weaverbirdllm/famma · Datasets at Hugging Face

800

english_314_2_r1

nan

In question 1,suppose that Macrosoft stock is selling for $140 per share on the expiration date. How much is your options investment worth?

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$30,000

If the stock price at expiration is $140, the payoff is: Payoff = 10(100)($140 – 110) Payoff = $30,000

easy

open question

derivatives

english

314

2

1

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release_basic

801

english_314_3_r1

nan

In question 1,suppose that Macrosoft stock is selling for $125 per share on the expiration date. How much is your options investment worth?

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table

$15,000

If the stock price at expiration is $125, the payoff is: Payoff = 10(100)($125 – 110) Payoff = $15,000

easy

open question

derivatives

english

314

3

1

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release_basic

802

english_314_4_r1

nan

Suppose you buy 10 contracts of the August 110 put option. What is your maximum gain?

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$105,300

Remembering that each contract is for 100 shares of stock, the cost is: Cost = 10(100)($4.70) Cost = $4,700 The maximum gain on the put option would occur if the stock price goes to $0. We also need to subtract the initial cost, so: Maximum gain = 10(100)($110) – $4,700 Maximum gain = $105,300

medium

open question

derivatives

english

314

4

1

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release_basic

803

english_314_5_r1

nan

On the expiration date, Macrosoft is selling for $104 per share. What is your net gain?

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table

$1,300

If the stock price at expiration is $104, the position will have a profit of: Profit = 10(100)($110 – 104) – $4,700 Profit = $1,300

medium

open question

derivatives

english

314

5

1

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release_basic

804

english_314_6_r1

nan

In question4, suppose you sell 10 of the August 110 put contracts. What is your net gain or loss if Macrosoft is selling for $103 at expiration?

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table

–$2,300

At a stock price of $103 the put is in the money. As the writer, you will make: Net loss = $4,700 – 10(100)($110 – 103)Net loss = –$2,300

medium

open question

derivatives

english

314

6

1

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release_basic

805

english_314_7_r1

nan

In question4, suppose you sell 10 of the August 110 put contracts. What is your net gain or loss if Macrosoft is selling for $132 at expiration?

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table

$4,700

At a stock price of $132 the put is out of the money, so the writer will make the initial cost: Net gain = $4,700

medium

open question

derivatives

english

314

7

1

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release_basic

806

english_314_8_r1

nan

What is the break- even price—that is, the terminal stock price that results in a zero profit?

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table

$105.30

At the breakeven, you would recover the initial cost of $4,700, so: $\$4,700 = 10(100)(\$110 – S_T) $ $S_T = \$105.30$ For terminal stock prices above $105.30, the writer of the put option makes a net profit (ignoring transaction costs and the effects of the time value of money).

medium

open question

derivatives

english

314

8

1

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release_basic

807

english_315_1_r1

For the following characteristics<image_1>, answer the question.

What is the price of a call option?

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screenshot

$6.30

Using the Black–Scholes option pricing model to find the price of the call option, we find:<ans_image_1> Putting these values into the Black–Scholes model, we find the call price is:<ans_image_2>

medium

open question

derivatives

english

315

1

Not supported with pagination yet

release_basic

808

english_315_2_r1

nan

What is the price of a put option?

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screenshot

$8.11

Using put–call parity, the put price is:<ans_image_3>

medium

open question

derivatives

english

315

2

1

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release_basic

809

english_316_1_r1

For the following characteristics<image_1>, answer the question.

What is the price of a call option?

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screenshot

$14.70

Using the Black–Scholes option pricing model to find the price of the call option, we find:<ans_image_1>.Putting these values into the Black–Scholes model, we find the call price is:<ans_image_2>

medium

open question

derivatives

english

316

1

Not supported with pagination yet

release_basic

810

english_316_2_r1

nan

What is the price of a put option?

null

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screenshot

$10.21

Using put–call parity, the put price is:<ans_image_1>

medium

open question

derivatives

english

316

2

1

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release_basic

811

english_317_1_r1

For the following characteristics<image_1>, answer the question.

What is the deltas of a call option?

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screenshot

0.6895

The delta of a call option is N(d1), so:<ans_image_1>

medium

open question

derivatives

english

317

1

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release_basic

812

english_317_2_r1

nan

What is the deltas of a put option?

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screenshot

–.3105

For a call option the delta is .6895. For a put option, the delta is: Put delta = .6895 – 1 Put delta = –.3105

medium

open question

derivatives

english

317

2

1

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release_basic

813

english_318_1_r1

You are given the following information concerning options on a particular stock:<image_1>

What is the intrinsic value of the call option?

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screenshot

$3

Call intrinsic value = Max[S – E, 0] = $3

easy

open question

derivatives

english

318

1

Not supported with pagination yet

release_basic

814

english_318_2_r1

nan

What is the intrinsic value of the put option?

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screenshot

$0

Put intrinsic value = Max[E – S, 0] = $0

easy

open question

derivatives

english

318

2

1

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release_basic

815

english_318_3_r1

nan

What is the time value of the call option?

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screenshot

$10.49

Using the Black–Scholes option pricing model to find the price of the call option, we find:<ans_image_1>Putting these values into the Black–Scholes model, we find the call price is:<ans_image_2> Option value consists of time value and intrinsic value, so: Call option value = Intrinsic value + Time value $13.49 = $3 + TV TV = $10.49

hard

open question

derivatives

english

318

3

1

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release_basic

816

english_318_4_r1

nan

What is the time value of the put option?

