04 Jun BRIEFLYEXPLAINTHEUNDERLYINGPRINCIPLE AND RATIONALIZETHEUSEOF SPINNINGBY INVESTMENTBANKS
Finance
Tenyearsago,in 2003,
GeorgeReebyfounded
a smallmail-?order
companysellinghigh-? quality
sportsequipment.SincethoseearlydaysReebySportshas grownsteadilyand been consistently profitable.
The companyhas issued2millionshares,
all of whichareowned
byGeorgeReebyand
his five children.Thecompany
doesnot useanydebtin its capitalstructure.Forsomemonths George has been
wonderingwhetherthetimehas come
to takethecompany
public.This wouldallowhimto cash
in on partof his investmentand would
makeit easierforthefirmto
raise
capital should it wish to expand
in the future.
But how much are the
shares worth? George’s
first instinct is to look at the firm’s
balance
sheet, which shows
that the book value of the
equity
is $26.34 million, or $13.17
per share.
A share price
of 13.17
would put the stock on a P/E ratio
of 6.6.
That is quite a bit lower than
the 13.1 P/E
ratio of Reeby’s larger the
rival, Molly
Sports.
Georgesuspects
that bookvalueis not necessarilya goodguideto a share’smarketvalue. Hethinks
of his daughterJenny,whoworksin an investmentbank.Shewouldundoubtedly
knowwhatthesharesareworth.Hedecidesto phone
heraftershefinishesworkthat
evening
at 9 o’clock or
before
she starts
the next
day at 6.00 a.m.
Beforephoning,
Georgejots downsomebasicdata on thecompany’sprofitability.After recoveringfromits earlylosses,
thecompanyhas earneda returnthat is
higherthan its estimated10%costof capital.Georgeis fairlyconfident
that thecompanycouldcontinueto grow
steadilyforthenextthree
to fiveyears.In fact,
hefeelsthat the
company’sgrowthhas been
somewhatheldbackin
thelast fewyearsbythedemandsfromtwoof the
childrenfor the company
to make large dividend payments.
Perhaps, if the company went
public, it
could hold back
on dividends and plow more money
back into the business.
Therearesomeclouds
on thehorizon.Competitionis increasingand
onlythat morning MollySports
announcedplans to forma mail-?order division.
Georgeis worriedthat beyond thenextthreeorso
yearsit mightbecomedifficultto find worthwhileinvestment opportunities.
Georgerealizes
thatJennywillneedto know
muchmoreabouttheprospectsforthe businessbefore
shecanputa
final figureon thevalueof
ReebySports,buthehopes
that
theinformationbelowis sufficientforherto give
a preliminaryindicationof the
valueof the
shares.
Column1 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013E
earningspershare,$ -?0.70 -?0.23 0.81 1.10 1.30 1.52 1.64 2.00 2.03 2.33 2.68
Dividend,$ 0.00 0.00 0.20 0.20 0.30 0.30 0.60 0.60 0.80 0.80 1.00
Bookvaluepershare,$ 7.70 7.00 7.61 8.51 9.51 10.73 11.77 13.17 14.40 15.93 17.62
ROE,% -?7.14 -?2.99 11.57 14.45 15.28 15.98 15.28 16.99 15.41 16.21 16.85
a) HelpJenny
to forecastdividendpayments
forReebySports
and to estimatethevalue
of thestock.You do notneedto providea singlefigure.Forexample,youmaywishto
calculatetwofigures,oneon the
assumptionthattheopportunityforfurther
profitableinvestmentis reducedin year3and anotheron theassumptionthatitis reducedin year5.You can
assumea costof equity
of 12%forthecalculation.
(21points)
OnceReebyoperatesas a marketlistedfirm,George
willhaveto justifythefirm’scapital structuretowardsshareholders.Hehas
heardfromhis daughterthatmostfirmsshould use atleastsomedegree
of debtif thegoalis
themaximizationof shareholdervalue.Jenny
mentioneda “debttax shield”as thereasonforherclaim.
George,on theotherhand
is worriedabouttheincreasedriskthatdebtmightbringforequity
holders.
b) Brieflyexplain
theleverageeffectand
howitis relatedto theexpected
riskfor shareholders.Also,explainthebalancing(ortrade-?off) theoryof capitalstructure.
Whatarethetwoeffects
thatneedto bebalancedand what
doesthetheory
implyfor thedebt/equitychoiceof Reeby?(13
points)
Georgeis increasinglyconfidentto takethefirmpublic.
However,therearestill
someissues aroundtheIPOprocess
thathehas notyetfigured
out. Hehas writtendownthesequestions and asksforyourhelp:
c) Please
explainwhata „Greenshoeoption“ is and underwhatcircumstancesitis used.
(4points)
d) WithintheIPOprocess
underwritersplayan importantrole.Definetheterms
underwriterand syndicateand explaintheirrole/purpose.(4points)
e) In 2003,
prosecutorschargedseveral
investmentbankersforwhatis called
“spinning”.
Brieflyexplaintheunderlyingprinciple
and rationalizetheuseof
spinningby investmentbanks.
(8points)
Our website has a team of professional writers who can help you write any of your homework. They will write your papers from scratch. We also have a team of editors just to make sure all papers are of HIGH QUALITY & PLAGIARISM FREE. To make an Order you only need to click Ask A Question and we will direct you to our Order Page at WriteDemy. Then fill Our Order Form with all your assignment instructions. Select your deadline and pay for your paper. You will get it few hours before your set deadline.
Fill in all the assignment paper details that are required in the order form with the standard information being the page count, deadline, academic level and type of paper. It is advisable to have this information at hand so that you can quickly fill in the necessary information needed in the form for the essay writer to be immediately assigned to your writing project. Make payment for the custom essay order to enable us to assign a suitable writer to your order. Payments are made through Paypal on a secured billing page. Finally, sit back and relax.
About Writedemy
We are a professional paper writing website. If you have searched a question and bumped into our website just know you are in the right place to get help in your coursework. We offer HIGH QUALITY & PLAGIARISM FREE Papers.
How It Works
To make an Order you only need to click on “Order Now” and we will direct you to our Order Page. Fill Our Order Form with all your assignment instructions. Select your deadline and pay for your paper. You will get it few hours before your set deadline.
Are there Discounts?
All new clients are eligible for 20% off in their first Order. Our payment method is safe and secure.