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2017CFA二級-Corporate Finance · 9 Tests

Corporate Finance - Chu
Hi Chu manages a manufacturing subdivision of Restar Corporation. Restar is a conglomerate with divisions in the container industry. Chu’s task is to forecast the profitability of a four -year project for the manufacturing of specialty labeled aluminum cans. Restar has never manufactured such an item before and will require new equipment for the project. Exhibit 1 displays Chu’s abridged forecasted financial projections for the project. Exhibit 1 Specialty Labeled Aluminum Cans Project Financial Projections, Year End Totals ($ thousands) Fixed capital Working capital Total investment Sales Operating costs Depreciation Earnings before interest and taxes (EBIT) Interest Earnings before taxes (EBT) Tax (40%) Net income Dividends Addition to retained earnings Capital used 100,000 4,000 7,000 2,800 4,200 1,680 2,520 3,112 15,088 6,035 9,053 3,621 5,432 2,154 24,686 9,874 14,812 5,925 8,887 1,118 36,090 14,436 21,654 8,662 12,992 11,000 18,200 26,840 37,208 Year 0 100,000 0 100,000 60,000 24,000 25,000 72,000 28,800 25,000 86,400 34,560 25,000 103,680 41,472 25,000 Year 1 Year 2 Year 3 Year 4





Restar’s Cost of Capital and Capital Structure Cost of debt (pretax) Cost of equity Debt ratio (Total debt/Total assets) 8.00% 15.00% 50.00%

In a meeting with Restar’s CFO, Trey Papier, Chu discusses the merits of the project. Chu makes the following points: ? All assumptions in the projections are based on Restar’s overall debt and equity mix and on Restar’s corporate policy regarding dividend payout. ? Instead of using the weighted average cost of capital (WACC), however, the project should be evaluated with a project-specific market-determined discount rate of 16% because the project is unlike any of the firm’s current manufacturing processes. Papier asks Chu if he has considered other evaluation methods. Chu replies that he has computed the economic profit using the WACC. Chu states that he is uncertain about the appropriate cost of equity to use, however, because two weeks earlier, Restar’s management announced that the financing mix would change by increasing the target debt ratio to 60%. As a result, he says, the choices seem to be the ? firm’s current cost of equity, or ? cost of equity based on the Modigliani–Miller tax model and the new target debt ratio, assuming that the pretax cost of debt rises to 8.75%. Papier interjects that the current cost of equity would be better because the implementation of the new financing mix is likely to be delayed. Papier states that the delay is because the structure of the board of directors is about to change in the following manner: ? The CEO will no longer be the chairman of the board. ? The retired original founder of Restar will become the chairman of the board. ? The board will now have a majority of members that are independent. Despite these changes, Papier believes it is still important to explore the potential value of this new project. Three weeks later, Chu and Papier meet again to review Chu’s work. After some discussion, they think an alternative project will perform the same task as the original project. The alternative project will cover a six-year period. Chu has calculated its net present value (NPV) based on after-tax operating cash flows with the same discount rate of 16% used for the original project. Chu and Papier agree that because the two projects are mutually exclusive, they can decide between the projects using the equivalent annual annuity approach. Exhibit 2 summarizes the two projects’ NPVs. Exhibit 2 Comparison of Project NPVs Project Original Project Life 4 years NPV $6,406,450

1 of 6

6 years


Based on Exhibit 1, the after-tax operating cash flow (in thousands) for Year 1 is closest to: $31,600. $46,600. $33,200.
Question 2 of 6

Based on Exhibit 1, the economic profit (in thousands) for Year 1 is closest to: $1,100. –$8,400. –$3,300.
Question 3 of 6

The dividend payment policy assumed by Chu in Exhibit 1 is most accurately described as a: residual dividend payout policy. constant dividend payout ratio policy. stable dividend policy.
Question 4 of 6

The cost of equity under the newly announced financing mix using Chu's assumption on the change in the cost of debt and the Modigliani–Miller tax model is closest to: 15.6%. 16.3%. 15.1%.
Question 5 of 6

Which changes to the board of directors is least consistent with best practices in the composition of a board? Specific choice of the new chairman of the board Change regarding the CEO Change in the composition of the board membership
Question 6 of 6

Based on the equivalent annual annuity method for the original and alternative projects, the most appropriate conclusion is to: accept the original project. be indifferent between the two projects. accept the alternative project.