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screenshot

$8.13

Using put–call parity, we find the put price is:<ans_image_3> Put option value = Intrinsic value + Time value $8.13 = $0 + TV TV = $8.13

hard

open question

derivatives

english

318

4

1

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release_basic

817

english_318_5_r1

nan

Does the call or the put have the larger time value component?

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screenshot

Yes.

The time premium (theta) is more important for a call option than a put option; therefore, the time premium is, in general, larger for a call option.

medium

open question

derivatives

english

318

5

0

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release_basic

818

english_319_1_r1

An analyst has recently informed you that at the issuance of a company’s convertible bonds, one of the two following sets of relationships existed:<image_1>

Assume the bonds are available for immediate conversion. Which of the two scenarios do you believe is more likely? Why?

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Scenario A.

Since a convertible bond gives its holder the right to a fixed payment plus the right to convert, it must be worth at least as much as its straight value. Therefore, if the market value of a convertible bond is less than its straight value, there is an opportunity to make an arbitrage profit by purchasing the bond and holding it until expiration. In Scenario A, the market value of the convertible bond is $1,000. Since this amount is greater than the convertible’s straight value ($900), Scenario A is feasible. In Scenario B, the market value of the convertible bond is $900. Since this amount is less than the convertible’s straight value ($950), Scenario B is not feasible.

hard

open question

derivatives

english

319

1

0

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release_basic

819

english_320_1_r1

Blue Steel Community Bank has the following market value balance sheet:<image_1>

What is the duration of the assets?

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table

4.51 years

The duration of a portfolio of assets or liabilities is the weighted average of the duration of the portfolio’s individual items, weighted by their relative market values. The total market value of assets in millions is: Market value of assets = $31 + 540 + 320 + 98 + 435 Market value of assets = $1,424 So, the market value weight of each asset is: Federal funds deposits = $31/$1,424 = .022 Accounts receivable = $540/$1,424 = .379 Short-term loans = $320/$1,424 = .225 Long-term loans = $98/$1,424 = .069 Mortgages = $435/$1,424 = .305 Since the duration of a group of assets is the weighted average of the durations of each individual asset in the group, the duration of assets is: Duration of assets = .022(0) + .379(.20) + .225(.65) + .069(5.25) + .305(12.85) Duration of assets = 4.51 years

hard

open question

fixed income

english

320

1

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release_basic

820

english_320_2_r1

nan

What is the duration of the liabilities?

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table

2.65 years

The total market value of liabilities in millions is: Market value of liabilities = $615 + 390 + 285 Market value of liabilities = $1,290 Note that equity is not included in this calculation since it is not a liability. So, the market value weight of each asset is: Checking and savings deposits = $615/$1,290 = .477 Certificates of deposit = $390/$1,290 = .302 Long-term financing = $285/$1,290 = .221 Since the duration of a group of liabilities is the weighted average of the durations of each individual asset in the group, the duration of liabilities is: Duration of liabilities = .477(0) + .302(1.60) + .221(9.80) Duration of liabilities = 2.65 years

hard

open question

fixed income

english

320

2

1

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release_basic

821

english_320_3_r1

nan

Is the bank immune to interest rate risk?

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table

No.

Since the duration of its assets does not equal the duration of its liabilities, the bank is not immune from interest rate risk.

medium

open question

fixed income

english

320

3

0

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release_basic

822

english_321_1_r1

This morning you agreed to buy a one-year Treasury bond in six months. The bond has a face value of $1,000. Use the spot interest rates listed here to answer the following questions:<image_1>

What is the forward price of this contract?

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table

$949.72

The forward price of an asset with no carrying costs or convenience value is: $Forward price = S_0(1 + R)$ Since you will receive the bond’s face value of $1,000 in 18 months, we can find the price of the bond today, which will be: $Current bond price = \$1,000 / (1.0473)^{3/2} $ Current bond price = $933.03 Since the forward contract defers delivery of the bond for six months, the appropriate interest rate to use in the forward pricing equation is the six month EAR, so the forward price will be: $Forward price = \$933.03(1.0361)^{1/2} $ Forward price = $949.72

hard

open question

corporate finance

english

321

1

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release_basic

823

english_321_2_r1

nan

Suppose shortly after you purchased the forward contract all rates increased by 30 basis points. For example, the six-month rate increased from 3.61 percent to 3.91 percent. What is the price of a forward contract otherwise identical to yours given these changes?

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$947.02

It is important to remember that 100 basis points equals 1 percent and one basis point equals .01%. Therefore, if all rates increase by 30 basis points, each rate increases by .003. So, the new price of the bond today will be: $New bond price = \$1,000 / (1 + .0473 + .003)^{3/2} $ New bond price = $929.03 Since the forward contract defers delivery of the bond for six months, the appropriate interest rate to use in the forward pricing equation is the six month EAR, increased by the interest rate change. So the new forward price will be: $Forward price = \$929.03(1 + .0361 + .003)^{1/2} $ Forward price = $947.02

hard

open question

derivatives

english

321

2

1

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release_basic

824

english_322_1_r1

Consider the following financial statement information for the Rivers Corporation: <image_1>

Calculate the operating cycle.

