FIE402N Corporate Finance, fall 2015

Cases and mini-cases

Case
Reeby Sport
Marriott Corp.
Bruce Honiball (mini)
Mr Thorndike (mini)
Crown
Fall 2013 exam
Fall 2014 exam

Due date
September 1
September 8
September 10
September 22
October 6
November 3
November 5

As outlined in the course description, there are a total of five case write-ups, to be solved in groups
of three to four students. Each write-up is due on the indicated date. A minimum requirement for
taking the exam is that at least one case write-up has been handed in and approved.
Each approved hand-in will give 4 points towards the final grade, for a maximum of 20 points. Any
one case write-up may be replaced with two mini-case write-ups (at your choice). Case write-ups
are graded as either approved (4 points) or not approved (0 points). Approval requires that the handin demonstrates an ability to analyze the material with a reasonable degree of judgment and
independent thinking. The graded assignments will not be returned to students. Instead, for each
case, a list of approved students will be posted on Its Learning within 2-3 weeks of the due date. In
addition, each case is carefully discussed in class.
The case write-ups count for 20 percent of the total grade, while the final exam counts for 80% of
the total grade.
The points from case write-ups are valid only once, and in the term that they were earned. That is, if
the exam is retaken at a later point in time, credits for case write-ups from the past will not be
honored.
Note also that the assigned practice problems in MyFinanceLab must be solved on time in order to
take the exam. Each home work carries equal weight and you must have at least 50% of the answers
correct. That is, if you miss one practice problem set, you need 100% correct on the next practice
problem set for an average of 50%. The course code in MyFinanceLab is XL21-I1YR-2020-3M02.

August 26, 2014

Instruction for handing in the FIE402N case write-ups

There has been some uncertainty regarding the format and the way to hand in the case write-ups.
Here are instructions that should help clarify things:
1. I prefer you to hand in the case write-up printed out on paper, and give it to Thore in class.
2. If you have to send it electronically, send it to jens.kvaerner@nhh.no. In the NHH address
list I am also listed with another e-mail address, jens.kvaerner@student.nhh.no which has
expired.
3. Include the full name of all group members on the hand-in. If you include only your student
number, I am not able to map it to the list of course participants (I would have to look it up
manually). If you send it by e-mail, include the name of all group members in both the e-mail
and the written report.
4. Excel sheets are NOT necessary. However, you should include relevant tables and
calculations from Excel in your report (copy tables from Excel into your report). Some
students did not hand in self contained assignments, and satisfactory reports for some of
the cases last year and therefore did not pass. Make sure you answer the questions asked,
and that it is possible for me to briefly examine how you did your calculations and whether
your assumptions are reasonable.
5. We will post a list of students who got a Pass grade on their hand-in on Its learning. The
list will be updated within 1-2 weeks after the deadline for each case.
6. If you handed in the case and did not get a Pass grade, please contact me at
jens.kvaerner@nhh.no as soon as possible. I might have made a mistake, since there are a
lot of hand-ins both via Its learning, e-mail and on paper.

Best regards

Jens Srlie Kvrner

Teaching Assistant FIE402N

Case:ReebySports
(fraBrealey,Myers&Allen;PrinciplesofCorporateFinance)

Tenyearsago,in1993GeorgeReebyfoundedasmallmailordercompanysellinghighqualitysports
equipment.ReebySportshasgrownsteadilyandbeenconsistentlyprofitable(seeTable1)The
companyhasnodebtandtheequityisvaluedinthecompanysbooksatnearly$41million(Table2).
ItisstillwhollyownedbyGeorgeReeby.
Georgeisnowproposingtotakethecompanypublicbythesaleof90,000ofhisexisting
shares.TheissuewouldnotraiseanyadditionalcashforthecompanybutitwouldallowGeorgeto

Table1
Summaryincomedata(figuresin$millions).

1999 2000 2001 2002 2003

Note:ReebySportshasneverpaidadividendandallthe
EBITDA
5.84 6.40 7.41 8.74 9.39
earningshavebeenretainedinthebusiness
Depreciation
1.45 1.60 1.75 1.97 2.22

Pretaxprofits
4.38 4.80 5.66 6.77 7.17
Tax
1.53 1.68 1.98 2.37 2.51
Aftertaxprofits 2.85 3.12 3.68 4.40 4.66

Table2
Summarybalancesheetforyear
st
endingDecember31 (figuresin
$millions)
Note:ReebySportshas200,000
commonsharesoutstanding,wholly
ownedbyGeorgeReeby.

Assets

Cash&securities
Othercurrentassets
Netfixedassets
Total

2002
3.12
15.08
20.75
38.95

2003
3.61
16.93
23.38
43.91

LiabilitiesandEquity

2002 2003
Currentliabilities 2.90 3.20

Equity
36.05 40.71
Total
38.95 43.91

cashinpartofhisinvestment.Itwouldalsomakeiteasiertoraisethesubstantialcapitalsumsthat
thefirmwouldlaterneedtofinanceexpansion.
GeorgesbusinesshasbeenmainlyontheEastCoastoftheUnitedStates,butheplansto
expandintotheMidwestin2005.Thiswillrequireasubstantialinvestmentinnewwarehousespace
andinventory.Georgeisawarethatitwilltaketimetobuildupanewcustomerbase,andinthe
meantimethereislikelytobeatemporarydipinprofits.However,iftheventureissuccessful,the
companyshouldbebacktoitscurrent12percentreturnonbookequityby2010.

