Business 2233: Assignment #2

1. You are currently not a shareholder of Jim Borton's coffee chain, but you see potential in the firm. As a result, you wish to obtain enough shares so that you can elect yourself and your business advisor as board members. There are eight members on Jim Borton's board, 4,000,000 shares outstanding, and the current share price is $7.50. Assume that the share price is not impacted by your purchasing of the shares.

a. If the company employs majority voting, how much would you need to spend to ensure your two seats on the board? [2 points]

b. If the company employs cumulative voting, how much would you need to spend to ensure a seat on the board for you and your business advisor? [3 points]

c. Assume that cumulative voting is employed and you wish to purchase enough shares to ensure the two board seats. However, you estimate that only 90% of the potential shares will cast a vote. In addition, you only have $500,000 to purchase shares, and will have to borrow the rest from the bank. The bank quotes you a rate on such a loan of 6% (or 0.5% per month). You will be making monthly payments and will pay off the loan over the next 5 years. What is the value of your monthly payment? [10 points]

2. Your firm is considering replacing its existing line of equipment. The details of the potential upgrade are below:

 The existing equipment was purchased 4 years prior. At that time it cost $15M. You could sell it today for its UCC value. Alternatively, it could be salvaged in 10 years for its UCC value at that time.

 The new equipment would be purchased today for $20M. It will last for 10 years, at which time it will have a salvage value of $4M.

 The new equipment will lower cash outflows from $15M to $12M annually, but will require a $3M increase in net working capital.

a. What are the resale and salvage values of the old machine? [10 points]

b. Calculate the PV of the CCA tax shield. [5 points]

c. What is the NPV of the upgrade? [5 points]

d. What is the EAC/EAB of the upgrade? [5 points]

3. This question uses the financial statements Research in Motion, found on ACORN.

a. Calculate the following ratios for RIM using 2011 data and comment briefly on what the ratio means. Clearly state any assumptions that you are making in calculating the ratios. [2 points each]

i. Debt-equity ratio

ii. Total debt ratio

iii. Times interest earned

iv. Cash coverage ratio

v. Fixed charge coverage ratio

vi. Net working capital

vii. Current ratio

viii. Quick ratio

ix. Cash ratio

x. Asset turnover

xi. Inventory turnover

xii. Net profit margin

xiii. Operating profit margin

xiv. ROA

xv. ROE

b. Comment on how each of the following ratios have changed (favorably or unfavorably) year-over-year for RIM. [2 points each]

i. Times interest earned

ii. Cash coverage ratio

iii. Net working capital

iv. Net profit margin

v. ROE

c. Using the financial statements, calculate approximately how many shares are outstanding. [5 points]

d. Calculate and comment on the gross profit margins of the Hardware versus the Services and Software divisions of the organization. [10 points]

e. Using the Depot System, comment on the ROA of RIM versus that of Imperial Oil (financials also found on ACORN). [10 points]

f. Assume that RIM's cost of capital is 4%. Calculate the firm's Economic Value Add. [10 points]

4. Research and comment on the IPO of Facebook Inc. Focus on the days leading up to the IPO, any changes that were made just prior to the IPO, and its performance since. Also, discuss the issues that happened with the exchange that day. Your write up should be no more than a single spaced page, excluding any charts that you may want to use. [80 points]

5. Answer the following questions concerning the capital structure of organizations.

a. In your own words, outline MM Proposition 1. Include any assumptions that are made in order for this assumption to hold. Also, provide a simple example to illustrate the proposition. [20 points]

b. Outline how an individual can mitigate the impact of capital structure changes on a firm. That is, how would an individual cancel out the effects of a firm taking on leverage or conversely how would an individual replicate leverage should he/she desire? [10 points]

c. Given MM Proposition I, does this imply that shareholders of the firm are unaffected by capital structure changes? What about shareholder value? Discuss. [10 points]

d. Outline MM Proposition II. [10 points]

e. In a market without distress costs but with corporate taxes, what would be the optimal capital structure of a firm? Why? [10 points]

f. How does the above change with distress costs? Explain [10 points]

g. In your own words, outline the tradeoff theory and the pecking order of capital structure. [10 points]

h. In your own words, outline Jensen's Free Cash Flow argument. [10 points]

6. Answer the following questions concerning payout policy.

a. Discuss why dividends may increase, decrease, or not affect the value of a firm. Be sure to include a brief outline of MM dividend irrelevance in this discussion. [10 points]

b. There are two main ways for a firm to return funds to shareholders. Discuss each. [10 points]

c. A firm has 150,000 shares outstanding, currently trading at $45 each.

i. If the firm were to undertake a three-for-one stock split, how many shares would be outstanding, and what would be the price of each? [5 points]

ii. How many shares would be outstanding and what would be the price of each if the firm did a one-for-two reverse stock split? [5 points]

7. Balance Inc. has the following information concerning its debt and equity:

 The firm has 2M common shares outstanding. They were issued at a price of $20 and are currently trading at a price of $35. The shares yesterday paid a dividend of $2.38 and the dividend is expected to grow by 5% per year, forever.

 The firm also has 15,000 zero coupon bonds outstanding. The bonds have four years to maturity and are trading at $850 each. The par value of each bond is $1,000.

 The firm has a marginal tax rate of 25%.

a. What is the required rate of return on the firm's common shares? [10 points]

b. What is the required rate of return on the firm's debt? [10 points]

c. What is the required rate of return on the firm's assets? [10 points]

d. Assuming that the cost of equity and debt remain the same, what will happen to the firm's required return on assets if they issue $10M in new debt and use it to repurchase common stock? [10 points]

e. The cost of debt can increase or decrease as a firm takes on additional debt. Discuss. [10 points]

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