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table

63.08 days

The operating cycle is the inventory period plus the receivables period. The inventory turnover and inventory period are: Inventory turnover = COGS / Average inventory Inventory turnover = $165,763 / [($17,385 + 19,108) / 2] Inventory turnover = 9.0846 times Inventory period = 365 days / Inventory turnover Inventory period = 365 days / 9.0846 Inventory period = 40.18 days And the receivables turnover and receivables period are: Receivables turnover = Credit sales / Average receivables Receivables turnover = $216,384 / [($13,182 + 13,973) / 2] Receivables turnover = 15.9370 times Receivables period = 365 days / Receivables turnover Receivables period = 365 days / 15.9370 Receivables period = 22.90 days So, the operating cycle is: Operating cycle = 40.18 days + 22.90 days Operating cycle = 63.08 days

hard

open question

financial statement analysis

english

322

1

Not supported with pagination yet

release_basic

825

english_322_2_r1

nan

Calculate the cash cycle.

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table

27.78 days

The cash cycle is the operating cycle minus the payables period. The payables turnover and payables period are: Payables turnover = COGS / Average payables Payables turnover = $165,763 / [($15,385 + 16,676) / 2] Payables turnover = 10.3405 times Payables period = 365 days / Payables turnover Payables period = 365 days / 10.3405 Payables period = 35.30 days So, the cash cycle is: Cash cycle = 63.08 days – 35.30 days Cash cycle = 27.78 days The firm is receiving cash on average 27.78 days after it pays its bills.

hard

open question

financial statement analysis

english

322

2

1

Not supported with pagination yet

release_basic

826

english_323_1_r1

The following is the sales budget for Shleifer, Inc., for the first quarter of 2016:<image_1>Credit sales are collected as follows: 65 percent in the month of the sale. 20 percent in the month after the sale. 15 percent in the second month after the sale. The accounts receivable balance at the end of the previous quarter was $122,800 ($87,750 of which were uncollected December sales).

Compute the sales for November.

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table

$233,666.67

The November sales must have been the total uncollected sales minus the uncollected sales from December, divided by the collection rate two months after the sale, so: November sales = ($122,800 – 87,750) / .15 November sales = $233,666.67

medium

open question

financial statement analysis

english

323

1

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release_basic

827

english_323_2_r1

nan

Compute the sales for December.

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table

$250,714.29

The December sales are the uncollected sales from December divided by the collection rate of the previous months’ sales, so: December sales = $87,750 / (.20 + .15) December sales = $250,714.29

medium

open question

financial statement analysis

english

323

2

1

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release_basic

828

english_323_3_r1

nan

Compute the cash collections from sales for January.

null

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table

$252,892.86

Collections = .15(Sales from 2 months ago) + .20(Last month’s sales) + .65(Current sales) January collections = .15($233,666.67) + .20($250,714.29) + .65($258,000) January collections = $252,892.86

medium

open question

financial statement analysis

english

323

3

1

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release_basic

829

english_323_4_r1

nan

Compute the cash collections from sales for February.

null

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table

$267,437.14

Collections = .15(Sales from 2 months ago) + .20(Last month’s sales) + .65(Current sales) February collections = .15($250,714.29) + .20($258,000) + .65($274,200) February collections = $267,437.14

medium

open question

financial statement analysis

english

323

4

1

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release_basic

830

english_323_5_r1

nan

Compute the cash collections from sales for March.

null

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table

$287,240

Collections = .15(Sales from 2 months ago) + .20(Last month’s sales) + .65(Current sales) March collections = .15($258,000) + .20($274,200) + .65($298,000) March collections = $287,240

medium

open question

financial statement analysis

english

323

5

1

Not supported with pagination yet

release_basic

831

english_324_1_r1

Here are the most recent balance sheets for Country Kettles, Inc. Excluding accumulated depreciation<image_1>

Determine whether item cash is a source or a use of cash, and the amount.

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table

Source,$2,365

$ 48,180-$ 45,815 = $2,365>0

easy

open question

financial statement analysis

english

324

1

Not supported with pagination yet

release_basic

832

english_324_2_r1

nan

Determine whether item Accounts receivable is a source or a use of cash, and the amount.

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table

Use, –$5,258

$100,155-$105,413=-$5,258<0

easy

open question

financial statement analysis

english

324

2

1

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release_basic

833

english_324_3_r1

nan

Determine whether item Inventories is a source or a use of cash, and the amount.

null

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table

Use, –$6,116

$83,600-$89,716 = -$6,116<0

easy

open question

financial statement analysis

english

324

3

1

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release_basic

834

english_324_4_r1

nan

Determine whether item Property, plant, and equipment is a source or a use of cash, and the amount.

null

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table

Use, –$23,094

$225,992-$249,086 = -$23,094<0

easy

open question

financial statement analysis

english

324

4

1

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release_basic

835

english_324_5_r1

nan

Determine whether item Accounts payable is a source or a use of cash, and the amount.

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table

Use, –$22,126

$ 50,396-$ 72,522 = -$22,196<0

easy

open question

financial statement analysis

english

324

5

1

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release_basic

836

english_324_6_r1

nan

Determine whether item Accrued expenses is a source or a use of cash, and the amount.