Georgesettleddowntoestimatewhathissharesareworth.Firstheestimatedtheprofits
andinvestmentthrough2010(Tables3and4).Thecompanysnetworkingcapitalincludesagrowing
proportionofcashandmarketablesecuritieswhichwouldhelptomeetthecostoftheexpansion
intotheMidwest.Nevertheless,itseemedlikelythatthecompanywouldneedtoraiseabout$4.3
millionin2005bythesaleofnewshares.(Georgedistrustedbanksandwasnotpreparedtoborrow
tofinancetheexpansion.)

Untilthenewventurereachedfullprofitability,dividendpaymentswouldhavetobe
restrictedtoconservecash,butfrom2010onwardGeorgeexpectedthecompanytopayoutabout
40percentofitsnetprofits.Asafirststabofvaluingthecompany,Georgeassumedthatafter2010it
wouldearn12percentonbookequityindefinitelyandthatthecostofcapitalforthefirmwasabout
10percent.Buthealsocomputedamoreconservativevaluation,whichrecognizedthatthemail
ordersportsbusinesswaslikelytogetintenselycompetitiveby2010.Healsolookedatthemarket
valuationofacomparablebusinessontheWestCoast,MollySports.Mollysshareswerecurrently
pricedat50percentabovebookvalueandweresellingataprospectivepriceearningsratioof12
andadividendyieldof3percent.

Georgerealizedthatasecondissueofsharesin2005woulddilutehisholdings.Hesetabout
calculatingthepriceatwhichthesesharescouldbeissuedandthenumberofsharesthatwould

needtobesold.Thatallowedhimtoworkoutthedividendspershareandtocheckhisearlier
valuationbycalculatingthepresentvalueofthestreamofpersharedividends.

Table3
Forecastedprofitsanddividends
(figuresin$millions)

Table4

2004 2005 2006 2007 2008 2009 2010

EBITDA
10.47 11.87 7.74 8.40 9.95 12.67 15.38
Depreciation
2.40 3.10 3.12 3.17 3.26 3.44 3.68
Pretaxprofits
8.08 8.77 4.62 5.23 6.69 9.23 11.69
Tax
2.83 3.07 1.62 1.83 2.34 3.23 4.09
Aftertaxprofits
5.25 5.70 3.00 3.40 4.35 6.00 7.60
Dividends
2.00 2.00 2.50 2.50 2.50 2.50 3.00
Retainedearnings 3.25 3.70 .50
.90 1.85 3.50 4.60

Summary

2004 2005 2006

balancesheet
Grossinvestmentinfixedassets
4.26 10.50 3.34
foryearending
st
December31
Investmentsinnetworkingcapital 1.39 .60
.28
(figuresin$
Total
5,65 11.10 3.62
millions).
Note:ReebySportshas200.000commonsharesoutstanding,whollyownedbyGeorgeReeby.

2007 2008 2009

3.65 4.18 5.37
.42
.93 1.57
4.07 5.11 6.94

2010
6.28
2.00
8.28

Questions
1. UseTables3and4toforecastfreecashflowforReebySportsfrom2004to2010.Whatis
thepresentvalueofthesecashflowsin2003,includingPV(terminalvalue)in2010?
2. UsetheinformationgivenforMollySportstocheckyourforecastofterminalvalue.What
wouldyourecommendasareasonablerangeforthepresentvalueofReebySports?
3. Whatisthepresentvalueofashareofstockinthecompany?Giveareasonablerange.
4. ReebySportswillhavetoraise$4.3millionin2005.Doesthisprospectiveshareissueaffect
thepersharevalueofReebySportsin2003?Explain.

FIE402N Corporate Finance / fall 2013

Marriott Corporation: Cost of Capital

Should be handed in at the beginning of (and will be discussed in) class on
Tuesday September 17
This is a group assignment that should be solved and written up in teams of 3-4
students. The write-up should be no more than 10 pages long plus tables.

QUESTIONS
1. What is the WACC (Weighted Average Cost of Capital) for Marriott Corporation?
a. What risk-free rate and market risk premium did you use to compute the companys cost of
equity?
b. How did you estimate Marriotts cost of debt?
c. What type of investments would you value using Marriotts WACC?
2. If Marriott used a single corporate cost of capital for evaluating investment opportunities
across its different divisions, how would this affect the companys expected profitability
over time?
3. What is the cost of capital for Marriotts lodging and restaurant divisions?
a. How did you determine the cost of debt for each individual division?
Should the divisions have a different cost of debt? Why or why not?
b. How did you measure the beta for each division?
4. What is the cost of capital for Marriotts contract services division?
How could you estimate the cost of equity for this division without knowing the cost of
equity for comparable publicly traded firms?
5. Calibrate your WACC estimates with the markets valuation of Marriott. What implications
do the observed return on capital employed (ROCE) and the accompanying market pricing
have for your WACC estimate? For the company as a whole? For the individual divisions?
Use a tax rate of 35% percent.

MINICASE
BruceHoniballsInvention
(fraBrealey,Myers&Allen;PrinciplesofCorporateFinance)

ItwasanotherdisappointingyearforBruceHoniball,themanagerofretailservicesattheGibbRiver
Bank.Sure,theretailsideofGibbRiverwasmakingmoney,butitdidntgrowatallin2006.Gibb
Riverhadplentyofloyaldepositors,butafewnewones.Brucehadtofigureoutsomenewproduct
orfinancialservicesomethingthatwouldgeneratesomeexcitementandattention.

