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A 1 C 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 B Question 1. 10 points). Explain how each of the following affects corporate governance and whether the impact is positive or negative. a. Block ownership A block holder is if a person ownes a large amout of a comapies shares. they have a bigger influence in to the company then to the one that is on the board of directors. so yes they have a big affect on the corporat governance. b. Greenmail A greenmail is a term that we use for mergers and acquisitions. it is if a unfriendly company is thretening to do a hostile takeover. this would be both it depens on the comapny that will try to buy the new other company. c. Stock options as part of compensation An employee stock option (ESO) is a stock option granted to specified employees of a company. ESOs carry the right, but not the obligation, to buy a certain amount of shares in the company at a predetermined price. An employee stock option is slightly different from a regular exchange-traded option because it is not generally traded on an exchange, and there is no put component. Furthermore, employees typically must wait as d. High level of debt Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated by dividing a company's total liabilities by its stockholders' equity. The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders' equity 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 Question 2. (20 points) Company Z issued bonds with detachable warrants several years ago. 8 Each warrant allows the holder to purchase one share of stock at $30 per share. The stock has 9 a beta of 1.3. 10 11 a Calculate the exercise value of the warrants if the price of the underlying stock is $35. 12 13 14 15 Exercis value $ 30.00 16 17 18 19 20 21 b. How much would an investor likely be willing to pay for the warrant over and above its 22 exercise value? Why? 23 Inveestor warrant over the exercis value $ 5,00 24 25 26 d. Assume the Problem the effect on earnings per share $20 per share. The company 27 c. What is 21-6. firm's stock now sells forof each alternative, if it is assumed 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. 28 EachHowlandinvestor Company 50 warrants, eachduring for the warrant if the stock had a The bond will have attachedwilling to pay more or less the past 5 years. c. Would the Carpet likely be has grown rapidly exercisable into 1 29 shareof 1.0? Why?an exercise urged of $25. The firms straight bonds its Recently, its commercial bank price the company to consider increasing beta of stock at 30 yield 12 percent. Regardless loan under a lineto part b,has risen to $250,000, permanent financing. Its bank of your answer of credit assume that 31 each warrant1percent interest rate. Howland has been 30 to 60investor would bay more carrying an 8 will have a that the risk of of $3 whenlowe stock sells at in paying If the beta is that means market value the stock is the so the days late 32 $20. What coupon interest rate, and dollar coupon, must the company trade creditors. warrant. amount for the 33 set on the bonds with warrants if they are to clear the market? Discussions with an investment banker have resulted in the decision to raise 34 $500,000 at this time.similar to a call option have assured the firm the following d. Is a warrant more Investment bankers or a put option? Why? 35 alternatives are feasible (flotation costs will be ignored): 36 A warrant is more similar to a call option. A warrant is a security that gives the holder the 37 Alternative 1:the obligation to buy atcommon share directly from the company at a fiexec price right but not Sell common stock a $8 Alternative 2: Sell convertible bonds at also8gives the holder the right without the obligation 38 for a pre-defined time. the call option is an percent coupon, convertible into 100 shares of common share at period of time. bond (that is, the conversion price is $10 tho buy a common stock for each $1,000 39 per share). 40 Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 41 100Why might an investor prefer to buy warrants rather than the underlying stock? e. warrants to buy common stock at $10 42 43 John L Howland,be better because if the price is dropingcommon stock andthe inverstor will a warrant would the president owns 80 percent of the over a period that wishes to maintain much money as with a share. ahundred thousandcheaper are not loese as control of the company. One warrent is always shares to buy as a share. 44 outstanding. The following are extracts of Howland's financial statements: 45 46 47 48 49 50 51 52 53 A 54 55 56 B C D E F G A 1 B C D E F Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 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. Year 16 Initial Investment 17 Cash Inflows 18 Cost of Capital 19 20 21 22 ($50,000,000) 1 2 3 8,500,000 8,500,000 8,500,000 10% Present Value of Cash Flows @ 10% Net Present Value 23 IRR 24 MIRR 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 0 ($50,000,000) 7727272.72727273 7024793 6386175.8 $2,228,820 11.03% 5.45% b. Should the company go ahead with the project based on your calculations? Why or why not? Yes they should, as we can see from the calculations the NPV is positive and the IRR is greater than the discount rate. C. Discuss 3 factors that might change your decision, e.g., what might cause NPV, IRR, or MIRR to change. it would change if the returen on project increses to more then 11%. It would also change if the expected net cash flow reduces by more the 11%. If the cost acquisition increses by more than 11 %. So all of this factors would make a change if it is higher or lower than the 11%. A 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 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 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 105 It represents the sell futures contracts. Sell is selling at. is expressed in = $20 million). January 2001 futures percentage point. 