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table

Use, –$1,140

$9,840-$10,980 = -$1,140<0

easy

open question

financial statement analysis

english

324

6

1

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release_basic

837

english_324_7_r1

nan

Determine whether item Long-term debt is a source or a use of cash, and the amount.

null

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table

Use, –$4,500

$45,000-$49,500 = -$4,500<0

easy

open question

financial statement analysis

english

324

7

1

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release_basic

838

english_324_8_r1

nan

Determine whether item Common stock is a source or a use of cash, and the amount.

null

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table

Source, $5,000

$30,000-$25,000 = $5,000>0

easy

open question

financial statement analysis

english

324

8

1

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release_basic

839

english_324_9_r1

nan

Determine whether item Accumulated retained earnings is a source or a use of cash, and the amount.

null

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table

Source, $46,484

$269,215-$222,731 = $46,484>0

easy

open question

financial statement analysis

english

324

9

1

Not supported with pagination yet

release_basic

840

english_325_1_r1

Cleveland Compressor and Pnew York Pneumatic are competing manufacturing firms. Their financial statements are printed here.<image_1><image_2><image_3><image_4>

How is the current asset of firm Cleveland Compressor financed?

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table

By retained earnings.

The current assets of Cleveland Compressor are financed largely by retained earnings. From 2015 to 2016, total current assets grew by $7,212. Only $2,126 of this increase was financed by the growth of current liabilities. .

hard

open question

financial statement analysis

english

325

1

0

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release_basic

841

english_325_2_r1

nan

How is the current asset of firm Pnew York Pneumatic financed?

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table

By current liabilities.

Pnew York Pneumatic’s current assets are largely financed by current liabilities. Bank loans are the most important of these current liabilities. They decreased by $3,077 as current assets decreased by $8,333.

hard

open question

financial statement analysis

english

325

2

0

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release_basic

842

english_325_3_r1

nan

Which firm has the larger investment in current assets? Why?

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table

Cleveland Compressor.

Cleveland Compressor holds the larger investment in current assets. It has current assets of $92,616 while Pnew York Pneumatic has $70,101 in current assets. The main reason for the difference is the larger sales of Cleveland Compressor.

hard

open question

financial statement analysis

english

325

3

0

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release_basic

843

english_325_4_r1

nan

Which firm is more likely to incur carrying costs?

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table

Pnew York Pneumatic.

That ratio for Pnew York Pneumatic is .77.Pnew York Pneumatic is incurring more carrying costs for the same reason, a higher ratio of current assets to sales.

hard

open question

financial statement analysis

english

325

4

0

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release_basic

844

english_325_5_r1

nan

which is more likely to incur shortage costs?

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table

Cleveland Compressor.

Cleveland Compressor is more likely to incur shortage costs because the ratio of current assets to sales is .57. That ratio for Pnew York Pneumatic is .77.

hard

open question

financial statement analysis

english

325

5

0

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release_basic

845

english_326_1_r1

Paper Submarine Manufacturing is investigating a lockbox system to reduce its collection time. It has determined the following:<image_1>The total collection time will be reduced by three days if the lockbox system is adopted.

What is the PV of adopting the system?

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screenshot

$1,063,950

The present value of adopting the system is the number of days collections are reduced times the average daily collections, so: PV = 3(410)($865) PV = $1,063,950

easy

open question

financial statement analysis

english

326

1

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release_basic

846

english_326_2_r1

nan

What is the NPV of adopting the system?

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screenshot

$38,950

The NPV of adopting the system is the present value of the savings minus the cost of adopting the system. The cost of adopting the system is the present value of the fee per transaction times the number of transactions. This is a perpetuity, so: NPV = $1,063,950 – [$.50(410)/.0002] NPV = $38,950

easy

open question

financial statement analysis

english

326

2

0

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release_basic

847

english_326_3_r1

nan

What is the net cash flow per day from adopting?

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screenshot

$7.79

The net cash flow is the present value of the average daily collections times the daily interest rate, minus the transaction cost per day, so: Net cash flow per day = $1,063,950(.0002) – $.50(410) Net cash flow per day = $7.79

medium

open question

financial statement analysis

english

326

3

1

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release_basic

848

english_326_4_r1

nan

What is the net cash flow per check from adopting?

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screenshot

$0.02

The net cash flow per check is the net cash flow per day divided by the number of checks received per day, or: Net cash flow per check = $7.79 / 410 Net cash flow per check = $.02 Alternatively, we could find the net cash flow per check as the number of days the system reduces collection time times the average check amount times the daily interest rate, minus the transaction cost per check. Doing so, we confirm our previous answer as: Net cash flow per check = 3($865)(.0002) – $.50 Net cash flow per check = $.02 per check

medium

open question

financial statement analysis

english

326

4

1

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release_basic

849

english_327_1_r1

Bird’s Eye Treehouses, Inc., a Kentucky company, has determined that a majority of its customers are located in the Pennsylvania area. It therefore is considering using a lockbox system offered by a bank located in Pittsburgh. The bank has estimated that use of the system will reduce collection time by two days.

Based on the following information<image_1>, should the lockbox system be adopted?

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Yes.

