paid last.
Its significance is that ordinary shareholders are exposed to greater risk than all other claimants.

9-Q6 Define private equity. What are the main features that distinguish private equity from other forms
of equity finance?

Private equity refers to equity capital raised by issuing securities that are not publicly traded.
It is often associated with a new business, in which case the term venture capital (VC) is
generally used.
Or needed for acquisition of a public company where a business is purchase by its management
team MBO
Other features of private equity include the following
Degree of control and involvement in decision-making
Promised returns must be high to compensate investors for taking high risks
Investors are usually prepared to hold the investment for a period of 5 to 7 years

9-Q20 MWB Ltd is a profitable company whose ordinary shares are listed on the ASX. The company has
paid regular dividends to shareholders and has generally financed its growth by retaining about 50 per
cent of profits. Its current 5-year plan includes investment in fixed assets on a scale that will require the
raising of external equity finance during the planning period. Advise the directors on the main factors
that they should consider in deciding how to raise equity. The directors are considering

a) Rights issue
A rights issue is an issue of new shares to existing shareholders in proportion to their current
shareholding.
A rights issue can be used to raise a large amount of capital at one time
If all shareholders take up their rights, there is no change in the proportional ownership and
control of any investor
Requires a prospectus, and involves relatively high issue costs if it is underwritten
b) A series of share placement
Private issues: directly placed with chosen investors rather than the public
Can be arranged quickly and issue costs are lower than from rights issue
The ownership and control of existing shareholders will be diluted
Some companies have raised funds by combining an institutional placement with a Share
Purchase Plan that allows existing shareholders to buy additional shares at the same price
- Both involves low issue costs, because funds can be raised without issuing a prospectus
c) Establishing a dividend reinvestment plan
 The investor does not receive quarterly dividends as cash; instead, the investors dividends are
directly reinvested in the underlying equity
Can be used to raise moderate amounts of funds on a regular basis
The amounts that can be raised are limited by the companys profits/dividends, and will depend
on the extent to which shareholders decide to participate
o Participation can be encouraged by issuing shares at a discount, but this
disadvantages shareholders who choose not to participate
Flexibility is possible, in that plan can be suspended if the company does not need additional
funds

9-Q24 A listed company may make a public offer of shares, possibly in conjunction with a rights issue.
Identify factors that may favour the use of a further public offer of shares rather than a placement or a
rights issue alone

Have diverse group of investors

9-Q27 What are internal funds? What are their advantages as a source of equity?

Internal funds are retained earnings. The mgt team has the flexibility to manage the funds as compared
to getting external funds. It is also faster and cheaper to use internal funds (no transaction costs)

Internal funds are funds generated by a companys operations

The simplest measure of internal funds is cash profit which is measured before payment of interest and
dividends
Internal funds may be favoured by management:
- No issue costs are incurred
- No explicit justification for the manner in which the funds are invested
- Does not affect the control of the company
- More flexible for the firm: management can influence the level of internal funds through
dividend policy

10-Q9 Only small companies ever need bridging finance. Do you think this statement is likely to be true
or untrue? Why?

Bridging Finance: a short-term loan, usually in the form of a mortgage, to cover a need normally arising
from timing differences between two or more transactions
If bridging finance is taken to mean a short-team loan based on a mortgage, it is a form of finance
more likely to be used by smaller companies
If a large company found itself with a similar need, it would probably have access to lines of credit, or it
would probably have access to other lines of credit, or it would issue marketable securities to raise the
funds required
But large companies have used a form of bridging finance to enable a reconstruction of its liabilities to be
made.
10-Q11 From the viewpoint of the borrower, compare and contrast debtor finance and a bank overdraft.

An overdraft and debtor finance are similar in that both are flexible forms of short-term borrowing
provided by financial institutions
The main difference between debtor finance and overdraft is:
Debtor Finance Bank Overdraft
Secured primarily by accounts receivable Generally has to be secured by tangible assets,
usually real estate
Increases in line with the growth of a business Will be capped at an agreed limit, and to increase
the limit it will be necessary to make an
application to the bank

10-Q21 How does commercial paper differ from a bill of exchange?

Commercial Paper Bill of Exchange

Two parties involved
- Only the borrower has the
responsibility to pay on the maturity
date
Usually issued only by blue chip companies and
government entities
Conventional for commercial paper to be sold
without endorsement in a secondary market
transaction
Three parties involved
- Acceptor who also carries
responsibility for repayment
Can be used by a much wider range of borrowers
because of the credit-worthiness of acceptor
Conventional for bills of exchange to be sold with
endorsement in a secondary market transaction

10-Q31 Outline the main features of project finance. What distinguishes project finance from other
types of long-term finance? Explain why completion is of critical importance to the project sponsors
and the lenders.

Completion signifies the point in the life of the project when construction is completed, the project is
operational and specified cash flow levels are achieved. It does not just mean that the project assets are
physically complete. Prior to completion, the lenders have limited recourse for payment of principal or
interest (ie they have restricted access to the sponsors). Once the project is complete, lenders have no
recourse to the project sponsors and rely only on the project itself as a source of cash flows to provide
loan repayments.

The distinguishing features of project finance include:

- Base on expected cash flows and assets of the project, rather than on financial position of
the project sponsors;
- The project is established as a separate legal and financial entity;
- High proportion of debt finance (70-90%), with remainder being equity;
- Sponsor arrange a limited recourse loan;
o If the project is complete and operational, lenders have recourse only to the projects
cash flows;
o In the event of default, lenders have limited recourse to the projects sponsor.
- Are generally for much longer terms than other commercial loans
 - Completion signifies the point in the life of the project when construction is completed, and
the project is operational and specified cash flow levels are achieved
- Prior to completion, the lenders have limited recourse for repayment of principal or interest
(ie they have restricted access to the sponsors)
- Once the project is complete, lenders have no recourse to the project sponsors and rely only
on the project itself as a source of cash flows to provide loan repayments

10-Q32 It has been suggested that preference shares offer advantages over ordinary shares and bonds
in three areas: (a) the control of the original shareholders; (b) the ability of relatively uninformed
investors to value the securities; and (c) the bankruptcy risk of the company (Baskin & Miranti 1997, pp.
151-7). Consider each of these three areas in turn and compare the issue of new preference shares with
the alternatives of issuing new ordinary shares or issuing new bonds.

