Please see the attached file.

Here are 9 questions and 8 answers.

You have to make paraphrase for all 8 answers. Because 8 answers are written by my class mate.

Please wire down Q8 answers. I need it.

It has to be look like my own words

Thank you

Question 1: 1. Consider a bank (Bank of America), an utility (NYSEG), a large software developer (Oracle), a small bio-tech company (Avanir Pharma), and a steel producer (US Steel). Which of these companies will have large amounts of debt and why? Base your answers on the (violation of) assumptions in M&M (Taxes, Bankruptcy costs, information asymmetry, etc.). Consider as many aspects as you can think of. (8) Answer: M&M World assumes that capital structuring does not matter and that a firm's true value is derived solely from the cash flows derived from operating activity (M&M 1958). This M&M world functions as a result of five basic assumptions: 1. There are no market regulations (Taxes, compliance, tariffs) 2. There are no transaction costs (for acquiring or selling debt/equity) 3. Information Asymmetry does not exist (everyone has the same information) 4. Markets Operate Efficiently 5. Debt does not impact a company's earnings before interest and taxes These assumptions do not represent the actual world but rather provide a framework to ask the right question when analyzing capital structuring decisions. We will first address the 1st assumption, that is, that firms operate in a tax-free environment. This is not the case. We do live in a world with taxes and furthermore, taxes vary based on source and form. Corporate taxes are addressed differently than personal taxes, corporate Equity obligations (dividends) are addressed differently than corporate debt obligation (interest) and personal income from dividends/interest are addressed differently than personal income from net gains. The primary and most impactful tax caveat is that firms can minimize taxes using debt financing as a tax shield. Interest expense can be written off as an expense similar to SG&A or operating expense. Therefore, debt issuance decreases the taxable income of a for-profit company. This benefit must be considered against the costs of financial stress a firm will face as a result of debt interest. Financial distress comes from a firm's inability to pay back its outstanding debts. There are both direct (lawyers, accountants, and administrative costs) as well as indirect costs (loss of customers, loss suppliers, management loss/costs, agency costs (taking risk with debtors money), debt overhang costs (not taking positive NPV projects with equity holders money). The perfect capital structuring of a firm is one where a firm received a tax break equal to that of the costs of the financial distress from the existing outstanding debt. To address the question of optimal capital structuring for the companies in the question we must assume that taxes do apply to all companies and that each company has a different cost associated with financial distress. Table 6.1 pg 106 Company Industry Market Value Direct Costs of Financial Indirect Costs of Financial Debt Distress Distress 2-5% * likelihood Volatility of cash flows (Stable) Financing Bank of Financial 92% America Loss of customer (Low) Loss of suppliers (medium) Agency Costs (High) Debt Overhang (High) NYSEG Utilities 42.5% 2-5% * likelihood Volatility of cash flows (Stable) Loss of customer (Low) Loss of suppliers (medium) Agency Costs (High) Debt Overhang (High) Oracle Computer 17.46% 2-5% * likelihood Software Volatility of cash flows (Less Stable) Loss of customer (Low) Loss of suppliers (medium) Agency Costs (High) Debt Overhang (High) Avanir Pharma Science 23.78% 20-30% * likelihood Volatility of cash flows (Not stable) Loss of customer (High) Loss of suppliers (High) Agency Costs (High) Debt Overhang (High) US Steel Manufacturer 34.2% 2-5% * likelihood Volatility of cash flows (Stable) Loss of customer (Low) Loss of suppliers (Low) Agency Costs (High) Debt Overhang (High) Asymmetric information will also play a role in a firm's debt level. For example, when a company issues equity, the market usually views the equity issuance as negative due to not having enough information about the motivation for issuing equity. Therefore, a company will be more reluctant to issue equity and will more likely turn to obtaining debt. In order to do this, a company must have the financial flexibility to do so, such as having a debt ratio that allows them to take on more debt. Question 2: a. By increasing borrowings (debt), firms are able to generate more cash-flow to shareholders thus increasing their value. Comment. (3) Answer: False, issuing debt by itself does not create value. This debt must be used instead of equity to fund assets in order to be valuable. Furthermore, if the company has already issued its optimal amount of debt, further debt issuances would increase costs of financial distress more than additional tax break's would benefit. b. What is the difference between a stock's volatility and its beta? (2) Answer Beta refers to how the firm moves compared to the market, it does not necessarily encapsulate drastic swings in either direction, but rather the long term view of the firm and its return as it relates to the market. Beta also takes into account not only market/operational performance, but also capital structuring of the entity. If the firm has capital structuring associated with high bankruptcy percentage, it could increase the