q3fall13 answers

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University of Pennsylvania *

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238

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Finance

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Nov 24, 2024

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THIRD QUIZ FNCE 238/738 October 9, 2013 WRITE ALL ANSWERS ON THE TEST. IF YOUR ANSWER CONTINUES ON THE BACK, MAKE A NOTE OF IT ON THE FRONT. 30 PTS / 25 MINUTES NAME:_____________________________________________ SECTION (12, 1:30 or 3):__________________________________
1. (10 pts) In a year, Kepler Motorcars will be worth either 100 or 40, each with probability ½. Kepler has a bond outstanding, with principal amount 100, maturing in a year. The bond is held by 100 investors, each holding principal amount 1. The bond has a covenant making it senior to all other Kepler debt, and this covenant can be amended by a majority vote of bondholders (i.e. at least 51). To bondholders, Kepler offers an exchange: bondholders can tender their bonds while voting to remove the covenant, and if the vote passes, those who tendered get a new bond with principal amount 0.9, senior to the old bond. If you are a bondholder, are you better off tendering your bond? Why or why not? What considerations are important? Suppose at least 51 others tender. Then there will be at least 51(0.9)=45.9 in SR debt. If you didn’t tender, then if the fir m is worth 100 you’ll get 1 (since there’s <100 in total debt) and if the firm is worth 40 you’ll get 0 (since there’s >40 in debt SR to you). So your expected payoff is 0.5. If you did tender, then if the firm is worth 100 you’ll get 0.9, and if it is worth 40 you’ll get at least 40/100=0.4. So your expected payment is 0.65. So you’re better off if you tendered. Suppose no more than 49 others tender. Then it doesn’t matter what you did, because it fails with or without you. If exactly 50 tender, the n it fails if you don’t tender, so you get ½(1)+ ½(0.4)=0.7, and it succeeds if you do tender, so you get ½(0.9) + ½(40/51)=0.84. So you’re better off tendering. [if you just said that this is an unlikely scenario, so it doesn’t much matter in your calculation, that’s OK] So in the world where you don’t know how many others are tendering, tendering either helps you or doesn’t make a difference, so you would be better off tendering. But you would be better off still if you coordinated with other investors and agreed collectively not to tender, because with the tender offer you all end up with 0.65, whereas you have 0.7 without it, and nobody has the incentive to tender if they know others won’t.
2. (10 pts) Bob has two possible projects, P1 and P2, which both cost 150, and the value of his firm in a year depends on which project he chooses, and whether the price of gas is high or low, each of which has probability ½: Project Price of Gas: High Low P1 130 200 P2 100 220 Bob wants to raise money toward the 150 cost of the project by selling a bond that would mature in one year. Bob will pay in whatever the bond doesn’t raise, and then choose the project. Suppose Bob has decided that the bond will have face value 120, and is trying to decide whether the bond should be convertible into ¾ of the firm’s equity (that is, up until the last moment, the bondholders can convert their bonds into ¾ of the firm’s equity; don’t worry here about the convertible being callable). What would you advise Bob? Why? If the bond is not convertible, then the payoff to equity, given the debt of 120 outstanding, is Project D P E[payout to equity] A 10 80 45 B 0 100 50 -> B is chosen Given that B will be chosen, investors pay ½(100) + ½(120) = 110 for the bond, so the entrepreneur pays in 150-110=40 for an expected payout of 50, so the NPV to him is +10. If the bond is convertible, then bondholders will convert when ¾ of the firm is worth more than 120, i.e. when the firm is worth more than 160. So regardless of the project choice, bondholders will convert in state P and not convert in state D. Therefore, the payoff to equity is Project D P E[payout to equity] A 10 50 30 -> A is chosen B 0 55 27.5 Given that A will be chosen, investors pay ½(120) + ½(150) = 135 for the bond, so the entrepreneur pays in 150-135 = 15 for an expected payout of 30, so the NPV to him is +15, which is better. So the bond should be convertible .
