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A 1 B D E F G Name______________________________________ Final Examination FINC 5880 Session 9 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 C Question 1. 10 points). Explain how each of the following affects corporate governance and whether the impact is positive or negative. a. Block ownership b. Greenmail c. Stock options as part of compensation . d. High level of debt e. Board of Directors comprised by majority of outsiders and compensating based in part on performance of company. . A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 Question 2. (20 points) Company Z issued bonds with detachable warrants several years ago. Each warrant allows the holder to purchase one share of stock at $30 per share. The stock has a beta of 1.3. a Calculate the exercise value of the warrants if the price of the underlying stock is $35. b. How much would an investor likely be willing to pay for the warrant over and above its exercise value? Why? c. What is 21-6. firm's stock now sells forof each alternative, if it is assumed d. Assume the Problem the effect on earnings per share $20 per share. The company that profits before interest andannual interest, percent par value bonds. wants to sell some 20-year, taxes will be 20 $1,000 of total assets. EachHowland Carpet attached 50 warrants, eachduring the past 5 years. The bond will have Company has grown rapidly exercisable into 1 share of stock at an exercise willingof $25. more or less straight bonds if the stock had a Recently, thecommercial bank urged thepay The firms for the warrant its c. Would its investor likely be price to company to consider increasing yield of 1.0? financing. Its bank loan under a lineto part b,has risen to $250,000, permanent Why?Regardless of your answer of credit assume that beta 12 percent. each warrant percent interest rate. Howland has been 30 to 60sells at $20. paying carrying an 8 will have a market value of $3 when the stock days late in What creditors.interest rate, and dollar coupon, must the company set trade coupon on the bonds with warrants if they are to clear the market? Discussions with an investment banker have resulted in the decision to raise $500,000 at this time. Investment bankers have assured the firm the following alternatives are feasible (flotation costs will be ignored): Alternative 1: Sell common stock at $8 d. Is a warrant more similar to a call option percent coupon, convertible into 100 Alternative 2: Sell convertible bonds at an 8or a put option? Why? shares of common stock for each $1,000 bond (that is, the conversion price is $10 per share). Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 100 warrants to buy common stock at $10 John L Howland, the president owns 80 percent of the common stock and wishes to maintain control of the company. One hundred thousand shares are outstanding. The following are extracts of Howland's financial statements: e. Why might an investor prefer to buy warrants rather than the underlying stock? A 53 54 55 56 B C D E F G A 1 B C D E Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 Question 3. (15 points) Company X wants to acquire another similar company. It estimates that net cash flows for the acquired company will be $8,500,000 per year for 10 years. The cost is $50,000,000. The company's cost of capital is 10 percent. A. Calculate NPV, IRR, and MIRR. b. Should the company go ahead with the project based on your calculations? Why or why not? C. Discuss 3 factors that might change your decision, e.g., what might cause NPV, IRR, or MIRR to change. F A 50 51 52 B C D E F A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 Question 4. (20 points) The Marcus Corporation plans to issue $5,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 12 percent. However, the firm's financial manager is concerned that interest rates will increase in coming months, and has decided to take a short position in U. S. government t-bond futures. See the settlement data below for t-bond futures. (Note: One standard futures contract is $100,000) Delivery Month (1) Dec Mar June Open (2) 97'28 98'03 98'13 High (3) 99'17 98'21 98'27 Low (4) 98'22 97'23 97'01 Settle (5) 99'17 98'01 97'12 Change (6) +5 +12 +7 Open Interest (7) 387,255 90,353 9,802 a. Calculate the present value of the corporate bonds if rates increase by 3 percentage points. Use short hedge, percentage of par the bond 200 contractsIt($100,000 x 100 full percentage points plus 32nds of a selling for It represents the sell futures contracts. Sell is selling at. is expressed in = $20 million). January 2001 futures percentage 105 9/32, current value sell in units of $100,000, so the value of oneIfsuch unitrates rise by January company can The easiest point. Treasury bonds is $21,056,250 ($20 million x 105 9/32%). interest would be $100,000 x 105 9/32%. repurchase futures do the calculation is to first divide help offset the loss from financing at the higher interest rate. So, the firm has hedged way to contracts at lower cost which will 9 by 32 and then add 100, or 105.28125%. Then 105.28125% x $100,000 = against rising interest rates. $105,281.25. b. Calculate the gain or loss on the corporate bond position. c. Calculate the number of futures contracts required to cover the bond position. Then calculate the current value of the futures position (round up to next whole number). A 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 B C D E F G d. Calculate the implied interest rate based on the current value of the futures position. e. Interest rates increase as expected, by 3 percentage points. Calculate the present value of the futures position based on the rate calculated above plus the 3 points. f. Calculate the gain or loss on the futures position. g. Calculate the overall net gain or loss. h. Is the company hedging or speculating? Why? Which is riskier? Why? A company plans to issue $20,000,000 of 10-year bonds 6 months from now in January 2001. Currently the company could issue the bonds at an annual rate of 12 percent. The company plans to hedge its position with Treasury bond futures because it thinks interest rates will rise in the future. Currently January 2001 Treasury bond futures are selling at 105-9. A 1 B C D E Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 Question 5. (20 points) Tundra Tots is being liquidated under Chapter 7 of the Bankruptcy Act. Its current balance sheet is shown below. Fixed assets are sold for $25,000,000 and current assets are sold for $18,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $500,000. No employee is owed over $2,000. Sale of current assets Sale of fixed assets Trustee costs 18,000,000 25,000,000 500,000 Current Assets Net fixed assets Before Default 75,000,000 50,000,000 Total assets 125,000,000 Balance Sheet Accounts payable Accrued taxes Accrued wages Notes payable Total current liabilities First-mortgage bonds Second-mortgage bonds Debentures Subordinated debentures Common stock Retained earnings Total claims Before Default 15,000,000 10,000 550,000 3,800,000 19,360,000 18,000,000 20,000,000 45,000,000 14,000,000 2,500,000 6,140,000 125,000,000 a. How much will SHs receive? b. How much will mortgage bondholders receive? c. How much will priority creditors receive? d. Identify the remaining general creditors. How much will each receive before subordination adjustment? e. How much will each of the general creditors receive after subordination adjustment? A 62 63 B C D E A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 Question 6. (15 points) Your portfolio is diversified. It has an expected return of 11% and a beta of 1.10. You want to add 200 shares of Tundra Corporation at $40 a share to your portfolio. Tundra has an expected return of 13.0% and a beta of 1.50. The total value of the investor's current portfolio is $45,000. a. Calculate the expected return on the portfolio after the purchase of the Tundra stock? b. Calculate the expected beta on the portfolio after you have added the new stock? c. Is your portfolio less risky or more risky than the market? Explain. d. Will your portfolio likely outperform or underperform the market in a period when stocks are rapidly falling in value? e. Is beta always an accurate predictor of a portfolio's performance? Explain? A 73 74 B C D E F G