Corporate finance

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Mid-term Assessment Written assignment – Case Studies BCO315 Corporate Finance (3CH/4ECTS) Online campus Professor: Miguel Corte-Real – [email protected]

Description The assessment includes four case studies, each contributing for a fourth of the total score of the assessment

Format This activity must meet the following formatting requirements:

• Font size 12

• Double-spaced

• Harvard Referencing System

• Please submit the document: Pdf format

• (Word count to be discussed in class)

Goal(s) The student should be able to link the material covered during the sessions and the 4 case studies

Due date Date: 21st June 2021 at 14:00h CEST

Weight towards final grade

This activity has a weight of 50% towards the final grade.

Learning outcomes

This task assesses the following learning outcomes: Demonstrate a deep understanding of:

• Basic concepts of corporate finance

• Challenges within capital Structure • Dividend and payout policy • Issuing shares/IPOs/Capital

markets/SPACs

Assessment criteria

Please refer to the rubric – written assignment, in the next page.

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Case 1

We claim that the goal of the corporations is to maximize current market value and therefore shareholders value.

Please comment on the above statement (please link your answer to the material covered during the class sessions – use examples discussed during the sessions to strengthen your argument – please share your knowledge)

Case 2

The Jones Family, Incorporated

The Scene: Early evening in an ordinary family room in Manhattan. Modern furniture, with old copies of The Wall Street Journal and the Financial Times scattered around. Autographed photos of Alan Greenspan and George Soros are prominently displayed. A picture window reveals a distant view of lights on the Hudson River. John Jones sits at a computer terminal, glumly sipping a glass of chardonnay and putting on a carry trade in Japanese yen over the Internet. His wife Marsha enters.

Marsha: Hi, honey. Glad to be home. Lousy day on the trading floor, though. Dullsville. No volume. But I did manage to hedge next year’s production from our copper mine. I couldn’t get a good quote on the right package of futures contracts, so I arranged a commodity swap.

John doesn’t reply. Marsha: John, what’s wrong? Have you been selling yen again? That’s been a losing trade for weeks.

John: Well, yes. I shouldn’t have gone to Goldman Sachs’s foreign exchange brunch. But I’ve got to get out of the house somehow. I’m cooped up here all day calculating covariance’s and efficient risk-return trade-offs while you’re out trading commodity futures. You get all the glamour and excitement.

Marsha: Don’t worry, dear, it will be over soon. We only recalculate our most efficient common stock portfolio once a quarter. Then you can go back to leveraged leases.

John: You trade, and I do all the worrying. Now there’s a rumor that our leasing company is going to get a hostile takeover bid. I knew the debt ratio was too low, and you forgot to put on the poison pill. And now you’ve made a negative-NPV investment!

Marsha: What investment? John: That wildcat oil well. Another well in that old Sourdough field. It’s going to cost $5million! Is there any oil down there?

Marsha: That Sourdough field has been good to us, John. Where do you think we got the capital for your yen trades? I bet we’ll find oil. Our geologists say there’s only a 30% chance of a dry hole.

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John: Even if we hit oil, I bet we’ll only get 150 barrels of crude oil per day. Marsha: That’s 150 barrels day in, day out. There are 365 days in a year, dear. John and Marsha’s teenage son Johnny bursts into the room.

Johnny: Hi, Dad! Hi, Mom! Guess what? I’ve made the junior varsity derivatives team! That means I can go on the field trip to the Chicago Board Options Exchange. (Pauses.) What’s wrong?

John: Your mother has made another negative-NPV investment. A wildcat oil well, way up on the North Slope of Alaska.

Johnny: That’s OK, Dad. Mom told me about it. I was going to do an NPV calculation yesterday, but I had to finish calculating the junk-bond default probabilities for my corporate finance homework. (Grabs a financial calculator from his backpack.) Let’s see: 150 barrels a day times 365 days per year times $50 per barrel when delivered in Los Angeles . . . that’s $2.7 million per year.

John: That’s $2.7 million next year, assuming that we find any oil at all. The production will start declining by 5% every year. And we still have to pay $10 per barrel in pipeline and tanker charges to ship the oil from the North Slope to Los Angeles. We’ve got some serious operating leverage here.

Marsha: On the other hand, our energy consultants project increasing oil prices. If they increase with inflation, price per barrel should increase by roughly 2.5% per year. The wells ought to be able to keep pumping for at least 15 years.

Johnny: I’ll calculate NPV after I finish with the default probabilities. The interest rate is 6%. Is it OK if I work with the beta of .8 and our usual figure of 7% for the market risk premium?

Marsha: I guess so, Johnny. But I am concerned about the fixed shipping costs.

John: (Takes a deep breath and stands up.) Anyway, how about a nice family dinner? I’ve reserved our usual table at the Four Seasons.

Everyone exits.