Brucehadbeenmusingononeideaforsometime.Howaboutmakingiteasyandsafefor
GibbRiverscustomerstoputmoneyinthestockmarket?Howaboutgivingthemtheupsideof
investinginequitiesatleastsomeoftheupsidebutnoneofthedownside?

Table22.3

Interest
Market
EndYear
Year
Interest Market
EndYear Year
Rate
Return
Dividend
Rate
Return
Dividend
Yield
Yield
1987
14,1%
7.9%
4.7%
1997
5.5%
12.2%
3.9%
1988
11.7
17.9
5.1
1998
5.0
11.6
3.5
1989
17.3
17.4
5.7
1999
4.9
16.1
3.2
1990
15.9
17.5
6.8
2000
4.9
5.2
3.4
1991
11.1
34.2
3.8
2001
4.8
10.4
3.3
1992
6.8
2.3
3.8
2002
4.8
8.8
4.0
1993
5.3
45.4
3.0
2003
4.8
14.6
3.9
1994
5.4
8.7
4.0
2004
5.4
28.0
3.5
1995
8.0
20.2
4.0
2005
5.6
22.8
3.7
1996
7.4
14.6
3.6
2006
5.9
24.2
3.7

Brucecouldseetheadvertisementsnow:

HowwouldyouliketoinvestinAustralianstockscompletelyriskfree?YoucanwiththenewGibb
RiverBankEquityLinkedDeposit.Youshareinthegoodyears;wetakecareofthebadones.

Hereshowitworks.Deposit$A100withusforoneyear.Attheendofthatperiodyouget
backyour$A100plus$A5forevery10%riseinthevalueoftheAustralianAllOrdinariesstockindex.
Butifthemarkedindexfallsduringthisperiod,theBankwillstillrefundyour$A100depositinfull.

Theresnoriskofloss.GibbRiverisyoursafetynet.

Brucehadfloatedtheideabeforeandencounteredimmediateskepticism,evenderision:
Headstheywin,tailsweloseisthatwhatyouareproposing,MrHoniball?Brucehadnoready
answer.Couldthebankreallyaffordtomakesuchanattractiveoffer?Howshoulditinvestthe
moneythatwouldcomeinfromcustomers?Thebankhadnoappetiteformajornewrisks.

Brucehadpuzzledoverthesequestionsforthepasttwoweeksbuthasbeenunabletocome
upwithasatisfactoryanswer.HebelievesthattheAustralianequitymarketiscurrentlyfullyvalued,
butherealizesthatsomeofhiscolleaguesaremorebullishthanthanheisaboutequityprices.

Fortunately,thebankhadjustrecruitedasmartnewMBAgraduate,SheilaLiu.Sheilawas
surethatshecouldfindtheanswerstoBruceHoniballsquestions.Firstshecollecteddataonthe
Australianmarkettogetapreliminaryideaofwhetherequitylinkeddepositscouldwork.Thesedata
areshowninTable22.3.Shewasjustabouttoundertakesomequickcalculationswhenshereceived
thefollowingfurthermemofromBruce:
1


Sheila,Ivegotanotheridea.Alotofourcustomersprobablysharemyviewthatthemarketis
overvalued.Whydontwealsogivethemachancetomakesomemoneybyofferingabearmarket
deposit?Ifthemarketgoesup,theywouldjustgetbacktheir$A100deposit.Ifitgoesdown,they
gettheir$A100backplus$5foreach10%thatthemarketfalls.Canyoufigureoutwhetherwecould
dosomethinglikethis?Bruce.

QUESTION
1. WhatkindofoptionsisBruceproposing?Howmuchwouldtheoptionsbeworth?Wouldthe
equitylinkedandbearmarketdepositsgeneratepositiveNPVforGibbRiverBank?

Minicase
TheShockingDemiseofMr.Thorndike
(fraBrealey,Myers&Allen;PrinciplesofCorporateFinance)

ItwasoneofMorsesmostpuzzlingcases.ThatmorningRupertThorndike,theautocraticCEOof
ThorndikeOil,wasfounddeadinapoolonhisbedroomfloor.Hehadbeenshotthroughthehead,
butthedoorandwindowswereboltedontheinsideandtherewasnosignofthemurderweapon,

MorselookedinvainforcluesinThorndikesoffice.Hehadtotakeanothertack.Hedecided
toinvestigatethefinancialcircumstancessurroundingThorndikesdemise.Thecompanyscapital
structurewasasfollows:
5%debentures:$250millionfacevalue.Thebondsmaturedin10yearsandofferedayieldof
12%
Stock:30millionshares,whichclosedat$9asharethedaybeforethemurder.
10%subordinatedconvertiblenotes:Thenotesmatureinoneyearandareconvertibleat
anytimeataconversionratioof110.Thedaybeforethemurderthesenoteswerepricedat
5%morethantheirconversionvalue.

YesterdayThorndikehadflatlyrejectedanofferbyT.SpooneDickenstobuyallofthecommonstock
for$10ashare.WithThorndikeoutoftheway,itappearedthatDickenssofferwouldbeaccepted,
muchtotheprofitofThorndikeOilsandothershareholders1

Thorndikestwonieces,DorisandPatsy,andhisnephewJohnallhadsubstantialinvestments
inThorndikeOilandhadbitterlydisagreedwithThorndikesdismissalofDickenssoffer.Theirstakes
areshowninthefollowingtable:

5%Debentures(Face
SharesofStock
10%ConvertibleNotes
value)
(Facevalue)
Doris
$4million
1.2million
$0million
John
0
.5
5
Patsy
0
1.5
3

AlldebtissuedbyThorndikeOilwouldbepaidoffatfacevalueifDickenssofferwent
through.Holdersoftheconvertiblenotescouldchoosetoconvertandtendertheirsharesto
Dickens.

