Question

Which of the following best describes a best efforts underwiting commitment? If the entire issue cannot be sold at the offering price, the deal is called off and the issuing company receives nothing Underwriter is only responsible for half of the issue Underwriter commits to selling as much of the issue as possible at the agreed-on offering price but can return any unsold shares to the issuer without inancial responsblity The underriter agrees to buy the eire issue and assume fuil financial responsibility for any unsold shares Free Cash Flow Growth rate 100 Cost of Capital Debt4o-total value 50% Given the data in the above table, what is the present value of the business today lusing the growing perpetuity formula)? 3000 3356 3400 3600 100,000 Debt Discount Rate Enterprise Value Perpetual Growth Rate 500,000 4% Given the data in the above table, cakculate market capitalization of this hypotheticall company 100,000 5400,000 540,000

Answer 1

Question 1: One of the merits of underwriting is it enables the company to get minimum subscription, even if public fails to subscribe , underwriters will fulfill their commitments i.e, they will assume full responsiblity for any unsold shares. Hence the correct option is (d)

Question 2 : Present value of Growing perpetuity = cash flow after tax at year 1/ (discount rate-growth rate)

Cash flow at year end =100+2% growth rate = 102

Cash flow after tax = 102-102*1% = 102-1.02= 100.98

By applying the above values, we get Present value of growing perpetuity = 100.98/(0.05-0.02) =$3366.

Hence option (b) is correct

Question 3:

Enterprise value = market value of common stock + market value of debt - cash and investments.

Hence after applying the given values,

500000 = Maket cap + 60000-100000

Market cap = 500000-60000+100000 = $540000. Hence option (d) is correct.

Question 4:

WACC Formula = (E/V * Ke) + (D/V) * Kd * (1 – Tax rate)

• E = Market Value of Equity
• V = Total market value of equity & debt
• Ke = Cost of Equity
• D = Market Value of Debt
• Kd = Cost of Debt
• Tax Rate = Corporate Tax Rate

Given debt/equity ratio =1.5 .Hence for every 1 equity , there is 1.5 debt. Total is 2.5.

Hence weight of debt = 1.5/2.5

weight of equity = 1/2.5

Therefore cost of capital = 1.5/2.5*7% + 1/2.5*5% = 6.2%. Hence option (c) is correct.

Question 5:

Debt investors take less risk because they have the first claim on the assets of the business in the event of bankruptcy. For this reason, they accept a lower rate of return, and thus the firm has a lower cost of capital when it issues debt compared to equity.

Equity investors take more risk as they only receive the residual value after debt investors have been repaid. In exchange for this risk equity investors expect a higher rate of return and therefore the implied cost of equity is greater than that of debt.

Hence , for high risk tolerance company ideal capital structure to ensure highest return on equity is 20% debt and 80% equity among the 4 options, correct option is (d)

Question 6 :

Financial buyers :These include private equity firms (also known as “financial sponsors”), venture capital firms, hedge funds, family investment offices and ultra high net worth individuals (UHNWs). These firms and executives are in the business of making investments in companies and realizing a return on their investments. Their goal is to identify private companies with attractive future growth opportunities and durable competitive advantages, invest capital, and realize a return on their investment with a sale or an IPO. hence corrrect option is (b)

Question 7 :

The difference between subordinated debt and senior debt is the priority in which the debt claims are paid by a firm in bankruptcy or liquidation. If a company has both subordinated debt and senior debt and has to file for bankruptcy or faces liquidation, the senior debt is paid back before the subordinated debt.

Hence most secure debt is senior debt followed by subordinated debt and equity .Hence correct option is (d).

Question 10:

Subordinated debts include high yield bonds, mezz warrantless, PIK notes and vendor notes etc. Revolver is a part of senior debt a not part of subordinated debt. Hence correct option is (c)

Question 9 : EV/EBITDA is a not a cashflow measure to assess the debt capacity of an organisation. Hence option(c) is correct option.

Question 8: Mezzanine debt is bullet repaid and accrues return. Hence, option(d) is correct