Advanced Corporate Finance

Advanced Corporate Finance

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ASSIGNMENT A

1. Explain the path for a successful Merger and Acquisition.

2. What is the relationship between EVA and MVA? Highlight the approaches.

3. What are the symptoms to declare an enterprise as a ‘Sick enterprise”?

ASSIGNMENT B

1.’Working capital is a life blood of a business’. Explain. How can we manage the working capital? Explain its approaches.

2. Explain Leveraged buyout as one of the options in mergers and acquisition. Explain the procedure for leveraged buyout.

3. What are the different approaches for valuation of a value based firm? Explain them.

CASE STUDY

(i) (a) Explain how dividend decisions are relevant to a firm. Explain the different models of dividend policy.

(b) ABC corp. is following a fixed dividend payout of 75%. The EPS for 2008-2009 is $4 and it is expected to grow by 25% during 2009-2010. The firm earns a return of 20% on its investment. The cost of equity of the company is 15%.

You are required to compute the value of shares as on 31^st March 2010, using Gordon’s model.

(ii) Solve the following using Walter’s model:

Growth firm: r = 0.20; k = 0.10; EPS = $10

Normal firm: r = 0.15; k = 0.10; EPS = $10

Declining firm: r = 0.08; k = 0.10; EPS = $10

The above data is given for three firms operating as normal, growth and declining firms. How is the value of each firm affected when they are following the given DP ratio?

(a) 0%

(b) 30%

(c) 70%

(d) 100%

                                                                                      

ASSIGNMENT C

1. High P/E ratios tend to indicate that a company will _______, ceteris paribus.

A.   grow quickly

B.   grow at the same speed as the average company

C.   grow slowly

D.   not grow

2. _________ is equal to common shareholders' equity/common shares outstanding.

A.   Book value per share

B.   Liquidation value per share

C.   Market value per share

D.   Tobin's Q

3. The _______ is defined as the present value of all cash proceeds to the investor in the stock.

A.   dividend payout ratio

B.   intrinsic value

C.   market capitalization rate

D.   None of the above

4. The Gordon model

A.   is a generalization of the perpetuity formula to cover the case of a growing perpetuity.

B.   is valid only when g is less than k.

C.   is valid only when k is less than g.

D.   A and B.

5. Low Tech Company has an expected ROE of 10%.  The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends.

A.   6.0%

B.   4.8%

C.   7.2%

D.   3.0%

6. Music Doctors Company has an expected ROE of 14%.  The dividend growth rate will be ________ if the firm follows a policy of paying 60% of earnings in the form of dividends.

A.   4.8%

B.   5.6%

C.   7.2%

D.   6.0%

7. Xlink Company has an expected ROE of 15%.  The dividend growth rate will be _______ if the firm follows a policy of plowing back 75% of earnings.

A.   3.75%

B.   11.25%

C.   8.25%

D.   15.0%

8. A preferred stock will pay a dividend of $2.75 in the upcoming year, and every year thereafter, i.e., dividends are not expected to grow.  You require a return of 10% on this stock.  Use the constant growth DDM to calculate the intrinsic value of this preferred stock.

A.   $0.275

B.   $27.50

C.   $31.82

D.   $56.25

9. An analyst has determined that the intrinsic value of Dell stock is $34 per share using the capitalized earnings model.  If the typical P/E ratio in the computer industry is 27, then it would be reasonable to assume the expected EPS of Dell in the coming year is ______.

A.   $3.63

B.   $4.44

C.   $14.40

D.   $1.26

10. Consider the free cash flow approach to stock valuation.  Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year.  The firm's corporate tax rate is 30%.  It is expected that $200,000 of operating cash flow will be invested in new fixed assets.  Depreciation for the year will be $100,000.  After the coming year, cash flows are expected to grow at 6% per year.  The appropriate market capitalization rate for unleveraged cash flow is 15% per year.  The firm has no outstanding debt.  The total value of the equity of Utica Manufacturing Company should be

A.   $1,000,000

B.   $2,000,000

C.   $3,000,000

D.   $4,000,000

11. A firm's earnings per share increased from $10 to $12, dividends increased from $4.00 to $4.80, and the share price increased from $80 to $90.  Given this information, it follows that ________.

A.   the stock experienced a drop in the P/E ratio

B.   the firm had a decrease in dividend payout ratio

C.   the firm increased the number of shares outstanding

D.   the required rate of return decreased

12. In the dividend discount model, _______ which of the following are not incorporated into the discount rate?

A.   real risk-free rate

B.   risk premium for stocks

C.   return on assets

D.   expected inflation rate

13. Which of the following would tend to reduce a firm's P/E ratio?

A.   The firm significantly decreases financial leverage

B.   The firm increases return on equity for the long term

C.   The level of inflation is expected to increase to double-digit levels

D.   The rate of return on Treasury bills decreases

14. Costs are accumulated for each activity as a separate cost object in

A.   ABC analysis

B.   Target Costing

C.   Traditional Costing

D.   None of the above

15. The target profit is subtracted from the target price to arrive at the target cost.

A.   True

B.   False

16. Why should a company go for transfer pricing?

A.   To maximize the company's total profitability.

B.   To increase internal specialization.

C.   To complement the capacity utilization of the supplier division.

D.   All of the above

17. "Shareholder wealth" in a firm is represented by:

A.   The number of people employed in the firm.

B.   The book value of the firm's assets less the book value of its liabilities.

C.   The amount of salary paid to its employees.

D.   Number of shares held X market price of shares

18. Which of the following are relevant in formulating and implementing business strategy?

A.   The rivalry amongst existing organizations within the industry.

B.   The bargaining power of suppliers.

C.   The bargaining power of customer.

D.   All of the above

19. Other things being equal, a low ________ would be most consistent with a relatively high growth rate of firm earnings and dividends.