Morsekeptcomingbacktotheproblemofmotive.Whichnieceornephew,hewondered
stoodtogainmostbyeliminatingThorndikeandallowingDickenssoffertosucceed?

QUESTION
1. HelpMorsesolvethecase.WhichofThorndikesrelativesstoodtogainmostfromhisdeath?

RupertThorndikesshareswouldgotoacharitablefoundationformedtoadvancethestudyoffinancialengineeringandits
crucialroleinworldpeaceandprogress.Themanagersofthefoundationsendowmentwerenotexpectedtoopposethetakeover.

FIE 402 / fall 2013

Crown Corporation
Analyze the various financing options available to Crown Corp. in 1969. For example, how will
the different financing alternatives (equity/straight debt/convertible debt) affect various key
financial ratios for Crown? How do you think they will affect Crowns credit rating?
What financing do you recommend? Discuss why. What are drawbacks or problems with the
other alternatives? What risks, if any, are associated with the alternative that you suggest?
Indicate the plan of action that should be set up to meet the company's anticipated financing
requirements over the next 3-5 years. Argue why your recommended plan is better suited to the
company's needs than viable alternative plans.
Feel free to use public sources if you need additional information to that found in the case. For
your information, in 1969, Alcoa had an equity beta of 1.2 and the risk free rate was 6%.
A good starting point for the assignment is to project the companys future cash flow and
financing needs. The following income and balance sheet projections (Exhibits A-C) represent
one attempt to project Crowns financials for 1969-1972, ignoring the effect of any new financing.
You may or may not agree with the underlying assumptions. Therefore, try to reconstruct these
projections in a spreadsheet, and use them to evaluate the effects of any alternative
assumptions. Could you derive the need for external funds in a different way than through the
balance sheet (Exhibit C)?
To be handed in by Tuesday October 8.

Exhibit A: Net Income & Retained Earnings

Actual
1968
$230.0

1969
$246.0

EBIT (68: 28,5 + 2,4 / 69-70: 12%; 71-72: 14%)

Interest (6%)
Net income before taxes
Income taxes (48%)
Net income after taxes
Dividends
Retained earnings

30.9
3.4
$27.5
13.8
$13.6
5.1
$8.5

29.5
3.2
$26.3
12.6
$13.7
5.1
$8.6

31.6
2.9
$28.7
13.8
$14.9
5.1
$9.8

39.5
2.6
$36.9
17.7
$19.2
5.1
$14.1

42.1
2.3
$39.8
19.1
$20.7
5.1
$15.6

Earnings per share

$1.87

$1.88

$2.05

$2.64

$2.85

Sales

(7% growth)

Projected
1970
1971
$263.0
$282.0

1972
$301.0

Note: Sales are projected to increase by 7% per year. EBIT is projected at 12% of sales for 1969 and 1970,
and at 14% of sales for 1971 and 1972. Dividends are projected at 70 c per share outstanding in 1968
(7.273 mio shares). No allowance is made for additional financing needs in 1969 or later years.

FIE 402 / fall 2013

Exhibit B: Assumptions for growth in sales, EBIT, and current assets/liabilities

Sales growth
Profit margin (EBIT/Sales

1965
16 %
7%

1966
25 %
11 %

1967
21 %
14 %

1968
8%
13 %

1969
7%
12 %

Projected
1970
1971
7%
7%
12 %
14 %

Acc.rcvbls/Sales
Inventory/Sales
Acc pbls/Sales
Accr.liab./Sales

14 %
20 %
6%
4%

13 %
22 %
6%
4%

16 %
22 %
6%
3%

18 %
22 %
6%
4%

18 %
22 %
6%
4%

18 %
22 %
6%
4%

18 %
22 %
6%
4%

1972
7%
14 %
18 %
22 %
6%
4%

Exhibit C: Balance Sheets & External Funds required

Cash & securities

Accounts receivable
Inventory
Other
Current assets
Net fixed assets
Other
Total assets

(18% of sales)
(22% of sales)

Accounts payable
(6% of sales)
Accrued liabilities
(4% of sales)
Accrued taxes
(prop. to profit)
Dividends payable
(last quarter)
Current portion - long-term debt
Current liabilities
Long-term debt
Deferred taxes
Net worth
Liabilities & net worth
Cum. external funds needed
Total liabilities & net worth
Annual external funds needed

Actual
1968
$10
42
50
1
$103
82
4
$189

1969
$10
44
54
1
$109
113
4
$226

Projected
1970
1971
$10
$10
47
51
58
62
1
1
$116
$124
133
126
4
4
$253
$254

1972
$10
54
66
1
$131
162
4
$297

$14
10
6
1
4
$35
52
3
99
$189
$189

$15
10
6
1
4
$36
48
4
108
$195
31
$226

$16
11
7
1
4
$38
44
5
117
$205
48
$253

$17
11
8
1
4
$41
40
5
131
$218
36
$254

$18
12
9
1
4
$44
36
7
147
$234
63
$297

$31

$17

-$12

$27

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NORWEGIAN SCHOOL OF ECONOMICS

Examination fall semester 2012

Code: FIE402N
Title: Corporate Finance /
Foretakets Finansiering
Date:

19 November

Time: 09:00-13:00

The course instructor will not visit the examination room, but may be contacted by an
examination attendant at 59 291 or mob. 970 19 567
The students may respond in Norwegian or English.

