Corporate Finance

27 Jun


Reliance company has a $ 1,000 face value convertible bond issue that is currently selling in the market for $ 950. Each bond is exchangeable at any time for 25 shares of the company’s stock. The convertible bond has a 7 percent coupon. Payable semi-annually. Similar non-convertible bonds are priced to yield 10 percent.

The bond matures in 10 years stock in Reliance sells for $ 36 per share.

Q1) What are the conversion ratio, conversion price, and conversion premium?

Q2) What is the straight bond value?

Q3) What is the conversion value?

Q4) What is the option value of the bond?



Suppose your company needs $ 15 million to build a new assembly line. Your target debt equity ratio is 0.90. The flotation cost for new equity is 8 percent, but the flotation cost for debt is only 5%. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.

Q1) What do you think about the rationale behind borrowing the entire amount?

Q2) What is your company’s weighted average flotation cost, assuming all equity is raised externally?

Q3) What is the true cost of building the new assembly line after taking flotation costs into account?

Q4) Does it matter in this case that the entire amount is being raised from debt?



ABC Co. & XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $ 800,000 in stock XYZ uses both stocks and perpetual debt, its stock is worth $ 400,000 and the interest rate on its debt is 10 per cent. Both firms expect EBIT to be $ 90000. Ignore taxes.

Q1) Rico owns $ 30,000 worth of XYZ’s stock. What rate of return is he expecting?

Q2) Show how Rico could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage?

Q3) What is the cost of equity for ABC? What is it for XYZ?

Q4) What is the WACC for ABC? For XYZ? What principle have you illustrated?



The Nike Company sells 3000 pairs of running shoes per month at a cash price of $88 per pair. The firm is considering a new policy that involves 30 days credit and an increase in price to $ 90.72 per pair on credit sales. The cash price will remain at $ 88 and the new policy is not expected to affect the quantity sold. The discount period will be 20 days. The required return is 1 percent per month.

Q1) How would be the new credit terms be quoted?

Q2) What investment is receivables is required under the new policy?

Q3) Explain why the variable cost of manufacturing the shoes is not relevant here?

Q4) If the default rate is anticipated to be 10 per cent, should the switch be made? What is the break even credit price?

Corporate Finance

27 Jun

Question 1

TATA Steels is looking forward for entering into a joint venture with United States Steel Corporation in USA. The company is planning to access funds from the international market. Discuss

  • Meaning of the overseas sources of finance
  • Why the company wants to raise fund from international market?
  • Methods which can be employed by the company to raise fund from the international market.
  • Is it advisable that company should go for Sourcing equity globally?


Question 2

LIMBDI Ltd started a chain of hotels with “profit maximization” as the basic financial objective and TEBDI Ltd started with a portfolio management company with the basic objective as “wealth maximization”. In light of the relevant concepts of financial management give your opinion on “which company will surely survive in long run” and why?


Question 3

Kabra Motors is considering a proposal to install new machine. The initial capital outflow will be 15 lacs. The expected cost of capital is 12 %. The expected cash inflows from the operations will be as under –

Year Cash inflows
1 2
2 3
3 4
4 5
5 5


a) Calculate the NPV of the proposal. And give your opinion whether to accept or reject the proposal.

b) Calculate the profitability index and give your opinion whether to accept or reject the proposal.