Corporate Finance – BA303

Tutorial 9 (Answers)
Corporate Finance – BA303
1. What are the two types of lease agreements?
Answer:
• Operating Lease

An operating lease is a contract that allows for the use of an asset, but does not convey rights
of ownership of the asset.

• Finance lease

A finance lease or capital lease is a type of lease in which a finance company is typically the
legal owner of the asset during the duration of the lease, while the lessee not just has
operating control over the asset, but also has a substantial share of the economic risks and
returns from the change in the valuation of the underlying asset. At the end of the lease
arrangement, once all the payments have been made, the ownership title is transferred to the
lessee.

2. Many businesses issue loan notes, which carry the right for holders to convert them into
ordinary shares in the same business at a later date. Why might a business choose to issue
convertible loan notes rather than make an issue of equity in the first place?

Answer:

The reasons for the relative popularity of convertible loan notes include the following factors:

a. They might be easier to issue than equity, in terms of acceptability to potential

investors, because they are loan notes as long as the loan notes holder wishes
them to be, yet they can be converted to equity if it is beneficial to the loan
notes holder to do so. Thus their value is underpinned by their value as pure
loan notes, yet they have ‘upside’ potential because, in effect, they bestow the
right to buy equity at a predetermined price.
b. The business may prefer to issue loan notes to gain advantage from the tax
relief on interest, but may find it hard to do so if investors seek investments
with more potential for capital gains.

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3. The ordinary shares of Anglia Paper Company are currently trading at £3.20. Existing
shareholders are offered one new share at £2 for every three held. What is the value of the
rights issue ?

Answer:

4. Polecat plc has 18 million £0.50 ordinary shares in issue. The current stock market value
of these is £1.70 per share. The directors have decided to make a one-for-three rights issue
at £1.25 each. Julie owns 3,000 Polecat ordinary shares. Assuming that the rights issue will
be the only influence on the share price:

(a) What, in theory, will be the ex-rights price of the shares (that is, the price of the
shares once the rights issue has taken place)?
(b) For how much, in theory, could Julie sell the ‘right’ to buy one share? Will it
matter to Julie if she allows the rights to lapse (that is, she does nothing)?

Answers :

One for three rights issue means for every 3 shares that the shareholder owns, he/she get the
offer to buy 1 share. This means for 18 million shares on issue, (18/3) million or 6 million
shares are offered as rights issue to the existing shareholders.

(a) Ex-rights share price = [(18,000,000 x £1.70) + (6,000,000 x £1.25)] / 24,000,000 =

£1.5875/share

(b) Julie could sell the “right” to buy one share at (£1.5875 - £1.25) or £0.3375/share.

Yes, it does matter to Julie if she allows the rights to lapse. If that is the case, the following
happens :

Ex-rights share price = [(18,000,000 x £1.70) + (5,999,000 x £1.25)] / 23,999,000 = £1.5875 /

share

By doing that, she loses 3,000 x (£1.70 - £1.5875) or £337.50. If she take up the rights issue,
she gains 1,000 x (£1.5875 - £1.25) or £337.50 but loses 3,000 x (£1.70 - £1.5875) or £337.50
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resulting in a net gain/loss of zero. Therefore, Julie is better off by taking up the rights issue
of 1,000 shares at a price of £1.25/share as compared to the scenario where she decline it.

5. A bond with nominal value of £100 and coupon rate of 8.3 per cent has market value of
£110 What is:
(a) its flat yield?
(b) its yield to maturity in three years?

Answer:

6. What is the yield to maturity on a zero-coupon bond issued at £50, repayable at par of
£100, in ten years’ time?
Answer :