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SIXTH QUIZ FNCE 238/738 November 30, 2011 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, 3):__________________________________

1. (5 pts) Recent Mattress news: Mattress Firm Holding Corp. Mattress Firm Prices Initial Public Offering Investment Weekly News © Copyright 2011 Investment Weekly News via VerticalNews.com Mattress Firm Holding Corp. announced the pricing of its initial public offering of 5,555,555 shares of common stock at $19.00 per share. The common stock is expected to begin trading on the NASDAQ Global Select Market on November 18, 2011 under the ticker symbol "MFRM." The underwriters have a 30-day option to purchase from the Company up to an additional 833,333 shares of common stock, at the same price per share, to cover over-allotments, if any. The offering is expected to close on November 23, 2011, subject to customary closing conditions. All shares are being offered by the Company. The Company will utilize the net proceeds from the offering (which are estimated to be approximately $95 million, after deducting the underwriting discount and other estimated fees and expenses payable by the Company, prior to any exercise of the underwriters' overallotment option) primarily to repay indebtedness and to pay accrued management fees and interest, and the remainder for working capital and other general corporate purposes. What practical difference will it make if this offering trades below $19/share, as opposed to above, in its first month? Why?  Underwriters support the price after IPO. They do this by overselling the offering upfront by the “overallotment” amount.  If the price threatens to fall below the offering price of $19, they buy back the extra from the market.  If the price is above $19, they exercise the overallotment option to buy shares from the issuer, expanding the offering by this amount.  So if the offering trades below $19, the option is not exercised, and the number of shares ultimately issued is 5,555,555, rather than 5,555,555 plus the 833,333 overallotment.

2. (10 pts) A firm has existing assets and an investment opportunity that costs 10, 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 ‐ in ‐ place are worth 9 and the investment opportunity pays off 11 (i.e. has an NPV of 1), or it is in state 2 where the assets ‐ in ‐ place are worth 27 and the investment opportunity pays off 13 (i.e. has an NPV of 3). The manager knows for sure which state the firm is in, whereas everybody else puts a 50% probability on each state. If the firm has to finance the new investment by selling equity for 10, then will the new investment get financed in both states or just one state? Explain. Suppose the public expects both states. Then if the firm raises 10 and finances the project, then  If the firm is in state 1, then it is worth 9 + 11 = 20  If it is in state 2, then it is worth 27 + 13 = 40  So its expected value is ½(20+40) = 30, so the firm has to sell 10/30 = 1/3 of the equity to raise 10  So the original shareholders own 2/3 o In state 1, that’s worth 2/3(20) = 13.33 > 9, so the financing adds value o In state 2, that’s worth 2/3(40) = 26.67 < 27, so the financing subtracts value  So in fact, the firm will finance only in state 1, so it isn’t rational for the public to expect both states  Showing that state 2 won't finance in this equilibrium was enough to answer the question. Suppose the public expects financing only in state 1  If the firm is in state 1, it is worth 20, so it has to sell 10/20 = ½ of the equity to raise 10  Original shareholders own ½, and ½(20) =10 > 9, so they’re better off  If the firm is in state 2, it is worth 40  Original shareholders own ½, and ½(40) < 27, so they’re worse off  So the firm will indeed finance only in state 1, so this is rational all around It is pretty obvious that the public won’t expect financing only in state 2; I won’t go through that.

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3. (10 pts) From the WSJ, 9/19/11: Last week ConAgra Foods set a deadline for today for Ralcorp Holdings to begin negotiating ConAgra’s $94‐a‐share takeover bid for Ralcorp. Otherwise, ConAgra says, it will withdraw its takeover proposal. Ralcorp management and its advisers are undoubtedly popping the champagne corks. The Ralcorp board previously rejected the $94 bid and the ultimatum actually amounts to an unconditional surrender by ConAgra. There is no reason to think Ralcorp, having fought so hard to defeat the ConAgra bid, will do anything but let the deadline pass and hold ConAgra to its word that it will walk away. … Shareholders may not exactly be celebrating in the streets. On Friday the Ralcorp stock closed at $76.19, a long ways below the soon to be gone $94‐a‐share ConAgra bid. Monday, Ralcorp’s shares opened about 3.6% lower to $73.44. This deal, like the earlier defeat of Air Products’ bid for Airgas, demonstrates what has become a fundamental principle of takeover defense. Three tools, when used together, constitute an almost bullet‐proof defense: A poison pill, a staggered board and a strategic plan that gives a board cover to turn down a takeover offer. Consider the last sentence. How (briefly) does Air Products / Airgas demonstrate this?  Poison pill severely dilutes hostile bidder, making it uneconomical to take over the firm without getting the poison pill redeemed.  Staggered board slows down the acquisition of a majority of board seats to at least a year, so it will take at least that long to populate the board with sympathetic members who may vote to redeem the pill.  Board that does not let shareholders sell the firm to a hostile bidder is exposed to the charge that it is violating its fiduciary duties to shareholders, but a strategic plan that argues for a higher price helps the board argue that the bid is a threat to long term shareholder value. o Might also bring up that the board can also argue that merger ‐ arb shareholders, such as those that showed up in the Airgas case, have a short ‐ term bias that may encourage them to sell for less than the long ‐ term value. o Might also bring up that Air Products’ own candidates agreed with the other board members that Air Products’ bid was too low.

4. (5 pts) Contrast two scenarios where you are voting on whether one slate of directors should be replaced by another, your goal is to maximize shareholder value, and you think that the directors should not be replaced, but you are far from sure. In the first scenario, replacement requires a simple majority of shares. In the second, it requires a two ‐ thirds majority of shares. How might your approach to voting differ across the two scenarios? Does it matter whether the other voters share your goal, or vote in line with their own beliefs, or whether you see their votes before you cast your own? Explain.  In the simple majority case, your vote is pivotal when everyone else's vote is tied, and it makes sense to vote with your belief.  In a supermajority setting, your vote is pivotal only when the vote of everyone else is strongly in one direction.  If other voters vote their opinions, and share your goals, this is a strong signal that the value ‐ maximizing vote is in that direction. It could be strong enough that you vote against your own information.  To the extent other voters have goals different from yours, their votes are not information about the vote that makes you better off. And to the extent that other voters do not vote according to their information, their aggregate vote conveys less information, and so reveals less about the vote that makes you better off.  You don’t have to see the vote of others to impute this information in your vote. It is rational to vote as if your vote is pivotal, when you have no idea whether it will be or not, because that is the only situation where your vote has an effect.

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