Corporate Finance Examination

FIN 460 Take-Home Midterm Examination- Spring, 2018

The following pages contain the take home midterm for Finance 460. The exam is due no later than Friday, March 23rd at noon. By electronically submitting the final exam, you are attesting to the following. Please READ carefully.

1. I understand that this is an examination and attest that the work presented is my own; that it is done without outside assistance of any kind (except that provided by the instructor). I understand that the penalty for cheating or collusion of any kind is a grade of F for the course.

1. I will submit a printed copy, one essay per page, and each problem starting on a new page. Everything will be submitted in order.

1. Spreadsheet solutions will be appropriately formatted and developed in a logical, readable, coherent fashion. Confusing or unformatted spreadsheets may result in a reduction of points.

1. You may send me a spreadsheet as a backup, but I require a printed copy to grade.

1. I understand that the due date and time for the exam is Friday, March 23rd at noon. I understand that the exam must be passed in in printed form. I understand that exams passed in after that time will be considered late and will incur a minimum penalty of 1 point lost per minute late.

1. The exam is being made available to you on March 6th and is due March 23rd . That means you have ample time to ask questions in class, during office hours, via email, or through myriad other means. If you don’t understand a question, ask BEFORE the exam is due for clarification. Misunderstood questions leading to wrong answers will count against you.

1. Good luck!

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Finance 380 Midterm Name

Essays: Limit your response to no more than one page; double spaced.

FIGHT [10] Read the attached press release. In the long run, do you think the actions of Dana’s management is harmful or helpful to shareholders? Explain.

Automakers ArvinMeritor to Launch Hostile Bid for Dana By TSC Staff 07/08/2003 12:48 PM EDTURL: http://www.thestreet.com/stocks/automakers/10098416.html

ArvinMeritor (ARM:NYSE - news - commentary) plans to launch a hostile takeover bid for fellow auto parts supplier Dana (DCN:NYSE - news - commentary) , saying that it will take its $15-a-share offer directly to the target company's shareholders after executives rejected a merger proposal.

In a press release Tuesday, ArvinMeritor said its offer represents a 56% premium over Dana's closing stock price on June 3, the last trading day before ArvinMeritor submitted its first proposal to Dana, and a 25% premium to Monday's closing price.

The proposed transaction has a total equity value of about $2.2 billion. ArvinMeritor said the deal, if it closes, "is anticipated to be significantly accretive" to earnings in the first year.

"We believe that to succeed in today's increasingly global and competitive automotive supplier industry, we must take actions that will increase the opportunities available to our company in the future and enhance value for our shareowners, customers and employees," ArvinMeritor said in a press release.

"We would prefer to meet with the Dana board and its advisers to discuss our all-cash offer and negotiate a mutually acceptable transaction; however, Dana has rejected our prior proposals and refused our requests to enter into discussions," the company continued. "Therefore, we believe it is necessary to take our offer directly to Dana's shareowners."

ArvinMeritor said the offer will require, among other things, the removal of Dana's poison pill, acceptance by more than two-thirds of Dana's shares and the necessary regulatory approvals.

The company also filed a lawsuit against Dana and its board, asserting that they breached their fiduciary duties to Dana shareholders by rejecting the proposal without meeting with ArvinMeritor. ArvinMeritor currently owns nearly 1.1 million Dana common shares. Dana had around 148 million shares outstanding as of March 31.

Separately, Dana said that ArvinMeritor's offer will be evaluated by its board. Within 10 business days of the start of the tender offer, Dana will advise shareholders of its position regarding the bid. In the meantime, Dana said investors shouldn't make a decision on whether to accept or turn down the takeover terms.

Shares of Dana were rising $4.26, or 35%, to $16.28 on news of the offer. ArvinMeritor was down 82 cents, or 4%, to $20.18.

AGENCY [10] A basic agency problem arises when stockholders (through management) expropriate wealth from bondholders. Consider three situations: an increase in dividends paid, a leveraged buyout, and the purchase of a business with more risk than the existing firm. Explain how each of these decisions could decrease bondholder wealth and increase stockholder wealth. What can bondholders do to protect themselves from this form of wealth expropriation?

GOALS [10] The goal of financial management is to maximize the wealth of the firm’s owners, the stockholders, and this can be accomplished through maximization of the current stock price. Others argue that such an objective is inappropriate; the firm needs to consider all stakeholders, including the public, and that shareholder wealth maximization occurs at the expense of operating in a socially responsible fashion. Why is shareholder wealth maximization an appropriate goal? Give examples of how shareholder wealth maximization can lead to a firm operating in a socially responsible manner.