To find the NPV of taking the lockbox, we first need to calculate the present value of the savings. The present value of the savings will be the reduction in collection time times the average daily collections, so: PV = 2(850)($630) PV = $1,071,000 And the daily interest rate is: $Daily interest rate = 1.070^{1/365} – 1$ Daily interest rate = .00019, or .019% per day The transaction costs are a perpetuity. The cost per day is the cost per transaction times the number of transactions per day, so the NPV of taking the lockbox is: NPV = $1,071,000 – [$.22(850) / .00019] NPV = $62,279.38 The lockbox system should be accepted.

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Based on the following information<image_2>, if there were a fixed charge of $5,000 per year in addition to the variable charge, should the lockbox system be adopted?

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No.

To calculate the NPV of the lockbox with the annual fee, we can use the NPV of the lockbox without the annual fee and subtract the additional cost. The annual fee is a perpetuity, so, with the fee, the NPV of taking the lockbox is: NPV = $62,279.38 – [$5,000 / .07] NPV = –$9,149.20 With the fee, the lockbox system should not be accepted.

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Leeloo, Inc., is considering a change in its cash-only sales policy. The new terms of sale would be net one month.

Based on the following information<image_1>, determine if the company should proceed or not. Describe the buildup of receivables in this case. The required return is .95 percent per month.

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NPV = $577,752.63

The cost of switching is any lost sales from the existing policy plus the incremental variable costs under the new policy, so: Cost of switching = $720(1,130) + $495(1,190 – 1,130) Cost of switching = $843,300 The benefit of switching is any increase in the sales price minus the variable costs per unit, times the incremental units sold, so: Benefit of switching = ($720 – 495)(1,190 – 1,130) Benefit of switching = $13,500 The benefit of switching is a perpetuity, so the NPV of the decision to switch is: NPV = –$843,300 + $13,500 / .0095 NPV = $577,752.63 The firm will have to bear the cost of sales for one month before they receive any revenue from credit sales, which is why the initial cost is for one month. Receivables will grow over the one month credit period and will then remain stable with payments and new sales offsetting one another.

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The Harrington Corporation is considering a change in its cash-only policy. The new terms would be net one period.

Based on the following information<image_1>, determine if Harrington should proceed or not. The required return is 2.5 percent per period.

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NPV = $268,405

The cash flow from either policy is: Cash flow = (P – v)Q So, the cash flows from the old policy are: Cash flow from old policy = ($104 – 47)(2,870) Cash flow from old policy = $163,590 And the cash flow from the new policy would be: Cash flow from new policy = ($108 – 47)(2,915) Cash flow from new policy = $177,815 So, the incremental cash flow would be: Incremental cash flow = $177,815 – 163,590 Incremental cash flow = $14,225 The incremental cash flow is a perpetuity. The cost of initiating the new policy is: Cost of new policy = –[PQ + v(Q' – Q)] So, the NPV of the decision to change credit policies is: NPV = –[($104)(2,870) + ($47)(2,915 – 2,870)] + $14,225 / .025 NPV = $268,405

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Happy Times currently has an all-cash credit policy. It is considering making a change in the credit policy by going to terms of net 30 days.

Based on the following information<image_1>, what do you recommend? The required return is .95 percent per month.

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NPV = $279,075.79

The cash flow from the old policy is: Cash flow from old policy = ($289 – 226)(1,105) Cash flow from old policy = $69,615 And the cash flow from the new policy will be: Cash flow from new policy = ($296 – 229)(1,125) Cash flow from new policy = $75,375 The incremental cash flow, which is a perpetuity, is the difference between the old policy cash flows and the new policy cash flows, so: Incremental cash flow = $75,375 – 69,615 Incremental cash flow = $5,760 The cost of switching credit policies is: Cost of new policy = –[PQ + Q(v' – v) + v'(Q' – Q)] In this cost equation, we need to account for the increased variable cost for all units produced. This includes the units we already sell, plus the increased variable costs for the incremental units. So, the NPV of switching credit policies is: NPV = –[($289)(1,105) + (1,105)($229 – 226) + ($229)(1,125 – 1,105)] + ($5,760 / .0095) NPV = $279,075.79

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The shareholders of Flannery Company have voted in favor of a buyout offer from Stultz Corporation. Information about each firm is given here:<image_1>Flannery’s shareholders will receive one share of Stultz stock for every three shares they hold in Flannery.

What will the EPS of Stultz be after the merger?

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$5.40

The EPS of the combined company will be the sum of the earnings of both companies divided by the shares in the combined company. Since the stock offer is one share of the acquiring firm for three shares of the target firm, new shares in the acquiring firm will increase by one-third of the number of shares of the target company. So, the new EPS will be: EPS = ($230,000 + 690,000) / [146,000 + (1/3)(73,000)] EPS = $5.401

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What will the PE ratio be if the NPV of the acquisition is zero?

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11.11

The market price of Stultz will remain unchanged if it is a zero NPV acquisition. Using the PE ratio, we find the current market price of Stultz stock, which is: P = 12.7($690,000) / 146,000 P = $60.02 If the acquisition has a zero NPV, the stock price should remain unchanged. Therefore, the new PE will be: PE = $60.02 / $5.401 PE = 11.11

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What must Stultz feel is the value of the synergy between these two firms? Explain how your answer can be reconciled with the decision to go ahead with the takeover.

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The market value of the company.

