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A 1 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 B C D E Name_______________________________________ Final Examination FINC 5880 Session 9 Question 1. 10 points) Both Cameron and Daley are large public corporations with subsidiaries throughout the world. Cameron uses a centralized approach and makes most of the decisions for its subsidiaries. Daley uses a decentralized approach and its subsidiaries make many of their own decisions. a. Would the agency problem be more pronounced for Cameron or for Daley? Explain. b. Would agency costs likely be higher for Cameron or for Daley? Why? c. Discuss a major advantage and a major disadvantage to a centralized approach such as Cameron uses. d. Discuss a major advantage and a major disadvantage to a decentralized approach such as Daley uses. e. Which is better, a centralized or decentralized approach? Explain. F 1 2 3 4 5 6 with subsidiaries 7 throughout the ns for its subsidiaries. Daley uses a 8 s. 9 ? Explain. 10 11 12 13 14 15 16 17 18 oach such as Cameron uses. 19 20 21 22 proach such as 23Daley uses. 24 25 26 27 28 29 30 31 32 33 34 35 36 G Name_______________________________________ Final Examination FINC 5880 Session 9 Question 2. (20 points) TRANE Corporation plans to raise $4million to pay off its existing short-term bank loan of $1.2 m increase total assets by $2,800,000. The bank loan bears an interest rate of 11 percent. The company's president owns 2,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percen information is shown below. The company is considering two alternatives to raise the $4 million: (1) sell common stock at $10 per share, or (2) Sell b coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share. Current Balance Sheet Total Assets $3,200,000 - a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of th b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares. c. Calculate earnings per share for both alternatives, assuming that EBIT is 12% of total assets. d. Calculate the debt ratio under both alternatives e. Which alternative do you recommend and why? amination 5880 sion 9 existing short-term bank loan of $1.2 million and to ercent. The company's president owns 65 % of the ny. The company's tax rate is 30 percent. Balance sheet mon stock at $10 per share, or (2) Sell bonds at a 12% share. Current Liabilities Common Stock, Par $1 Retained earnings Total claims $1,500,000 1,000,000 700,000 $3,200,000 w the balance sheet after exercise of the warrants. 't buy any of the additional shares. of total assets. Name_______________________________________ Final Examination FINC 5880 Session 9 Question 3. (15 points) Mantra Corporation is interested in acquiring Corlos Corporation. Corlos has 20 million shares and a target capital structure consisting of 40 percent debt and 60 percent equity. The debt interest rate is 9%. Assum free rate of interest is 2% and the market risk premium is 10%. Corlos' free cash flow (FCF0) is $8 million per year and is expected to grow at a constant rate of 5% a year; its beta is 1. $8 million in debt. The tax rate for both companies is 35%. a. Calculate the required rate of return on equity using equation: rs= rRF + RPM(b) b. Calculate weighted average cost of capital, using equation: WACC = Wdrd(1-%) + wsrs c. Calculate the value of operations, using equation: Vops = FCF0(1+g)/WACC - g) Vops = FCF0(1+g)/(WACC - g) = d. Calculate the value of the company's equity, using equation: Vs = Vops - debt e. Calculate the current value of the company's stock. nation 80 n9 Corporation. Corlos has 20 million shares outstanding quity. The debt interest rate is 9%. Assume that the risk- t a constant rate of 5% a year; its beta is 1.2. Corlos has Name_______________________________________ Final Examination FINC 5880 Session 9 Question 4. (20 points) A Treasury bond futures contract settles at 103'16. a. Calculate the present value of one futures contract in dollars? b. Are current market interest rates higher or lower than the standardized rate on a futures contract? Explain. c. Calculate the implied annual interest rate on the futures contract. d. Calculate the new value of the futures contract if interest rates increase by 1 percentage point annually. e. Describe differences between forward and futures contracts? Illustrate, using a specific example, of how companies could use either a futures or forward contract to hedge a position. es contract? Explain. ge point c example, of how Name_______________________________________ Final Examination FINC 5880 Session 9 Question 5. (20 points) Kemper Company's balance sheet and income statement are shown below (in millions of do and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of the $5 preferred wil share of $1.00 preferred with a par value of $25 plus one 9% subordinated income debenture with a par value of $7 issue will be retired with cash. The company's tax rate is 30 percent. Current Assets Net fixed assets Balance Sheet prior to Reorganization (in millions 400 450 Total assets 850 a. Construct the pro forma balance sheet after reorganization takes place. Show the new preferred at its par value. b. Construct the pro forma income statement after reorganization takes place. How does the recapitalization affect ne stockholders? Income Statement (in millions) Prior to Reorganization Net sales 900.0 Operating expense 725.0 Net operating income 175.0 Other income 7.0 EBT Taxes Net income Dividends on $5 PS Dividends on $8 PS Income to Common SHs 182.0 54.6 127.4 5.0 122.4 30% Increased income available to common SHs with reorganization: c. Calculate the required pre-tax earnings to cover debt and preferred stock obligations, before and after the recapita d. Calculate the debt ratio before and after the reorganization? e. Would the common stockholders be in favor of the reorganization? Explain your answer, providing at least 2 reasons Final Examination FINC 5880 Session 9 eet and income statement are shown below (in millions of dollars). The company zation plan. In this plan, each share of the $5 preferred will be exchanged for one 9% subordinated income debenture with a par value of $75. The $9 preferred s 30 percent. Sheet prior to Reorganization (in millions Current liabilities Advance payments $5 preferred stock, $100 par value (1,000,000) shares $9 preferred stock, no par, callable at 100 (160,000 shares) Common stock, $0.10 par value (10,000,000) shares Retained earnings Total claims tion takes place. Show the new preferred at its par value. 350 20 100 30 50 300 850 anization takes place. How does the recapitalization affect net income available to common e Statement (in millions) After Reorganization and preferred stock obligations, before and after the recapitalization? ganization? Explain your answer, providing at least 2 reasons for it. Name_______________________________________ Final Examination FINC 5880 Session 9 Question 6. (15 points) Stock A has an expected return of 10% and a standard deviation of 30%. Stock B has an expected return of 13% and a standard deviation of 45%. The correlation coefficient between Stocks A and B is 0.25. Stock A has a beta of .85 and Stock B has a beta of 1.20. Portfolio is invested 40% in Stock A and 60% in Stock B. a. Calculate the expected return of the portfolio. b. Calculate the standard deviation of the portfolio. c. Calculate the beta of the portfolio d. Is the portfolio likely to do better or worse than average when the stock market is going down