beta (i.e., more risk of bankruptcy requires a higher rate of return), despite what would average operating conditions. Volatility: How volatile a stock has been historically Beta: How sensitive a stock is to fluctuations in comparison to an industry or an index More info here: http://www.morningstar.com/cover/videocenter.aspx?id=385852 c. What should the risk-premium measure? How might you measure it? Justify your answer. (2) Answer: Market risk premium measures the difference between the risk free rate of return and the expected market return. Essentially, market risk premium acts as a multiplier based on a firm's levered beta. It provides the standard needed to meet market average, thus it allows you to evaluate the costs associated with a risky/safe firm. From a non finance background, i would define a market risk premium as the minimum expected return from the market. The estimates use the average (mean) of the difference between Rm - Rf over time. How is the mean calculated? There are two ways to calculate the mean: an arithmetic mean (add up all the numbers and divide by the number of numbers) or a geometric mean (the compound rate of return, or the nth root of theproduct of the n values). Imagine an investor starts with $100, makes 30%, and then loses 10%. How much does the investor have in the end? The answer is $117. (The math is: $100 * (1 + 30%) = $130, next $130 * (1 - 10%) = $117). The arithmetic (or average) mean return is 10% ((30% - 10%)/2). The compound return (or geometric mean) is 8.17% ($117/(1 + r)2). So, should we use the arithmetic or geometric mean? The arithmetic mean. Why? Because our best estimate of the return going out one year is the arithmetic mean (in this case 10%). This is the expected return each and every year given the time series of returns. The fact that the returns are variable year to year does not change what our expected return is. Risk premium is the return above the risk-free rate of return demanded by investors as compensation for owning an asset. A firm's risk premium can be calculated with the firm's beta, the risk-free rate of return and the market risk premium. The risk premium is derived by adding the product of the firm's beta and market risk premium to the risk-free rate of return. Usually the risk-free rate of return utilized is the return on US Treasuries. d. How do you calculate WACC? Explain its meaning in lay-man terms. (2) Answer: WACC is the: (% of Debt * After Tax Cost of debt) + (% of Equity * CAPM) In layman terms, WACC is the cost of a business to borrow money. It provides the true cost of capital and provides a clear indicator of if a Firm's ability to make financial decisions. WACC can be compared to other leaders in industry (to see if CFO made good decisions about debt structuring) e. Explain the intuition behind the unleveraged beta formula? (3) Answer: Unlevered beta seeks to eliminate all risk associated with capital structuring. Essentially the unlevered beta formula seeks to eliminate any tax break a firm receives as a result of debt issuance. It makes Unleveraged beta can be used to compare companies because different companies have different capital structures and unlevered beta can be used to compare them fairly. Unleveraged beta can also be used to measure the cost of capital for a company. f. If you minimize WACC, you will maximize value of firm. Is this true? What would M&M say about it? Explain. (3) Answer: Yes, similar to minimizing labor costs or securing the lowest possible costs of material, by minimizing WACC the firm is maximizing available funds to use towards operations. M&M would say that capital structuring does not pertain. However, if we relax their first two assumptions, (which they themselves did in 1963), they would concur that a firm's value is maximized when it's debt level reaches a point where tax-shield benefits are equivalent to financial distress costs. https://insight.factset.com/optimal-capital-structure-why-do-firms-borrow g. Coca-Cola Company recently announced that it is acquiring Chi Ltd. a Nigeria based leading dairy and juice company. Chi Ltd. was the leader in the Nigerian juice industry in 2014. Taking advantage of the ban on imported juices in the country, the company was able to create a strong image for its brand. Assume that Coca-Cola primarily operates in the carbonated soft drinks market. The current capital structure of Coca-Cola is about 25% debt (market value based). They currently have about $45 Billion in Debt, 30 billion in long-term debt and 15 billion in short-term debt. The interest rate on the short-term (average 1-year maturity) is 2% (which is the current market interest rate), and the market yields are about 4% on the long-term debt (average 10-year maturity, 3% coupons). Current beta of the CocaCola's stock is about 0.7. Marginal tax rate is 30%. Market Risk-Premium is 5%. Risk-free rate is 3%. The juice and diary segment is slightly less risky than the carbonated drinks market. National Beverage Corp is one of the largest juice producer in the United States. They currently have no long-term debt, and its stock market capitalization is about $2.5 billion. The stock's beta is about 0.6. Coca-Cola needs to make additional investments of about $500 million in Nigeria to take advantage of the growing market. If they fund this $500m with the same capital structure as they have currently, and the juice segment risk is similar to that of National Beverage Company, what is the