FINC 5880 Final Examination

Question 1. (20 points) Both Berkley and Oakley are large public corporations with subsidiaries throughout the world. Berkley uses a centralized approach and makes most of the decisions for its subsidiaries. Oakley uses a decentralized approach and its subsidiaries make many of their own decisions.

a. Would the agency problem be more pronounced for Berkley or for Oakley? Explain.

b. Would agency costs likely be higher for Berkley or Oakley? Why?

c. Discuss a major advantage and a major disadvantage to a centralized approach such as Berkley uses.

d. Discuss a major advantage and a major disadvantage to a decentralized approach such as Oakley uses.

e. Which is better, a centralized or decentralized approach? Explain.

Question 2. (20 points) Assume the firm's stock now sells for $30 per share. The company wants to raise $20 million by issuing 20-year, annual interest, $1,000 par value bonds. Each bond will have 40 warrants attached, each exercisable into 1 share of stock at an exercise price of $36. The firms straight bonds yield 8%. Each warrant is expected to have a market value of $0.75 when the stock sells at $30. The company wants to establish a coupon interest rate and dollar coupon to ensure that the bonds will clear the market.

a. Calculate the value of the debt portion of the bonds with warrants.

Stock price $30

Bonds-life and par value 20

Par value $1,000

# of warrants per bond40

Exercise price $36

Warrant market value @ P=$30) $0.75

Yield on straight bonds 8%

b. Calculate the dollar coupon amount per bond with warrants.

. Calculate the coupon interest rate that should be set on the bonds with warrants.

d. Identify 3 advantages to the company of issuing a bond with warrants instead of straight bonds.

e. Identify 3 advantages to the investor of buying a bond with warrants instead of straight bonds.

Question 3. (20 points) Mantra Corporation is interested in acquiring Corlos Corporation. Corlos has 10 million shares outstanding and a target capital structure consisting of 30 percent debt and 70 percent equity. The debt interest rate is 8%. Assume that the risk-free rate of interest is 3% and the market risk premium is 7%.

Corlos' free cash flow (FCF0) is $5 million per year and is expected to grow at a constant rate of 6 percent a year; its beta is 1.2. Corlos has $5 million in debt. The tax rate for both companies is 30%.

Shares outstanding	100,00,000		FCF0	50,00,000
Target debt in capital structure	30%		Constant growth rate	6%
Debt interest rate	8%		Beta	1.2
rRF	3%		Amount of debt	50,00,000
Market risk premium	7%
Tax rate	30%
a. Calculate the required rate of return on equity using equation: rs= rRF + RPM(b)
b. Calculate weighted average cost of capital, using equation: WACC = Wdrd(1-%) + wsrs
c. Calculate the value of operations, using equation: Vops= FCF0(1+g)/WACC - g)

Question 4. (20 points) A Treasury bond futures contract settled at 97'16.

a. Calculate the present value of one futures contract in dollars?

b. b. Are current market interest rates higher or lower than the standardized rate on a futures contract? Explain.

c. c. Calculate the implied annual interest rate on the futures contract.

d. d. Calculate the new value of the futures contract if interest rates increase by 1 percentage point annually.

e. e. Describe differences between forward and futures contracts? Illustrate, using a specific example, of how companies could use either a futures or forward contract to hedge a position.

Question 6. (20 points) Your portfolio is diversified. It has an expected return of 10.0% and a beta of 1.10. You want to add 500 shares of Tundra Corporation at $30 a share to your portfolio. Tundra has an expected return of 14.0% and a beta of 1.30. The total value of your current portfolio is $50,000.

a. Calculate the expected return on the portfolio after the purchase of the Tundra stock?

b. Calculate the expected beta on the portfolio after you have added the new stock?

c. Is your portfolio less risky or more risky than the market? Explain.

d. Will your portfolio likely outperform or underperform the market in a period when stocks are rapidly falling in value? Explain.

e. Is beta always an accurate predictor of a portfolio's performance? Explain?