UITS

UNIVERSITY OF INFORMATION
TECHNOLOGY & SCIENCES
Term Paper

Assignment:
Solution the Mini case of different chapter (1,4,7,14)

Course code: FIN411

Course Title: Corporate Finance

Student Name: Md. Anim-Ul-Alam

ID No: 16301021

Presented to: Rabeya Bosri

Date of Submission:
23rdAugust,2020
 Chapter 1

Question-1: What are the advantages and disadvantages of changing the company
organization from a sole proprietorship to an LLC?

Ans : The McGee Cake Company, currently operating as a sole proprietorship, may benefit
from forming a limited liability company (LLC). An LLC is a comparatively new type of business
entity. With an LLC there are reduced legal formalities in comparison to setting up a corporation.
In addition, unlike a corporation, the McGees could set up an LLC yet remain the sole owners of
the company. Another advantage as the owners of an LLC, the McGees are taxable only for
personal income and not for the income of your LLC.Therefore, they would not pay double
income tax. An LLC also has a long existence it will exist forever, irrespective of the owner’s
death or retirement. Some negatives for the McGees to consider are the expense. Although
setting up an LLC is less expensive and hectic than setting up a corporation, the cost incurred in
setting up an LLC is definitely more than that of a sole proprietary firm or a partnership firm. If
they chose to convert their sole proprietorship to an LLC, they may be taxed on appreciated
assets.
Question-2: What are the advantages and disadvantages of changing the company
organization from a sole proprietorship to a corporation?

Ans : The other business structure for the McGees to consider is the formation of a corporation.
A corporation is defined as a legal entity independent of its owners, shareholders or the
management personnel running it. As owners of the corporation the McGees will enjoy limited
liability and they are not completely responsible for the profits and losses of the corporation.
Instead, their scope of liability remains confined to their investment in the venture. With a
corporation, expansion of the business is possible and easier than with alternative business
structures. Another advantage of a corporation is that their business transactions will remain
confidential. As a corporation, the McGees may be able to find new sources of funds for
business development. Many people, including shareholders, could invest in the corporation.
Finally, the corporation is the most reliable and trusted form of business entity.
Question-3: Ultimately, what action would you recommend the company undertake? Why?

Ans : After reviewing the pros and cons to LLC and corporation business structures, as well as
the business strategy of the McGee Cake Company, I would recommend to Doc and Lyn that
they form a corporation to move the company forward. Although initial set of a corporation up
may be complicated and have some cost, the potential for the company is great. The scope of
the possibility is what makes the corporation my preferred business structure. The interest in
McGee Cake Company by both a national supermarket and restaurant chains has the potential
to be very lucrative and lead may lead to more opportunities across many states. The commonly
recognized structure of a corporation, as opposed to the somewhat new LLC, will help the
company when doing business on this larger scale. In addition, I believe being a corporation
would allow the company to be most competitive in the prepared pastry/dessert market. For the
above reasons, I believe transitioning from sole proprietorship to corporation is the best choice
for the McGee Cake Company.
 Chapter 4

Question-1: Calculate the internal growth rate and the sustainable growth rate for S&S
Air.What do these numbers mean?

Ans : Internal Growth Rate :

ROA * b /1-(ROA*b) = 0.05/0.95 =6%

This means S&S Air can growth 6% without any external financing.
Sustainable Growth Rate:
ROE *b/1-(ROE*b) = 0.0971/0.9029 = 11%
This means S&S means can growth 11% without any external equity financing, whilemaintaining
a constant debt/equity ratio.

Question-2: S&S Air is planning for a growth rate of 12% next year. Calculate the EFN for the
company assuming the company is operating at full capacity. Can the company’s sales
increase at the growth rate?

Ans : The external financing needed (EFN) would be $2,090,390. For the company to grow at
this rate they would need to find external equity financing. This is so because the sustainable
growth rate, rate of possible growth without any external equity financing, is 11%. Growing at
this rate of 12% is risky because it forces the company to increase its financial leverage.

Question-3. Assume S&S Air is currently producing at 100% percent capacity. As a result, to
increase production, the company must set up an entirely new line at a cost of $5,000,000.
Calculated the new EFN with this assumption. What does this imply about capacity utilization for
the company next year?