Corporate Finance - Scott
Cindy Scott is reviewing cash flow projections for a $300,000 capital investment for adaptable equipment to service her company’s manufacturing efforts. After careful study, analysts have determined that when put to the best use over the next five years, the incremental contribution of the equipment produces a positive net present value (NPV) of $183,109, assuming a 15% annual discount rate (see Exhibit 1). Exhibit 1 Forecasted Cash Flow (all values in $) Sales Variable cash expenses Year 1 370,000 185,000 Year 2 425,500 212,750 Year 3 510,600 255,300 Year 4 663,780 331,890 Year 5 531,024 265,512

Fixed cash expenses












Operating income before tax Tax (40%) Operating income after tax After tax operating cash flow Salvage value Salvage value after tax





















20,000 12,000

Total after tax cash flow






Straight-line over five years

NPV (15% annual discount rate): $183,109 Scott receives a request from her manager, Pat Stevens, to calculate both economic and accounting income using the cash flow analysis in Exhibit 1. Scott learns that the equipment is to be financed entirely with a loan at 12%, with interest paid annually for five years and the full principal paid at the end of the fifth year. Scott asks Ted Ludlow, another coworker, for additional suggestions about the analysis. Ludlow makes the following three suggestions:

1. Consider the analysis in Exhibit 1 as a base case, and then produce two additional analyses, an optimistic and a pessimistic case, assuming different possible economic environments. 2. Produce these different analyses with a five-year modified accelerated cost recovery system (MACRS) accelerated depreciation schedule (Exhibit 2). 3. Calculate operating income after tax minus the dollar cost of capital (i.e., the weighted average cost of capital (WACC) multiplied by the capital investment).
Exhibit 2 MACRS Schedule 5-Year MACRS* Schedule Year 1 20.00% Year 2 32.00% Year 3 19.20% Year 4 11.52% Year 5 11.52% Year 6 5.76%

*MACRS: Modified Accelerated Cost Recovery System for accelerated deprecation

While applying the suggestions from Ludlow, Scott is informed about a competing project that performs the same task over a three-year period. The new project has an NPV of $128,146 with the same discount rate and capital investment as the project in Exhibit 1 (five-year project). Scott starts to consider the merits of the new project (three-year project) relative to the five-year project.
1 of 6

The economic income for Year 3 is closest to: $48,365.

$109,877. $57,407.
Question 2 of 6

The accounting income for Year 2 is closest to: $61,650. $40,050. $25,650.
Question 3 of 6

Ludlow's first suggestion is best described as an example of: scenario analysis. Monte Carlo simulation. sensitivity analysis.
Question 4 of 6

Following Ludow's second suggestion, the first year's after-tax operating cash flow will most likely: decrease. remain unchanged. increase.
Question 5 of 6

Ludlow's third suggestion is best described as the calculation of: free cash flow to equity. residual income. economic profit.
Question 6 of 6

When comparing the two projects, Scott should most likely accept: both projects. only the five-year project. only the three-year project.

Corporate Finance - National Plastics
National Plastics Corp. is a leading manufacturer of high-quality injection-molded plastic packaging materials used by various industries, primarily food and beverage processing and packaging firms. In late November 2012, the company received approval for two important patent applications—one providing for improved tamper protection for plastic containers and another for an improved biodegradable plastic film that allows for better food preservation. On 4 January 2013, Haines Foods and Snacks, Inc., launched a hostile takeover bid for all of the shares of National at $30 per share (a $5 premium in excess of the pre-bid price). Haines Foods is a national distributor of deli and dairy products. If its bid is successful, it plans to continue to operate National as a wholly owned subsidiary. Zenith ThermoPlastics Inc. produces plastic containers and bags that are used by the food and beverage industry. Keith Whelan, who is both chief executive officer and chief financial officer of Zenith, had been in discussions with National to either purchase or license their newly patented technologies. As a possible alternative, in view of the Haines bid, Whelan began to consider having Zenith make its own takeover bid for National. Whelan provided National’s most recent financial statements, shown in Exhibits 1, 2, and 3, to one of his assistants, Mike Noth, with directions to calculate National’s free c ash flow using the discounted cash flow approach as a first step in determining the maximum value that Zenith should be willing to pay for National’s shares.

Exhibit 1: National Plastics Corp. Selected Financial Data, for Year Ending 31 December ($ millions) Revenues Cost of goods sold Selling, general, and administrative expense Earnings before interest, taxes, depreciation, and amortization (EBITDA) Depreciation expense Operating income Interest expense Pretax income 61 276 47 229 2012 1,614 841 436 337

Income tax (32%) Net income Share Information Number of outstanding shares (millions) 2012 Earnings per share 2012 Dividends paid (millions) 2012 Dividends per share

73 156

60 $2.60 $37 $0.62

Exhibit 2 National Plastics Corp. Consolidated Balance Sheets ($-millions) At 31 December Cash and cash equivalents Other current assets Total current assets Fixed assets Less Accumulated depreciation Fixed assets, net Total assets 2012 $8 315 323 1,384 181 1,203 $1,526 2011 $5 295 300 1,250 120 1,130 $1,430

