Case 1

We claim that the goal of the corporations is to maximize current market value and therefore shareholders value.

Please comment on the above statement (please link your answer to the material covered during the class sessions use examples discussed during the sessions to strengthen your argument please share your knowledge)

Case 2

The Jones Family, Incorporated

The Scene: Early evening in an ordinary family room in Manhattan. Modern furniture, with old copies of The Wall Street Journal and the Financial Times scattered around. Autographed photos of Alan Greenspan and George Soros are prominently displayed. A picture window reveals a distant view of lights on the Hudson River. John Jones sits at a computer terminal, glumly sipping a glass of chardonnay and putting on a carry trade in Japanese yen over the Internet. His wife Marsha enters.

Marsha: Hi, honey. Glad to be home. Lousy day on the trading floor, though. Dullsville. No volume. But I did manage to hedge next years production from our copper mine. I couldnt get a good quote on the right package of futures contracts, so I arranged a commodity swap.

John doesnt reply. Marsha: John, whats wrong? Have you been selling yen again? Thats been a losing trade for weeks.

John: Well, yes. I shouldnt have gone to Goldman Sachss foreign exchange brunch. But Ive got to get out of the house somehow. Im cooped up here all day calculating covariances and efficient risk-return trade-offs while youre out trading commodity futures. You get all the glamour and excitement.

Marsha: Dont worry, dear, it will be over soon. We only recalculate our most efficient common stock portfolio once a quarter. Then you can go back to leveraged leases.

John: You trade, and I do all the worrying. Now theres a rumor that our leasing company is going to get a hostile takeover bid. I knew the debt ratio was too low, and you forgot to put on the poison pill. And now youve made a negative-NPV investment!

Marsha: What investment? John: That wildcat oil well. Another well in that old Sourdough field. Its going to cost $5million! Is there any oil down there?

Marsha: That Sourdough field has been good to us, John. Where do you think we got the capital for your yen trades? I bet well find oil. Our geologists say theres only a 30% chance of a dry hole.

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John: Even if we hit oil, I bet well only get 150 barrels of crude oil per day. Marsha: Thats 150 barrels day in, day out. There are 365 days in a year, dear. John and Marshas teenage son Johnny bursts into the room.

Johnny: Hi, Dad! Hi, Mom! Guess what? Ive made the junior varsity derivatives team! That means I can go on the field trip to the Chicago Board Options Exchange. (Pauses.) Whats wrong?

John: Your mother has made another negative-NPV investment. A wildcat oil well, way up on the North Slope of Alaska.

Johnny: Thats OK, Dad. Mom told me about it. I was going to do an NPV calculation yesterday, but I had to finish calculating the junk-bond default probabilities for my corporate finance homework. (Grabs a financial calculator from his backpack.) Lets see: 150 barrels a day times 365 days per year times $50 per barrel when delivered in Los Angeles . . . thats $2.7 million per year.

John: Thats $2.7 million next year, assuming that we find any oil at all. The production will start declining by 5% every year. And we still have to pay $10 per barrel in pipeline and tanker charges to ship the oil from the North Slope to Los Angeles. Weve got some serious operating leverage here.

Marsha: On the other hand, our energy consultants project increasing oil prices. If they increase with inflation, price per barrel should increase by roughly 2.5% per year. The wells ought to be able to keep pumping for at least 15 years.

Johnny: Ill calculate NPV after I finish with the default probabilities. The interest rate is 6%. Is it OK if I work with the beta of .8 and our usual figure of 7% for the market risk premium?

Marsha: I guess so, Johnny. But I am concerned about the fixed shipping costs.

John: (Takes a deep breath and stands up.) Anyway, how about a nice family dinner? Ive reserved our usual table at the Four Seasons.

Everyone exits.

Announcer: Is the wildcat well really negative-NPV? Will John and Marsha have to fight a hostile takeover? Will Johnnys derivatives team use BlackScholes or the binomial method? Find out in the next episode of The Jones Family, Incorporated.

QUESTIONS: 1. Calculate the NPV of the wildcat oil well, taking account of the probability of a dry hole, the shipping costs, the decline in production, and the forecasted

increase in oil prices. How long does production have to continue for the well to be a positive-NPV investment? Ignore taxes and other possible complications.

2. Now consider operating leverage. How should the shipping costs be valued, assuming that output is known and the costs are fixed? How would your answer change if the shipping costs were proportional to output? Assume that unexpected fluctuations in output are zero- beta and diversifiable. (Hint: The Joness oil company has an excellent credit rating. Its long-term borrowing rate is only 7%.)

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Case 3

Please elaborate on the recent rise of SPACs (Special-purpose acquisition company) interest by the investors (what are the advantages and disadvanges of SPACs and why so much interest during the last 12 months)?

(Please note that a SPAC is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company)

Case 4

1. Consider the following two statements: Dividend policy is irrelevant, and Stock price is the present value of expected future dividends. They sound contradictory.

The current price of the shares of Charles River Mining Corporation is $50. Next years earnings and dividends per share are $4 and $2, respectively. Investors expect perpetual growth at 8% per year. The expected rate of return demanded by investors is r 12%.

We can use the perpetual-growth model to calculate stock price Po= DIV/r-g = 2/.12-.08 = 50

Suppose that Charles River Mining announces that it will switch to a 100% payout policy, issuing shares as necessary to finance growth. Use the perpetual- growth model to show that current stock price is unchanged.

2. If a company pays a dividend, the investor is liable for tax on the total value of the dividend. If instead the company distributes the cash by stock repurchase, the investor is liable for tax only on any capital gain rather than on the entire amount. Therefore, even if the tax rates on dividend income and capital gains are the same, stock repurchase is always preferable to a dividend payment. Explain with a simple example why this is not the case. (Ignore the fact that capital gains may be postponed.)