Announcer: Is the wildcat well really negative-NPV? Will John and Marsha have to fight a hostile takeover? Will Johnny’s derivatives team use Black–Scholes or the binomial method? Find out in the next episode of The Jones Family, Incorporated.

QUESTIONS:

1. Calculate the NPV of the wildcat oil well, taking account of the probability of a dry hole, the shipping costs, the decline in production, and the forecasted increase in oil prices. How long does production have to continue for the well to be a positive-NPV investment? Ignore taxes and other possible complications.

2. Now consider operating leverage. How should the shipping costs be valued, assuming that output is known and the costs are fixed? How would your answer change if the shipping costs were proportional to output? Assume that unexpected fluctuations in output are zero- beta and diversifiable. (Hint: The Jones’s oil company has an excellent credit rating. Its long-term borrowing rate is only 7%.)

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Case 3

Please elaborate on the recent rise of SPACs (Special-purpose acquisition company) interest by the investors (what are the advantages and disadvanges of SPACs and why so much interest during the last 12 months)?

(Please note that a SPAC is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company)

Case 4

1. Consider the following two statements: “Dividend policy is irrelevant,” and “Stock price is the present value of expected future dividends.” They sound contradictory.

The current price of the shares of Charles River Mining Corporation is $50. Next year’s earnings and dividends per share are $4 and $2, respectively. Investors expect perpetual growth at 8% per year. The expected rate of return demanded by investors is r 12%.

We can use the perpetual-growth model to calculate stock price Po= DIV/r-g = 2/.12-.08 = 50

Suppose that Charles River Mining announces that it will switch to a 100% payout policy, issuing shares as necessary to finance growth. Use the perpetual- growth model to show that current stock price is unchanged.

2. “If a company pays a dividend, the investor is liable for tax on the total value of the dividend. If instead the company distributes the cash by stock repurchase, the investor is liable for tax only on any capital gain rather than on the entire amount. Therefore, even if the tax rates on dividend income and capital gains are the same, stock repurchase is always preferable to a dividend payment.” Explain with a simple example why this is not the case. (Ignore the fact that capital gains may be postponed.)

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Rubric: written presentation

Criteria Accomplished (A) Proficient (B) Partially proficient (C) Borderline (D) Fail (F) Problem identification

The business issue has been correctly identified, with a competent and comprehensive explanation of key driving forces and considerations. Impact on company operations has been correctly identified. Thorough analysis of the issue is presented.

The student correctly identified the issue(s), taking into account a variety of environmental and contextual drivers. Key case information has been identified and analyzed.

The student correctly identified the case (issues), considering obvious environmental/contextual drivers. There is evidence of analysis, but it lacks depth.

The student correctly identified the issue(s) but analysis was weak. An absence of context – the work is basically descriptive with little analysis.

The student failed to correctly identify the issue(s); analysis was incorrect or too superficial to be of use; information was misinterpreted.

Information gathering

The student showed skill in gathering information and analyzing it for the purposes of filling the information gaps identified. Comprehensive and relevant.

Relevant information gaps were identified and additional relevant information was found to fill them. At least two different types of sources were used. The student demonstrates coherent criteria for selecting information but needs greater depth.

The student correctly identified at least one information gap and found relevant information, but which was limited in scope. Some evidence of sound criteria for selecting information but not consistent throughout. Needs expansion.

An information gap was identified and the student found additional information to fill it. However, this was limited in scope. Weak criteria for the selection of necessary information.

Information was taken at face value with no questioning of its relevance or value. Gaps in the information were not identified or were incorrect.

Conclusions The student evaluated, analyzed, synthesized all information provided to create a perceptive set of conclusions to support the decisions and solutions.

The student evaluated, analyzed and synthesized to create a conclusion(s) which support decisions and solutions.

The student reached conclusions, but they were limited and provided minimal direction for decision-making and solutions.

The conclusion was reasonable but lacked depth and would not be a basis for suitable strategy development.

The student formed a conclusion, but it was not reasonable. It was either unjustified, incorrect or unrelated to the case in hand.

Solutions The student used problem solving techniques to make thoughtful, justified decisions about difficult and conflicting issues. A realistic solution was chosen which would provide maximum benefit to the company. Alternative solutions were explored and ruled out.

The student used problem solving techniques to make appropriate decisions about complex issues. Relevant questions were asked and answered. A realistic solution was chosen. Alternatives were identified, explored and ruled out.

The student used problem- solving techniques to make appropriate decisions about simpler issues. The solution has limited benefit but does show understanding of implications of the decision. Alternatives were mentioned but not explored.

The student used problem solving techniques to make decisions about simpler issues but disregarded more complex issues. Implications of the decision were not considered. Alternatives were not offered.

The student formed a conclusion, but it was not reasonable. It was either unjustified, incorrect or unrelated to the case in hand.