Current liabilities Long-term debt Common stockholders’ equity Total liabilities and stockholders’ equity

$696 562 268 $1,526

$670 611 149 $1,430

Exhibit 3: Other Financial Information for National Plastics Corp. as of 31 December 2012

Effective tax rate Cost of equity Weighted average cost of capital

32.00% 12.00% 9.00%

Noth soon returns and points out that the free cash flows from National will differ in future years as a result of its new patents—he suggests that, just as Zenith wanted to license the technology, other plastic firms would also be interested. Noth also suggests that because National has a lower debt-to-equity ratio than the rest of the industry, it could support more debt, so he has adjusted the weighted average cost of capital (WACC) accordingly. Noth’s projected cash flows and other estimates are provided in Exhibit 4.

Exhibit 4: Estimates and Assumptions of Mike Noth Used in Valuing National Plastics as of January 2013 ($ millions except WACC) 2013 End-of-year free cash flow to firm 170 165 180 195 Growth at 5% a year 2014 2015 2016 Thereafter

WACC Total debt immediately following acquisition

10.50% 650

After a discussion about the appropriate cash flow estimates and discount rates to use in determining the value of National to Zenith, Whelan decides that Zenith should make a mixed offer for all of National’s shares at $35 per share, consisting of $23 in cash and Zenith common stock with an exchange ratio of 0.24. The details of the offer are in Exhibit 5. Exhibit 5: Details of Zenith’s Planned Tender Offer for All of National Plastics’ Common Shares National Plastics Pre-merger price Shares outstanding $25/share 60 million Zenith ThermoPlastics $50/share 100 million

Zenith will pay $35 per share for National, Tender Offer consisting of $23 in cash and Zenith common shares with an exchange ratio of 0.24. Following the merger, Zenith’s shares are Post-merger expected to be priced at $53/share. Zenith believes that most of the synergies arising Synergies from the merger from the merger will result from National’s new patents.

Because National and Zenith are based in the United States, Whelan also decides to have Noth calculate the pre- and post-acquisition Herfindahl-Hirschman Index (HHI) for the industry. Noth’s HHI calculations are 1,910 pre-acquisition and 2,000 post-acquisition. Based on the HHI values, Whelan concludes that (1) the industry is currently highly concentrated but (2) under applicable US law, an increase in the HHI of less than 100 should not generate any governmental challenges to block the acquisition of National. When Whelan presents Zenith’s proposed takeover to the board of directors the following day, one of the directors made the following statements:

1. Although I am certainly in favor of this takeover, I think we would achieve the greatest
value from the acquisition if we offered more stock and less cash.

2. If Zenith does not realize the potential synergies of this acquisition in the next five
years, I suggest a ―spin-off‖ as a means to recover some of the money lost in this venture.

3. A positive initial market reaction will confirm that we did not overpay for National.
1 of 6

If Haines Foods is successful in its attempt to acquire National Plastics, the business combination is best classified as which type of merger? Horizontal, conglomerate Vertical, backward Vertical, forward
Question 2 of 6

National's free cash flow to the firm (FCFF) for 2012 is closest to (in millions): $104. $182. $121.

3 of 6

Based on Noth's assumptions in Exhibit 4, the most that Zenith should be willing to pay per share of National is closestto: $60. $40. $51.
Question 4 of 6

Based on Zenith's proposed tender offer and information in Exhibit 5, the synergy arising from this merger is closest to (in millions): $1,063. $943. $643.
Question 5 of 6

The most accurate interpretation of Whelan's conclusions concerning the pre- and post-acquisition HHI is that they are: incorrect in regard to the industry being highly concentrated. incorrect in regard to the increase in HHI necessary to trigger a governmental challenge to the acquisition. both correct.
Question 6 of 6

Which of the statements made by the member of the Board of Directors is most accurate? Statement 2 Statement 3 Statement 1

Corporate Finance - Earl Case
John Earl is a project analyst for Kames Inc. Earl is currently reviewing the projected annual income statements, shown in Exhibit 1, for the five-year life of Project #162 to determine the net present value (NPV) of the project using an annual discount rate of 10%. Exhibit 1 Project #162 Forecasted Income Statements

Year 1 Sales Cash operating expenses Depreciation Operating income Interest expense Taxable income Tax expense (40%) Net income

