Grand Co. has an Equity Market Value Today of $965mm and $425mm: Finance Assignment, CU, Canada

University Carleton University (CU) Canada
Subject Finance

Question I

  1. Grand Co. has an equity market value today of $965mm and $425mm in net debt. A private equity firm, BBM, decides to purchase Grand Co. at a 25% premium to the current stock price using an LBO structure. The capital structure that BBM uses is 38% equity, 62% debt. Assume that seven years later Grand Co. has paid off all the debt and its capital structure is 100% equity. BBM sells it for $2,900mm at that time. What was the annual internal rate of return that BBM earned on this investment?
    1. 20.6%
    2. 23.9%
    3. 24.7%
    4. 27.2%
  1. Which of the following are considered to be important factors when assessing corporate governance strength?
    1. Board composition and independence.
    2. Director compensation.
    3. The company’s capital structure.
    4. Executive compensation.
    1. I and IV only.
    2. I, II, and IV only.
    3. I, II, and III only.
    4. I, II, III, and IV.

Please use the following information to answer the next four multiple-choice questions (Multiple Choice Questions 3, 4, 5, and 6):

Big Buyer would like to buy Tiny Target for a 25% control premium. Currently, Big Buyer’s stock price is $38.67, its EPS is $3.49 and it has 107mm shares outstanding. Currently, Tiny Target’s stock price is $42.50 (before control premium), its EPS is $2.48 and it has 23.5mm shares outstanding. Big Buyer’s cost of debt is 4% and its tax rate is 38%.

  1. If Big Buyer uses stock to acquire Tiny Target what would Big Buyer’s proforma EPS be?
    1. $2.98
    2. $3.04
    3. $3.10
    4. $3.17
  1. If Big Buyer uses stock to acquire Tiny Target what amount of pre-tax synergies are required for Big Buyer to breakeven on an EPS basis?
    1. $54.4mm
    2. $59.6mm
    3. $85.3mm
    4. $87.7mm
  1. If Big Buyer uses debt to acquire Tiny Target what would Big Buyer’s proforma EPS be?
    1. $3.75
    2. $3.73
    3. $3.71
    4. $3.69
  1. What is the maximum price Big Buyer can pay before the deal becomes dilutive if it acquires Tiny Target with debt?
    1. $95.38
    2. $97.36
    3. $99.00
    4. $100.00
  1. In which of the following scenarios is an agency problem least likely to arise?
    1. The Chair of a Board of Directors also being the CEO of a publicly-traded company.
    2. A carpenter repairing his bookshelf.
    3. A real estate agent selling your house.
    4. The majority of owners of a publicly listed company having super-voting stock and management responsibilities.
  1. Which of the below options is the best source of weights to calculate a company’s Weighted Average Cost of Capital?
    1. The values found in the Balance Sheet from the company’s most recent Annual Report (regardless of whether this is the most recent publicly available document).
    2. The values found in the Balance Sheet from the company’s most recent Quarterly Report (assuming this is the most recent publicly available document).
    3. Using the most recent stock price.
    4. Market values.
  1. Which of the following most accurately describes credit rating agencies:
    1. They provide an unbiased assessment of firm default risk.
    2. The announcement of their ratings’ changes often moves the YTM of corporate bonds.
    3. Unlike in school, a “D” is the best credit rating a firm’s bond can receive and an “A” is the worst
    4. There is conflict of interest issues due to the way they get paid for their work.
    1. i).
    2. ii) & iv).
    3. ii).
    4. ii), iii) & iv).
  1. A bond is issued on January 1, 2020, and pays its coupons once annually. Its coupon rate is 4.7%, its maturity is 2 years, its face value is $1,000, and it is purchased at par on January 1, 2020. What is the rate of return from January 1, 2020, until January 2, 2021, if the bond is selling at a yield to maturity of 3.6% by January 2, 2021?
    1. 1.06%.
    2. 2.82%.
    3. 5.73%.
    4. 5.76%.
  1. Assume you fully believe in the Efficient Market Hypothesis (“EMH”). Which of the following beliefs could be considered to be implications of your belief in the EMH?
    1. You believe technical analysis is silly.
    2. You believe Warren Buffet is largely lucky because the fundamental analysis doesn’t allow you to beat the market.
    3. You can’t make returns superior to those of the market.
    1. I and III only.
    2. II and III only.
    3. III only.
    4. All of the above.
  1. Which one of the following would most likely have the strongest impact on the results of a discounted cash flow analysis for a risky, early-stage technology company?:
    1. Whether the “full year” or the “half-year” discounting convention is used.
    2. The pre-tax cost of the company’s debt.
    3. The company’s tax rate.
    4. Whether the arithmetic means or the geometric mean was used in determining the equity market risk premium.
  1. You have the following bonds to choose from:
    1. 4% coupon, 15-year maturity
    2. 4% coupon, 10-year maturity
    3. a zero-coupon, 15-year maturity
    4. 2% coupon, 15-year maturity

    Assume your primary goal is to minimize price sensitivity. Which of the following bond rankings best meets this goal (i.e. order the bonds from least price-sensitive to the most price-sensitive)?