9/32, current value isin units of $100,000,million xvalue9/32%).such unit would be $100,000 x 105 9/32%. can repurchase futures the Treasury bonds sell $21,056,250 ($20 so the 105 of one If interest rates rise by January company The easiest way to do contracts atis to first divide 9 by 32 15.00000% loss from financing at the higher interest rate. So, the = $105,281.25. against calculation lower cost which will help offset the 100, or 105.28125%. Then 105.28125% x $100,000 firm has hedged and then add YTM rising interest rates. PMT Rate Nper Present value $ 300,000.00 7.50000% 20.00 $ 4,235,413.15 b. Calculate the gain or loss on the corporate bond position. Loss $ (764,587) 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). Settlement price 46 Value of the contract 47 48 49 Open (2) 97'28 98'03 98'13 97.38% $4,868,750.00 A 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 C D E F G d. Calculate the implied interest rate based on the current value of the futures position. Settlement price Value of the contract Future value PMT Number of period Rate YTM 97.38% $4,868,750.00 $5,000,000.00 $300,000.00 20 6.23% 12.47% 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. Increased Rate Rate 71 PMT 72 PV 70 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 B 15.47% 7.73% $300,000.00 $4,102,405.22 f. Calculate the gain or loss on the futures position. Gain 766,344.78 g. Calculate the overall net gain or loss. Overall Loss 1,757.93 h. Is the company hedging or speculating? Why? Which is riskier? Why? The company is hedging. Hedging is a risk management strategy to reduce the adversity due to exchange rate risk or interest rate risk. On the other hand speculation is to bet against the market to earn higher profits. 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 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? 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 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 A 1 C 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 B Question 1. 10 points). Explain how each of the following affects corporate governance and whether the impact is positive or negative. a. Block ownership A block holder is if a person ownes a large amout of a comapies shares. they have a bigger influence in to the company then to the one that is on the board of directors. so yes they have a big affect on the corporat governance. b. Greenmail A greenmail is a term that we use for mergers and acquisitions. it is if a unfriendly company is thretening to do a hostile takeover. this will have a negative affect on the as majority of the shareholdera are against this. c. Stock options as part of compensation An employee stock option (ESO) is a stock option granted to specified employees of a company. ESOs carry the right, but not the obligation, to buy a certain amount of shares in the company at a predetermined price. An employee stock option is slightly different from a regular exchange-traded option because it is not generally traded on an exchange, and there is no put component. it would have a effect on the corporate governance and emplyee have more controll till the execution of the stock. d. High level of debt Debt/Equity Ratio is a debt ratio used to measure a company's financial leverage, calculated by dividing a company's total liabilities by its stockholders' equity. The D/E ratio indicates how much debt a company is using to finance its assets relative to the amount of value represented in shareholders' equity. this would have a negative impace on the corporat governance becuase the creditors will force the decision making to be favorable to them and not to the company. e. Board of Directors comprised by majority of outsiders and compensating based in part on performance of company. It will have a positive impact to the corporate governance because the majorety of the board is from outside and they are independent. . A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 Question 2. (20 points) Company Z issued bonds with detachable warrants several years ago. 8 Each warrant allows the holder to purchase one share of stock at $30 per share. The stock has 9 a beta of 1.3. 10 11 a Calculate the exercise value of the warrants if the price of the underlying stock is $35. 12 13 14 15 Exercis value $ 30.00 16 17 18 19 20 21 b. How much would an investor likely be willing to pay for the warrant over and above its 22 exercise value? Why? 23 Inveestor warrant over the exercis value $ 5,00 24 25 26 d. Assume the Problem the effect on earnings per share $20 per share. The company 27 c. What is 21-6. firm's stock now sells forof each alternative, if it is assumed 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. 