appropriate cost of capital that Coca-Cola should apply to this project? Assume cost of debt will be similar to the yields of Coca-Cola's current debt. (6) Answer: WACC: 5.566% h. Some companies add a premium to the WACC for the political risk of the country. Explain how you will determine whether or not to add such a premium. (2) Answer: A country risk premium can be applied to cost of capital when operating in a politically risky environment. If the company decides to factor this in, the risk premium of operating in a location is added to the market risk premium when calculating the CAPM formula. If the market risk premium is 4% for example, and the country risk premium is 3% the adjusted risk premium over the risk free rate would be 7% which now takes into account political risk. A political or country risk premium is the additional risk associated with investing in an international company rather than a domestic company for reasons such as political instability, volatile exchange rates, or economic distress. To determine whether or not to add such a premium, I would check for news on the current state of the country and add a premium accordingly. Given that Nigeria has many issues right now, such as an economic crisis brought on by the low prices of oil and attacks by the extremist group Boko Haram, I would add a political risk premium for Nigeria. Question 3: Jeffrey Ubben's ValueAct Capital Management hedge fund is activist in nature (i.e. they take ownership stakes and propose changes in the firm). Find news reports regarding his stake in Microsoft. One of their proposals is for Microsoft to return more cash to shareholders. How much did Microsoft return to shareholders? What was the (cash-related) problem with Microsoft before his stake formation and has it reduced significantly afterwards? (5) Answer: Late in 2013 Value Act Capital Management helped spearhead many changes at Microsoft. Value Act parlayed their ownership of a block of shares into a seat on Microsoft's board beginning in 2014. Value Act also lead the charge in the retirement of longtime Microsoft CEO Steve Ballmer and his replacement by Satya Nadella. One of the many changes Microsoft made was to return more cash to its shareholders. Microsoft long had a stagnant, relatively low stock price and large cash reserves. Beginning in 2013 the company embarked on a $40 billion share repurchase program. At this point in time this buyback program represented more than 10% of the company's market capitalization. Under its new leadership, Microsoft became more aggressive in its acquisitions. Two of the largest were the purchases of the mobile device unit of Nokia and the social networking giant LinkedIn. When the first repurchase program concluded in 2016 Microsoft authorized another $40 billion repurchase and increased their quarterly dividend $0.03. Share price effectively doubled in the period from 2013 when Value Act began to exert influence on the company to present. Through these methods, Microsoft returned more cash to its shareholders. While the company still has enormous cash reserves, Microsoft under Satya Nadella has shown a new willingness to make large acquisitions which they feel may fit the company, engage in large stock repurchases and increase their dividend, which currently is among the most generous of large tech firms. Value Act Capital Management had a profound impact on the course of Microsoft, consequently the company is more innovative, strong and returns a greater amount of cash to its shareholders. Question 4: a. Explain the concept of \"adverse selection\". Does it apply to the Snap IPO? Find information about the sellers from the prospectus https://www.sec.gov/Archives/edgar/data/1564408/000119312517068848/d270216d424b 4.htm#rom270216_15, and explain whether the adverse selection argument is significant here and how it is alleviated. Since the price increases significantly at the IPO, why aren't the founders and the selling shareholders unhappy that the investment banks discounted the price so much? (5) Answer a: \" The holders of our outstanding Class C common stock, each of whom is a founder, an executive officer, and a director, will hold 89.0% of the voting power of our outstanding shares (approximately 88.5% is attributable to Class C common stock held by them) following this offering and will have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of our directors and the approval of any change in control transaction\" Almost all Voting stock is still held by ownership/executives of the company. Adverse selection, or information asymmetry, occurs when the market knows less than the organization and leads the market to make assumptions based on owner's actions. In the case of SNAP INC. information asymmetry leads me to the assumption that the executives have great faith in the future of their company as they have only relinquished 10.5% -11% of voting rights to the general public. Furthermore this 10.5-11% is diversified amongst over \"279,490,968\" shares. The executives faith in this company, in addition with looking at the initial rounds of equity financing show that the A) the executives have faith that the company will continue to grow B) that this equity is being issued to continue increasing capital (expected $2.4 Billion) without leaving them straddled by the burden of issuing debt. As Shown by the chart below, Their initial rounds of equity funding totalled less than $2 billion dollars, the price