Materials permitted for use during the examination:

Materials permitted: YES, cf list below: X
Electronic calculator: YES: X
In accordance with the rules specified in Utfyllende bestemmelser til Forskrift om
eksamen ved Norges Handelshyskole (fulltidsstudiene)
List of materials permitted:
One dictionary

1 of 8

FIE 402 CORPORATE FINANCE FALL 2012

All five problems on the next six pages should be answered. The last sheet contains a
collection of formulas, some of which may be useful during the exam.
The stated time limits may be helpful in allocating your time among the questions they are
also the weights for the total grade. Short and precise answers are favored.
PROBLEM 1. Multiple Choice (Q1 through Q10) (max 85 min)
Q1
Which of the following statements is false?
A.
B.
C.
D.

The intrinsic value of an option is the value it would have if it expired immediately.
European option cannot be worth less than its American counterpart.
A put option cannot be worth more than its strike price.
Put options increase in value as the stock price falls.

Q2
Which of the following statements about M&A is false?
A. Cost-reduction synergies are hard to predict and achieve.
B. Because the CEOs of small firms receive information so quickly, small firms are
often able to react in timely way to changes in the economic environment.
C. Synergies usually fall into two categories: cost reductions and revenue
enhancements.
D. There may also be costs associated with size.

Q3
Luther Industries currently has 100 million shares of stock outstanding at a price of $25 per
share. The company would like to raise money and has announced a rights issue. Every
existing shareholder will be sent one right per share of stock that he or she owns. The
company plans to require twenty rights to purchase one share at a price of $20 per share.
The amount of money that Luther will raise through its rights offering is closest to:
A.
B.
C.
D.

$125 million
$500 million
$100 million
$400 million
2 of 8

Q4
Capital Structure and Asset Beta Estimates for Comparable Firms
Firm
Oakley
Luxottica
Nike

1.00
0.83
1.05

0.00
0.17
-0.05

E
1.50
0.75
0.60

D
--0
0

A
1.50
?
0.63

The asset beta for Luxottica is closest to:

A.
B.
C.
D.

1.00
0.70
0.60
1.50

Q5
Which of the following statements regarding poison pills is false?
A. Poison pills also increase the bargaining power of the target firm when negotiating
with the acquirer because poison pills make it difficult to complete the takeover
without the cooperation of the target board.
B. Companies with poison pills are harder to take over, and when they are taken over,
the premium that existing shareholders receive for their stock is higher.
C. Because a poison pill increases the cost of a takeover, all else equal, a target
company must be in better shape to justify the expense of waging a takeover battle.
D. By adopting a poison pill, a company effectively entrenches its management by
making it much more difficult for shareholders to replace bad managers, thereby
potentially destroying value.
Q6
Kinston Industries just announced that it will cut its dividend from $3.00 to $2.00 per share
and use the extra funds to expand its operations. Kinston's dividends were expected to grow at
a 2% rate, and its share price was $37.50. With the new expansion, Kinston dividends are
expected to grow at a 5% rate. Kinston's share price following this announcement should
be:
A.
B.
C.
D.

$30.00
$40.00
$20.00
$37.50

3 of 8

Q7
You founded your own firm three years ago. You initially contributed $200,000 of your own
money and in return you received 2 million shares of stock. Since then, you have sold an
additional 1 million shares of stock to angel investors. You are now considering raising
capital from a venture capital firm. This venture capital firm would invest $5 million and
would receive 2 million newly issued shares in return.
The post-money valuation of your firm is closest to:
A.
B.
C.
D.

$10.0 million
$5.0 million
$12.5 million
$5.2 million

Q8
Luther Industries is currently trading for $27 per share. The stock pays no dividends. A oneyear European put option on Luther with a strike price of $30 is currently trading for $2.60.
The risk-free interest rate is 6% per year.
The price of a one-year European call option on Luther with a strike price of $30 will be
closest to:
A.
B.
C.
D.

$1.30
$7.10
$1.95
$2.60

Q9
Which of the following is not one of the four characteristics of IPOs that puzzle financial
economists?
A. On average, IPOs appear to be underpriced.
B. The long-run performance of a newly public company (three to five years from the
date of issue) is superior to the overall market return.
C. The number of issues is highly cyclical.
D. The costs of the IPO are very high, and it is unclear why firms willingly incur such
high costs.

4 of 8

Q10
Which of the following statements about a firms pay-out policy is false?
A. Managers are much less committed to dividend payments than to share
repurchases.
B. Share repurchases are a credible signal that the shares are under-priced, because if
they are over-priced a share repurchase is costly for current shareholders.
C. While an increase of a firms dividend may signal managements optimism
regarding its future cash flows, it might also signal a lack of investment
opportunities.
D. Managers will clearly be more likely to repurchase shares if they believe the stock to
be under-valued.

