Reference no: EM131303054

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: An investment company recently issued convertible bonds with a $1,000 par value. The bonds have a conversion price of $25 a share.  At the time of issue, the company's underlying stock price is $20.

 

a. Calculate the convertible issue's conversion ratio?

 

b. After issuance, will the bond likely increase, decrease, or not change in value if the underlying stock price changes to $23 per share and everything else remains constant? Why?

 

c. The bondholder converts the bond to common stock when the price of the underlying stock reaches $35. What is the total market value of the new shares?

 

d. How does the company's balance sheet change at the point the bondholders convert their bonds to common stock? Explain?

 

e. What are 3 advantages to the investor in buying convertible bonds instead of the stock itself?

 

Question 3: Tundra Corporation is interested in acquiring Cantrell Corporation. Cantrell has 20 million shares outstanding and a target capital structure consisting of 30 percent debt and 70 percent equity.  Cantrell's debt interest rate is 8 percent.  Assume that the risk-free rate of interest is 2 percent and the market risk premium is 8 percent.

 

Cantrell's free cash flow (FCF0) is $8 million per year and is expected to grow at a constant rate of 6 percent a year; its beta is 1.1. Cantrell has $5 million in debt. The tax rate for both companies is 30 percent.

 

a. Calculate the required rate of return on equity using equation: r_s = r_RF + RP_M(b).

 

b. Calculate weighted average cost of capital, using equation: WACC = W_dr_d(1-%) + w_sr_s

 

c. Calculate the value of operations, using equation: V_ops = FCF₀(1+g)/WACC - g)

 

d. Calculate the value of the company's equity, using equation: V_s = Vops - debt.

 

e. Calculate the current value of the company's stock, using equation: Price per share = Vs/shares outstanding.

 

Question 4: The Aleander Company plans to issue $10,000,000 of 20-year bonds at par next  June, with semiannual interest payments. The company's current cost of debt is 9 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 future contract is $100,000)

 

Delivery Month	Open	High	Low	Settle	Change	Open Interest
(1)	(2)	(3)	(4)	(5)	(6)	(7)
Dec	102'13	102'25	102'15	102'17	+2	489,777
Mar	102'02	102'25	101'01	101'01	-5	105,033
June	101'13	101'15	100'02	100'12	-1	15,002

 

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 futures 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.  Fixed assets are sold for $900,000 and current assets are sold for $700,000.  All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable.  Trustee costs are $70,000. 

 

Sale of current assets	700,000
Sale of fixed assets	900,000
Trustee costs	70,000
	Before			Before
	Default		Balance Sheet	Default
Current Assets	1,260,000		Accounts payable	300,000
Net fixed assets	1,200,000		Accrued taxes	40,000
			Accrued wages	25,000
			Notes payable	45,000
			Total current liabilities	410,000
			First-mortgage bonds	600,000
			Second-mortgage bonds	400,000
			Debentures	500,000
			Subordinated debentures	300,000
			Common stock	200,000
			Retained earnings	50,000
Total assets	2,460,000		Total claims	2,460,000

 

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?

 

e. How much will each general creditor receive after subordination adjustment?

 

Question 6: The standard deviation of stock returns for Stock A is 25%.  The standard deviation of the market return is 15% 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?