Prof. Thomas J.
Chemmanur
MFIN8881: Advanced Corporate Finance
CASE QUESTIONS
Case I: Atlantic Corporation (For class discussion only: No case write-up needed)
1. What is the cost of capital to be applied in valuing the Mill and Box Plants that Atlantic is buying from
Royal Corporation?
2. Compute the fair value of assets that Atlantic is purchasing from Royal Corporation. Using the Free
Cash Flow (FCF) method in valuing the Mill and Box Plants that Atlantic is purchasing.
Case II: Apex Investment Partners (A)
1. Is Accesline an attractive investment opportunity? Why or why not? What are the key risks associated
with this investment?
2. How has Accessline financed itself to date? Why have they chosen this strategy? What have been the
implications for the firm? Why is Dan Kranzler raising funds from Apex Investment Partners?
3. Analyze the terms of the Series B financing, as proposed by Acessline to Apex, and set forth in the
term sheet for the financing. How does the deal structure address the risks of the investment? What issues,
if any, should concern Apex?
4. Compare the terms of the Series B financing with those in the Series A financing. Are there any
investor protections offered in the Series A financing which are not present in the new (Series B)
financing? If so, discuss these briefly.
5. Compute the appropriate valuation of Accessline using the "venture capital" method (i.e., using
comparables, as we did in class problems). In particular, assuming that Accessline's IPO will take place in
April 1999, what share of the firm's equity should the venture capitalists demand in return for the $16
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million investment raised in the new round (Series B) of financing? Do the valuation using both the
average sales and the net income multiples of the comparable firms given.
Make the following assumptions in developing this valuation:
(i) Target rate of return for V.Cs: 60%
(ii) Additional shares that will be issued in new rounds of financing before IPO: 50%
(iii) You may assume straight line growth in revenues during 1995-1999, and straight line growth in profit
margins during 1996-1999.
You may make any other assumptions required (state and justify these assumptions clearly).
6. Compute the appropriate valuation of Accessline using the discounted cash flow method. In addition to
assumption (iii) under question 5 above, you may make the following assumptions in developing this
valuation:
(i) The beta of Accessline is equal to the average beta of the comparable firms given. Its beta remains the
same in the future, and it maintains an all-equity capital structure.
(ii) Ratio of new Capital Expenditure to Sales Growth remains constant from 1995 onwards.
(iii) Net Working Capital remains flat (no growth).
(iv) Cash flow growth rate from 2000 onwards: 5% in perpetuity.
(v) Market risk-premium (equity premium): 7.3%
You may make any other assumptions required (state and justify these assumptions clearly).
(7) Assume that you are working for Apex Investment Partners. Could you suggest a counteroffer to
Accessline's term sheet on behalf of Apex that you think will help to resolve the impasse between the two
parties in terms of the pricing of shares in the new round of financing (Series B)? You need to focus only
on the price and the number of the securities to be given to Apex in return for the investment--- you do
not need to specify any other provisions of the financing in your proposed counteroffer
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Case III: Immunologic Pharmaceutical Corporation
1. Is Immunologic Pharmaceutical Corporation ready to go public at this time? Should it go public?
(Answer this question both from the point of view of Immunologic as a firm: i.e., Immunologic's position in
the firm life cycle, and also with reference to conditions in the IPO market at the time this IPO is being
considered).
2. Discuss the incentives, and critique the reasoning of the followers players in deciding to take the firm
public at this time:
(i) Malcolm Gefter, the entrepreneur
(ii) Henry McCance, the venture capitalist
3. (i) Discuss the incentives, and critique the reasoning of Katherine Kirk in deciding to take the firm public
at this time. How do you square her decision with her 1990 advise to the company not to go public at this
time?
(ii) Is immunologic an attractive deal for Hambrecht and Quist? Why?
(iii) From the point of view of Immunologic, is Hambrecht and Quist the right investment bank to lead this
deal? Why or why not?
(iv) Comment on the compensation received by the investment banks in this deal. Is this compensation
"fair"?
(v) What are the trade-offs/concerns that have to be addressed by Hambrecht and Quist in pricing this deal?
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4. What is the fair value of Immunologic? Give a fair price per share in the IPO, based on your calculations.
In arriving at this fair price, should undertake:
(i) A discounted cash flow analysis. Make suitable assumptions (when necessary data is not available in the
case), stating these assumptions carefully.
(ii) Valuation using comparables. In addition to a valuation based on (Market Value)/Earnings, you should
attempt valuation based on other ratios (keeping in mind the discussion in the article by Ritter on "Valuing
IPOs"), which may prove to be quite useful.