    1. iii), i), iv), ii).
    2. ii), iii), iv), i).
    3. ii), i), iv), iii).
    4. iii), iv), i), ii).
  1. You manage a portion of the balance sheet of a pension fund and know that you will need to pay out $100 million in 30 years to retiring air force pilots. You are only allowed to invest in bonds and you are concerned about how future interest rate changes will affect the value of the pension fund’s bond portfolio. Which of the below best describes how you should mitigate the risk of future interest rate changes on the value of your bond portfolio over the next 30 years?
    1. You should use the concept of duration and employ a net worth immunization strategy.
    2. You cannot do anything about changing interest rates on your bond’s portfolio – when interest rates go up, you will definitely lose money overall as the value of your bond portfolio will go down.
    3. You should ensure that your bond portfolio’s duration is 30 years.
    4. You should employ a laddering strategy to optimize the returns of the bond portfolio.
  1. The Eternal Gift Insurance Company is offering you a policy that will pay you and your heirs $30,000 per year forever at the end of each year. The $30,000 payment will grow forever by 1% per year. The cost of the policy is $378,900. What is the annual rate of return on this policy?
    1. 92%
    2. 92%
    3. 92%
    4. 92%
  1. Which of the following best describes the most common criticisms of the investment styles of Warren Buffett and David Swensen, respectively?
    1. Lack of understanding of new technologies/lack of diversification.
    2. Too much domestic US focus/disregard for rebalancing.
    3. Lack of diversification / too little emphasis on income needs.
    4. Lack of diversification / too much focus on equity.
  1. You would like to invest in the stock of a company and would like to perform a public market comparable company analysis. When trying to select the most comparable publicly traded companies for comparison purposes, what should you never take into consideration?
    1. The stage of the potential comparable company’s life cycle.
    2. The type of shareholders that the potential comparable company has.
    3. The amount of debt that the potential comparable company has.
    4. None of the above.
  1. In the context of doing a Publicly Traded Comparable Analysis on a company in a mature stage of its life cycle, which of the following multiple calculations would be logical to use?
    1. Enterprise Value / Net Income.
    2. Enterprise Value / “Eyeballs”.
    3. Enterprise Value / EBITDA.
    4. Equity Value / Subscribers.
    5. Equity Value / Net Income.
  1. I, iii, and iv only.
  2. ii, iii, and iv only.
  3. ii, iii, and v only.
  4. iii, iv, and v only.
  1. All else constant, a coupon bond that is selling at a discount to par value, must have:
    1. A coupon rate that is equal to the yield to maturity.
    2. A par value that is less than the market price.
    3. A par value which is different than its face value.
    4. A yield to maturity that is more than the coupon rate.
  1. You expect that interest rates will decline in the near future (contrary to the market consensus that rates will rise). Which bond would be your best investment if you are right?:
    1. Zero-coupon, 25-year maturity.
    2. 8% coupon, 5-year maturity.
    3. 1% coupon, 25-year maturity.
    4. 8% coupon, 25-year maturity.
  1. Which of the below are typical reasons that a company which buys another company doesn’t perform well post-acquisition?
    1. Overpaying
    2. Lack of integration preparedness.
    3. Unexpected synergies.
    4. Cultural differences.
    1. I and IV only.
    2. I, II, and IV only.
    3. I, II, and III only.
    4. I, II, III, and IV.
  1. What is the best way to value a stock?
    1. Performing a discounted cash flow analysis.
    2. Performing a public market comparable company analysis.
    3. Performing a dividend discount model (“DDM”) analysis.
    4. Using a combination of approaches since no single approach is without flaws.
  1. You are considering creating a portfolio with 10,000 securities which are equally weighted. Which of the following statements is the truest when determining the risk of your portfolio?
    1. The sum of the risks of individual securities is the most important factor.
    2. The weighted average expected returns of the portfolio is the most important factor.
    3. The correlation of the securities with each other is the most important factor.
    4. The portfolio’s efficient frontier is the most important factor.
  1. Which of the following statements are NOT typical reasons for selling 100% of a segregated asset?
    1. To exit a weak business.
    2. In a hostile defense scenario, selling a valuable asset to make the overall company less attractive.
    3. In the context of an M&A deal, selling an asset of the newly merged company to appease antitrust concerns.
    4. To pay down debt.
    1. II and III only.
    2. III only.
    3. All of the above.
    4. None of the above.
  1. What is the implied stock price today for a company that is expecting to pay $3.25 per share in dividends next year, has a cost of equity of 7.5%, a WACC of 6%, and an expected future dividend growth rate of 4%?
    1. $43.33.
    2. $92.86.
    3. $162.50.
    4. $163.33.
  1. A ten year semi-annual bond’s price is $1,134.68. It has a yield to maturity of 3.4% and a par value of $1,000. What is its coupon rate?
    1. 95%.
    2. 00%.
    3. 00%.
    4. 05%.
  1. What is the price of a five year 1.8% coupon bond paid semi-annually with a $1,000 par value and a yield to maturity of 1.64%?
    1. $1,014.65
    2. $1,007.65
    3. $1,007.62
    4. $932.26
  1. Which of the below is the most important determinant of how many years into the future you should project a company’s cash flows when doing a discounted cash flow analysis?:
    1. A company’s tax rate.
    2. A company’s cost of debt.
    3. The growth rate of the company’s projections.
    4. The expected capital expenditures of a company.
  1. Assume you own a bond that will mature in 9 years and has a yield to maturity that is less than its coupon rate. Your investment time horizon is one year. If your primary goal is capital gains (or avoiding capital loss!) and you strongly believe that interest rates will not change over the next year, what should you do?
    1. Buy more of this bond.
    2. Continue holding this bond but sell it in one year.
    3. Nothing
    4. Sell this bond now.

