Instructor: Kai Chung
Trent University - PTBO Campus
ADMN 4300H – Section A (Winter 2022)
Individual Assignment (15%)
Assignment information:
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This is an individual assignment, and each student is expected to answer ALL the questions within the
assignment.
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You are expected to source, read, and derive the appropriate answers based on the lecture slides, the
recommended textbook, as well as reliable internet-based resources.
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This assignment makes up 15% of your total 100% marks for this course.
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Please write your answers in a separate Microsoft Word document. I am not particular about margins,
font type/size, and line spacing. I am more interested in your understanding of the concepts, theories,
and their relevant application and appropriate calculations. However, for ease of my reading and
grading, font size of 11-12 is generally preferred.
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Please remember to add a Cover page – with a title, date of submission, your name, and your student
number.
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Each student must submit this assignment by the deadline – which is on February 10th (Thursday) by
11.59pm. Please submit in Microsoft Word or PDF by uploading to the Blackboard. Alternatively, you
can also hand in the physical assignment to me in class on February 10th or at earlier classes (if
preferred). For online submission, each student has 3 attempts to upload your individual assignment
in the ‘Assignments’ tab (left column) of your Blackboard. Look for the correct Individual Assignment
number to upload.
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Late submissions will have point deduction of one-tenth (10%) of your total assignment marks for
each calendar day after the deadline – unless valid reason is provided for the deadline. Note that I
rarely give deadline extension unless due to extenuating circumstances (with reasonable
documentation) or if I had been informed by SAS.
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Please take note that your individual assignment will be automatically tested with ‘SafeAssign’ in
BlackBoard for plagiarism.
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Should you have any question, please email me: kchung@trentu.ca
Have fun and enjoy the process of doing this assignment!
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Instructor: Kai Chung
Section A: True or False (20%)
Please answer all the following questions by underlining either True or Fales into the blank space
given. Each question is 2% (out of 100%)
Chapter 15:
1. Venture capitalists tend to avoid involvement in the actual running of a business.
( TRUE / FALSE )
2. Venture capital is considered private debt.
( TRUE / FALSE )
3. The risk that new securities will be sold at a loss is transferred from the issuing firm to the
underwriter in best efforts underwriting.
( TRUE / FALSE )
4. Arguments that have been presented to support IPO underpricing include diminishing the risk to the
underwriter who has agreed to a firm commitment underwriting.
( TRUE / FALSE )
5. The value of a right granted by a rights offering depends upon the price-earnings ratio of the stock.
( TRUE / FALSE )
Chapter 16:
6. The optimal capital structure is the mixture of debt and equity which maximizes the value of the firm
and minimizes the firm's weighted average cost of capital.
( TRUE / FALSE )
7. Ignoring financial distress costs, borrowing money decreases the value of the firm by increasing the
firm's tax liability.
( TRUE / FALSE )
8. When EBIT is positive, increasing financial leverage increases the sensitivity of EPS and ROE to
changes in EBIT.
( TRUE / FALSE )
9. Volatility of earnings will affect the optimal level of debt for a firm.
( TRUE / FALSE )
10. Assume there are no personal or corporate income taxes and that the firm's WACC is unaffected by
its capital structure, then a firm's cost of equity depends on the firm's business and financial risks.
( TRUE / FALSE )
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Instructor: Kai Chung
Section B: Multiple Choice Questions (40%)
Please answer all the following questions by circling or underlining the best answer choice provided.
Each question is 5% (out of 100%).
Chapter 15:
1. If an underwriter buys securities from an issuing firm and sells them directly to a small number of
investors, the underwriter has:
A. Used best efforts underwriting.
B. A bought deal.
C. A firm commitment offer.
D. A larger bid-ask spread on the securities.
E. Used regular underwriting to sell the securities.
2. Which of the following best defines the term best efforts underwriting?
A. Underwriter sells as much of the issue as possible, but can return any unsold shares to the issuer
without financial responsibility.
B. Financing for new, often high-risk ventures.
C. A group of underwriters formed to reduce the risk and help to sell an issue.
D. Loans made by a group of banks or other institutions.
E. Direct business loans of, typically, one to five years.
3. Which of the following best defines the term public issue?
A. A public issue of securities in which securities are first offered to existing shareholders. Also called
a rights offering.
B. The purchase of securities from the issuing company by an investment banker for resale to the
public.
C. A preliminary prospectus distributed to prospective investors in a new issue of securities.
D. The creation and sale of securities on public markets.
E. Legal document describing details of the issuing corporation and the proposed offering to
potential investors.
