03 Jan a. Calculate the expected

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.

Question 2 . (20 points) Reuth 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 20 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

Current Balance Sheet

Current Liabilities

$9,00,000

Common Stock, Par $1

10,00,000

Retained earnings

7,00,000

Total Assets

$26,00,000

Total claims

$26,00,000

a. Show the new balance sheet under both alternatives. For Alternatives 2, show the balance sheet after exercise of the warrants.

b. Calculate the president’s ownership position for both alternatives. He doesn’t buy any of the additional shares

c. Calculate earnings per share for both alternatives, assuming that EBIT is 10 percent of total assets.

d. Calculate the debt ratio under both alternatives

e. Which alternative do you recommend and why?

Question 3. (15 points). Talcon Corporation has a 11% unlevered cost of equity. The company forecasts the free cash flows shown below. The cash flows are expected to grow at a constant rate of 4% rate after Year 3.

Unlevered cost of equity

11%

Growth rate after Year 3

4%

Year 1

Year 2

Year 3

Free Cash Flow

450

750

805

a. Calculate the expected free cash flow for Year 4. What might cause the free cash flow to be lower?

b. Calculate the horizon value of the unlevered operations.

c. Calculate the total value of unlevered operations at Year 0.

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)

Futures Prices: Treasury Bonds–$100,000; Pts. 32nds of 100%

Delivery Month

Open

High

Low

Settle

Change

Open Interest

(1)

(2)

(3)

(4)

(5)

(6)

(7)

Dec

103’14

103’14

102’11

102’17

-6

6,78,000

Mar

102’11

102’23

100’28

101’01

-5

1,35,855

June

101’14

101’26

99’32

99’08

-5

17,255

a. (1) Calculate the implied yield on the futures contract?

(2) How many futures contracts will be needed to hedge potential losses in bond proceeds (based on current market conditions) due to waiting (round up to the nearest integer)?

(3) Calculate the total value of the hedge position.

b. Interest rates in general increase by 200 basis points The bond’s terms don’t change and that the coupon rate is still 10%.

(1) Calculate the amount of proceeds be given the new market rates?

(2) Calculate the loss in proceeds based on the original target for proceeds??

c. Assume that Zinn had entered the hedge found in part a.

(1) Calculate the new price of the hedge position?

(2) Calculate the gain on the hedge?

(3) Calculate the net effect of the loss of proceeds and the gain on the hedge?

d. Is this problem an example of a perfect hedge or a cross hedge? Is it an example of speculation or hedging? Why?

Question 5. (20 points) Pontrain Imports will be liquidated. Its current balance sheet is shown below. Current assets are sold for $2,100,000 and fixed assets are sold for $5,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $500,000.

Sale of current assets

21,00,000

Sale of fixed assets

50,00,000

Trustee costs

5,00,000

Before

Before

Default

Balance Sheet

Default

Current Assets

30,00,000

Accounts payable

4,65,000

Net fixed assets

76,00,000

Accrued taxes

80,000

Accrued wages

95,000

Notes payable

60,000

Total current liabilities

7,00,000

First-mortgage bonds

20,00,000

Second-mortgage bonds

35,00,000

Subordinated debentures

45,00,000

Common stock

2,00,000

Retained earnings

(3,00,000)

Total assets

1,06,00,000

Total claims

1,06,00,000

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 and after adjustment?

Question 6. (15 points) A portfolio consists of Stock Aand Stock B. Data for the 2 stocks is shown below.

Stock A: expected return

12%

Stock A: standard deviation

40%

Stock B: expected return

14%

Stock B: standard deviation

60%

Correlation between A and B

0.35

Stock A beta

0.90

Stock B beta

1.20

% portfolio in Stock A

45%

% portfolio in Stock B

55%

a. Calculate the expected return of the portfolio.

b. Calculate the standard deviation of the portfolio.

c. Calculate the beta of the portfolio

d. Does the portfolio have more risk, less risk, or the same risk as the market? Explain.

e. Will your portfolio likely outperform, underperform, or perform the same as the market in a period when stocks are rapidly falling in value? Why?