Question

I) Differentiate the key differences between debt and equity?

a) Debt represents ownership in a company, while equity represents a loan.

b) Debt involves fixed payments, while equity provides a share of ownership.

c) Debt holders have voting rights, while equity holders do not.

d) Equity is a liability on the balance sheet, while debt is an asset.

ii) What general procedures must a private firm follow to go public via an initial public offering (IPO), where an investment banker plays a crucial role in a public offering?

a) Hire an investment banker, conduct due diligence, and file a registration statement with the SEC.

b) Skip due diligence, negotiate with individual investors, and announce the IPO.

c) Bypass SEC registration, disclose limited financial information, and issue shares directly to the public.

d) Conduct a reverse merger with a public company, avoiding the need for an investment banker.

iii) The common stock of Denis and Denis Research, Inc., trades for $80 per share. Investors expect the company to pay a $3.90 dividend next year, and they expect that dividend to grow at a constant rate forever. If investors require a 12% return on this stock, what is the dividend growth rate that they are anticipating?

a) 10.5%

b) 12.0%

c) 13.5%

d) 15.0%

iv) Vicky Robb is considering purchasing the common stock of Hawaii Industries, a rapidly growing boat manufacturer. What is the current (end-of-2020) value of Hawaii’s common stock, P0 = P2020?

a) $78.26

b) $82.61

c) $87.12

d) $91.78

Answer 1

Debt involves borrowing with fixed repayments and no ownership, while equity implies ownership in a company with profits via dividends and capital gains. Going public involves hiring an investment banker, due diligence, and SEC registration. Home equity is calculated as the property value minus outstanding debt, with a 10% down payment on a $200,000 home resulting in $20,000 equity.

Step-by-step explanation:

The key differences between debt and equity are significant in corporate finance. Debt involves borrowing money and repaying it over time with interest. When a firm issues bonds, it is similar to taking out a bank loan, with the primary obligation being fixed interest payments to bondholders, known as a coupon rate. However, they differ because bonds typically involve more investors and can be traded, whereas bank loans are generally with one financial institution and are more private transactions.

Regarding going public, a private firm must follow certain steps. These include hiring an investment banker, conducting due diligence, and filing a registration statement with the Securities and Exchange Commission (SEC). This process ensures that all the necessary financial information is disclosed to potential investors.

Equity, in contrast to debt, represents ownership in a company. When someone holds common stock, they do not just lend money to the firm; they own part of it and can gain through dividends and capital gains. Dividends are a direct payment from a firm to its shareholders, providing a return on their investment.

To calculate the equity a homeowner has in their home, one would subtract any outstanding debt from the property's value. In the example of a $200,000 house with a 10% down payment, the initial equity would be $20,000, as this is the amount paid upfront by the homeowner.