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3. (5 pts) A news item from last month: Furniture Brands closes six stores, including one in Triad By Katie Arcieri 10 September 2013 The Business Journal of the Greater Triad Area Online © 2013 American City Business Journals, Inc. All rights reserved. St. Louis-based Furniture Brands International Inc. has closed six under-performing Drexel Heritage and Thomasville stores, including a corporate-owned Drexel Heritage store across from Furnitureland South in Jamestown, according to Furniture Today. News of the store closings come on the heels of the company announcing Monday it has filed for bankruptcy. Los Angeles-based Oaktree Capital Management LP plans to purchase most of the assets of Furniture Brands, a move that some say could help the company emerge as a stronger business. Furniture Today reports that Furnitureland South has acquired everything in the Drexel building in Jamestown and is displaying the merchandise in its outlet center. A company spokesman said Furniture Brands also has closed a Drexel Heritage store in Greenville, S.C., and four company-owned Thomasville stores in Greenville, S.C., Beaufort, Ga., Brookfield, Conn., and Geneva, Ill., because they were underperforming and in poor locations. Drexel Heritage's headquarters are in High Point, while Thomasville is based in Davidson County. What all could explain Oaktree’s decision to buy Furniture Brands out of bankruptcy, rather than before they filed? In bankruptcy, the transactors have access to Section 363, whereby assets can be sold free and clear of liabilities, and without risk of attack ex post as fraudulent transfers. Outside of bankruptcy, there would be the risk of hidden liabilities and vulnerability to being viewed ex post as fraudulent transfers Also, bankruptcy allows Furniture Brands to exit leases cheaply, and therefore to close the under- performing stores at a lower cost.
4. (5 pts) A couple years ago: Quiznos seeks deal 27 December 2011 The Advertiser Copyright 2011 News Ltd. All Rights Reserved DENVER: Quiznos says a majority of its creditors have agreed to a plan by the restaurant chain to restructure or pay off some $875 million in debt, but it may yet file for bankruptcy protection. The plan outlined calls for one of Quiznos's major creditors, investment firm Avenue Capital, to invest $150 million of new equity capital into the chain The plan would eliminate nearly one-third of Quiznos's debt and provide it with $75 million Quiznos says it will file for bankruptcy protection if it fails to reach restructuring deals with all of its creditors and cannot receive significant concessions from former executives and certain landlords and former area developers… Quiznos said it had reached debt restructuring support agreements with parties representing 75.1 per cent of its first-lien loans and 72.8 per cent of its second-lien loans. The plan involves restructuring the loans and equity interests in the company through either the out-of- court exchange offer or a prepackaged Chapter 11 filing. The exchange offer would pay the holders of $650 million in Quiznos's first-lien debt $75 million in cash and extend the due date on the balance of the loans for five years after the restructuring plan closes. All of the first- lien debt holders would be able to swap about $200 million in loans for a new second-lien debt, Quiznos said. Some of its lenders already have agreed to swap about $150 million in first-lien loans. Creditors with some $225 million in second-lien loans will exchange their loans for a proportional share of 40 per cent of new equity in the reorganised company, Quiznos said It already has begun soliciting creditors for support of a prepackaged reorganisation plan under Chapter 11.. Quiznos never did file Chapter 11. Did the rules of Chapter 11 play a role in this successful restructuring? Why or why not? Explain. Outside of bankruptcy, a debtor must voluntarily exchange his right to principal, interest and maturity, but in Ch. 11, a reorganization plan that is binding on everybody requires on 2/3 by value and ½ by number of approval from each class. So a creditor can potentially free ride on the concessions of others outside of Ch. 11, but not in. In this case, Quiznos threatened a prepackaged filing if all of its creditors didn’t participate, and this may have encouraged creditors to participate rather than free-ride, since they know that they would have to participate if Quiznos filed, and that Quiznos had a reasonably credible threat to file, since prepackaged filings can be relatively quick and therefore not so costly.