(a) Control of the original shareholders

Preference shares can be non-voting -> their issue does not dilute the control that the original
board/shareholders have over the affairs of the company
(b) Valuing the securities
Because preference shares require fixed payments, it is much easier to value preference shares
than ordinary shares, especially if the new investors are currently outside the company, and
hence may not be well informed
(c) Bankruptcy risk
Preference shareholders cannot force a company into a liquidation (bankruptcy); only creditors
can do that

9-P2 Katz Pty Ltd is a well-established company whose directors have decided to convert to public
company status, make a public share issue and list on the stock exchange. The company needs to raise
$7,920,000 to expand its operations. Its prospectus forecasts a dividend of 20 cents per share in its first
year as a public company and dividends are expected to grow at 6 percent per annum indefinitely.
Shareholders require a return of 14 percent per annum and the cost of listing amounts to 12 percent of
the gross proceeds from the issue. How many shares must Katz issue?

Po = d/(k-g) = 0.20 / (0.14 0.06) = $2.50

(100% - 12%)
88% -> $7920000
100% -> $9 000 000
9 000 000 / 2.50 = 3 600 000 shares to be issued
With listing costs of 12 percent, the total amount to be raised is equal to:
7,920,000 / (1 0.12) = $9 million
Using the dividend growth model, the value of a share is:
Po = D1 / (ko g) = 0.20 / (0.14 0.06) = 2.50
Therefore, the number of shares to be issued is: 9,000,000 / 2.50 = 3 600 000

10-P1 Sealex Ltd has a fixed-rate term loan of $2 million at an interest rate of 8.75 per cent per annum.
The company has earnings before interest and tax (EBIT) of $1.4 million per annum. A covenant in the
loan agreement specifies that EBIT must be at least 3.5 times greater than the total interest paid on the
companys debt. The directors of Sealex are planning to raise additional debt by borrowing at a variable
rate, initially 7.5 percent per annum. What is the maximum amount that Sealex can borrow on these
terms?

The maximum annual interest payment is 1,400,000/3.5 = $400,000

Interest on the existing loan is $2,000,000 x 8.75% = $175,000 per annum
Therefore, the additional interest must be no more than $400,000 - $175,000 = $225,000 per annum
Corresponds to additional debt of $225,000 / 7.5% = $3,000,000

10-P5 Calculate the bill prices needed to complete the following table. Assume in every case that the
face value in $1 million.

Yield = 5.1% pa 5.2% pa 5.3% pa

30d 995825.72 995744.22 995662.73
90d 987580.83 987340.40 987100.09
180d 975466.35 974997.23 974528.76

P = F / (1 + r x d/365) = 1 000 000 / (1 + 0.052 x 90/365) = 987340.40

The most obvious patterns in the table are that the price is negatively related to both the yield (r) and the
term (d). For example, if the yield increases (decreases) then the price decreases (increases)

Suppose yields were 5.2 percent per annum for all terms to maturity, and then they decrease to 5.1
percent per annum, or increase to 5.3 percent per annum, then the capital gains or losses would be:
Yield decreases to 5.1 pa Yield increases to 5.3 pa
30 days $81.50 gain $81.49 loss
90 days $240.43 gain $240.31 loss
180 days $469.02 gain $468.57 loss
Slightly less obvious patterns are present in the price changes:
- The absolute size of the gain or loss increases with term
- The losses are slightly less (in absolute value) than the gains
-
10-P10 XYZ Ltd converting preference shares have a face value of $15 and are due to convert to ordinary
shares on 31 July 2019. Each converting preference share will convert to a number of ordinary shares
that is determined by dividing $15 by:

i. An amount equal to the price of XYZ ordinary shares on 31 July 2019, less 5 percent; or
ii. $15, whichever yields the greater number of ordinary shares.

How many ordinary shares will be received by the holder of one converting preference share if the price
of an XYZ ordinary share is:

$5 $15/$5 x (1-5%) = 3.1579 > 1

$7.50 $15/$7.50 x (1-5%) = 2.1053 > 1
$10 $15/$10 x (1-5%) = 1.5789 > 1
$15 $15/$15 x (1-5%)= 1.0526 > 1
$20 $15/$20 x (1-5%) = 0.7895 < 1
Therefore, the answers are 3.1579, 2.1053, 1.5789, 1.0526 and 1
BQ1) stock split: lower the price of the share so that is more affordable

a. $2.90 x 30 = $87
b. Not true. Considering the reverse split on its own, the market capitalization of the common
equity would be unchanged. If the reverse split was interpreted as a good decision (e.g. because
the company will be able to retain the advantages of being listed on the NYSE), the market
capitalization might increase
But other factors such as continued deterioration of its loans, or more required government
investment leading to further common share dilution could drive down the shares value

BQ2)

a. Issue date: March 02, 2017; Issue Price: $17; Opening prices: $24; Closing price: $24.50
b. Return = ($24.50 - $17) / $17 = 44%
c. ($24.50 - $17) x 160.3million = $1.202 billion
d. Greater underpricing of IPOs is associated with higher trading volume in the post-listing market.
Accordingly, greater liquidity appears to be a benefit of underpricing