Question 1. 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.
Question 2. Pierre Imports recently issued two types of bonds. The first issue consisted of 10-year straight debt with a 9 percent annual coupon. The second issue consisted of 10-year bonds with a 8 percent annual coupon and attached warrants. Both issues sold at $1,000 par. The company's stock is currently selling for $27.50 per share.
a. Calculate the implied value of the warrants attached to each bond.
b. Discuss 3 advantages to the investor of purchasing bonds with warrants instead of straight bonds?
c. Discuss 3 advantages to the company of issuing a bond with warrants instead of straight bonds?
d. What will happen to the value of the bond with warrants if the company's stock price increases? Why?
e. What will likely happen to the value of the straight bond if the company's stock price increases? Why?
Question 3. Differentiate between each of the following and provide a specific example of each to illustrate your answers.
a. A golden parachute and a poison pill.
b. A friendly merger and a hostile merger.
c. A vertical merger and a horizontal merger.
d. An acquiring company and a target company
e. Purchase accounting and pooling of interest accounting
Question 4. (20 points) A Treasury bond futures contract settles at 105'8.
a. What is the present value of the futures contract in dollars?
b. If the contract settles at 105-8, 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.
Question 5. (15 points) Your portfolio is diversified. It has an expected return of 10.0% and a beta of .95. You want to add 500 shares of Tundra Corporation at $40 a share to your portfolio. Tundra has an expected return of 9.0% and a beta of .75. The total value of the investor's current portfolio is $60,000.
a. Calculate the expected return on the portfolio after the purchase of the Tundra stock?
b. Calculate the expected beta on the portfolio after you have added the new stock?
c. Is your portfolio less risky or more risky than the market? Explain.
d. Will your portfolio likely outperform or underperform the market in a period when stocks are rapidly falling in value? Explain.
e. Is beta always an accurate predictor of a portfolio's performance? Explain?
Question 6. (20 points) Corizon Company's balance sheet and income statement are shown below (in millions of dollars). Corizon and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of the $5 preferred will be exchanged for one share of $2.00 preferred with a par value of $50 plus one 10 percent subordinated income debenture with a par value of $50. The $8 preferred issue will be retired with cash. The company's tax rate is 30 percent.
| Balance Sheet prior to Reorganization |
| Current Assets |
200 |
|
Current liabilities |
175 |
| Net fixed assets |
225 |
|
Advance payments |
10 |
| |
|
|
$5 preferred stock, $100 par value (1,000,000) shares |
100 |
| |
|
|
$8 preferred stock, no par, callable at 100 (80,000 shares) |
8 |
| |
|
|
Common stock, $1.00 par value (5,000,000) shares |
25 |
| |
|
|
Retained earnings |
107 |
| Total assets |
425 |
|
Total claims |
425 |
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 net income available to common stockholders?
| Income Statement |
|
| Prior to Reorganization |
| Net sales |
700.0 |
|
| Operating expense |
630.0 |
|
| Net operating income |
70.0 |
|
| Other income |
7.0 |
|
| |
|
|
| |
|
|
| EBT |
77.0 |
|
| Taxes |
23.1 |
|
| Net income |
53.9 |
|
| Dividends on $5 PS |
5.0 |
|
| Dividends on $8 PS |
0.6 |
|
| Income to Common SHs |
48.3 |
|
c. Calculate the required pre-tax earnings to cover debt and preferred stock obligations, before and after the recapitalization?
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 for it.