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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) Company Z issued bonds with detachable warrants several years ago. Each warrant allows the holder to purchase one share of stock at $30 per share. The stock has a beta of 1.3.

a. Calculate the exercise value of the warrants if the price of the underlying stock is $35.

b. How much would an investor likely be willing to pay for the warrant over and above its exercise value? Why?

c. Would the investor likely be willing to pay more or less for the warrant if the stock had a beta of 1.0? Why?

d. Is a warrant more similar to a call option or a put option? Why?

e. Why might an investor prefer to buy warrants rather than the underlying stock?

Question 3. (15 points) Company X wants to acquire another similar company. It estimates that net cash flows for the acquired company will be $8,500,000 per year for 10 years. The cost is $50,000,000. 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. Discuss 3 factors that might change your decision.

Question 4. (20 points) The Marcus Corporation plans to issue $5,000,000 of 10-year bonds at par next June, with semiannual interest payments. The company’s current cost of debt is 12 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 Settlment

(1) (5)

Dec 99-17

Mar 98-01

June 97-12

a. Calculate the present value of the corporate bonds if rates increase by 3 percentage points.

b. Calculate the gain or loss on the corporate bond position.

c. Calculate the number of futures contracts required to cover the bond position. Then calculate the current value of the futures position (round up to next whole number)

d. Calculate the implied interest rate based on the current value of the futures position.

e. Interest rates increase as expected, by 3 percentage points. Calculate the present value of the futures position based on the rate calculated above plus the 3 points.

f. Calculate the gain or loss on the futures position.

g. Calculate the overall net gain or loss.

h. Is the company hedging or speculating? Why? Which is riskier? Why?

Question 5. (20 points) Tundra Tots is being liquidated under Chapter 7 of the Bankruptcy Act. Its current balance sheet is shown below. Fixed assets are sold for $25,000,000 and current assets are sold for $38,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $500,000. No employee is owed over $2,000.

Sale of current assets 38,000,000

Sale of fixed assets 25,000,000

Trustee costs 500,000

Before Before

Default Balance Sheet Default

Current Assets 75,000,000 Accounts payable 15,000,000

Net fixed assets 50,000,000 Accrued taxes 10,000

Accrued wages 550,000

Notes payable 3,800,000

Total current liabilities 19,360,000

First-mortgage bonds 18,000,000

Second-mortgage bonds 20,000,000

Debentures 45,000,000

Subordinated debentures 14,000,000

Common stock 2,500,000

Retained earnings 6,140,000

Total assets 125,000,000 Total claims 125,000,000

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?

Question 6. (15 points) Your portfolio is diversified. It has an expected return of 11% and a beta of 1.10. You want to add 200 shares of Tundra Corporation at $40 a share to your portfolio. Tundra has an expected return of 13.0% and a beta of 1.50. The total value of the investor’s current portfolio is $45,000.

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?

e. Is beta always an accurate predictor of a portfolio’s performance? Explain?

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