Year 2

Year 3

Year 4

Year 5

$300,000 $320,000 $350,000 $390,000 $440,000 210,000 30,000 $60,000 13,500 $46,500 18,600 $27,900 224,000 30,000 $66,000 10,800 $55,200 22,080 $33,120 245,000 30,000 $75,000 8,100 $66,900 26,760 $40,140 273,000 30,000 308,000 30,000

$87,000 $102,000 5,400 $81,600 32,640 $48,960 2,700 $99,300 39,720 $59,580

The project will require an increase in fixed assets of $150,000 that will be fully depreciated. Current assets are expected to increase by $80,000 and current liabilities are expected to increase by $45,000. This increase in net working capital will be recovered when the project is finished. Just prior to completing the analysis, Earl finds out that the fixed assets can be depreciated using an accelerated method, as shown in Exhibit 2. Exhibit 2 Project #162 Forecasted Income Statements with Accelerated Depreciation Year 1 Sales Cash operating expenses Depreciation Operating income Interest expense Taxable income Tax expense (40%) Net income Year 2 Year 3 Year 4 Year 5

$300,000 $320,000 $350,000 $390,000 $440,000 210,000 49,995 $40,005 13,500 $26,505 10,602 $15,903 224,000 66,675 $29,325 10,800 $18,525 7,410 $11,115 245,000 22,215 273,000 11,115 308,000 0

$82,785 $105,885 $132,000 8,100 5,400 2,700

$74,685 $100,485 $129,300 29,874 $44,811 40,194 $60,291 51,720 $77,580

Given the use of the accelerated depreciation method, Earl concludes that the NPV of Project #162 increases to $127,818.

In an initial discussion with a fellow analyst, David North, about Project #162, Earl tellsNorth: ―I have prepared the analysis using nominal values and a nominal discount rate. 鈥?‖ North responds: ―Even though the analysis is in nominal terms, the discount rate should be increased by an inflation rate of 2% based on the historical inflation rate.‖ Later, Earl and North continue their discussion. Earl explains: ―I intend to also calculate the economic profit by subtracting the dollar cost of capital from the net income. Do you have any further suggestions for analysis? ‖ North replies: ―I suggest you determine the key inputs for the analysis, and then examine each input separately by varying its value between plus or minus 1% or 2%. This variance will give you better insight about the project’s profitability.‖

1 of 6

Given the information in Exhibit 1, the after-tax operating cash flow (in thousands) for Year 1 for Project #162 is closestto: $71.4. $66.0. $36.0.
Question 2 of 6

The initial investment outlay (in thousands) for Project #162 is closest to: $275. $230. $185.
Question 3 of 6

By switching to an accelerated depreciation method, the increase in NPV for Project #162 is closest to: $4,445. $11,112. $6,667.
Question 4 of 6

In their initial discussion, North’s response to Earl is most likely: incorrect because the discount rate does not need to be adjusted. incorrect because the inflation rate adjustment should be based on expected inflation. correct.
Question 5 of 6

Earl’s statement in regard to economic profit is most likely: incorrect because it is a residual income calculation. incorrect because the calculation should not be based on net income. correct.
Question 6 of 6

The final suggestion by North is best described as: scenario analysis. Monte Carlo analysis. sensitivity analysis.

Corporate Finance - England
Telemtogo Inc. (TLGO) is a manufacturer and distributor of camping and hiking equipment in the United States. TLGO management is considering a new division to manufacture outdoor patio products to be sold in the same retail outlets as TLGO’s existing products.

Exhibit 1 TLGO Outdoor Patio Product Division Abridged Financial Statement, Year-End Projections End of Year (inflation adjusted, $ millions) Consultant fee Capital investment required Additional net working capital 0.55







10.36 2.2 0.62 0.43 0.28 0.19 0.12

Sales Variable expenses Fixed expenses Depreciation Earnings before interest and taxes (EBIT) Interest

2.7 1.62 0.2 0.21 0.67 0.36

3.24 1.94 0.21 0.21 0.88 0.36

3.89 2.33 0.21 0.21 1.14 0.36

4.67 2.8 0.22 0.21 1.44 0.36

5.6 3.36 0.23 0.21 1.81 0.36

Taxable income Tax expense (32%) Net income

0.31 0.1 0.21

0.52 0.17 0.35

0.78 0.25 0.53

1.08 0.34 0.74

1.45 0.46 0.99

Note: The inflation rate is assumed to be 0.78% annually.

