differences between capital budgeting decisions and capital structure decisions
Sample Solution
Exercise 1: Differences
Capital Budgeting vs. Capital Structure
- Capital Budgeting: Focuses on the long-term investment decisions a company makes. This involves evaluating potential projects (e.g., new equipment, product lines) to determine if they are financially viable and will create value for the company.
- Capital Structure: Deals with the mix of financing sources a company uses to fund its operations and investments. This includes debt (loans, bonds), equity (common stock), and retained earnings.
Operating Lease vs. Capital Lease
- Operating Lease: Similar to renting an asset. The company uses the asset for a defined period and returns it at the end. It is recorded as an off-balance sheet expense.
- Capital Lease: Essentially a financing arrangement. The lease contract transfers most of the risks and rewards of ownership to the lessee. It is capitalized (recorded as an asset and liability) on the company's balance sheet.
Key Differences:
| Feature | Operating Lease | Capital Lease |
|---|---|---|
| Impact on Balance Sheet | No impact | Asset and liability recorded |
| Treatment of Payments | Expense | Depreciation and interest expense |
| Control Over Asset | Less control | More control, similar to ownership |
Exercise 2: Shareholder Distribution
Information:
- Total Assets = Unknown (given value equals total assets)
- Shares Outstanding = 30,000
- Dividend Distribution = $200,000
Full Answer Section
1. Par and Market Value (Assumption: Total Assets = Value of Company):
Since the value of the company equals total assets and we don't have a specific par value, we can't determine the exact par value per share. However, we can calculate the book value per share:
Book Value per Share = Total Assets / Shares Outstanding
(Assuming total assets = $3,000,000): Book Value per Share = $3,000,000 / 30,000 shares = $100 per share
Market value is the current price at which a share is traded in the market. We don't have this information in the problem.
2. Balance Sheet After Dividend:
- Assets will decrease by $200,000 (dividend payment).
- Equity (retained earnings) will decrease by $200,000.
- New Book Value per Share = ($3,000,000 - $200,000) / 30,000 shares = $80 per share.
3. Balance Sheet After Stock Repurchase:
- Retained earnings will decrease by $200,000.
- Treasury Stock account will increase by $200,000 (represents the repurchased shares).
- The number of outstanding shares will decrease (specific number depends on the repurchase price).
New Book Value per Share Calculation:
We cannot determine the exact new book value per share without knowing the repurchase price per share.
Scenario 1: Repurchase at Market Price (if market price = $80):
New Shares Outstanding = 30,000 - ($200,000 / $80) = 25,000 shares New Book Value per Share = ($3,000,000 - $200,000) / 25,000 shares = $120 per share (This assumes all other factors remain constant)
Scenario 2: Repurchase at Different Price:
If the repurchase price is different from the market price, the calculation for new shares outstanding and book value per share will change accordingly.
Exercise 3: Rights Offering
Information:
- Outstanding Shares = 300,000
- Share Price = $20
- New Shares Issued = 20,000
- Subscription Price = $15
1. New Market Value:
We cannot directly calculate the new market value of the firm without additional information on how the rights offering affects the share price. Rights offerings typically dilute existing shareholders' ownership, potentially leading to a decrease in share price.
2. Ex-Rights Price:
The ex-rights price is the price of a share after the right to purchase new shares has been detached. We don't have enough information to calculate this precisely. However, it will likely be lower than the pre-rights price due to the dilution effect.
3. Value of a Right:
The value of a right represents the difference between the pre-rights share price and the ex-