Ans:
 S & S air, Inc
2008, Proforma Income statement

Amount ($)

Details

sales 40,259,230

Cost of goods sold (29,336,446)

Other expenses (5,105,100)

Depreciation (1,804,220)

EBIT $4,013,464

Interest (630,520)

Taxable income $3,382,944

Taxs (40%) (1,353,178)

Net Income $2,029,766

Dividends $610,000

Retained earning $1,419,766

S&S air , Inc

2008, Proforma Balance sheet

Assets Amount ($) Liabilities and Equity Amount ($)

Current assets Current liabilities

cash 456,435 Accounts payable 929,005

Accounts receivable 733,125 Notes payable 2,121,350

Inventory 1,073,180 Total current $3,050,355

liabilities

Total current assets $2,262,740 Long-term debt $5,500,000

Assets Amount ($) Liabilities and Equity Amount ($)

Fixed assets Shareholder equity

Net plant and 17,723,430 Common stock 400,000

equipment

Total Assets $19,986,170 Retained earnings 11,035,815

Total equity $11,435,815

Total liabilities and $19,986,170

equity

Chapter-7

Question-1 : The security of the bond—that is, whether the bond has collateral.

Ans : A bond with collateral will have a lower coupon rate. Bondholders have the claim on the
collateral, even in bankruptcy. Collateral provides an asset that bondholders can claim, which
lowers their risk in default.

Question-2: The seniority of the bond.

Ans: Each security, either debt or equity, that a company issues has a specific seniority or
ranking. Bonds that have the same seniority in a company's capital structure are described as
being pari passu.

Question-3: The presence of a sinking fund.

Ans: A sinking fund is money or negotiable securities set aside for the purpose of redeeming
debt. Bonds backed by a sinking fund are less likely to default on interest payments and
repayment of principal, making them safer investments and more attractive to risk-averse
investors.

Question-4: A call provision with specified call dates and call prices.

Ans: A call provision is a stipulation on the contract for a bond—or other fixed-income
instruments—that allows the issuer to repurchase and retire the debt security. Call provision
triggering events include the underlying asset reaching a preset price and a specified
anniversary or other date being reached. The bond indenture will detail the events that can
trigger the calling of the investment. An indenture is a legal contract between the issuer and the
bondholder.
Question-5: A deferred call accompanying the call provision.

Ans: A deferred call accompanying the call provision. The deferred call means that the
company cannot call the bond for a specified period. This offers the bondholders protection for
this period. The disadvantage of a de-ferred call is that the company cannot call the bond during
the call protection period.

Question-6: A make-whole call provision.

Ans: A make-whole call provision is a type of call provision on a bond allowing the issuer to pay
off remaining debt early. The issuer typically has to make a lump-sum payment to the investor.
The payment is derived from a formula based on the net present value (NPV) of previously
scheduled coupon payments and the principal that the investor would have received.

Question-7: Any positive covenants. Also, discuss several possible positive covenants S&S Air
might consider.

take or a condition the company must abide by (Jordan, B. Westerfield, R. Ross, S. (2010) p-
213). Moreover, a positive covenant causes to reduce the coupon rate. must maintain a
minimum
specified level of working capital or a minimum specified current ratio; the company
must
maintain any collateral in good working order. The negative side of positive covenants is that the
company is restricted in its actions. The positive covenant may force the company into actions
in
the future that it would rather not undertake.
Ans: A positive covenant is a type of covenant which makes obvious for the company to agrees
to take or a condition the company must abide by. Moreover , a positive covenant causes to
reduce the coupon rate. Must maintain a minimum specified level of working capital or a
minimum specified current ratio. The company must maintain any collateral in good working
order. The positive covenant may force the company into actions in the future that it would
rather not undertake.

Question-8: Any negative covenants. Also, discuss several possible negative covenants S&S
Air might consider.

Ans: A negative covenant would reduce the coupon rate. The presence of negative covenant
protects bondholders from action by the company that would harm the bondholders. Remember,
the goal of a corporation is to maximize shareholder wealth. This says nothing about
bondholders. Examples of negative covenants would be: The company cannot increase
dividends or at least increase beyond a specified level ; The company cannot issue new bonds
senior to the current bond issue; the company cannot sell any collateral. The downside of
negative covenant is the restriction of the company’s actions.

Question-9: A conversion feature (note that S&S Air is not a publicly traded company).

