Advanced Corporate Finance

Spring 2008 Professor Serdar Din

QUESTIONS FOR CONSIDERATION (These are starters only!! They may help you identify the main issue)

Times Mirror. 1. What is PEPS? How can it be priced? Hint: Ignore the early redemption option.

2. Why does Times Mirror want to issue PEPS? Does it achieve its purpose? Compare it with other alternatives? What are the risks? Hint: Read the prospectus.

Chrysler 1. Estimate the value of warrants on Sept. 14, 1979, Jan. 7, 1980, April 8, 1980, May 12, 1980, and September 1, 1983. To which parameters are the warrant values especially sensitive? Notice that one should multiply the daily variance of returns by 252, the number of trading days in a year, not by 365 as stated in the case, to find the annualized variance of returns. Do not work with implied volatility as the warrants on those dates are either very much out-of-the-money or very much in-the-money. Is it reasonable for the government to return the warrants for free? Who would benefit from such action and by how much? Is the government fairly compensated as of May 12, 1980 for the loan guarantees given for Chrysler?

2. 3.

American Chemical Corporation 1. Estimate the weighted average cost of capital appropriate for discounting the Collinsville plant's incremental cash flows. 2. Project the incremental cash flows associated with the acquisition of the Collinsville plant without the laminate technology and estimate the acquisition's net present value. Project the incremental cash flows associated with the 1980 investment in laminate technology and 1

estimate the investment's net present value. 3. Is the Collinsville proposal attractive on economic grounds? 4. As CEO of Dixon Corporation, would you approve the acquisition of the Collinsville plant at the price and on the terms proposed? Why, or why not? What alternatives, if any, would you suggest?

Nova 1. 2. Humana 1. Assess the different restructuring alternatives. What would be your recommendation Why? (Do not be surprised if you are doing less number crunching for this case than previous cases. Due to the lack of more detailed information, you can do a multiples analysis for this case) Regardless of your recommendation, suppose Humana decided on a spin-off. Design the spin-off. You can assume that it will be tax-free. Assess the sale of IPD. You can assume that the tax savings from any asset write-off after the sale will be captured in full in the year of write-off. Analyze the financing options for Nova with and without the sale of IPD. Consider only debt and/or equity.

2.

General Motors 1. How will changes in test rates affect General Motors' business? Speculate on the various ways in which changes interest rates influence the demand for auto prices, the prices the firm can charge, its input costs, etc. Apart from engaging in derivative securities, like those discussed in the case, how could a firm like GM control its exposure to interest rates? How does managing interest rate exposure differ for a bank and for an industrial firm like GM? What should be GM's over-arching policy toward managing interest rate exposure? For example, should GM seek to ensure that changes in interest rates do not affect operating cash flow? The market value of the firm's equity? GM's ability to invest in new technologies? Should it abandon all efforts to manage its interest rate exposure? Be prepared to discuss GM's stated policies. How do interpret these policies?

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How has GM measured its exposure? How would you propose that GM measures its interest rate exposure? How would you propose that GM reports the interest rate exposure of its business, and of its liabilities? What is a "rate view"? What role does it play in the liability management policy at GM? What role should it play in the liability management program? Why? Explain each of the interest rate derivatives that Bello is considering (listed in Exhibit 7.) How do they work, and how would they affect the incremental interest rate exposure of the five-year fixed-rate note that GM is about to issue? Assuming that each of the instruments is fairly priced, what should Bello recommend? Why? As a director or institutional investor in GM, how would you evaluate the liability management program at GM? What might you suggest should be studied or changed, and why?

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Enron Corp. 1. 2. 3. 4. 5. What is a credit derivative? Why is the management of a firms own credit risk important to its derivatives operations? What are the different approaches to managing ones own credit risk? How are credit derivatives being used as an alternative to other approaches of managing credit risk? Are they more efficient? The Enron credit sensitive note (CSN) is an example of a security with embedded credit derivatives to manage issuer credit risk. What are the benefits to the issuer of such a note? What can you infer about the company's perception of Enron's future credit standing? As a buyer of the Enron CSN, how would you analyze its value? What are the benefits to the buyer of this issue?