The consultant fee will have been paid prior to year-end 2013. Karen England is a consultant hired by TLGO to explore the feasibility and profitability of the new division. England begins by developing future financial projections for the division based on comparable firms that produce similar products. England assumes the capital investment will be made at the end of 2013 (see Exhibit 1). England begins her analysis by determining TLGO’s real weighted average cost of capital (real WACC), which she presents in Exhibit 2. Exhibit 2 TLGO’s Real WACC Components Risk-free rate Market risk premium Equity beta Pretax cost of debt Real WACC 2.5% 8.2% 1.6 9.3% 10.1%

Note: All values are nominal except for real WACC. Project financing is with equal portions of debt and equity She then proceeds to determine the project’s feasibility in two ways: 1. discounting the after-tax operating cash flows from the project, and 2. calculating its economic profit. In a phone conversation with England, Terry Weinberger, a member of TLGO’s management team, suggests that the risk of the new division may differ from the current risk faced by TLGO, making TLGO’s real WACC inappropriate for her analysis. He suggests implying the cost of equity from a firm within the outdoor patio products industry named Outerside Inc. (OUT) to obtain a more appropriate real WACC. England later estimates OUT’s current beta and adjusts it to account for TLGO’s leverage. The value of the adjusted beta for OUT is 1.8. Weinberger continues to tell England that five years ago, TLGO considered acquiring OUT. Unfortunately, OUT successfully defended itself from being acquired by seeking an angel

investor who bought a substantial minority stake of its stock —enough to block TLGO’s hostile takeover bid. Weinberger further suggests calculating the project’s net present value (NPV) with an assumption of selling the division for $12 million at the end of 2018 (note that capital gains are fully taxed at 32%) and recapturing all working capital. Weinberger also asks England to calculate the NPV for three different possible sets of economic conditions under which prices and costs differ to give management a broader perspective on making the decision. In response to her conversation with Weinberger, England produces the analysis in Exhibit 3. Exhibit 3 NPV Analysis of TLGO Project Economic conditions Below average Average Above average Probability 25% 50% 25% NPV ($ millions) –5.21 –3.08 1.25

In a second phone conversation with Weinberger, England discusses the value of possible real options. When she implements the value of the real options into the NPV analysis, the expected NPV for the project based on Exhibit 3 becomes $0.75 million.
1 of 6

The 2015 after-tax operating cash flow for the new division (in millions) is closest to: $0.81. $0.38. $0.56.
Question 2 of 6

Prior to her first conversation with Weinberger and based on the information from Exhibits 1 and 2, England's estimate of the 2014 economic profit for the new division (in millions) is closest to: –$0.81. –$0.87. –$0.59.
Question 3 of 6

Based on England's first conversation with Weinberger, the real cost of equity for determining the NPV for the proposed new division is closest to: 16.4%. 17.1%. 14.7%.
Question 4 of 6

Which of the following is the best characterization of OUT's takeover defense tactic in response to TLGO's takeover bid five years ago? White Knight defense White Squire defense Greenmail
Question 5 of 6

If Weinberger is correct about the selling price of the division, the after-tax non-operating cash flow (in millions) from the sale at the end of 2018 will be closest to: $15.32. $14.98. $11.14.
Question 6 of 6

Following her second conversation with Weinberger and based on Exhibit 3, the expected additional value (in millions) created by real options is closest to: $3.28. $3.83. –$1.78.

Corporate Finance - Kocher
In 2008, Roger Kocher joined the board of directors of Bricktech Inc. (BKT) as one of 14 independent board members on a 17-member board. At the time, Kocher was also a member (and currently is a member) of the board of HTF Industries (HTF), a former BKT customer. When HTF sold a division in the early 2000s, it no longer needed BKT as a vendor. The combination of independent and non-independent board members has been maintained since 2008. But in early 2013, Kocher was hired to be the CEO of BKT to replace the previous CEO, who suddenly decided to retire from the company and the board. Prior to being hired as

CEO, Kocher had become the chairman of the board of directors and was also a member of the nominating and audit committees at BKT. Soon after the news of the retirement of the former CEO, a current independent member of the board of directors of HTF, Ted Herman, was suggested as a possible replacement for the vacated membership on the board. Herman was familiar with BKT because he had worked at another firm in the same industry that was eventually acquired by BKT after Herman had left. As CEO, Kocher began to look at two issues that had been left unresolved by the previous CEO. First, he began discussing BKT’s current mix of debt and equity with the chief financial officer, Cheryl Stevens. Kocher said that the company’s current capital structure resulted in an overall cost of capital of 5.77%. Stevens eventually produced two potential variations to the capital structure that BKT could easily implement, as indicated in Exhibit 1. Exhibit 1 Alternative Financing Mix Scenarios Current Proportion of debt Proportion of equity Pre-tax cost of debt Cost of equity Corporate tax rate: 30% Next, Kocher and Stevens began discussing BKT’s dividend policy. In the past, Kocher noticed that there were times when outside financing was required for positive net present value (NPV) projects because too much of the earnings were being paid out as dividends. In particular, Kocher noted that in 2009 and 2010 (see Exhibit 2), if dividends had been reduced by $0.8 million and $0.6 million respectively, there would have been no need for BKT to undertake additional borrowing that was relatively expensive at the time. Kocher further stated that based on project investment forecasts at the time, it was known that too much of the earnings were going to be paid out as dividends. Exhibit 2 BKT Dividend History (8 million shares outstanding) Year 2009 2010 2011 2012 2013

