Practice Set For Exam 3 - Solutions
Practice Set For Exam 3 - Solutions
4. Assume that interest rates on 20-year Treasury and corporate bonds with different ratings, all of which are
noncallable, are as follows:
1. T-bond = 7.72% A = 9.64%
2. AAA = 8.72% BBB = 10.18%
The differences in rates among these issues were most probably caused primarily by:
a. Real risk-free rate differences.
b. Tax effects.
c. Default and liquidity risk differences.
d. Maturity risk differences.
e. Inflation differences.
6. In a merger with true synergies, the post-merger value exceeds the sum of the separate companies' pre-merger
values.
a. True
b. False
7. Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.
a. True
b. False
8. A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.
a. True
b. False
*A conglomerate merger is a merger of two firms that have completely unrelated business activities
9. A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
a. True
b. False
*In a "spin-off," a parent company distributes shares of a subsidiary to the parent company's shareholders so that the subsidiary
becomes a separate, independent company.
11. Which of the following statements is CORRECT? *senior debt is repaid first in case of bankruptcy
a. Senior debt is debt that has been more recently issued, and in bankruptcy, it is paid off after junior debt
because the junior debt was issued first.
b. A company's subordinated debt has less default risk than its senior debt.
c. Bonds with a sinking fund generally have lower yields than the company’s bonds without a sinking fund.
d. Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
e. A debenture is a secured bond that is backed by some or all of the firm’s fixed assets.
12. Which of the following statements is NOT true regarding venture capitalists?
a. They can provide substantial capital for young companies.
b. The firms offer limited partners a number of advantages over investing directly in start-ups themselves as
angel investors.
c. They use their control to protect their investments, so they may therefore perform a key nurturing and
monitoring role for the firm.
d. They might invest for strategic objectives in addition to the desire for investment returns.
e. Venture capitalists typically control about one-third of the seats on a start-up's board of directors, and
often represent the single largest voting block on the board.
16. When it comes to project financing, the project’s income goes to servicing the debt, covering operating expenses,
and generating a return on the investors’ equity. Therefore, managers are generally not able to make reinvestment
decisions.
a. True
b. False
17. The project company (SPV) can provide financing on a project basis by issuing debt only.
a. True
b. False
19. Firms use defensive tactics to fight off undesired mergers. These tactics do NOT include
a. raising antitrust issues.
b. developing poison pills.
c. getting white knights to bid for the firm.
d. repurchasing their own stock.
e. engaging in risk arbitrage.
23. What feature is generally NOT attributable to the project finance transactions:
a. high capital intensity
b. long-term orientation
c. low level of leverage
d. special purpose vehicle (project company) has a finite life
e. controlled dividend policy
26. Varying degrees of political risk insurance can be obtained through the use of financing products available from:
a. multilateral institutions and export credit agencies
b. investment bankers
c. credit rating agencies
d. bank syndicate
e. International Monetary Fund
27. Chambers Industries has a market capitalization of $800 million and 250 million shares outstanding. The
management of this firm plans to raise further capital through a rights issue. Which of the following rights schemes
will raise the most money, if all shareholders exercise their rights?
a. two rights to purchase one share at $1.60 per share (250m/2) x 1 x 1.60 = 200m
b. three rights to purchase two shares at $1.80 per share (250m/3) x 2 x 1.80 = 300m
c. four rights to purchase three shares at $2.00 per share. (250m/4) x 3 x 2.00 = 375m
d. five rights to purchase two shares at $1.50 per share (250m/5) x 2 x 1.50 = 150m
Problem 1
You are the CFO of a company that has a market capitalization of $5 billion. The firm has 250 million shares outstanding, so
the shares are trading at $20 per share. You need to raise $500 million and have announced a rights issue. Each existing
shareholder is sent one right for every share he or she owns. You have not decided how many rights you will require to
purchase a share of new stock. You will require either five rights to purchase one share at a price of $10 per share, or ten
rights to purchase three new shares at a price of $6.45 per share. Which approach will raise more money?
Problem 2
Apilado Appliance Corporation is considering a merger with the Vaccaro Vacuum Company. Vaccaro is a publicly traded
company, and its current beta is 1.30. Vaccaro has been barely profitable, so it has paid an average of only 20% in taxes
during the last several years. In addition, it uses little debt, having a debt ratio of just 25%.
If the acquisition were made, Apilado would operate Vaccaro as a separate, wholly owned subsidiary. Apilado would pay
taxes on a consolidated basis, and the tax rate would therefore increase to 35%. Apilado also would increase the debt
capitalization in the Vaccaro subsidiary to 40% of assets, which would increase its beta to 1.47. Apilado’s acquisition
department estimates that Vaccaro, if acquired, would produce the following net cash flows to Apilado’s shareholders (in
millions of dollars):
These cash flows include all acquisition effects. Apilado’s cost of equity is 14%, its beta is 1.0, and its cost of debt is 10%.
The risk-free rate is 8%.
a. What discount rate should be used to discount the estimated cash flows? (Hint: Use Apilado’s rs to determine the
market risk premium.)
b. What is the dollar value of Vaccaro to Apilado?
c. Vaccaro has 1.2 million common shares outstanding. What is the maximum price per share that Apilado should
offer for Vaccaro? If the tender offer is accepted at this price, what will happen to Apilado’s stock price?