Case IV: California PERS (A) (For class discussion only: No write-up required): To be discussed
along with the reading from the course pack, "The long-term rewards from shareholder activism:
A study of the CALPERS effect"
1. What is Calpers’ corporate governance agenda?
2. What are the constraints (limitations) faced by Calpers in pursuing the above agenda?
3. How does one measure the performance of firms in which Calpers played a role: i.e., the
effectiveness of Calpers’ corporate governance activities?
4. During which period has Calpers been more effective: 1987-89 or 1990-92?
Case V: Dividend Policy at FPL Group Inc. (to be discussed along with the reading from course
pack, “The Dividend Cut Heard Around the World: The Case of FPL”)
1. What were the most important issues confronting FPL group in May 1994 that prompted them to
re-evaluate their dividend policy? Answer this question in terms of: (a) Economic and industry
environment; and (b) Firm level issues.
2. What are the arguments, if any, in favor of FPL retaining its current dividend policy? Discuss
from both the point of view of the economic environment and firm specific factors.
3. Consider the possibility that, instead of cutting its dividends in 1994, FPL adopted a policy of
slowing its growth in dividends per share (DPS) to 1% from 1993 to 1998. Develop a rough
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sources and uses of funds projection from 1993 to 1998 under this assumption (makes suitable
additional assumptions as necessary), and project dividend payout ratios from 1994 to 1998 under
this policy. Could this have been a sustainable dividend policy, in the sense that FPL could have
funded this level of dividends from internal financing by 1998? Would you have recommended
this slowing dividend growth policy over one of cutting dividends (discuss why or why not)?
4. What are the arguments, if any, for FPL to cut its dividend significantly? Discuss from both the
point of view of the economic environment and firm specific factors.
5. What does the equity market’s reaction to FPL’s dividend cut tell us about the validity of
dividend signaling (to the extent that one can generalize from a single event)?
6. What does the equity market’s reaction to FPL’s dividend tell us about how much weight
management should give to “clientele” effects in deciding whether or not to cut dividends (for
similarly situated companies)?
7. What are the advantages of a combination of a smaller dividend and a stock repurchase program
over a larger dividend (and no stock repurchase program)? Why did FPL choose to authorize and
announce a stock repurchase program simultaneously with the dividend cut?
8. Comment on how FPL communicated the change in its dividend policy to the equity market.
Could management have done a better job of communicating the change in policy, and if so, what
improvements would you suggest?
Case VI: Chrysler's Warrants
1. Value the Chrysler Warrants held by the government on five dates:
(i) September 14, 1979 (case Exhibit 5 gives stock return volatility calculation).
(ii) January 7, 1980 (See Exhibit 6 for stock return volatility calculation).
(iii) April 8, 1980 (See Exhibit 7 for stock return volatility calculation).
(iv) May 12, 1980 (See Exhibit 8 for stock return volatility calculation).
(v) September 1, 1983 (See Exhibit 4 for stock return volatility calculation).
What explains the change in warrant value over these dates?
Note: In conducting the above calculation you need to:
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Use the yield on a T-bond (computed as of the date you are valuing the warrant) with maturity equal to the
length of the relevant warrant as the risk-free rate in your calculations. (b) For each date, give three different
warrant values: Warrant value without adjusting for dilution (i.e, value of an equivalent call option on the
firm); warrant value after adjusting for the dilution caused by the exercise of the warrants held by the
government alone (but not by the banks); warrant value after adjusting for the dilution caused by the
exercise of the warrants held by both the government and the banks. (c) You need to adjust the stock price
for the infusion of cash into the firm due to warrant exercise (i.e., do the iteration in computing warrant
valuation only for part (i); in other words, you can assume S = Ŝ in the warrant computation for parts (ii) to
(v)). (d) In doing this case, you can assume throughout that the number of shares outstanding in Chrysler was
68.5 million (as mentioned in the case at the bottom of page 2 of the case). In other words, for simplicity, I
want you to ignore the information given in the case about new shares being sold in the firm during the
summer of 1983.
2. Make use of the value of Chrysler's publicly traded warrants on September 1, 1983 (Exhibit 10) to
compute the implied volatility of the underlying stock (a rough estimate based on trial-and-error will do).
Compare this with the volatility used to value the warrants in question 1.(v) above. What could explain any
difference in these two volatilities?
3. Value the government's loan guarantee as of May 12, 1980. A loan guarantee is essentially a put option,
which allows the banks to put their risky Chrysler loans to the government. The variance of loans on
Chrysler debt is given by Exhibit 11. You can use the put-call parity pricing relationship to value this put
option.
4. Do you agree with Lee Iacocca that "The government's money was never at risk in the first place..." Was
the government's "profit...almost indecent?" Give a rough calculation of the government's projected Internal
Rate of Return (IRR), assuming that it sold the warrants it received from Chrysler as of the day the loan
guarantee was signed.