Financing Mix 1 40% 60 5.0 7.5

Financing Mix 2 60% 40 5.5 8.3

50% 50 5.2 7.9

Net income ($ millions) 10.40 8.20 12.50 13.70 14.25

Dividends ($ millions) 3.12 2.46 3.75 4.11 N/A

This is a forecasted value.

After further discussion of incorporating project investment needs into the dividend policy,

Stevens and Kocher decide to propose to the board a new dividend policy of paying a dividend of $0.50 a share annually for the foreseeable future.
1 of 6

According to best practices in corporate governance, upon becoming CEO, Kocher most likely should have: stayed on the board of directors but not remain as chairman of the board of directors. replaced the retiring CEO's membership on the board with an independent director. left the board of directors.
Question 2 of 6

If Ted Herman joins the BKT board of directors, he would most accurately be considered a non-independent board member because: Herman is a former employee of a firm that is now part of BKT. HTF is a former customer of BKT. there are interlocking directorships.
Question 3 of 6

According to best practices in corporate governance, upon becoming CEO, Kocher should most likely leave the: audit and nominating committees. audit committee only. nominating committee only.
Question 4 of 6

Based on Exhibit 1, the optimal financing mix is most likely: financing mix 1. the current financing mix. financing mix 2.
Question 5 of 6

Prior to 2013, the dividend policy for BKT is best described as a: constant dividend payout ratio policy. residual dividend payout policy. stable dividend policy.
Question 6 of 6

Based on the current financing mix and the projected earnings in 2013, the expected amount of capital available for project investment under Kocher and Steven's proposed dividend policy is closest to: $25.63 million. $20.50 million. $10.25 million.

Corporate Finance - Timitz
Walter Timitz is the CEO and founder of the publicly traded firm, TIMITZ Corporation (TMTZ). TMTZ manufactures commercial and non-commercial grade fasteners. With a large bond issue coming due in the near future, Timitz had to enact a number of measures to increase and preserve cash within TMTZ to repay the bond. The following measures were executed over the last twelve months: ? ? ? ? the dividends to common shareholders were cut by one half product prices were increased to offset price increases by suppliers operating costs were reduced by outsourcing some processes resulting in a reduction in the workforce an incentive pay package was negotiated with the remaining employees to impove productivity and efficiency Also within the last twelve months, Timitz implemented measures concerning board structure and board operations: ? ? ? ? the board of directors membership increased from ten to fourteen. The membership now consists of Timitz, eight divisional managers, and independent board members. the audit committee now has one independent board member who is also the head of the committee the compensation committee now has a majority of independent board members with at least one member from management who cannot be the head of the committee a new auditing firm has been appointed that is not affiliated with the accounting firm that provides routine services and consulting to TMTZ TMTZ uses various distributors of approximately the same size in terms of employee numbers to bring their product to market. The process for selecting distributors was based on the ability of the distributor to perform to TMTZ’s satisfaction and on cost. One of the distributors selected was QDROP who, in the past, had performed at a satisfactory level and was also the lowest cost distributor for the particular region it served.

A few months after entering into the contract with QDROP, QDROP was accused of paying below market wages to its employees. A legal representative for the employees stated: ―Any impartial party under a veil of ignorance can see that QDROP’s management purposefully underpays its employees.‖ Authorities investigated, found no apparent violations of the law, and pursued no legal action. TMTZ’s management, who believe that TMTZ should abide by the ethical code stated in their mission statement, discussed breaking the contract with QDROP, but ultimately decided not to do so because QDROP had not broken any laws. Further, TMTZ’s management also decided to consider the acquisition of QDROP at what TMTZ believed was a fair price. When the acquisition proposal was presented to QDROP’s management, the acquisit ion price was viewed as fair, but QDROP’s management also requested that one half of the management team be maintained after the acquisition with the other half receiving significant severance compensation. TMTZ agreed to QDROP’s terms and the acquisition occurred late in the year.
1 of 6

TMTZ’s actions to increase and preserve cash over the previous twelve months most likely gave which stakeholder group preference over shareholders? Employees Bondholder s Customers
Question 2 of 6

