StudentShare solutions
Triangle menu

Capital structure analysis - Math Problem Example

Nobody downloaded yet

Extract of sample
Capital structure analysis

Since the managers are not sure of the accurate share price IST, the company would face a lemons problem if it would wish to raise the amount of capital required through issuing equity. A lemons problem takes place when both the buyers as well as the sellers have asymmetric information about the worth of the product in order to take an informed choice, and it is not possible to get hold of the correct information. For example, if in the market, the buyer cannot determine the value or worth of the product precisely, then he might be willing to pay only an average price for it, which is near about the mean value of the bid price and the offer price. But, this skews the balance towards the lemon seller (whose products are not of high quality), because receiving an average price for his low quality product is good enough for him; as the average price would definitely be higher than the price the product would command if the buyer knew in advance about the quality of the product. This occurrence also places the seller of a good quality product in a disadvantageous position, since the best value such a seller can anticipate to get for his product is an average price, which is actually lower than the value the product should command (Tel Aviv University, n.d.). Prob. a) In the case of IST, since the managers of IST are not sure about the accurate price of these shares and feel that it is either $12.5 or $14.5, so as the investors have chosen an average price and hence the shares of IST are presently trading at $ 13.50. i) At present, if the company issues equity to raise the required capital, the share price will remain $13.5. The managers of IST would always want to maximize the long-term share price of the company. If the managers know that the accurate value of the share is $12.5; because the shares would be priced at $13.5 which is higher than the actual correct price, the company will have to issue comparatively lesser number to shares as compared to the situation if the shares were priced at $12.5. If the share price was $12.5, IST would have to issue 40 million shares to raise $500 million and now that the share is trading at $13.5, it will have to issue 37.037 million shares. Thus, since in this case IST has to issue 2.96 million less shares, it gains around $40 million (2.96 million times 13.5) and hence the managers would definitely choose to issue equity to raise $500 million ii) But, if the managers know that the accurate value of the shares is $14.5, issuing equity would mean that the share price would remain at $13.5 though its actual value is more. This would go against their policy to maximize the long-term share price of the company and would also imply that the company would have to issue 2.55 million more shares than it would have at share price of $14.5. This would lead to a loss of $34.42 million (2.55 million times 13.5). If the company borrows the required amount, it has a threat of potential financial distress and the present value of the financial distress cost would be more than any tax benefit, by at least $20 million. The potential loss by issuing debt is much less than the loss by issuing equity, hence in this case the mangers would choose to borrow $500 million instead of issuing equity. Prob. b) If the management of IST issues equity, then the investors should conclude that the ...Show more

Summary

Capital Structure Analysis Table of Contents Problem 28 3 Prob. a) 4 Prob. b) 5 Prob. c) 5 Prob. d) 5 References 7 Bibliography 7 Problem 28 Info Systems Technology (IST) is a manufacturer of microprocessor chips. The company has 100 million shares outstanding and no debt…
Author : eyundt
Capital structure analysis essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the math problem on your topic
"Capital structure analysis"
with a personal 20% discount.
Grab the best paper

Check these samples - they also fit your topic

Capital Budgeting: Math Case Study (Answering questions)
1. From the given data, it can be seen that Project ‘p’ has a higher NPV as compared to Project ‘q’. Hence, if NPV is chosen as the criterion, Project ‘p’ must be preferred. However, it is also seen that Project ‘q’ has a higher IRR. Thus, form IRR point of view ‘q’ is the preferred project.
7 pages (1750 words) Math Problem
Capital Budgeting: Cash flow projections of Bauer Industries
As the capital expenditure is marked in negative, the NPV is computed by adding the Capital Expenditure to the summation of the PVs of the ten cash flows. The deduction of the capital expenditure value from the summation of the above mentioned PVs gives us the project’s NPV which is equal to 57.
3 pages (750 words) Math Problem
Quantative analysis for business
The technique revolves around five (5) simple steps. These steps are: i. Setting up a probability distribution for each of the three variable – material cost, labor cost and utilities cost ii. Preparing a cumulative probability distribution for each of the three variables iii.
16 pages (4000 words) Math Problem
Cost Benefit Analysis
In most cases such inefficiencies are caused by monopoly pricing or taxation (Brent 89). In other words, a deadweight loss can be termed as the total surplus resulting from market distortion especially from the side of government regulations on prices and in most cases the levied taxes.
12 pages (3000 words) Math Problem
Ratio Analysis
3 pages (750 words) Math Problem
Numerical analysis
These types of problems (especially systems of differential equations) are solved numerically using a number of similar algorithms which are based on the principles of numerical integration. The definition of the task "solve differential equation" means "integrate differential equation" so all differential equation numerical solving techniques are based on numerical integration, which is the problem of finding area under the curve described by differentiated function.
6 pages (1500 words) Math Problem
Fundementals of finance
The return on this combination of portfolio is measured by getting the weighted return for each stock and adding them; as apparent in the equation where wa is the proportion of stock a to the whole portfolio investment and ra is the expected return for it.
8 pages (2000 words) Math Problem
Multiple criteria decision analysis
In connection to this the main aim of this project is to use MCDA to solve the problem. For the last 10 year Bernard has wanted to own a home. After discussing with his wife, they decided to take a mortgage. But now the problem is, he does not
7 pages (1750 words) Math Problem
FINANCIAL DATA ANALYSIS
Free cash flow model of valuation estimates value of a firm based on its fundamentals. The company is expected to pay its shareholders based on intrinsic value of the firm. In addition, this value is reflected by net present cash flow. It’s
3 pages (750 words) Math Problem
Hire a pro to write
a paper under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger
Your email
YOUR PRIZE:
Apply my DISCOUNT
Comments (0)
Click to create a comment