to the public of the offering is that of $3.4 billion dollars. The profit to made at even this low discount price is still extraordinary. Additionally, the volume of shares is likely in part due to the power controlled by Preferred C shares. Equity Funding Date of first sale: Amount Raised: 12/3/2012 $15,034,520 Clarification or Response: Series A and A-1 Preferred Stock and the underlying Common Stock issuable upon conversion thereof 06/04/2013 $5,999,934 Series B Preferred Stock and the underlying Common Stock issuable upon conversion thereof 11/26/2013 $50,000,004 Series C Preferred Stock and the underlying Common Stock issuable upon conversion thereof 2/17/2015 $537,639,783 (No Comment) Initial filing made 5/29/15 2/17/2015 $1,808,560,006 Amendment made (5/26/2016) 3/2/17 $3.4 Billion IPO Adverse selection describes a state in which there is a disparity of information between the parties of an agreement. In a simple example, it represents a point where a buyer or a seller may have key information which they factor into their decision that is not available to the other party. It can be a problem regarding IPOs, when determining how to price a stock before it is offered to the public. If an underwriter prices a stock at a figure judged too high for the market it may not be able to sell the shares. If they price too low the shares will sell, but it can cost the issuing company possibly billions of dollars in revenue. Although you could argue the SNAP IPO was underpriced I do not think adverse selection applies here for several reasons. The IPO was priced at $17 a share. Many analysts project this figure being near where SNAP should be trading at. Some analysts think it should be significantly lower. Furthermore, the company is not profitable and its future of reaching profitability is unclear yet. Finally, only a relatively small portion of the company's stock was sold to the public. The founders are still firmly in control of Snapchat. Due to the existence of Class C shares which are held by the founders and represent 10 votes per share, only approximately 11% of voting rights of Snapchat have been sold to the public. Due to relatively small power of the stock issued, the tremendous buzz generated from the successful IPO and the fact it raised $3.4 billion, and finally the fact the company is continuing to trade above its IPO price I don't think the founders and selling shareholders are upset by this IPO. Especially considering the founders are still solidly in control of the firm with almost 90% of the voting rights. It remains to be seen what the long-term future of Snapchat will be, considering the fact the company continues to burn hundreds of millions of dollars per year and has yet to chart out a path to profitability. b. Many firms in the S&P500 have continuously increased their dividends year after year. If they stop increasing, what might happen to the stock price? Explain. (3) Answer b: The price of the stock may drop. Information asymmetry would lead to the casual assumption that if a firm has continued to increase dividends, that it was performing well. A sudden decline in return of dividends may imply that the firm is no longer operating at such a high return. A casual investor may see this as a sign of falling profits and question the future profits of the company. In reality the Firm could be channeling these excess earnings in a variety of ways. Perhaps they are considering restructuring to a higher debt level to increase optimal capital structuring (minimizing WACC). In the case of marriott, it is possible that the firm is shifting its operations and the new operational structure requires a financial structure to match. 5. What is the agency cost of debt? If a firm wants to reduce this problem, explain how the design of debt itself may decrease the problem (bond maturity, convertibility, seniority, etc.) (5) Answer: Agency Cost is the excess risk taken by management of a firm when using debt to finance projects. Essentially, management is using other people's money to fund risky and possibly negative NPV projects. When a firm has a value less than that of its outstanding debt, the equity holders (both shareholders and management) have already lost the rights to any value derived from the company. Debtors have first rights to any assets the company has prior to equity holders. Lenders are not powerless in this situation however, there are numerous ways that lenders can protect their investment. The first method is covenants. \"Covenants are restrictions placed in a debt contract by lenders to monitor and control the borrowing firm's actions. If a covenant is violated, even if the interest is paid on time, the borrower is technically in default and can be forced to pay back the debt immediately.\" Common caveats include debt/asset ratios ensuring that the firm does not take on a level of debt that causes financial distress. Other Caveats include cross-default measures, that state if a firm is to default on one debt it must default on all debts. This ensures that a firm does not default on one debt source in favor of another. 