Question

Anonyma Inc. needs financing, but does not know whether it should issue bonds or common stocks. The characteristics of each type of securities are presented below : Bonds : Anonyma could issue 10,000 traditional bonds. These bonds would have a $1,000 face value (each), a 20-year maturity, and a 4% coupon rate (coupons payable every six months). These bonds would most likely be issued at a 5% yield-to-maturity (annual, compounded every six months). However, if Anonyma accepted to pay monthly coupons (with the coupon rate remaining 4% APR, compounded every six months), the bond’s YTM would decrease to 4.5% APR, six-months compounding. The other characteristics of the bond would remain the same. Independently of the frequency of the coupons, the bond issuing fees are $500,000, payable immediately. Common shares : Alternatively, Anonyma could issue 500,000 common shares. Anonyma believes that if it issues common shares, its earnings per share next year will be $5.00. During the first four years, Anonyma plans to reinvest 60% of its net profits in the firm. The return on equity is 14% annual effective, and will be constant at least for the first four years. During the first four years, dividends will grow at the sustainable growth rate. Starting in Year 5, and forever after, dividends will grow at a rate of 2% annual effective. The expected return on common shares is 14% effective annual. Issuing fees for common shares are $1,000,000, payable immediately. Suppose that the tax rate is zero percent (0%). a) If the unique criteria that Anonyma considers to choose among these financing sources is the net amount of proceeds, which source of financing should Anonyma choose? What would be the proceeds associated with that source of financing? What would be the proceeds associated with the other sources of financing? b) Besides the net amount of proceeds, which other factor(s) should Anonyma consider? (Qualitative answer, no calculations necessary to answer part b.) Corporate

Answer 1