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Question II.

Assume you have a 15 year, 2.45% semiannual coupon bond with a face value of $1,000. Assume that the bond’s yield to maturity was 2.95% but has increased to 3.28%. What has been the impact on the price of the bond (in percentage terms)? Please show all of your work.

Question III.

GreedyCo. is considering a stock repurchase event. The Company currently has no debt and no cash. The Adams family currently owns 48% of the outstanding stock of GreedyCo. and none of the family members want to sell their shares. Please see the below GreedyCo. summary information (income statement data is for a full year, all other data is the most recent available):

Summary of Financial Data

EBITDA:$250,000,000
EBIT:200,000,000
EBT:200,000,000
Net Income:$150,000,000
EPS:$1.11
Net Current Assets – Current Liabilities:50,000,000
Net Fixed Assets:500,000,000
Shareholder’s Equity:550,000,000
Shares Outstanding:135,000,000
Current Stock Price:$7.50

The company would like to repurchase 16,000,000 shares at the current stock price using 100% debt at a 4.9% interest rate. Assuming they are successful, please answer the following questions. Please show all your work and round to the nearest two decimals.

What is the pro forma EPS of GreedyCo. (i.e. the EPS after the repurchase)?

What is the pro forma Return on Equity of GreedyCo.?

What are the pro forma Debt / EBITDA and EBITDA / Interest ratios?

Do you think Adam’s family would want to go ahead with the proposed share repurchase? Please explain and support your explanation with quantitative data.

Question IV.

You are given the task of calculating the cost of capital of KaBoom Toy Company. The company faces a tax rate of 40%. The company has 100,000 common shares and 10,000 preferred shares outstanding. Each preferred share has a par value of $60 and is currently priced at 90% of the par value. The preferred shares are paying dividends that total 5% of the par value. You estimate that the beta of the common stock is 1.5. The equity market risk premium is estimated to be 5%, and the risk-free rate is 5%. The company has just paid a dividend of $2 per share. You expect that the dividends will grow at a rate of 15% until Year 4. After Year 4, the dividends are expected to grow at a constant rate of 5% forever. You decide to employ the CAPM approach to calculate the cost of equity.

The company has two different debt issues that are outstanding. The first issue consists of 1,000 semi-annual coupon bonds. Each bond has a face value of $1,000. The annual coupon rate is 10%, and the bonds are currently trading at a YTM that equals 12%. The bonds will mature 10 years from now. The second issue consists of 1,000 zero-coupon bonds. Each bond has a face value of $1,000 and will mature 15 years from now. The zero-coupon bonds are trading at 50% of their face value.

Using the information provided above, calculate the weighted average cost of capital of KaBoom Toy Company.

Question V.

Using the following table, please answer the question below.

Using the following table

You have the following information about the company “WooHoo” which you are trying to value:

(amounts in millions)LTMLFY+ 1LFY+ 2
EBITDA$682.0$749.0$802.0
Net Income$324.2$351.4$386.8

In addition, you know that “WooHoo” has Net Debt of $879 million and 78 million shares outstanding. What is “WooHoo” worth on a per-share basis, given the publicly traded comparable company analysis shown above? Please show your work.

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