A.   dividend payout ratio

B.   degree of financial leverage

C.   variability of earnings

D.   inflation rate

20. A firm has a return on equity of 14% and a dividend payout ratio of 60%.  The firm's anticipated growth rate is _________.

A.   5.6%

B.   10%

C.   14%

D.   20%

21. The dividend discount model

A.   ignores capital gains.

B.   incorporates the after-tax value of capital gains.

C.   includes capital gains implicitly.

D.   restricts capital gains to a minimum.

22. The most appropriate discount rate to use when applying a FCFF valuation model is the ___________.

A.   required rate of return on equity

B.   WACC

C.   risk-free rate

D.   A or C depending on the debt level of the firm

23. Suppose that the market price of Company X is $45 per share and that of Company Y is $30. If X offers three-fourths a share of common stock for each share of Y, the ratio of exchange of market prices would be:

A.   .667

B.   1.0

C.   1.125

D.   1.5

24. The restructuring of a corporation should be undertaken if

A.   The restructuring can prevent an unwanted takeover.

B.   The restructuring is expected to create value for shareholders.

C.   The restructuring is expected to increase the firm's revenue.

D.   The interests of bondholders are not negatively affected.

25. In the long run, a successful acquisition is one that:

A.   Enables the acquirer to make an all-equity purchase, thereby avoiding additional financial leverage.

B.   Enables the acquirer to diversify its asset base.

C.   Increases the market price of the acquirer's stock over what it would have been without the acquisition.

D.   Increases financial leverage.

26. A tender offer is

A.   a goodwill gesture by a "white knight."

B.   a would-be acquirer's friendly takeover attempt.

C.   a would-be acquirer's offer to buy stock directly from shareholders.

D.   None of the above.

27. One means for a company to "go private" is

A.   divestiture.

B.   the pure play.

C.   the leveraged buyout (LBO).

D.   the prepackaged reorganization.

28. A firm's degree of operating leverage (DOL) depends primarily upon its

A.   sales variability.

B.   level of fixed operating costs.

C.   closeness to its operating break-even point.

D.   debt-to-equity ratio.

29. EBIT is usually the same thing as:

A.   funds provided by operations.

B.   earnings before taxes.

C.   net income.

D.   operating profit.

30. A firm's degree of total leverage (DTL) is equal to its degree of operating leverage ----------------- its degree of financial leverage (DFL).

A.   plus

B.   minus

C.   divided by

D.   multiplied by

31. The term "capital structure" refers to:

A.   long-term debt, preferred stock, and common stock equity.

B.   current assets and current liabilities.

C.   total assets minus liabilities.

D.   shareholders' equity.

32. Economies of scale, market share dominance, and technological advances are reasons most likely to be offered to justify a __________.

A.   financial acquisition

B.   strategic acquisition

C.   divestiture

D.   supermajority merger approval provision

33. A firm can acquire another firm __________.

A.   only by purchasing the assets of the target firm

B.   only by purchasing the common stock of the target firm

C.   by either purchasing the assets or the common equity of the target firm.

D.   None of the above are methods of acquiring the target firm

34. How do you refer to the public sale of stock in a subsidiary in which the parent usually retains majority control?

A.   Virtual corporation.

B.   Joint venture.

C.   Corporate liquidation.

D.   Equity carve-out.

35. Modigliani and Miller argue that the dividend decision __________.

A.   is irrelevant as the value of the firm is based on the earning power of its assets

B.   is relevant as the value of the firm is not based just on the earning power of its assets

C.   is irrelevant as dividends represent cash leaving the firm to shareholders, who own the firm anyway

D.   is relevant as cash outflow always influences other firm decisions

36. The __________ is the proportion of earnings that are paid to common shareholders in the form of a cash dividend.

A.   retention rate

B.   1 plus the retention rate

C.   growth rate

D.   dividend payout ratio

37. A critical assumption of the net operating income (NOI) approach to valuation is:

A.   that debt and equity levels remain unchanged.

B.   that dividends increase at a constant rate.

C.   that ko remains constant regardless of changes in leverage.

D.   that interest expense and taxes are included in the calculation.

38. The traditional approach towards the valuation of a company assumes:

A.   that the overall capitalization rate holds constant with changes in financial leverage.

B.   that there is an optimum capital structure.

C.   that total risk is not altered by changes in the capital structure.

D.   that markets are perfect.

39. The cost of capital for a firm -- when we allow for taxes, bankruptcy, and agency costs --

A.   remains constant with increasing levels of financial leverage.

B.   first declines and then ultimately rises with increasing levels of financial leverage.

C.   increases with increasing levels of financial leverage.

D.   decreases with increasing levels of financial leverage.

40. When sequential long-term financing is involved, the choice of debt or equity influences the future financial------------- of the firm.

A.   timing

B.   flexibility

C.   liquidity

D.   None of the above

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