PLEASE ANSWER THE FOLLOWING QUESTION

Section B if at any point you feel that anything is unclear, please make any additional assumptions that you feel are necessary and state them clearly. 4 (a) Comment on the following statements, saying whether they are true or false, and explaining your argument precisely. (a.i) (5 marks) Convertibles represent cheaper debt. For a given face value, convertible bonds should command a higher price than regular bonds. (a.ii) (5 marks) Equity holders in real-world companies should be indifferent between nancing with convertibles vs nancing with regular debt because though they get a higher price for a given face value on convertibles this is just because they are giving up more cash ows. (a.iii) (5 marks) For a fast-growing company which undertakes a lot of regular CAPEX, it may not be appropriate to discount the tax shields associated with debt at the required rate of return of debt, even if the amount of debt is fixed in perpetuity. (b) (10 marks) Mr B. Ossy, known simply as Bossy amongst his friends (and enemies!) is the extremely successful CEO of Boring Inc, a proverbial cash cow. At present Boring Inc is allequity nanced and operates in a frictionless economy with no depreciation, amortization, CAPEX, or changes in Net Working Capital. Financial markets are perfectly competitive. Denote time in years as t = 0, 1, 2... Today is t = 0. After paying for any expenses, the rm produces in total an annual cash ow of x(t) at the end of year t, for each t = 1, 2, 3. For each t, x(t) can be variable. The expected cash ow, x, is the same for all t. The appropriate discount rate for the stream of cash flows x(t) is r t rr > 0 where rf is the risk-free rate of return. There are currently N shares outstanding. Bossy wants to shorten the vesting period of his unvested shares in Boring Inc, because he has identified an excellent house in Anacapri for his forthcoming retirement that is only available to (very rich) ash buyers. He is convinced that the only way to get a positive vote from his shareholders to achieve this is to make them believe that they are getting very "good value\" for their shareholdings, which Bossy thinks (having observed his loyal shareholders closely over the years) they measure by Boring Inc's price to earnings (PIE) ratio. The lower the PE ratio, the happier these shareholders will be to hold these shares (believing Boring to be "good value\" and condent that the market price will rise eventually to reect the high earnings), and the more likely they are to waive Bossy's vesting periods in an extraordinary vote at Boring Inc's upcoming annual general meeting. Bossy considers the following strategy: At t = 0, he will make Boring Inc issue safe perpetual debt with market value D and use the proceeds immediately to repurchase shares in the open market. Comment carefully on Bossy's proposals. Be as quantitative as possible. On the basis of what you know about the shareholders of Boring Inc, do you think his plan may succeed? If you were a shareholder in Boring Inc, how would you react to Bossy's proposal