The value of Flannery to Stultz must be the market value of the company since the NPV of the acquisition is zero. Therefore, the value is: $V^* = \$230,000(6.35) V^* = \$1,460,500$ The cost of the acquisition is the number of shares offered times the share price, so the cost is: Cost = (1/3)(73,000)($60.02) Cost = $1,460,500 So, the NPV of the acquisition is: $NPV=0=V^* +\bigtriangleup V–Cost=\$1,460,500+\bigtriangelup V–1,460,500$ $\bigtriangleup V = \$0$ Although there is no economic value to the takeover, it is possible that Stultz is motivated to purchase Flannery for other than financial reasons.

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Cholern Electric Company (CEC) is a public utility that provides electricity to the central Colorado area. Recent events at its Mile-High Nuclear Station have been discouraging. Several shareholders have expressed concern over last year’s financial statements.<image_1>. Recently, a wealthy group of individuals has offered to purchase half of CEC’s assets at fair market price. Management recommends that this offer be accepted because “We believe our expertise in the energy industry can be better exploited by CEC if we sell our electricity generating and transmission assets and enter the telecommunications business. Although telecommunications is a riskier business than providing electricity as a public utility, it is also potentially very profitable.”

Should the management approve this transaction? Why or why not?

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No.

The decision hinges upon the risk of surviving. That is, consider the wealth transfer from bondholders to stockholders when risky projects are undertaken. High-risk projects will reduce the expected value of the bondholders’ claims on the firm. The telecommunications business is riskier than the utilities business. If the total value of the firm does not change, the increase in risk should favor the stockholder. Hence, management should approve this transaction. If the total value of the firm drops because of the transaction, and the wealth effect is lower than the reduction in total value, management should reject the project.

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Consider the following premerger information about a bidding firm (Firm B) and a target firm (Firm T). Assume that both firms have no debt outstanding.<image_1> Firm B has estimated that the value of the synergistic benefits from acquiring Firm T is $12,600.

If Firm T is willing to be acquired for $24 per share in cash, what is the NPV of the merger?

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$2,400

The NPV of the merger is the market value of the target firm, plus the value of the synergy, minus the acquisition costs, so: NPV = 3,400($21) + $12,600 – 3,400($24) NPV = $2,400

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What will the price per share of the merged firm be assuming the conditions in the first question?

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$46.29

Since the NPV goes directly to stockholders, the share price of the merged firm will be the market value of the acquiring firm plus the NPV of the acquisition, divided by the number of shares outstanding, so: Share price = [8,300($46) + $2,400] / 8,300 Share price = $46.29

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In question1, what is the merger premium?

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$10,200

The merger premium is the premium per share times the number of shares of the target firm outstanding, so the merger premium is: Merger premium = 3,400($24 – 21) Merger premium = $10,200

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Suppose Firm T is agreeable to a merger by an exchange of stock. If B offers one of its shares for every two of T’s shares, what will the price per share of the merged firm be?

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$46.58

The number of new shares will be the number of shares of the target times the exchange ratio, so: New shares created = 3,400(1/2) New shares created = 1,700 new shares The value of the merged firm will be the market value of the acquirer plus the market value of the target plus the synergy benefits, so: VBT = 8,300($46) + 3,400($21) + $12,600 VBT = $465,800 The price per share of the merged firm will be the value of the merged firm divided by the total shares of the new firm, which is: P = $465,800 / (8,300 + 1,700) P = $46.58

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What is the NPV of the merger assuming the conditions in question 4?

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$4,814

The NPV of the acquisition using a share exchange is the market value of the target firm plus synergy benefits, minus the cost. The cost is the value per share of the merged firm times the number of shares offered to the target firm shareholders, so: NPV = 3,400($21) + $12,600 – 1,700($46.58) NPV = $4,814

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Consider the following premerger information about Firm A and Firm B:<image_1>

What will the earnings per share, EPS, of Firm A be after the merger?

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$2.95

The cost of the acquisition is: Cost = 300($13) = $3,900 Since the stock price of the acquiring firm is $60, the firm will have to give up: Shares offered = $3,900 / $60 Shares offered = 65 shares The EPS of the merged firm will be the combined EPS of the existing firms divided by the new shares outstanding, so: EPS = ($2,100 + 750) / (900 + 65) EPS = $2.95

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What will Firm A’s price per share be after the merger if the market incorrectly analyzes this reported earnings growth (i.e., the price–earnings ratio does not change)?

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$75.94

The PE of the acquiring firm is: Original PE = $60 / ($2,100 / 900) Original PE = 25.71 times Assuming the PE ratio does not change, the new stock price will be: New price = $2.95(25.71) New price = $75.94

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What will the price–earnings ratio of the postmerger firm be if the market correctly analyzes the transaction?

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20.32 times

If the market correctly analyzes the earnings, the stock price will remain unchanged since this is a zero NPV acquisition, so: New PE = $60 / $2.95 New PE= 20.32 times

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If there are no synergy gains, what will the share price of A be after the merger?

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$59.69

The new share price will be the combined market value of the two existing companies divided by the number of shares outstanding in the merged company. So: Price = [(900)($60) + 300($12)] / (900 + 65) Price = $59.69

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If there are no synergy gains, what will the price–earnings ratio be?

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20.21 times

The PE ratio of the merged company will be: PE = $59.69 / $2.95 PE = 20.21 times

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Bentley Corp. and Rolls Manufacturing are considering a merger. The possible states of the economy and each company’s value in that state are shown here:<image_1> Bentley currently has a bond issue outstanding with a face value of $125,000. Rolls is an all-equity company.