4. As an existing shareholder you have the right to participate in a privileged subscription. This gives you
the ability to do each of the following EXCEPT:
A. Maintain your percentage ownership in the firm.
B. Sell some of your rights to another party.
C. Receive the rights even after you have sold the stock, provided you sell before the holder- ofrecord date.
D. Exercise your rights and then sell the new stock you just acquired.
E. Incur a loss of wealth if you let your rights expire unexercised.
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Instructor: Kai Chung
Chapter 16:
5. The optimal capital structure has been achieved when the:
A. Debt-equity ratio is equal to 1.
B. Weight of equity is equal to the weight of debt.
C. Cost of equity is maximized given a pre-tax cost of debt.
D. Debt-equity ratio is such that the cost of debt exceeds the cost of equity.
E. Debt-equity ratio selected results in the lowest possible weighed average cost of capital.
6. M&M Proposition II with tax supports the argument that a firm's:
A. Cost of equity decreases as its weighted average cost of capital decreases.
B. Cost of equity increases as the firm increases its debt-equity ratio.
C. Cost of debt varies inversely with the debt-equity ratio.
D. Use of debt decreases the value of the firm.
E. Weighted average cost of the capital remains constant as the debt-equity ratio rises.
7. Which one of the following statements concerning bankruptcy is correct?
A. A firm is considered bankrupt when it becomes delinquent on a loan payment.
B. The administrative expenses of a bankruptcy are classified as indirect bankruptcy costs.
C. Bankruptcy costs may offset the tax-related gains from leverage.
D. The higher cost of capital which a firm pays in order to avoid excessive debt is considered a direct
cost of bankruptcy.
E. Bankruptcy is a relatively inexpensive process.
8. Which one of the following statements is correct?
A. The greater the volatility of EBIT, the more a firm should borrow.
B. Firms with a large percentage of assets invested in intangibles, should borrow more than a
comparable firm with a minimal investment in intangibles.
C. A firm with a high annual depreciation write-off benefits more from leverage than a comparable
firm with a low annual depreciation write-off.
D. The static model of capital structure identifies the precise debt-equity ratio that optimizes the
value of the firm.
E. Firms with high tax rates have a greater incentive to borrow than firms with low tax rates.
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Instructor: Kai Chung
Section C : Short Answer Questions (40%)
Please answer all the following questions, and provide relevant workings/calculation steps as part of
your answer in the space given below. Each question is 10% (10 marks).
Question 1: The Peterborough Kai Chung Corporation has announced a rights offer to raise $30 million
for a new journal, Peterborough Financial. The stock currently sells for $52 per share, and there are 3.9
million shares outstanding.
a) What is the maximum possible subscription price for the rights offer? What is the minimum
possible subscription price? (2 marks)
b) If the rights subscription price is set at $46 per share, how many rights shares must be sold? How
many rights rights will it take to buy one share? (3 marks)
c) What is the ex-rights price? What is the value of a rights? (3 marks)
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Instructor: Kai Chung
d) Show how a shareholder with 1,000 shares before the rights offering and no desire (or money) to
buy additional shares is not harmed by the rights offer. (2 marks)
Question 2: The Kai Co. and the Chung Co. have both announced IPOs at $40 per share. One of these is
undervalued by $11/share, and the other is overvalued by $3/share – but you, as an investor, does not
know which is which. You plan to buy 1,000 IPO shares from each company. If an IPO is underpriced, it
will be oversubscribed by investors, resulting in you being able to purchase half of the intended IPO
shares. Somehow, your order for 1,000 IPO shares in both companies are filled and you intend to sell all
your IPO shares on the first day of IPO share trading.
a) What profit do you actually realise at the end of the first day of IPO share trading? (5 marks)
b) What expected profit do you initially estimated? (5 marks)
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Instructor: Kai Chung
Question 3: Kaichung Corp. has no debt but can borrow at 6.4%. The firm’s WACC is currently at 9.5%,
and the tax rate is 35%.
a) What is the company’s cost of equity? (2 marks)
b) If the firm converts to 25% debt, what will its cost of equity be? (2 marks)
c) If the firm converts to 50% debt, what will its cost of equity be? (2 marks)
d) What is the company’s new WACC be in part (b) above, and in part (c) above? (4 marks)
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Instructor: Kai Chung
Question 4: Chung Manufacturing has an expected EBIT of $67,000 in perpetuity and a tax rate of 35%.
The firm has $139,000 in outstanding debt at an interest rate of 6.85%, and its unlevered cost of capital
is 10.25%.
a) What is the value of the firm according to M&M Proposition I with corporate taxes? (6 marks)
b) Should the company change its debt-equity ratio if the goal is to maximize the value of the firm?
Explain the reason for your answer. (4 marks)
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