Ans : Even though the company is not public, a conversion feature would likely lower the
coupon rate. According to corporate finance essential “The conversion feature would permit
bondholders to benefit if the company does well and also goes public”. The downside is that the
company maybe selling equity at a discounted price.
Question-10: A floating-rate coupon.

Ans: A floating rate fund is a fund that invests in financial instruments paying a variable or
floating interest rate. A floating rate fund invests in bonds and debt instruments whose interest
payments fluctuate with an underlying interest rate level. Typically, a fixed-rate investment will
have a stable, predictable income. However, as interest rates rise, fixed-rate investments lag
behind the market since their returns remain fixed.

Chapter-14

Question-1 : Most publicly traded corporations are required to submit quarterly (10Q) and
annual reports (10K) to the SEC detailing the financial operations of the company over the past
quarter or year, respectively. These corporate filings are available on the SEC Web site at
www.sec.gov. Go

to the SEC Web site; follow the “Search for Company Filings” link and the “Companies & Other
Filers” link; enter “Dell Inc.”; and search for SEC fi lings made by Dell. Find the most recent 10Q
or 10K, and download the form. Look on the balance sheet to find the book value of debt and
the book value of equity. If you look further down the report, you should fi nd a section titled
“Long-term Debt and Interest Rate Risk Management” that will provide a breakdown of Dell’s
long-term debt.

Ans: The book value of a company equity is the same as stockholders equity, which can be
computed by subtracting the total value of liabilities from total assets.(Total Assets) = (Total)
Liabilities + Stockholders Equity (book value of equity).Stockholders Equity (book value of
equity) = Total Assets –Total Liabilities. The book value of the company’s liabilities and equity
was found from the sitehttp://www.sec.gov . I found Dell’s Form 10K, dated January 28, 2011,
and snap shot is attached here with. Dell’s Form 10K shows the following: Book value of equity:
10-k:Total Assets =38,599 millions; Total Liabilities = 30,833 (Dell 10-K, January 28, 2011,
p.57)Book value of equity = Total Assets –Total Liabilities = $38,599 – $30,833 = $7,766
millions, (Dell 10-K, January 28, 2011, p.57).

1.Goff Computer, Inc. 3The book value of the company’s liabilities and equity was found from
the sitehttp://www.sec.gov . I found Dell’s Form 10q, dated October 28, 2011, and snap shot is
attached here with. Dell’s Form 10q showed the following (Note: 10q form also shows data of
Dell 10K dated January 28, 2011.]:Book value of equity: 10-Q:Total Assets =42,043 millions;
Total Liabilities = 33,380 (Del 10-Q, October 28, 2011)Book value of equity = Total Assets –
Total Liabilities = $42,043 – $33,380 = $8,663 millions, (Dell 10-Q, October 28, 2011)

2. Goff Computer, Inc. 4Book value of debt: It is labeled in the balance sheet as Shareholders
Equity and Liabilities.Book Value of Debt: 10k = $38,599 millions, (Dell 10-K, January 28, 2011,
p.57). 10Q = $42,043 millions, (Dell 10-Q, October 28, 2011).Long-term Debt: 10k = $5,146
millions, (Dell 10-K, January 28, 2011, p.57). 10Q = $6,430 millions, (Dell 10-Q, October 28,
2011).

Question-2: To estimate the cost of equity for Dell, go to finance.yahoo.com and enter the
ticker symbol DELL. Follow the links to answer the following questions: What is the most recent
stock price listed for Dell? What is the market value of equity, or market capitalization? How
many shares of stock does Dell have outstanding? What is the most recent annual dividend?
Can you use the dividend discount model in this case? What is the beta for Dell? Now go back
to finance.yahoo.com and follow the “Bonds” link. What is the yield on three-month Treasury
bills? Using the historical market risk premium, what is the cost of equity for Dell using CAPM?

Ans: To estimate the cost of equity, I collected various pieces of information dated March 4
2012, to calculate the CAPM. The following information, necessary for my Goff Computer, Inc.
5calculations, was gathered from finance.yahoo.com. The screen shots below show this
information .Most recent stock price is: $17.36 (finance.yahoo.com)Market Capitalization:
30.87B (finance.yahoo.com)Shares Outstanding: 1,918 millions (Dell 10-K, January 28,
2011).Dell Beta: 1.39 (finance.yahoo.com)Yield on 3-month Treasury bills: 0.04 (= 4%);
(finance.yahoo.com).Using a 7% market risk premium, what is the cost of equity for Dell using
the CAPM?