6. a. In words, explain what free-cash-flow to Equity measures. (2) b. Pick a mature firm of your choice. Go through their 10-K and compute the Free cash flow to equity. Assuming that the FCFE will last in perpetuity, what is the value of the firm? Assume a cost of equity capital of 7% for the firm. If the new administration reduces corporate taxes to 15%, how much will the firm value increase? (5) I need answer 7. Read about the demise of Massey-Ferguson from the book. Was capital structure a reason for their demise? Explain. (4) Answer: Capital structure was absolutely a factor in the demise of Massey Ferguson. The company was rapidly growing at a level higher than sustainable growth. As their largest shareholder did not want to issue additional equity to raise funds due to not wanting to dilute his ownership position, Massey became highly leveraged through the issuance of debt. Furthermore, this debt was in the form of bank debt with variable interest rates held by 250 separate banks. When the demand for farm equipment tanked across the world and interest rates rose, Massey soon found themselves under crushing interest expenses. They were unable to easily renegotiate this debt either due to the fact it was held by so many separate entities. The high leverage, type of debt and the fact it was held by so many different banks were all problems with Massey Ferguson's capital structure which contributed to its demise. 8. Read the chapters relating the acquisition of Family Dollar (especially Chapter 21). There are multiple bidders in this acquisition? Why did the merger attempts not happen earlier? What are the synergies? Why are there multiple bidders? Who benefits the most when there are multiple bidders? Why does the management resist? How do the bidders get around the management resistance? (5) Answer: The acquisition of Family Dollar was a long and complicated process. The first party interested in acquiring the firm was investment firm Trian Partners. After disclosing they were a large block-holder in the firm they attempted to purchase the firm outright in early 2011. Family Dollar which was a company still controlled by its founding family did not want to sell. The parties reached a compromise where Trian kept ownership under 9.9 percent for two years and a board seat. At first, they tried to improve operations of the firm and then later wanted to sell the firm to another bidder. The two companies which became interested in Family Dollar were Dollar Tree and Dollar General. These two firms were direct competitors of Family Dollar in the same discount retail industry. Due to this, both had strong synergies with Family Dollar and were looking to acquire the firm to improve their own operations. Generally, when there are multiple bidders the stockholders of the target firm benefit the most. The two interested parties must compete with their offers for the target firm. Management may resist a takeover for a variety of reasons. These can include but are not limited to, reluctance of a company still held by its founding parties to give it up, concerns about the loss of their jobs which while not explicitly said could be behind the reticence to agree to a takeover and finally the belief that the firm is worth more than the offers tendered. Bidders can overcome managerial resistance in many ways. First off, a board of directors has a fiduciary responsibility to its stockholders and there are some offers which truly are too good of a deal to be refused. If the board still does not want to acquiesce bidders can engage in both tender offers or orchestrate proxy battles. In a tender offer a bidder announces its intent to acquire as many shares on the outside of the target firm as possible at a set price. The goal is to gain enough shares to have majority control of the target firm. In a proxy battle, a bidder goes to the firm's shareholders when the target firm's board is up for reelection. They nominate an alternate slate of board candidates which would be receptive to the takeover. The final method a bidding firm can engage in would be lawsuits against the target firm's board trying to prove they were breaching their fiduciary duty by not accepting the takeover offer. (Let me know what you think of this: Mike) 9. In page 197, while discussing about the new AT&T, the book asks a set of questions: What debt rating should AT&T seek? If AT&T is no longer an utility, should it try to maintain its AAA rating? How does the book answer these questions? Do you agree? Discuss. (5) Answer: Similar to the Marriott case, a firm's operational changes must be met with capital structuring changes. In the case of Marriot, they took on more debt because they felt that they were not in risk of bankruptcy, and that being a services organization, they could operate without constantly worrying about the loan's an A Bond rating privy a company to. Through its projections and then comparisons to what happened, the book says AT&T should continue to maintain its AAA rating. The levels of debt which the book prescribes correspond to maintaining this rating. Over the period studied, AT&Ts debt levels averaged 29% which is not particularly high. I would agree with the book's projections and that it was correct for the firm to maintain its AAA score even though it was no longer a utility. As previously mentioned AT&Ts debt levels were not excessively high and having a high credit score provides a firm with the ability to easily add additional debt good terms to the firm. The ability to access this capital is important to a firm such as AT&T which at this period was no longer a monopoly and having to compete with other firms, furthermore this is an innovative field and capital may need to be raised for new projects and innovations. Having a high bond rating is beneficial for these situations