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Chapter 5: Q5DQ (page 524)

Take the following list of securities and arrange them in order of their priority of claims: (LO16-1)

Preferred stock Senior debenture

Subordinated debenture Senior secured debt

Common stock Junior secured debt

Short Answer

Expert verified

According to the priority of claims, secured debts are settled first, and then other claims are paid.

Step by step solution

01

Funds

Funds refer to the pool of money collected by the corporations to function their business operations. The primary sources of funds collection are the issuance of stocksand bonds.

02

Order of claims’ settlement

The order of settling the claims according to the priority should be:

  • Senior secured debt
  • Junior secured debt
  • Senior debenture
  • Subordinate debenture
  • Preferred stock
  • Common stock

According to the settlement of claims order, those categories should be paid first with which assets are pledged.

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Most popular questions from this chapter

Discuss the reason for the differences between underwriting spreads for stocks and bonds.

Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

b. Compare the price in part a to the 8 percent call premium over par value. Which appears to be more attractive in terms of reacquiring the old bonds?

Bonds of different risk classes will have a spread between their interest rates. Is this spread always the same? Why? (LO16-2)

In what way is an investment banker a risk taker?

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of $48)? What will be the price per share immediately after the sale of stock if the P/E stays constant?
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