6. 7.

American Barrick Resources Corp. 1. In the absence of a hedging program using financial instruments, how sensitive would Barrick stock be to gold price changes? For Every 1% change in gold prices, how might its stock be affected? How could the firm manage its gold price exposure without the use of financial contracts? 2. What is the stated intent of ABX's hedging program? What should be the goal of a gold mine's price risk management program?

3. What would convince you that a price risk management program created value for its shareholders ex ante? 4. How would you characterize the evolution of Barricks price risk management activities? Are they consistent with the stated policy goals? 5. How should a gold mine which wants to moderate its gold price risk compare hedging strategies (using futures, forwards, gold loans, or spot deferred contracts) with insurance strategies (using options)? On what basis should these decisions be made? Once a firm has decided on either a hedging or an insurance strategy, how should it choose from among specific alternatives? Tiffany & Co. 1. In what way(s) is Tiffany to exposed exchange-rate risk subsequent to its new distribution agreement with Mitsukoshi? How serious are these risks? 2. Should Tiffany actively manage its yen-dollar exchange-rate risk? Why or why not? 3. If Tiffany were to manage exchange-rate activity, what should be the objectives of such a program? Specifically, what exposures should be actively managed? How much of these exposures should be covered, and for how long? 4. As instruments for risk management, what are chief differences of foreign exchange options and forward or futures contracts? What are the advantages and disadvantages of each? Which, if either, of these types of instruments would be most appropriate for Tiffany to use if it chose to manage exchange-rate risk? 5. How should Tiffany organize itself to manage its exchange-rate risk? Who should be responsible for executing its hedges? Who should have oversight responsibility for this activity? What controls should be put in place?

Enron Gas Services 1. How would you describe Enron Gas Services business? How is it like a bank? What type of bank? In what ways is it different from a bank? What circumstances created an opportunity that EGS was designed to exploit? 2. Contracting with Gas Users a. Why might users of gas want ot use the services of EGS? b. What is the Enfolio product line? How are the offerings differentiated from one another? How can Enron hope to turn an unbranded commodity into a differentiated product? c. Why might electric utilities and independent power producers such as Sithe Energies be especially receptive to EGSs proposals?
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3. Contracting with Gas Suppliers a. What problems of gas suppliers does EGS attempt to solve? What other solutions might exist to solve their problems? b. How could EGS raise funds to fund its financing of gas suppliers? What is a Volumetric Production Payment contract? How does it work? What risks does EGS run by entering into VPP? How does it manage these risks? What are the Cactus Funds? How do they work? 4. Centralization and Coordination a. What is ERMS? What is its role at EGS? Describe the risk books at EGS. How do they work to measure the exposure of EGS to various risks? How does the person managing each book offset the risks which the rest of the organization creates? b. Explain how the ABC, Inc. transaction will affect the different books of EGS. c. Based on the risk profile in Exhibit 9 of the case, how does EGS manage its exposures? How does EGSs mark-to-market accounting work? (Work through the Appendix to the case.) Does this reporting system provide investors with the information they would find most valuable? 5. What are the major risks facing EGS? Honeywell, Inc. 1. What are the objectives of Honeywells new risk management program? How do they relate to the goal of maximize shareholder value? 2. Consider the proposed insurance contract that covers both currency and insurance risk. Aside from the specific risks covered by the proposed contract, does it differ in other ways from Honeywells old policy? 3. Does the proposed aggregation of risks together in the one insurance contract make sense? What are the advantages and disadvantages relative to an approach that uses individual contracts for each type of risk? Does it change the total risk of the firm? Leaving aside the issue of whether administrative costs are higher or lower for the new contract, would you expect the contract to cost more or less than the old one? Why? 4. Is the new contract cheaper than the old one? How was Honeywell able to get such a low quote from AIG? Can AIG afford to give low prices to every customer? 5. Should Honeywell go forward with the new contract? Consider both the advantages and disadvantages of the contract. What advice would you offer Honeywells board as they move forward to more fully develop a long-term risk management plan?
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6. Is the new contract really an integrated risk management program?