PROBLEM 2. Valuation and cost of capital (45 min)

A company has total assets of $ 1 000 million at book value, and is funded with $ 400 million
of interest bearing liabilities (debt), 200 million of other liabilities and $ 400 million in equity.
The average interest cost of the debt is 6%, which also corresponds to the cost of new debt.
The tax rate is 35%.
The 10 million shares outstanding are trading at twice book value per share. The firm is
expected to pay a constant fraction of yearly earnings as dividends, and not to
issue/repurchase shares. The stock is expected to earn a dividend return of 4%.
The risk free rate is 4%, the market risk premium is 5% and the stocks beta is 1.2.
a) Determine the firms cost of equity and the expected yearly growth in dividends
(implicit in the current price).
b) Determine the firms expected return on equity (ROE), and separate the stock price
into static and PVGO value. Explain.
The firm is expected to maintain a constant debt to equity ratio, in market value terms.
c) Determine the firms WACC, ROCE (after tax return on capital employed), and
next years total EVA.
d) Show that the added Enterprise Value relative to Capital Employed may be
determined directly by the sum discounted values of future expected EVAs. Explain.
e) Alternatively, determine the added Market value of Equity relative to the book value
by the sum discounted values of Residual Income (super profit). Explain any
difference to your analysis of EVA and Enterprise Value added in questions c-d).
5 of 8

PROBLEM 3. Equity Rights Issue (40 min)

A company is planning a rights issue at $10 a share of one new share per four shares held.
Before the issue there were 10 million shares outstanding, and the share price was $12.
a) Determine the number of shares issued and the prospective stock price after the
issue.
b) Current shareholders receive one Right per share held. Determine the value of each
right. Explain
c) For a stockholder holding four shares before the issue, compare her financial
situation before and after the issue, and dependent upon whether she uses or sells
her rights. Explain.
Suppose they issue the new shares at $8 per share instead of $10.
d) Redo questions a-b) above and explain differences in your answers.
e) Are the current shareholders any better off with this lower issue price? Why/why
not?

PROBLEM 4. Mergers and Acquisitions (40 min)

Rearden Metal has earnings per share of $2. It has 10 million shares outstanding and is trading
at $20 per share. Rearden Metal is thinking of buying Associated Steel, which has earnings
per share of $1.25, 4 million shares outstanding, and a price per share of $15. Rearden Metal
will pay for Associated Steel by issuing new shares. There are no expected synergies from the
transaction. Assume that Rearden offers an exchange ratio such that, at current preannouncement share prices for both firms, the offer represents a 20% price premium to buy
Associated Steel.
a) Determine the total number of shares offered to the owners of Associated Steel
and earnings per share for Rearden Metal after the merger.
b) What will be the price per share for Associated Steel immediately after the
announcement of Reardens offer? Explain.
c) What will be the price per share for Rearden Metal immediately after the
announcement of Reardens offer? Explain.
d) What is the premium Rearden will actually end up paying for Associated Steel?
6 of 8

PROBLEM 5. Convertible Bond (max 30 min)

A company is considering making a $ 100 million convertible bond issue. Each bond having a
$ 1 000 face value and paying a yearly coupon of 5 %. 5 year length with full repayment at
maturity and no bond call. Conversion price of $ 25 per share.
The companys shares are trading at $ 20, and are not expected to pay any dividend within the
5 years period. The risk free rate is 4.60%, the stocks beta is 1.2, and the firm may
alternatively raise 5 years straight, subordinated debt at 8%.
a) Determine the implicit value of the conversion rights of the issue.
b) Using the 0.4-rule, determine the implicit volatility (p.a.) used in pricing the
conversion rights (the warrants). What do you think of the pricing of the issue?
Assume now, that the companys shares are assumed to pay a constant dividend of $ 1 per
share for each of the five years.
c) Redo question b), and explain the difference.

7 of 8

Useful formulas ??
WACC = Rf + A MP + Debt

C 0,4 T PV(F) 0,5 PV(F X)

ROCE

p =

V =

(1 t) EBIT
BE 1 D 1

ROE

E
BE 1

d1
k -g
E1
k

Inv*1 [R * /k - 1]
+
k -g

E
D
U

E (1- ) D D
E (1- ) D

E
D
E
A
D

E D
E D

qx
px

n
n 1

8 of 8

VT S
V A /n A

NORWEGIAN SCHOOL OF ECONOMICS

Examination fall semester 2013

Code: FIE402N
Title: Corporate Finance / Foretakets Finansiering
Date:

18 November

Time: 09:00-13:00

The course instructor will not visit the examination room, but may be contacted by an
examination attendant at 59 291 or mob. 970 19 567

The students may respond in Norwegian or English.

Materials permitted for use during the examination:

Materials permitted: YES, cf list below: X
Electronic calculator: YES: X
In accordance with the rules specified in Utfyllende bestemmelser til Forskrift om
eksamen ved Norges Handelshyskole (fulltidsstudiene)
List of materials permitted:
One dictionary

1 of 11

FIE 402 CORPORATE FINANCE FALL 2013

All four problem sets on the next six pages should be answered. The last sheet contains a
collection of formulas, some of which may be useful during the exam.
The stated time limits may be helpful in allocating your time among the questions they are
also the weights for the total grade. Short and precise answers are favored.
PROBLEM 1. Multiple Choice (Q1 through Q12) (max 85 min)
Q1
Which of the following is NOT one of Modigliani and Miller's set of conditions referred
to as perfect capital markets?
A) All investors hold the efficient portfolio of assets.
B) There are no taxes, transaction costs, or issuance costs associated with security
trading.
C) A firm's financing decisions do not change the cash flows generated by its
investments, nor do they reveal new information about them.
D) Investors and firms can trade the same set of securities at competitive market prices
equal to the present value of their future cash flows.

Q2
White Rock Energy had a net income of $ 78 million last year, and a free cash flow (FCF) of
$ 52 million. The company repurchased 1 million shares at $ 10 per share. Furthermore, the
company retained 40 % of last years net income (increased its cash holding) and increased
the net debt by $ 12 million. After-tax interest expenses were $ 4 million.
How much did White Rock pay in dividends?
A)
B)
C)
D)

$ 10 million
$ 10.8 million
$ 18.8 million
$ 26 million

2 of 11

Q3
Compare a convertible bond with an otherwise identical bond without a conversion feature.
Which of the following statements is TRUE?
A) Yield is determined by the risk free rate and credit spread, and is unaffected by the
conversion feature. Both bonds will have the same coupon.
B) The option to convert stock into bond is valuable, hence the price of the convertible
will be lower and its coupon is higher.
C) The option to convert bond into stock is valuable, hence the price of the convertible
will be lower and its coupon is higher.
D) The option to convert bond into stock is valuable, hence the price of the convertible
will be higher and its coupon is lower.

