Question 1. 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.
Question 2. ORNE Corporation plans to raise $2 million to pay off its existing short-term bank loan of $600,000 and to 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 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. Balance sheet information is shown below.
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 percent coupon, each $1,000 bond carrying 50 warrants to buy common stock at $15 per share.
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Current Balance Sheet
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|
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Current Liabilities
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$900,000
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|
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Common Stock, Par $1
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1,000,000
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Retained earnings
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700,000
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Total Assets
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$2,600,000
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Total claims
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$2,600,000
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Question 3. 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.
Question 4. 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)
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Delivery Month
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Open
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High
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Low
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Settle
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Change
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Open Interest
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(1)
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(2)
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(3)
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(4)
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(5)
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(6)
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(7)
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Dec
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103'14
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103'14
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102'11
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102'17
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-6
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678,000
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Mar
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102'11
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102'23
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100'28
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101'01
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-5
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135,855
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June
|
101'14
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101'26
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100'02
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100'12
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-5
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17,255
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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.
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?
Question 5. 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.
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Balance Sheet Before Default
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Current Assets
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1,200,000
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Accounts payable
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400,000
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Net fixed assets
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1,800,000
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Accrued taxes
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80,000
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Accrued wages
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60,000
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Notes payable
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60,000
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Total current liabilities
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600,000
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First-mortgage bonds
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900,000
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Second-mortgage bonds
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400,000
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Debentures
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500,000
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|
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Subordinated debentures
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300,000
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|
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Common stock
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200,000
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Retained earnings
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100,000
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Total assets
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3,000,000
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Total claims
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3,000,000
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a. How much will SHs receive?
b. How much will mortgage bondholders receive?
c. How much will priority creditors receive?
Question 6. 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.
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?