ASSIGNMENT 1: DUE SEPTEMBER 23, 2014
(a) “The fact that firms so heavily rely on their internal capital market as a source of financing is strong evidence that internal markets are more efficient than external markets.”
Although internal capital is preferable to external capital based on the reasons below:
* According to the pecking order theory (Myers, 1984; Myers & Majluf, 1984), firms follow a hierarchical financing pattern. Thus, firms would prefer internal funds (retained earnings) to external funds because:
* External capital would result in higher cost of capital, due to direct costs such as underwriters’ fees and indirect costs such as ...view middle of the document...
(a) price-to-earnings ratio =(Market value per share)/Earnings per share
=Value of firm in 5 years =Price-to-earnings ratio * expected net come
=Value of firm in 5 years = 12M x 20 = €240M
F = P*(1 + r)n
F = future value of the investment
P = present value of the investment
R=rate of annual return on investment
n= years of investment
Fraction of the firm the Venture Capitalist should request in exchange for its €10 million investment = (37,1M/240M)*100% = 15,5%
b) Entrepreneur’s share of the firm = €240,000,000 - €37,129,300 = €202,870,700
He has enjoyed a €201,870,700 / €1,000,000 = 201.9% return on investment over 5 years, i.e. 41.5% annual return.
a) How many new shares will the company issue?
If Ex-rights share price = market value of shares prior to right issue + cash raised from right issues/Total number of shares after right issue
=> Total Number of shares after the right Issue = market value of shares prior to right issue + cash raised from right issues /Ex-Right Price
=> Number of New Shares = Total Number of shares after the right Issue - outstanding shares prior to right issue
Market value of shares = 10M*€45=450M€
Cash raised from right issue = 30M€
Total Number of shares after the right Issue =450M€+30M€/40€ =12Mshares
Number of New Shares = Total Number of shares after the right Issue-outstanding shares prior to right issue =12MShares-10MShares = 2Million shares or 2,000,000 shares
b) Subscription Price = Cash raised from right issue/number of new shares = €30,000,000 / 2,000,000 = €15 per share
c) Number of rights to purchase 1 share = Existing number of shares /New shares = 10,000,000/2,000,000 = 5
d) Value of a right =(Right-on price – Subscription Price)/N+1
= (€45 - €15)/(5 + 1)
e) If the right sells for only €4, as a shareholder seeking to create immediate Profit I will explore three options: (1) subscribe to the rights issue in full, (2) sell the rights to someone else (3) Buy additional rights from the shareholders
Subscribe to the rights issue in full
* Assuming I am a shareholder with 1000 existing shares and have been given this 1 for 5 rights offer by Great Success Corp. @ a price of subscription price of €15, the offer is already at 67% cheaper to the price levels at which Great Success Corp stock trades. Given at 4€ it means it is almost 91% cheaper to its existing stock trades.
* If I take the issue, then I will spend €4 for every Great Success Corp share that I am entitled to under the issue. As I hold 1,000 shares, I can buy up to 200 new shares (One shares for every 5 share already own) at this discounted price of €4, giving a total price of €800.
* I will need to estimate how much Success Corp Share price will be diluted to see if the right issue does in real sense give a material discount. This is because the market price of Success Corp will not stay at €45 after...