Q4
The shares in Luther Industries are trading at $100. The company has just paid a dividend of
$4.50 per share, and the dividend is expected to grow at a constant rate. Luther has a cost of
equity capital of 12%. The grow rate of Luther's dividends are closest to:
A)
B)
C)
D)

7.0%
7.5%
16.5%
12%

Q5
Which of the following statements is FALSE?
A) After deciding to go public, managers of the company work with an underwriter, an
investment banking firm that manages the offering and designs its structure.
B) The shares that are sold in the IPO may either be new shares that raise new capital,
known as a secondary offering, or existing shares that are sold by current shareholders
(as part of their exit strategy), known as a primary offering.
C) Many IPOs, especially the larger offerings, are managed by a group of underwriters.
D) At an IPO, a firm offers a large block of shares for sale to the public for the first time.

3 of 11

Q6
Which of the following statements is FALSE?
A) The option price is more sensitive to changes in volatility for at-the-money options
than it is for in-the-money options.
B) A share of stock can be thought of as a put option on the assets of the firm with a
strike price equal to the value of debt outstanding.
C) In the context of corporate finance, equity is at-the-money when a firm is close to
bankruptcy.
D) Because the price of equity is increasing with the volatility of the firm's assets, equity
holders benefit from a zero-NPV project that increases the volatility of the firm's
assets.

Q7
You work for a leveraged buyout firm and are evaluating a potential buyout of Barrick
Mining. Barrick Minings stock price is $15 and it has 10 million shares outstanding. You
believe that if you buy the company and replace its management, its value will increase by
50%. You are planning on doing a leveraged buyout of Barrick Mining, and will offer $20 per
share for control of the company. Assume American legislation, such that the buyer is
allowed to consolidate the debt.
Assume that you get 50% control of Barrick Mining. The price of the non-tendered shares
will be closest to:
A)
B)
C)
D)

$12.50
$15.00
$17.50
$20.00

Q8
Use the information in the previous question. Regarding your tender offer, shareholders
will:
A)
B)
C)
D)

not tender their shares since the post LBO price is higher than the offer price.
not tender their shares since the post LBO price is higher than the current price.
tender their shares since the post LBO price is higher than the offer price.
tender their shares since the post LBO price is lower than the current price.

4 of 11

Q9
KT Enterprises is considering undertaking a new project. Based upon analysis of firms with
similar projects, KT has determined that an unlevered cost of equity of 12% is suitable for
their project. KT's marginal tax rate is 35%, its borrowing rate is 7%, and KT does not
believe that its borrowing rate will change if the new project is accepted.
KT expects to maintain a debt to equity ratio for this project of 1 (i.e., 50 % debt). KT's
equity cost of capital, rE, for this project is closest to:
A)
B)
C)
D)

17.0%
5.0%
15.0%
12%

Q10
Suppose that Rose Industries is considering the acquisition of another firm in its industry for
$100 million. The acquisition is expected to increase Rose's free cash flow by $5 million the
first year, and this contribution is expected to grow at a rate of 3% every year thereafter. Rose
currently maintains a debt to equity ratio of 1, its marginal tax rate is 40%, its cost of debt rD
is 6%, and its cost of equity rE is 10%. Rose Industries will maintain a constant debt-equity
ratio for the acquisition.
The unlevered value of Rose's acquisition is closest to:
A)
B)
C)
D)

$63 million
$50 million
$100 million
$167 million

Q11
Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of
this product, MI will have a value of either $100 million, $150 million, or $191 million, with
each outcome being equally likely. The cash flows are unrelated to the state of the economy
(i.e. risk from the project is diversifiable) so that the project has a beta of 0 and a cost of
capital equal to the risk-free rate, which is currently 5%. Assume perfect capital markets.
Assume that in the event of default, 20% of the value of MI's assets will be lost in bankruptcy
costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.
The initial value of MI's debt is closest to:
A) $108 million
B) $103 million
C) $125 million
D) $111 million
5 of 11

Q12
Which of the following statements is FALSE?
A) An investor that is long (holds) both a put and a call option, with exercise price equal
to the stock price at initiation (t=0), will always receive a positive payout from his
option portfolio at maturity.
B) When the exercise price of a call option is greater than the current price of the stock,
the option is said to be out-of-the-money
C) An American call option where the underlying asset does not pay dividends should not
be exercised early.
D) When the exercise price of a put option is greater than the current price of the stock,
the option is said to be in-the-money.

6 of 11

PROBLEM 2.

