at most, trifling disappointments? Say why or why not. 34. Pecking Order Theory.

Question

at most, trifling disappointments? Say why or why not. 34. Pecking Order Theory. Construct a simple example to show that a firm's existing stockhold ers gain if it can sell overpriced stock to new investors and invest the cash in a zero-Npu project. Who loses from these actions? If investors are aware that managers are likely to i issue stoxverpriced, what will happen to the stock price when the issue is announed? (LO16-4) 35. Peckin 8 Order Theory. When companies announce an issue of common stock, the share price typically falls. When they announce an issue of debt, there is typically only a negligible change in the stock price. Can you explain why? (LO16-4) SES 1. Log on to finance.yaboo.com and click the Key Statistics link for Pfizer (PFE) and Coca-Cola 1. Log on to finance ya (KO). Construct the debt ratio, debu/(debt +equity), for both firms. Now calculate their debt ratios by using the market value of equity but assuming that book value of debt approximates its market value. How does debt as a proportion of firm value change as you switch from book to market values? 2. On finance.yahoo.com find the profiles for PepsiCo (PEP) and IBM (IBM), and then look at each firm's annual balance sheet and income statement under Financials. Calculate the present value of the interest tax shield contributed by each company's long-term debt. Now suppose that each issues $3 billion more of fong term debt snd uses the proceeds to repurchase equity. How would the interest tax shield that the debt is fixed and permanent. 16R. W. Masulis, "The Effects of Capital Structure Change on Security Prices: A Study of Exchange Offers." Journal of Financial Economics 8 (June 1980), pp. 139-177, and "The Impact of Capital Structure Change on Firm Value," Journal of Finance 38 (March 1983), pp. 107-126.

Explanation / Answer

Data : (B=Billions)

Coca-cola(KO)

Debt Ratio Using Book Value :

Debt Ratio of PPE = $39.38B/($39.38B + $0.6335B)

= 0.984

Debt Ratio of KO = $47.11B/($47.11B + $0.25135B)

= 0.995

Debt Ratio Using Market Value :

Debt Ratio of PPE = $39.38B/($39.38B + $210.39B)

= 0.158

Debt Ratio of KO = $47.11B/($47.11B + $194.85B)

= 0.195

Change in Debt Proportion :

Particulars Pfizer(PPE)

Coca-cola(KO)

a. Debt $ 39.38B $ 47.11B b. Debt/Equity 62.16 187.47 c. Equity (Book value) [a/b] $ 0.6335B $ 0.2513B d. Equity (Market value) $ 210.39B $ 194.85B

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