FRE-GY 6023 Week 13 Homework
4/26/2023
1
Chapter 23 Problem 10:
1.1
Part (a):
A preemptive right is a right that gives existing shareholders the option to maintain their percentage
ownership in a company by purchasing newly issued shares of common stock at a lower than the
market price, before the shares are made available to the public.
According to the given information, Corporation ABC’s management is considering a preemptive rights offering, which means they are giving current shareholders the opportunity to purchase
new shares of stock before they are offered to the general public. This is done in order to give
existing shareholders the chance to maintain their percentage ownership in the company and to
prevent dilution of their ownership stake.
1.2
Part (b):
V alue per share = Share price right bref ore − Share price right af ter
30 · 40000 30 · 40000 + 25 · 10000
=
−
40000
40000 + 10000
= 30 − 29
=1
In conclusion, we may claim that the value per right is $1.
1.3
Part (c):
The main consideration behind designing a rights offering with a relatively high value per right is
to mitigate the risk of the offering failing and to increase the share price by reducing transaction
costs. When transaction costs are high, the share price tends to be lower. To increase the share
price, transaction costs must be minimized, which can be achieved through a rights offering. By
setting a high value per right, the share price is likely to increase, reducing the likelihood of the
rights offering failing.
2
Chapter 24 Problem 6:
2.1
Part (a):
V alue per equity f or owner =
X
E[P rice] · P (P rice)
1
1
1
·8+ ·7+ ·6
3
3
3
=7
=
In conclusion, we may claim that the value of equity from the point view of owners is $7.
1
2.2
Part (b):
V alue per equity f or f inancier =
X
E[P rice] · P (P rice)
1
1
1
·7+ ·6+ ·5
3
3
3
=6
=
In conclusion, we may claim that the value of equity from the point view of financier is $6.
2.3
Part (c):
Since the value of equity from the point view of financiers is $6, and the firm raises the needed
$5.5 through equity, then all the shareholders would demand the 5.5 out of 6 shares of the firm. In
11
another word, the proportion of the shares would the financiers demand will be: P = 5.5
6 = 12 ≈
91.67%.
And we can calculate the worth of the 5.5 out of 6 shares:
W orth f or owner = V alue per equity f or owner × P
11
=7×
12
77
=
≈ 6.42
12
In conclusion, we may claim that the shares worth about $6.42 from the point view of owners.
2.4
Part (d):
Since we suppose financiers propose a debt issue that promises to pay off $5.75 if the firm has the
funds, or whatever funds are available if the firm does not generate cash flows at least equal to
$5.75, then we can have:
X
V alue of debt f or f inancier =
E[Debt] · P (P rice)
1
1
1
· 5.75 + · 5.75 + · 5
3
3
3
16.5
=
3
= 5.5
=
In conclusion, we may claim that the financiers’ value of debt is $5.5.
2.5
Part (e):
Similar to what we did in part (d), we can have:
V alue of debt f or owner =
X
E[Debt] · P (P rice)
1
1
1
· 5.75 + · 5.75 + · 5.75
3
3
3
= 5.75
=
In conclusion, we may claim that the owners’ value of debt is $5.75.
2.6
Part (f ):
The above results show that financing through equity will increase the differences between the owners’ and financier’s valuations, while financing through debts will decrease the differences between
the valuations of the financiers and the owners. Therefore, they would choose to finance through
the debts.
2
3
Chapter 24 Problem 9:
Collateral serves as a screening device that helps lenders distinguish between high-risk and low-risk
borrowers. This can lead to more efficient credit allocation and help reduce the adverse selection
problem in credit markets. Since if borrowers have valuable assets to pledge as collateral, lenders
are more likely to lend to them because they know that if the borrower defaults on the loan, they
can seize the collateral and recover some or all of the loan amount. Thus, the presence of collateral
can serve as a signal of the borrower’s creditworthiness, which can help mitigate the effects of
informational asymmetries between lenders and borrowers.
3