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A 1 B 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 44 C Question 1. 10 points). Explain how each of the following affects corporate governance and whether the impact is positive or negative. a. Block ownership b. Greenmail c. Stock options as part of compensation d. High level of debt e. Board of Directors comprised by majority of outsiders and compensating based in part on performance of company. . A 1 B C D E Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 Question 2. (20 points) ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to 6 increase total assets by $1,400,000. The bank loan bears an interest rate of 10 percent. The company's president owns 57.5% percent 7 of the 1,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percent. 8 Balance sheet information is shown below. 9 The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share. 11 12 13 14 15 16 Current Balance Sheet 17 Current Liabilities $900,000 18 Common Stock, Par $1 1,000,000 19 Retained earnings 700,000 20 Total Assets $2,600,000 Total claims $2,600,000 21 22 23 24 25 26 27 a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants. 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 b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares. 55 56 57 58 59 60 F A 61 62 63 64 65 66 67 68 69 70 71 72 B C c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets. 73 d. Calculate the debt ratio under both alternatives 74 75 76 77 78 79 80 81 e. Which alternative do you recommend and why? 82 83 84 85 86 87 88 89 90 D E F 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 Question 3. (20 points) Company X wants to acquire another similar company. It estimates that net cash flows for the acquired company will be $4,500,000 per year for 10 years. The cost is $30,000,000. The company's cost of capital is 10 percent. a. Calculate NPV, IRR, and MIRR. b. Should the company go ahead with the project based on your calculations? Why or why not? c. Identify 3 factors that might change your decision. F 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 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 Question 4. (20 points) The Aleander Company plans to issue $10,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 10 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) 103'14 102'11 101'14 High (3) 103'14 102'23 101'26 Low (4) 102'11 100'28 100'02 Settle (5) 102'17 101'01 100'12 Change (6) -6 -5 -5 Open Interest (7) 678,000 135,855 17,255 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 contracts required to cover the bond position. Then calculate the current value of the futures position. A 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 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 B C D E F G d. Calculate the implied interest rate based on the current value of the futures position. Use short hedge, percentage of par the bond 200 contractsIt($100,000 x 100 full percentage points plus 32nds of a selling for 105 9/32, It represents the sell futures contracts. Sell is selling at. is expressed in = $20 million). January 2001 futures percentage point. current value is $21,056,250of $100,000, so105 9/32%). one such unit would by January company can repurchase futures contracts at Treasury bonds sell in units ($20 million x the value of If interest rates rise be $100,000 x 105 9/32%. The easiest way to do the lower cost whichfirst divide 9 by the and then add 100, or 105.28125%. Thenrate. So, the firm has hedged against rising interest rates. calculation is to will help offset 32 loss from financing at the higher interest 105.28125% x $100,000 = $105,281.25. 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. 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 Question 5. (20 points) Pierre Imports will be liquidated. Its current balance sheet is shown below. Current assets are sold for $600,000 and fixed assets are sold for $1,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $100,000. Balance Sheet Before Default Current Assets Net fixed assets 1,200,000 1,800,000 Total assets 3,000,000 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 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 and after adjustment? 400,000 80,000 60,000 60,000 600,000 900,000 400,000 500,000 300,000 200,000 100,000 3,000,000 51 52 53 54 55 56 57 58 59 60 61 62 d. Identify the remaining general creditors. How much will each receive before subordination adjustment and after A B C D adjustment? E A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 Question 6. (10 points) The standard deviation of stock returns for Stock A is 30%. The standard deviation of the market return is 20% and the correlation between Stock A and the market is 0.75. a. Calculate Stock A's beta. 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 b. In a bull market with rapidly increasing stock prices, will Stock A likely outperform or underperform the average stock? Why? 30 31 32 33 34 35 36 37 38 39 c. Is the beta of a diversified portfolio less stable or more stable than the beta of a single security? Why? A 40 B C D E F G A 1 B 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 44 C Question 1. 