What is the value of company Bentley before the merger?

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$227,000

The value of each company is the sum of the probability of each state of the economy times the value of the company in that state of the economy, so: $Value_{Bentley} = .65(\$290,000) + .35(\$110,000) $ $Value_{Bentley} = \$227,000$

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What is the value of company Rolls before the merger?

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$197,000

$Value_{Rolls} = .65(\$260,000) + .35(\$80,000) $ $Value_{Rolls} = \$197,000$

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What are the values of Bentley’s debt before the merger?

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$119,750

The value of Bentley’s debt in a boom is the full face value of $125,000. In a recession, the value of the company’s debt is $110,000 since the value of the debt cannot exceed the value of the company. So, the value of Bentley’s debt today is: DebtBentley = .65($125,000) + .35($110,000) DebtBentley = $119,750

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What are the values of Bentley’s equity before the merger?

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$107,250

The value of Bentley’s equity in a boom is $165,000 ($290,000 company value minus $125,000 debt value), and the value of Bentley’s equity in a recession is zero since the value of its debt is greater than the value of the company in that state of the economy. So, the value of Bentley’s equity is: EquityBentley = .65($165,000) + .35($0) EquityBentley = $107,250

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What are the values of Rolls’s equity before the merger?

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$197,000

The value of each company’s equity is sum of the probability of each state of the economy times the value of the equity in that state of the economy. The value of equity in each state of the economy is the maximum of total company value minus the value of debt, or zero. Since Rolls is an all equity company, the value of its equity is the total value of the firm, or $197,000.

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If the companies continue to operate separately, what is the total value of the companies?

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$424,000

Combined value = $227,000 + 197,000 Combined value = $424,000

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If the companies continue to operate separately, what is the total value of the equity?

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$304,250

Combined equity value = $107,250 + 197,000 Combined equity value = $304,250

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If the companies continue to operate separately, what is the total value of the debt?

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$119,750

Combined debt value = $119,750

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What would be the value of the merged company?

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$424,000

To find the value of the merged company, we need to find the value of the merged company in each state of the economy, which is: Boom merged value = $290,000 + 260,000 Boom merged value = $550,000 Recession merged value = $110,000 + 80,000 Recession merged value = $190,000 So, the value of the merged company today is: Merged company value = .65($550,000) + .35($190,000) Merged company value = $424,000

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What would be the value of the merged company’s debt?

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$299,000

Since the merged company will still have $125,000 in debt, the value of the equity in a boom is $425,000, and the value of equity in a recession is $65,000. So, the value of the merged company’s equity is: Merged equity value = .65($425,000) + .35($65,000) Merged equity value = $299,000

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What would be the value of the merged company’s equity?

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$125,000

The merged company will have a value greater than the face value of debt in both states of the economy, so the value of the company’s debt is $125,000.

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Is there a transfer of wealth in this case? Why?

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Yes.

There is a wealth transfer in this case. The combined equity value before the merger was $304,250, but the value of the equity in the merged company is only $299,000, a loss of $5,250 for stockholders. The value of the debt in the combined companies was only $119,750, but the value of debt in the merged company is $125,000 since there is no chance of default. The bondholders gained $5,250, exactly the amount the stockholders lost.

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Suppose that the face value of Bentley’s debt was $90,000. Would this affect the transfer of wealth?

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No.

If the value of Bentley’s debt before the merger is less than the lowest firm value, there is no coinsurance effect. Since there is no possibility of default before the merger, bondholders do not gain after the merger.

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Plant, Inc., is considering making an offer to purchase Palmer Corp. Plant’s vice president of finance has collected the following information:<image_1> .Plant also knows that securities analysts expect the earnings and dividends of Palmer to grow at a constant rate of 4 percent each year. Plant management believes that the acquisition of Palmer will provide the firm with some economies of scale that will increase this growth rate to 6 percent per year.

What is the value of Palmer to Plant?

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$16,114,285.71

To find the value of the target to the acquirer, we need to find the share price with the new growth rate. We begin by finding the required return for shareholders of the target firm. The earnings per share of the target are: $EPS_P = \$960,000 / 750,000 $ $EPS_P = \$1.28 per share$ The price per share is: $P_P = 10(\$1.28) $ $P_P = \$12.80$ And the dividends per share are: $DPS_P = \$470,000 / 750,000 $ $DPS_P = \$.63$ The current required return for Palmer shareholders, which incorporates the risk of the company, is: $R_E = [\$.63(1.04) / \$12.80] + .04 $ $R_E = .0909$ The price per share of Palmer with the new growth rate is: $P_P =\ $.63(1.06) / (.0909 – .06)$ $P_P = \$21.49$ The value of the target firm to the acquiring firm is the number of shares outstanding times the price per share under the new growth rate assumptions, so: $V_T^* = 750,000(\$21.49) $ $V_T^* = \$16,114,285.71$

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What would Plant’s gain be from this acquisition?

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$6,514,285.71

The gain to the acquiring firm will be the value of the target firm to the acquiring firm minus the market value of the target, so: Gain = $16,114,285.71 – 750,000($12.80) Gain = $6,514,285.71

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If Plant were to offer $20 in cash for each share of Palmer, what would the NPV of the acquisition be?