28 EachHowlandinvestor Company 50 warrants, eachduring for the warrant if the stock had a The bond will have attachedwilling to pay more or less the past 5 years. c. Would the Carpet likely be has grown rapidly exercisable into 1 29 shareof 1.0? Why?an exercise urged of $25. The firms straight bonds its Recently, its commercial bank price the company to consider increasing beta of stock at 30 yield 12 percent. Regardless loan under a lineto part b,has risen to $250,000, permanent financing. Its bank of your answer of credit assume that 31 each warrant1percent interest rate. Howland has been 30 to 60investor would bay more carrying an 8 will have a that the risk of of $3 whenlowe stock sells at in paying If the beta is that means market value the stock is the so the days late 32 $20. What coupon interest rate, and dollar coupon, must the company trade creditors. warrant. amount for the 33 set on the bonds with warrants if they are to clear the market? Discussions with an investment banker have resulted in the decision to raise 34 $500,000 at this time.similar to a call option have assured the firm the following d. Is a warrant more Investment bankers or a put option? Why? 35 alternatives are feasible (flotation costs will be ignored): 36 A warrant is more similar to a call option. A warrant is a security that gives the holder the 37 Alternative 1:the obligation to buy atcommon share directly from the company at a fiexec price right but not Sell common stock a $8 Alternative 2: Sell convertible bonds at also8gives the holder the right without the obligation 38 for a pre-defined time. the call option is an percent coupon, convertible into 100 shares of common share at period of time. bond (that is, the conversion price is $10 tho buy a common stock for each $1,000 39 per share). 40 Alternative 3: Sell debentures at an 8 percent coupon, each $1,000 bond carrying 41 100Why might an investor prefer to buy warrants rather than the underlying stock? e. warrants to buy common stock at $10 42 43 John L Howland,be better because if the price is dropingcommon stock andthe inverstor will a warrant would the president owns 80 percent of the over a period that wishes to maintain much money as with a share. ahundred thousandcheaper are not loese as control of the company. One warrent is always shares to buy as a share. 44 outstanding. The following are extracts of Howland's financial statements: 45 46 47 48 49 50 51 52 53 A 54 55 56 B C D E F G A 1 B C D E F Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 10 11 12 13 14 15 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. Year 16 Initial Investment 17 Cash Inflows 18 Cost of Capital 19 20 21 22 ($50,000,000) 1 2 3 8,500,000 8,500,000 8,500,000 10% Present Value of Cash Flows @ 10% Net Present Value 23 IRR 24 MIRR 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 0 ($50,000,000) 7727272.72727273 7024793 6386175.8 $2,228,820 11.03% 5.45% b. Should the company go ahead with the project based on your calculations? Why or why not? Yes they should, as we can see from the calculations the NPV is positive and the IRR is greater than the discount rate. C. Discuss 3 factors that might change your decision, e.g., what might cause NPV, IRR, or MIRR to change. it would change if the returen on project increses to more then 11%. It would also change if the expected net cash flow reduces by more the 11%. If the cost acquisition increses by more than 11 %. So all of this factors would make a change if it is higher or lower than the 11%. A 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 105 It represents the sell futures contracts. Sell is selling at. is expressed in = $20 million). January 2001 futures percentage point. 9/32, current value isin units of $100,000,million xvalue9/32%).such unit would be $100,000 x 105 9/32%. can repurchase futures the Treasury bonds sell $21,056,250 ($20 so the 105 of one If interest rates rise by January company The easiest way to do contracts atis to first divide 9 by 32 and then the loss from financing at the higher interest rate. So, the = $105,281.25. against calculation lower cost which will help offset add 100, or 105.28125%. Then 105.28125% x $100,000 firm has hedged YTM interest rates. 15.00000% rising PMT Rate Nper Present value $ 300,000.00 7.50000% 20.00 $ 4,235,413.15 b. Calculate the gain or loss on the corporate bond position. Loss $ (764,587) 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). Settlement price Value of the contract 97.38% $4,868,750.00 A 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 C D E F G d. Calculate the implied interest rate based on the current value of the futures position. Settlement price Value of the contract Future value PMT Number of period Rate YTM 97.38% $4,868,750.00 $5,000,000.00 $300,000.00 20 6.23% 12.47% 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. Increased Rate 70 Rate 71 PMT 72 PV 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 B 15.47% 7.73% $300,000.00 $4,102,405.22 f. Calculate the gain or loss on the futures position. Gain 766,344.78 g. Calculate the overall net gain or loss. Overall Loss 1,757.93 h. Is the company hedging or speculating? Why? Which is riskier? Why? The company is hedging. Hedging is a risk management strategy to reduce the adversity due to exchange rate risk or interest rate risk. On the other hand speculation is to bet against the market to earn higher profits. 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 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? Returen on stock Tundra Returen on portfolio 1040 5990 b. Calculate the expected beta on the portfolio after you have added the new stock? Total Value of portfolio Beta 53000 1.160377 c. Is your portfolio less risky or more risky than the market? Explain. The market has a beta of 1 and the portfolio of 1,16 this means that the portfolio is more risky than the market. d. Will your portfolio likely outperform or underperform the market in a period when stocks are rapidly falling in value? The portfolio will be underperform as the risk is higher then the market. e. Is beta always an accurate predictor of a portfolio's performance? Explain? No, beta is a good indicater becuase it looks in to the past records of a stock. If the stock is a new one it is not usfull because it has not eneove marekt volatility infromation. A 52 53 B C D E F G