PROBLEMS:

BETA: [15] This tab contains stock price data for Amazon and EBay (neither entity paid dividends), index levels for the S&P 500 and NASDAQ index (where both securities trade) and monthly t-bill yields. Estimate the beta for Amazon and EBay. Determine if either outperformed the market on a risk adjusted basis. In your explanation, justify the approach you chose to estimating beta as well as your choice of index. Verbally interpret your results.

DAVECO(a): [15] Daveco is a privately held multidivisional firm that operates in five distinct business segments: food (specifically junk food), computers, beer manufacturing, publishing, and gambling (gaming). Last year’s revenues were $143.5 Million dollars. The firm is trying to estimate its weighted average cost of capital and has asked your help. I have identified five “pure play” competitors, one for each segment. Calculate the unlevered (asset) beta for each segment. What is your best estimate of Daveco’s unlevered equity beta? Explain your computations and why your answer is your “best estimate” of Daveco’s unlevered equity beta.

Division	Revenue		Competitor	Equity Beta	Tax Rate	MV Debt	MV Equity
Food	$ 15,600		Foodco	0.61	29%	$ 16.6	$ 14.4
Computers	$ 52,100		Compco	1.91	23%	$ 36.3	$ 25.2
Beer	$ 45,500		Beerco	1.04	37%	$ 176.3	$ 71.1
Publishing	$ 17,200		Pubco	0.96	40%	$ 16.2	$ 10.7
Gaming	$ 13,100		Gamco	1.01	36%	$ 15.7	$ 6.9
Total	$ 143,500

DAVECO(b): [15] The company recently received an unsolicited bid for the entire company (including all assets and undertaking all existing liabilities) of $600M, which was rejected. The existing company is partially financed by two long-term bond issues, a $100 M five year issue with a 4.25% annual coupon, and a $150 M 10 year issue with a 4.75% annual coupon. The firm’s bonds are rated AA and the default risk premium is 0.50%. Five year default year government bonds carry a yield of 2.34%; 10 year government bonds yield 2.82%. Damodaran estimates the risk-free rate as 2.55% and the equity risk premium as 5.50%. The firm faces a tax rate of 36%.

a. Calculate Daveco’s (levered) equity beta.

b. Calculate Daveco’s WACC.

c. Calculate WACCs for each division of Daveco. Report all results to two decimal places (ie.X.XX%)

d. Justify (explain) your computational method.

NPV [15] Hurricane Industries is considering a capital budgeting project to use robotics to produce fan blades. The project has a projected life of 10 years. The project will require the purchase of $500,000 in specialty dies which are to be depreciated as 3 year assets, and $2,000,000 in other equipment which are depreciated as five year assets. The dies can be scrapped for $50,000 when the project is completed (year 11) but the other equipment will need to be disposed of at a cost of $150,000 (again in year 11). Project sales are expected to be $3,000,000 in year one, and sales are expected to increase at a rate of 5% per year until year 6. After that, they will decrease at a rate of 3% per year. Cost of goods sold amount to 72% of sales and fixed costs are expected to be $150,000 in year 1. They will increase at a rate of 2% per year. The firm will be required to invest in working capital equal to 5% of sales, starting in year 1. This investment can also be recovered in year 11. The company intends to finance the project partially using 10 year bonds ($1,000,000 worth) with a 5% annual coupon. The firm’s WACC is 10.5% and it faces a tax rate of 35%. What is the project’s NPV?

PENSKE [10] This tab contains abbreviated income statements for the past 3 years for Penske. Calculate and verbally interpret for each year the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage.

	12/31/2017	12/31/2016	12/31/2015
Sales	$ 21,386,900	$ 20,118,500	$ 19,284,900
Variable Costs	$ 18,164,400	$ 17,151,900	$ 16,417,400
Gross Profit	$ 3,222,500	$ 2,966,600	$ 2,867,500
Fixed Costs	$ 2,611,100	$ 2,391,700	$ 2,301,000
EBIT	$ 611,400	$ 574,900	$ 566,500
Interest	$ 170,800	$ 136,300	$ 113,900
EBT	$ 440,600	$ 438,600	$ 452,600
Tax	$ 164,800	$ 160,700	$ 158,000
NetIncome	$ 275,800	$ 277,900	$ 294,600