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$1,114,285.71

The NPV of the acquisition is the value of the target firm to the acquiring firm minus the cost of the acquisition, so: NPV = $16,114,285.71 – 750,000($20) NPV = $1,114,285.71

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What is the most Plant should be willing to pay in cash per share for the stock of Palmer?

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$21.49

The most the acquiring firm should be willing to pay per share is the offer price per share plus the NPV per share, so: Maximum bid price = $20 + ($1,114,285.71 / 750,000) Maximum bid price = $21.49 Notice that this is the same value we calculated earlier in part a as the value of the target to the acquirer.

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If Plant were to offer 225,000 of its shares in exchange for the outstanding stock of Palmer, what would the NPV be?

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$6,068,944.10

The price of the stock in the merged firm would be the market value of the acquiring firm plus the value of the target to the acquirer, divided by the number of shares in the merged firm, so: $P_{FP} = (\$60,900,000 + 16,114,285.71) / (1,500,000 + 225,000) $ $P_{FP} = \$44.65$ The NPV of the stock offer is the value of the target to the acquirer minus the value offered to the target shareholders. The value offered to the target shareholders is the stock price of the merged firm times the number of shares offered, so: NPV = $16,114,285.71 – 225,000($44.65) NPV = $6,068,944.10

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Should the acquisition be attempted? If so, should it be as in question3 or as in question 5?

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Yes.Question 5.

Yes, the acquisition should go forward, and Plant should offer shares since the NPV is higher.

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic. What is the value of Palmer to Plant?

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$12,061,099.80

Using the new growth rate in the dividend growth model, along with the dividend and required return we calculated earlier, the price of the target under these assumptions is: $P_P = \$.63(1.05) / (.0909 – .05) $ $P_P = \$16.08$ And the value of the target firm to the acquiring firm is: $V_P^* = 750,000(\$16.08)$ $V_P^* = \$12,061,099.80$

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic. What would Plant’s gain be from this acquisition?

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$2,461,099.80

The gain to the acquiring firm will be: Gain = $12,061,099.80 – 750,000($12.80) Gain = $2,461,099.80

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic.If Plant were to offer $20 in cash for each share of Palmer, what would the NPV of the acquisition be?

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–$2,938,900.20

The NPV of the cash offer is now: NPV cash = $12,061,099.80 – 750,000($20) NPV cash = –$2,938,900.20

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic. What is the most Plant should be willing to pay in cash per share for the stock of Palmer?

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$42.30

The new price per share of the merged firm will be: $P_{FP} = [\$60,900,000 + 12,061,099.80] / (1,500,000 + 225,000) $ $P_{FP} = \$42.30$

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic. If Plant were to offer 225,000 of its shares in exchange for the outstanding stock of Palmer, what would the NPV be?

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$2,544,434.61

The NPV of the stock offer under the new assumption will be: NPV stock = $12,061,099.80 – 225,000($42.30) NPV stock = $2,544,434.61

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Plant’s outside financial consultants think that the 6 percent growth rate is too opti- mistic and a 5 percent rate is more realistic. Should the acquisition be attempted? If so, should it be as in question3 or as in question 5?

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Yes.Question 5.

Even with the lower projected growth rate, the stock offer still has a positive NPV. The NPV of the stock offer is still higher. Plant should purchase Palmer with a stock offer of 225,000 shares.

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The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and form Fudge Swirl Consolidated. Both companies are exactly alike except that they are located in different towns. The end-of-period value of each firm is determined by the weather, as shown below. There will be no synergy to the merger.<image_1> The weather conditions in each town are independent of those in the other. Furthermore, each company has an outstanding debt claim of $450,000. Assume that no premiums are paid in the merger.

What is the possible value of Rain-Rain of the combined company?

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$460,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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What is the possible value of Rain-Warm of the combined company?

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$680,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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What is the possible value of Rain-Hot of the combined company?

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$1,135,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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What is the possible value of Warm-Wamr of the combined company?

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$900,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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What is the possible value of Warm-Hot of the combined company?

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$1,355,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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What is the possible value of Hot-Hot of the combined company?

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$1,810,000

To find the distribution of joint values, we first must find the joint probabilities. To do this, we need to find the joint probabilities for each possible combination of weather in the two towns. The weather conditions are independent; therefore, the joint probabilities are the products of the individual probabilities.<ans_image_1>. Next, note that the revenue when rainy is the same regardless of which town. So, since the state "Rain-Warm" has the same outcome (revenue) as "Warm-Rain", their probabilities can be added. The same is true of "Rain-Hot" / "Hot-Rain" and "Warm-Hot" / "Hot-Warm". Thus the joint probabilities are:<ans_image_2> Finally, the joint values are the sums of the values of the two companies for the particular state.<ans_image_3>

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899

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What is the possible value of Rain-Rain of end-of-period debt after the merger?

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$460,000

Recall that if a firm cannot service its debt, the bondholders receive the value of the assets. Thus, the value of the debt is reduced to the value of the company if the face value of the debt is greater than the value of the company. If the value of the company is greater than the value of the debt, the value of the debt is its face value. Here, the value of the common stock is always the residual value of the firm over the value of the debt. So, the value of the debt and the value of the stock in each state is:<ans_image_4>

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