Capital Asset Pricing Model (CAPM) Rs = RF + β X (RM – RF)Expected return on stock(Rs) =

risk-free rate (RF) + Stock beta (β) x Market Risk Premium (RM – RF)= 4% + (1.39 * 7.0%)=
0.04 + (1.39 * .07)= 0.04 + 0.0973= 0.1373= 13.73%Cost of equity for Dell = 13.73%.

Question-3: You now need to calculate the cost of debt for Dell. Go to
www.finra.org/marketdata, enter Dell as the company, and find the yield to maturity for each of
Dell’s bonds. What is the weighted average cost of debt for Dell using the book value weights
and using the market value weights? Does it make a difference in this case if you

use book value weights or market value weights?

Ans: Goff Computer, Inc. 10 Values from above table, and figures obtained by clicking each
bond links were used to calculate the cost of debt for Dell. The weighted average cost of debt
for Dell using both the book value and the market value is detailed in following table: Weighted
Weighted Percent Market Percent Yield to Book Market Book value of total Quoted value of
Maturity values values (millions) (c) price (millions) total(a) (b) (c*b) (a*b)Dell GB 300 0.17
126.580 275.016 0.17 4.723% 0.80% 0.80%Dell GF $600 0.33 104.235 $566.202 0.35 0.842%
0.28% 0.30%Dell GG 500 0.28 118.345 460.530 0.28 2.401% 0.67% 0.67%Dell GH 400 0.22
125.005 322.900 0.20 4.583% 1.01% 0.92%Total $1,800 $1.00 $1,624.65 1.00 2.76% 2.69%
Analyzing above table, it seems that weighted average cost of debt using book value, the
weights are 2.76 percent, and using market value, the weights are 2.69 percent. It seems
irrelevant whether we use book or market values to calculate the cost of debt for Dell, which
Goff Computer, Inc. 11means it would not make a difference whether the book or market values
were used because they are the approximately the same, and yields almost the same cost of
debt.

Question-4: You now have all the necessary information to calculate the weighted average cost
of capital for Dell. Calculate this using book value weights and market value weights,

Assuming Dell has a 35 percent marginal tax rate. Which number is more relevant?

Ans: Using book value weights, the total value of Dell using 10k annual values is: V =
$1,800,000,000 + $7,766,000,000 V = $9,566,000,000So, the WACC based on book value
weights using 10k annual values is: WACC = (E/V) x Re + (D/V) x Rd x (1-T)Where: Re = cost
of equity Rd = cost of debt E = market value of the firms equity D = market value of the firms
debt V=E+DE/V = percentage of financing that is equity D/V = percentage of financing that is
debt T = corporate tax rate WACC = (0.1373)($ 7.7660/$9.5660) + (.0276)($1.800/$9.5660)(1
– .35) = (0.1373)*(.812) + (0.0276) * (.188) * (.65) = (.112) + (.003) Goff Computer, Inc.
12WACC = 11.5%Now using the market value weights, the total value of Dell is: V =
$1,624,650,000 + $21,728,000,000V = $23,325,600,000WACC based on market value weights
is: WACC = (E/V) x Re + (D/V) x Rd x (1-T)WACC = (0.1373) * ($21.728/$23.3256) + (.0269) *
($1.62465/$23.3526) *(1 – .35) = (.128) + (.001)WACC = 12.9%Conclusion: The cost of capital
for Dell using market value weights is higher than book value weights because of higher market-
to-book ratio for Dell. The market value is more relevant because it is the actual sale value of
the company.

Question-5: You used Dell as a pure play company to estimate the cost of capital for HCI. Are
there any potential problems with this approach in this situation?

Ans : Using Dell as a representative company to estimate cost of capital, the leading potential
problem with GCI is that it operates stores for company’s sales, while Dell sales through its
internet site. This could potentially be one of the risk factor affecting the cost of capital. Another
factor affecting the cost of capital is that Dell is a fortune 500 company, and is one of the
leaders in its industry, so it can access capital being a public company, while GCI is privately
owned company. If I had to suggest improvements, I would advice GCI to go as a public sector
company, and sale its products on internet, rather than at stores, just like Dell Inc.