fall14q6ans

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University of Pennsylvania *

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238

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Finance

Date

Nov 24, 2024

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pdf

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5

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SIXTH QUIZ FNCE 238/738 November 24, 2014 WRITE ALL ANSWERS ON THE TEST. IF YOUR ANSWER CONTINUES ON THE BACK, MAKE A NOTE OF IT ON THE FRONT. 45 PTS / 25 MINUTES NAME:_____________________________________________ SECTION (12, 1:30 or 3):__________________________________
1. (15 pts) An all-equity firm has existing assets and an investment opportunity that costs 20, and everybody knows that the firm’s manager has private information about the value of each: the firm is either in state 1, where the assets are worth 30 and the investment opportunity pays off 24 (i.e. has an NPV of 4), or it is in state 2 where the assets are worth 10 and the investment opportunity pays off 22 (i.e. has an NPV of 2). The manager knows for sure which state the firm is in, whereas everybody else puts a 50% probability on each state. Assuming the project has to be financed with an equity offering, would the manager finance it only if he privately knew the firm was in state 2, if investors believe that the manager will finance it only if he privately knows the firm is in state 2? Explain. Investors believe the firm issues only in state 2 -> value the firm at 10+22 = 32. So the firm must sell 20/32 of the firm to raise 20, leaving 12/32 of the firm for the old shareholders. If the firm really is in state 2, this fraction is worth (12/32)32=12 > 10, so it benefits old shareholders. If the firm is actually in state 1, then the value for the old shareholders is (12/32)54=20.25 < 30. So it hurts old shareholders. So if investors believe the firm issues only in state 2, then indeed the firm issues only in state 2.
2. Last month, underwriters led by Jefferies took Dave & Buster’s public. On 9/8 they’d announced an initial price range of $16-18, and on 10/9 they priced it at $16. On 10/10, the first day of trading, it closed at $17.28, and here’s how it traded over its first month: a. (5 pts) Setting aside for the moment what actually happened on 10/10, would you have expected D&B to pop up substantially on its first day, given where it was priced? Why or why not? It was priced within the initial price range, and historically this has associated with a modest increase on average, not a big pop. This is consistent with a dynamic where underwriters underreact to enthusiasm from their investors, in order not to discourage enthusiasm, so that upward pricing predicts the big price rises. b. (5 pts) Looking at what happened on 10/10 and subsequently, would you expect the underwriter to exercise the overallotment option? Explain. The overallotment option allows the underwriter to prepare for aftermarket price support by overselling in the first place, because this way he can buy back from the market only when the offering does poorly; otherwise he covers the overselling by expanding the offering with the option. Since this offering went up and up, it stands to reason that the underwriter covered the overselling with the option, not by buying back shares
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3. (10 pts) From Value Walk , last Thursday (11/20/14) (slightly edited): Western Union vulnerable to activism The share price of The Western Union Company has seen several large swings since it was spun off from First Data Corp. in 2006. Its $5 billion-plus buybacks have not had much of an impact on the stock price. Citing Susquehanna Financial Group LLP, a Bloomberg report points out that Western Union’s management or an activist could enhance shareholder value by shifting the buyback funds towards a larger dividend. Alternatively, the firm could spin off or sell its non-core business-to-business division, which could fetch at least $400 million based on similar transactions. Joseph Stauff, a New York- based analyst on Susquehanna’s event -driven/special situations team, believes the recently de-staggere d board “suggests to us that the management team is vulnerable to some level of activism”. Focus on the last sentence. How is the management team now vulnerable to activism? Destaggering means the whole board, not just part of the board, is elected each year. So the team is now vulnerable because a hostile acquirer could take control of the whole board through a proxy battle, and thereby potentially defeat any anti-takeover tactics, such as poison pills, the board put in place.
4. News from Sweden, last Tuesday (11/18/14): The Board of Directors of CDON Group has set the final terms for CDON Group's rights issue that was resolved on 21 October 2014. Shareholders in CDON Group have preferential rights to subscribe for 1 new share per 2 existing shares. Every existing share in CDON Group entitles the holder to 1 subscription right, and 2 subscription rights entitle to subscription for 1 new share. The subscription price has been set at SEK 13 per new share. Preliminary timetable 24 November 2014, First day of trading in the CDON Group share excluding subscription rights 28 November - 10 December 2014, Trading in subscription rights a. (5 pts) On 11/17, the day before this announcement, CDON closed at SEK 20. Given that price and the terms above, at what discount to the theoretical ex-rights price is this offer priced? Using our formula, p 0 = 20, p r = 13, and x (# of new shares for each old share) = 0.5 TERP = 13 + (20-13)/1.5 = 17.667 b. (5 pts) The timetable shows that the rights will trade separately from the shares, starting later this week. Given the information above, at what price would you expect a right to trade? Two rights allow the investor to buy for 13 a share worth 17.67, and thereby to make a profit of 17.667- 13=4.667. So one right is worth half that, i.e. 2.33.