Based on the actions by TMTZ over the previous twelve months, which two parties most likely have a principal-agent problem that has been mitigated in an equitable manner? Management and shareholders in regard to board composition Suppliers and customers Management and employees
Question 3 of 6

Based on the actions by TMTZ in regard to its board and board operations, which action is most consistent with corporate governance best practices? Auditor selection Compensation committee composition Audit committee composition
Question 4 of 6

The statement made by the legal representative of QDROP’s employees is most consistent with: Rights Theory. Utilitarianism. Justice Theory.
Question 5 of 6

The reason for TMTZ’s decision to maintain the contract with QDROP is most consistent with: Rights Theory. the Friedman doctrine. Kantian Ethics.
Question 6 of 6

The terms agreed upon in the acquisition of QDROP by TMTZ are most likely an example of: an agency cost for TMTZ. opportunistic exploitation by TMTZ’s management. self-dealing by QDROP’s management.

Corporate Finance - Aubrey Yachts

Jack Aubrey and his brother Charles are co-founders of Aubrey Yacht Manufacturers in Miami, Florida. The company specializes in the production of yachts in the $500,000 to $1,200,000 price range. The Aubrey brothers took the company public in 1998 and its shares are now traded on NASDAQ under the symbol AYM. Jack is the President and Charles is the chief executive officer (CEO) and chairman of the board. Demand for yachts in AYM’s price range was strong during 2007, but a six-month strike that started in June of that year allowed the company to reduce its finished goods inventory substantially by year end. During the 2008 recession, demand fell. The company responded by reducing inventory and modifying its capital structure from its long run average of 25% long-term debt-to-equity until all of its outstanding long-term debt was finally repaid in 2009. Earnings and dividends had been growing strongly until the strike occurred. The company paid its first dividend in 2003 but discontinued it soon after the

strike began. Exhibit 1 shows the history of the company’s earnings per share (EPS) and dividends per share (DPS) since 2003.
Exhibit 1 Aubrey Yacht Manufacturers Earnings and Dividend History, 31 December 2003 to 31 December 2013 2003 EPS ($) DPS ($) 4.18 2.17 2004 4.52 2.31 2005 4.77 2.48 2006 5.05 2.58 2007 5.18 2.64 2008 2.6 2009 2.4 2010 3.5 2011 4.8 2012 5.2 2013 5.5

During 2012, sales of yachts in the company’s price range had recovered and Jack Aubrey is confident that the company will be able to reinstate its dividend in 2014. He also wants to ensure that future dividends are not cut as occurred in 2008 and has plans to determine dividends with a target payout adjustment model that uses a five-year period to adjust toward the target. His estimates and proposed payout plan are provided in Exhibit 2.
Exhibit 2 Jack Aubrey’s Estimates of Future Earnings and Dividends and Proposed Long- Policy Run Dividend Earnings For 2014 For 2015 $6.60/share $8.05/share Dividends $3.42/share

Proposed long-run dividend policy beginning in 2014 Long-run target payout Adjustment factor toward five-year target 35% 0.20 per year

Steve Maturin is the CEO of Standard Marine Containers, a manufacturer of plastic pallets and crates used in marine shipping. He is one of the four independent directors on the board of AYM; the board consists of eight directors with only the Aubreys having had an employment relationship with the company. Maturin has been a close friend of Charles Aubrey since childhood and Jack Aubrey is a director of Standard Marine Containers. Charles, Maturin, and their families have just returned from a two week cruise to Bermuda on one of the company’s best yachts. Maturin informed Jack that the weather on this year’s trip was much better than last year, that he was well

rested, and ready to tackle some thorny issues in AYM’s first board meeting of the year. Maturin started: ―In particular, alternatives to paying dividends, moving to a staggered board of directors, and the company’s financing mix are items of great interest to me.‖ Maturin said that after reviewing the company’s share price behavior during 2003–2007, he found that when the shares went ex-dividend, they normally fell by about $0.68 per $1.00 of dividend paid. Jack Aubrey reminded everyone about the results of a survey that was conducted last year on a large sample of the company’s investors. It had indicated that, on average, the investors’ tax rate on capital gains was 23%, but their tax rates on dividends varied widely across the sample. Jack asked Maturin: If these tax results had also applied to the time period for which you reviewed the ex-dividend share price behavior, what would have been the marginal tax rate on dividend income for those trading the company’s shares around the ex-dividend date? Maturin said he would answer Jack’s question later and continued: I’ve been thinking that our current annual election of the board is not in the best interests of our shareholders. I believe we should be moving to a staggered board for the following reasons: 1. The company would be less likely to resist hostile takeover attempts with a staggered board; 2. It would ensure the continuity of the knowledge and experience in the company that is so essential for good corporate governance; and 3. It would provide board members more time to learn and understand the needs of shareholders and to be in a better position to align their interests with them. Maturin concluded his remarks by saying: Although the company has not used any long-term debt since 2009, I would like to see the company use long-term debt again. It should issue long-term debt and repurchase shares to return to its historical level of 25% debt-to-equity. We should be able to issue long-term debt at a before tax cost of 5%, and this should not materially increase the costs of financial distress, agency costs, or asymmetrical information. With

our current cost of equity at 12% and a 30% tax rate, our weighted average cost of capital should drop, thus enhancing shareholder value.
1 of 6