Company Analysis & Valuation (75 min)

You are given the following income data for Telenor ASA for 2012, and balance sheet data
for 2011 and 2012 (MNOK; adjusted data).
STATEMENT OF INCOME 2012
Revenues
101 718
Op. Expense
-69 830
Depreciation
-14 402
Operating Income
17 486
Interest Income
605
Interest Expense
-2 812
Other income*
4 567
Taxes (20 %)
-3 969
Net Income
15 877
* Incl. Income from associated companies

BALANCE SHEET DATA

Cash & Securities
Op. Current assets
Long-Term Assets
Total Assets

2011
15 623
18 694
132 022
166 339

2012 Change
10 372 -5 251
19 570
876
144 923 12 901
174 865
8 526

Debt
Other liabilities

33 924
45 513

50 101
42 027

16 177
-3 486

Equity*

86 902

82 737

-4 165

Liabilities & Equity

166 339

174 865

8 526

# of shares year-end

1 627

1 549

-78

* Including Minority Interests

Telenor paid total dividends of 7 500 million ordinary shareholders in 2012 and 4 500 million
to minority interest owners (outside minority owners in subsidiaries). These payments are
assumed to be the same in 2013 (from 2012 earnings). At year-end 2012 the market value per
ordinary share were kr 117 (including the value of minority interests). The stocks beta was
1.0, the normalized risk free rate was 4.5% (2% real rate and 2.5% inflation), and the expected
market premium was 4.5%.
a) Determine and explain the following for 2012:
(i)
sources and uses of free cash flow,
(ii)
ROCE and ROE,
(iii) ratios of market to book values for capital employed and equity.
7 of 11

Telenor's invested capital has grown on average by 3 % - 4 % yearly for the last few years.
The equity capital includes minority interests, which on average have the same required return
as Telenors common shareholders. The company is borrowing at 1.5 % above the risk free
rate.
b) Determine Telenor's cost of equity, and WACC. Evaluate Telenor's EVA and
abnormal earning for 2012.
c) Evaluate the market value of equity (market cap) at year-end 2012. Explain.
d) Evaluate the market value added (above the book value) of Telenors invested capital
and equity at year-end 2012 based upon your analysis in question b and c.
Assume that the enterprise value of Telenors Nordic businesses constitute about 40 % of total
enterprise value while the remaining 60 % reflects operations in less developed and emerging
mobile markets. The value of Telenors Norwegian fixed line telecom business constitutes
about of the Nordic value. Peer group analyses indicate asset betas of 0.60 and 1.00 for the
Nordic and the emerging market mobile businesses, respectively.
e) Determine the implied asset beta for the Norwegian fixed line business. Assuming
that you find a significantly lower asset beta than for the other business areas, what
may be the explanation?

8 of 11

PROBLEM 3. Debt funding (max 50 min)

Concise answers to the following two questions will be appreciated.
a) Present an intuitive explanation of Miller & Modligianis claim that a companys
Enterprise Value will not be affected by changes in the companys capital structure.
b) In practice, the firms choice of a capital structure may well affect its Enterprise
Value. Identify the main reasons for this deviation from MM, and discuss why and
how they work. Relate your discussion to relevant company or industry
characteristics.
It is claimed that both Equity and Debt in a (significantly) leveraged corporation may be
viewed fully or partly as options.
c) Evaluate this claim with the use of a diagram. Why may this analogy to options give
a useful perspective for understanding a potential conflict between owners and
lenders? What can be done to reduce this conflict?
A corporation has an Enterprise Value (EV) of NOK 10 billion. The interest bearing debt
matures in one year with an amount of NOK 9 billion (face value plus interest). EV has a
volatility of 30 % p.a. and the risk free rate is 4 %. The stock is not paying dividends.
You observe the following premium values (B&S) for 1-year call and put options on a stock
index with volatility 30 % p.a. This is a total return index.
% av today's index value
Strike:
9.0
Call premium
1.91
Put premium
0.56

10.0
1.37
0.99

d) Calculate the market value of the companys equity and debt. Explain. What is the
yield on the debt?
e) Evaluate the B&S premium values in the table with a simplified .4/.5-calculation
The company has an asset beta of 0.8 and the market premium is 5 %.
f) Give an estimate of the probability of default at the end of the year, assuming a
normal distribution for next years enterprise value (hint: probability weight 68 % of
+/- 1 stdev. around the mean value). What if the enterprise value instead is lognormally distributed?

9 of 11

PROBLEM 4 Structured Products (max 30 min)

You are evaluating the premium levels of (European) options on a stock index with current
index value 100. 3 years Call and Put options (warrant) with strike 100 have premium values
of 23.7 and 10.1, respectively. The 3 years treasury rate is 5 %. The index is a return index,
which is adjusted for dividends. The shares in the index are expected to pay a combined
continuous dividend of 2.5 % p.a.
(a) Estimate the implicit volatility for one of these options, using the 0.4/0.5-rule.
In a bank, you are responsible for the pricing of two alternative retail products which is based
on the above index. The Bull or Bear Deposit: The customer will receive his invested amount
in 3 years, plus a rate of return on this amount equal to a multiplier m times any percentage
increase (Bull Deposit) or decrease (Bear Deposit) in the index over these three years.
(b) Determine the largest multiplier value m for each product which will give the bank
a total fee 4 % of the invested amount (in present value). Explain your calculations
and discuss why the Bear Deposit should have a significantly larger multiplier.
(c) Discuss the likely effect on the maximum multiplier of each product of using a price
version of the same index, which is not adjusted for dividends.

10 of 11

Useful formulas ??
WACC = Rf + A MP + Debt

C = 0,4 T PV(F) + 0,5 PV(F X)

ROCE =

p =

V =

(1 t) EBIT
BE 1 + D 1

ROE =

E
BE 1

d1
k -g
E1
k

Inv*1 [R * /k - 1]
+
k -g

E
D
U =

+
E

E + (1- ) D D
E + (1- ) D

E
D
E +
A =
D

E + D
E + D

t =

qx
px
=
n
n +1

11 of 11

VT + S
V A /n A