10 points). Explain how each of the following affects corporate governance and whether the impact is positive or negative. a. Block ownership b. Greenmail c. Stock options as part of compensation d. High level of debt e. Board of Directors comprised by majority of outsiders and compensating based in part on performance of company. . A 1 B C D E Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 Question 2. (20 points) ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to 6 increase total assets by $1,400,000. The bank loan bears an interest rate of 10 percent. The company's president owns 57.5% percent 7 of the 1,000,000 shares of common stock and wishes to maintain control of the company. The company's tax rate is 30 percent. 8 Balance sheet information is shown below. 9 The company is considering two alternatives to raise the $2 million: (1) sell common stock at $10 per share, or (2) Sell bonds at a 10 10 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share. 11 12 13 14 15 16 Current Balance Sheet 17 Current Liabilities $900,000 18 Common Stock, Par $1 1,000,000 19 Retained earnings 700,000 20 Total Assets $2,600,000 Total claims $2,600,000 21 22 23 24 25 26 27 a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants. 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 b. Calculate the president's ownership position for both alternatives. He doesn't buy any of the additional shares. 55 56 57 58 59 60 F A 61 62 63 64 65 66 67 68 69 70 71 72 B C c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets. 73 d. Calculate the debt ratio under both alternatives 74 75 76 77 78 79 80 81 e. Which alternative do you recommend and why? 82 83 84 85 86 87 88 89 90 D E F 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 Question 3. (20 points) Company X wants to acquire another similar company. It estimates that net cash flows for the acquired company will be $4,500,000 per year for 10 years. The cost is $30,000,000. The company's cost of capital is 10 percent. a. Calculate NPV, IRR, and MIRR. b. Should the company go ahead with the project based on your calculations? Why or why not? c. Identify 3 factors that might change your decision. F 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 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 Question 4. (20 points) The Aleander Company plans to issue $10,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company's current cost of debt is 10 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) 103'14 102'11 101'14 High (3) 103'14 102'23 101'26 Low (4) 102'11 100'28 100'02 Settle (5) 102'17 101'01 100'12 Change (6) -6 -5 -5 Open Interest (7) 678,000 135,855 17,255 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 contracts required to cover the bond position. Then calculate the current value of the futures position. A 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 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 B C D E F G d. Calculate the implied interest rate based on the current value of the futures position. Use short hedge, percentage of par the bond 200 contractsIt($100,000 x 100 full percentage points plus 32nds of a selling for 105 9/32, It represents the sell futures contracts. Sell is selling at. is expressed in = $20 million). January 2001 futures percentage point. current value is $21,056,250of $100,000, so105 9/32%). one such unit would by January company can repurchase futures contracts at Treasury bonds sell in units ($20 million x the value of If interest rates rise be $100,000 x 105 9/32%. The easiest way to do the lower cost whichfirst divide 9 by the and then add 100, or 105.28125%. Thenrate. So, the firm has hedged against rising interest rates. calculation is to will help offset 32 loss from financing at the higher interest 105.28125% x $100,000 = $105,281.25. 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. 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 Question 5. (20 points) Pierre Imports will be liquidated. Its current balance sheet is shown below. Current assets are sold for $600,000 and fixed assets are sold for $1,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $100,000. Balance Sheet Before Default Current Assets Net fixed assets 1,200,000 1,800,000 Total assets 3,000,000 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 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 and after adjustment? 400,000 80,000 60,000 60,000 600,000 900,000 400,000 500,000 300,000 200,000 100,000 3,000,000 51 52 53 54 55 56 57 58 59 60 61 62 d. Identify the remaining general creditors. How much will each receive before subordination adjustment and after A B C D adjustment? E A 1 B C D E F G Name______________________________________ 3 Final Examination FINC 5880 4 Session 9 2 5 6 7 8 9 Question 6. (10 points) The standard deviation of stock returns for Stock A is 30%. The standard deviation of the market return is 20% and the correlation between Stock A and the market is 0.75. a. Calculate Stock A's beta. 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 b. In a bull market with rapidly increasing stock prices, will Stock A likely outperform or underperform the average stock? Why? 30 31 32 33 34 35 36 37 38 39 c. Is the beta of a diversified portfolio less stable or more stable than the beta of a single security? Why? A 40 B C D E F G