The dividend policy that was used by Aubrey Yacht until the strike occurred is best described as a: constant dividend payout ratio policy. residual dividend policy. stable dividend policy.
Question 2 of 6

Using Jack Aubrey’s estimates in Exhibit 2, and assuming that the company adopts his suggested dividend policy, the company’s 2015 dividends per share will be closest to: $3.49 . $4.17 . $3.52 .
Question 3 of 6

Which of the following factors best supports Maturin’s classification as an independent director of AYM? Personal relationships between Maturin and Charles Aubrey Jack Aubrey’s membership on the board of Standard Marine Containers Maturin’s employment history with the company
Question 4 of 6

The best response that Maturin could give to Jack Aubrey’s question about the marginal tax rate on dividend income is that it was closest to: 47.6% . 15.6% . 32.0% .
Question 5 of 6

Which of Maturin’s reasons for adopting a staggered board is most supported by best practices of corporate governance? 3

2 1
Question 6 of 6

Using Maturin’s assumptions, the company’s weighted average cost of capital (WACC) under his proposed financing plan would be closest to: 9.8%. 11.3% . 10.3% .

Corporate Finance - Kloth
Clifford Kloth is a member of a strategy team for Elemetrics Corporation. The team’s task is to determine how to restructure Elemetrics’ capital structure, which has deviated from its target capital structure by having proportionately too much debt. With the economy in a recession, the team is considering alternatives to an equity issuance. In a meeting with upper management, Kloth began to present the team’s suggested strategy proposal. Kloth: After careful consideration of many alternatives, the strategy team suggests reducing the dividend payout ratio of Elemetrics from 40% to 20%. Despite how variable earnings can be, the team believes the additional earnings retained by the firm will reduce the proportion of debt to target levels in a five-year period and reduce the cost of equity as the debt is decreased. One member of the management team, Sven Hanson, immediately stated a concern about Elemetrics’ value as a result of the proposed debt reduction. Hanson: The debt-related tax savings will decrease as the debt is reduced, which, in turn, decreases the value of Elemetrics, even though the proposed change in the payout ratio will not impact the value of Elemetrics. Another member of the management team, Inga Trevard, thought that the proposal would not reduce the value of Elemetrics. Trevard: Actually, the reduction in potential financial distress costs may more than offset the reduction in the tax savings, thus making Elemetrics more valuable.

Hanson questions Kloth further about the proposal: Hanson: Assuming the proposal is value increasing, surely the shareholders will view a reduction in the dividend as bad news. Has the strategy team considered ways to prevent such a situation? Kloth responds: As part of the proposal, the strategy team suggests crafting a press release informing our shareholders the reason for the reduction in dividend. Furthermore, I strongly believe that the proposed financial policy initiatives will increase the shareholder value in three different ways: 1. The lower payout ratio will increase the return on equity (ROE). 2. The free cash flow to the firm (FCFF) will increase as a result of a lower payout ratio. 3. Although the free cash flow to equity (FCFE) declines in the year when debt is paid down, it will increase in subsequent years.
1 of 6

Based on the Modigliani–Miller propositions without taxes, the initial statement by Kloth is most likely: incorrect, because propositions I and II are violated. incorrect, because proposition I is violated. correct.
Question 2 of 6

Based on Kloth's initial suggestion, Elemetrics would best be described as following a: residual dividend policy. stable dividend policy. constant dividend payout ratio policy.
Question 3 of 6

Hanson's statement in response to Kloth's initial proposal is most consistent with: the "bird in the hand" argument concerning dividends. Modigliani–Miller's Proposition II with taxes. Modigliani–Miller's Proposition I with taxes.
Question 4 of 6

Trevard's statement is most consistent with the: agency cost of debt. static trade-off theory of capital structure. free cash flow hypothesis.
Question 5 of 6

Hanson's statement concerning shareholder reaction to the dividend proposal is most consistent with: symmetrical information between management and shareholders. the clientele effect. signaling.
Question 6 of 6

Kloth's response to Hanson's question is most accurate with respect to which of the following? FCF E FCF F ROE

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