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A 1 B C D E F Name______________________________________ Final Examination 2 3 Session 9 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 Question 1. 10 points) Both Berkley and Oakley are large public corporations with subsidiaries throughout the world. Berkley uses a centralized approach and makes most of the decisions for its subsidiaries. Oakley uses a decentralized approach and its subsidiaries make many of their own decisions. a. Would the agency problem be more pronounced for Berkley or for Oakley? Explain. b. Would agency costs likely be higher for Berkley or Oakley? Why? c. Discuss a major advantage and a major disadvantage to a centralized approach such as Berkley uses. d. Discuss a major advantage and a major disadvantage to a decentralized approach such as Oakley uses. e. Which is better, a centralized or decentralized approach? Explain. Brigham 14e Page 1 of 19 10/11/2016 G 1 2 3 4 5 6 sidiaries throughout the 7 bsidiaries. Oakley uses a 8 9 10 . 11 12 13 14 15 16 17 18 19 20 21 22 23 as Berkley uses. 24 25 26 27 28 29 30 31 ch as Oakley uses. 32 Brigham 14e Page 2 of 19 10/11/2016 A 1 B C D F Name______________________________________ 3 Final Examination 0 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 E Question 2. (15 points) An investment company recently issued convertible bonds with a $1,000 par value. The bonds have a conversion price of $25 a share. At the time of issue, the company's underlying stock price is $20. a. Calculate the convertible issue's conversion ratio? b. After issuance, will the bond likely increase, decrease, or not change in value if the underlying stock price changes to $23 per share and everything else remains constant? Why? c. The bondholder converts the bond to common stock when the price of the underlying stock reaches $35. What is the total market value of the new shares? d. How does the company's balance sheet change at the point the bondholders convert their bonds to common stock? Explain? e What are 3 advantages to the investor in buying convertible bonds instead of the stock itself? Brigham 14e Page 3 of 19 10/11/2016 Explain? A 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 B C D E F e What are 3 advantages to the investor in buying convertible bonds instead of the stock itself? Brigham 14e Page 4 of 19 10/11/2016 G 1 2 3 4 5 6 00 par value. The bonds 7 price is $20. 8 9 10 11 12 13 14 15 16 17 ying stock price changes to 18 19 20 21 22 23 24 25 k reaches $35. What is the 26 27 28 29 30 31 32 33 34 35 36 37 38 bonds to common stock? 39 40 41 42 43 lf? Brigham 14e Page 5 of 19 10/11/2016 lf? G 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 Brigham 14e Page 6 of 19 10/11/2016 A 1 B C D Name______________________________________ 3 Final Examination 0 4 Session 9 2 5 6 Question 3. (20 points) Tundra Corporation is interested in acquiring Cantrell Corporation. Cantrell has 20 million 7 shares outstanding and a target capital structure consisting of 30 percent debt and 70 percent equity. Cantrell's debt 8 interest rate is 8 percent. Assume that the risk-free rate of interest is 2 percent and the market risk premium is 8 percent. 9 Cantrell's free cash flow (FCF0) is $8 million per year and is expected to grow at a constant rate of 6 percent a year; its 10 beta is 1.1. Cantrell has $5 million in debt. The tax rate for both companies is 30 percent. 11 12 13 14 15 16 a. Calculate the required rate of return on equity using equation: rs= rRF + RPM(b) 17 18 19 20 21 22 23 24 25 26 b. Calculate weighted average cost of capital, using equation: WACC = Wdrd(1-%) + wsrs 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 c. Calculate the value of operations, using equation: Vops = FCF0(1+g)/WACC - g) 42 Brigham 14e Page 7 of 19 10/11/2016 A B C D 43 44 45 46 47 d. Calculate the value of the company's equity, using equation: Vs = Vops - debt 48 49 50 51 52 53 54 e. Calculate the current value of the company's stock, using equation: 55 Price per share = Vs/shares outstanding 56 57 58 59 60 Brigham 14e Page 8 of 19 10/11/2016 E F 1 2 3 4 5 6 on. Cantrell has 20 million 7 ent equity. Cantrell's debt 8 is 8 percent. arket risk premium 9 nt rate of 6 percent a year; its 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 Brigham 14e Page 9 of 19 10/11/2016 E F 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 Brigham 14e Page 10 of 19 10/11/2016 A 1 B C D F G Name______________________________________ 3 Final Examination 0 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 E Question 4. (20 points) The Aleander Company plans to issue $10,000,000 of 20-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 9 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 tbond futures. (Note: One standard future contract is $100,000) Delivery Month (1) Dec Mar June Open (2) 102'13 102'02 101'13 High (3) 102'25 102'25 101'15 Low (4) 102'15 101'01 100'02 Settle (5) 102'17 101'01 100'12 Change (6) +2 -5 -1 Open Interest (7) 489,777 105,033 15,002 a. Calculate the present value of the corporate bonds if rates increase by 2 percentage points. 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 the current value of the futures position. Brigham 14e Page 11 of 19 calculate 10/11/2016 51 52 53 54 55 56 57 58 A B C D E F c. Calculate the number of futures contracts required to cover the bond position. Then the current value of the futures position. Brigham 14e Page 12 of 19 G calculate 10/11/2016 A 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 96 97 98 99 100 101 102 103 104 105 106 107 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 2 percentage points. Calculate the present value of the futures position based on the rate calculated above plus the 2 points. f. Calculate the gain or loss on the futures position. g. Calculate the overall net gain or loss. h. Is this problem an example of a perfect hedge or a cross hedge? Is it an example of speculation or hedging? 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. Brigham 14e Page 13 of 19 10/11/2016 points. H 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 37 38 39 40 41 42 43 44 45 46 47 48 49 50 Brigham 14e Page 14 of 19 10/11/2016 H 51 52 53 54 55 56 57 58 Brigham 14e Page 15 of 19 10/11/2016 H 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 96 97 98 99 100 101 102 103 104 ry 2001. Currently 105 the o hedge its position 106 with January 2001 Treasury bond 107 Brigham 14e Page 16 of 19 10/11/2016 A 1 B C D Name______________________________________ 3 Final Examination 0 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 E Question 5. (20 points) Pierre Imports will be liquidated. Its current balance sheet is shown below. Fixed assets are sold for $900,000 and current assets are sold for $700,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $70,000. Sale of current assets Sale of fixed assets Trustee costs 700,000 900,000 70,000 Current Assets Net fixed assets Before Default 1,260,000 1,200,000 Total assets 2,460,000 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 300,000 40,000 25,000 45,000 410,000 600,000 400,000 500,000 300,000 200,000 50,000 2,460,000 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? Brigham 14e Page 17 of 19 10/11/2016 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 A B C D d. Identify the remaining general creditors. How much will each receive before subordination adjustment? E e. How much will each general creditor receive after subordination adjustment? Brigham 14e Page 18 of 19 10/11/2016 A 1 B C D F G Name______________________________________ 3 Final Examination 0 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 E Question 6. (15 points) The standard deviation of stock returns for Stock A is 25%. The standard deviation of the market return is 15% and the correlation between Stock A and the market is 0.75. a. Calculate Stock A's beta. b. In a bull market with rapidly increasing stock prices, will Stock A likely outperform or underperform the average stock? Why? c. Is the beta of a diversified portfolio less stable or more stable than the beta of a single security? Why? Brigham 14e Page 19 of 19 10/11/2016