科目集訓營（2019.06）

公金

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Case1

ThefollowinginformationrelatestoQuestions1—6

ThecapitalbudgetingcommitteeforLarocheIndustriesismeeting.LarocheisaNorthAmerican

conglomeratethathasseveraldivisions.Oneofthesedivisions,LarocheLivery,operatesalarge

fleetofvans.Laroche’smanagementisevaluatingwhetheritisoptimaltooperatenewvansfor

two,three,orfouryearsbeforereplacingthem.Themanagershaveestimatedtheinvestment

outlay,annualafter-taxoperatingexpenses,andafter-taxsalvagecashflowsforeachofthe

servicelives.Becauserevenuesandsomeoperatingcostsareunaffectedbythechoiceofservice

life,theywereignoredintheanalysis.LarocheLivery’sopportunitycostoffundsis10percent.

ThefollowingtablegivesthecashflowsinthousandsofCanadiandollars(C$).

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?SchoemanProducts,anotherdivisionofLaroche,hasevaluatedseveral

investmentprojectsandnowmustchoosethesubsetofthemthatfitswithin

itsC$40millioncapitalbudget.TheoutlaysandNPVsforthesixprojectsare

givenbelow.Schoemancannotbuyfractionalprojects,andmustbuyallor

noneofaproject.ThecurrencyamountsareinmillionsofCanadiandollars.

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Schoemanwantstodeterminewhichsubsetofthesixprojectsisoptimal.

AfinalproposalcomesfromthedivisionSocietyServices,whichhasaninvestmentopportunity

witharealoptiontoinvestfurtherifconditionswarrant.Thecrucialdetailsareasfollows:

?Theoriginalproject:

?AnoutlayofC$190millionattimezero.

?CashflowsofC$40millionperyearforYears1–10ifdemandis“high.”

?CashflowsofC$20millionperyearforYears1–10ifdemandis“l(fā)ow.”

?Additionalcashflowswiththeoptionalexpansionproject:

?AnoutlayofC$190millionattimeone.

?CashflowsofC$40millionperyearforYears2–10ifdemandis“high.”

?CashflowsofC$20millionperyearforYears2–10ifdemandis“l(fā)ow.”

?Whetherdemandis“high”or“l(fā)ow”inYears1–10willberevealedduringthefirstyear.The

probabilityof“high”demandis0.50,andtheprobabilityof“l(fā)ow”demandis0.50.

?Theoptiontomaketheexpansioninvestmentdependsonmakingtheinitialinvestment.Ifthe

initialinvestmentisnotmade,theoptiontoexpanddoesnotexist.

?Therequiredrateofreturnis10percent.

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SocietyServiceswantstoevaluateitsinvestmentalternatives.

TheinternalauditorforLarocheIndustrieshasmadeseveralsuggestionsforimproving

capitalbudgetingprocessesatthecompany.Theinternalauditor’ssuggestionsareas

follows:

“Inordertoputallcapitalbudgetingproposalsonanequalfooting,the

projectsshouldallusetherisk-freeratefortherequiredrateofreturn.”

Suggestion1

Suggestion2

“Becauseyoucannotexercisebothofthem,youshouldnotpermitagiven

projecttohavebothanabandonmentoptionandanexpansion/growth

option.”

“Whenrationingcapital,itisbettertochoosetheportfolioofinvestments

thatmaximizesthecompanyNPVthantheportfoliothatmaximizesthe

companyIRR.”

Suggestion3

Suggestion4

“Projectbetasshouldbeusedforestablishingtherequired

rateofreturnwhenevertheproject’sbetaisdifferentfromthecompany’s

beta.”

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1.WhatistheoptimalservicelifeforLarocheLivery’sfleetofvans?

A.Twoyears.

B.Threeyears.

C.Fouryears.

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Answer

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2.TheoptimalsubsetofthesixprojectsthatSchoemanisconsideringconsistsof

Projects:

A.1and5.

B.2,3,and4.

C.2,4,5,and6.

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Answer

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3.WhatistheNPV(C$millions)oftheoriginalprojectforSocietyServices

withoutconsideringtheexpansionoption?

A.–6.11.

B.–5.66.

C.2.33.

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Answer

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4.WhatistheNPV(C$millions)oftheoptimalsetofinvestmentdecisionsfor

SocietyServicesincludingtheexpansionoption?

A.6.34.

B.12.68.

C.31.03.

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Answer

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5.Shouldthecapitalbudgetingcommitteeaccepttheinternalauditor’sfirstand

secondsuggestions,respectively?

A.NoforSuggestions1and2.

B.NoforSuggestion1andYesforSuggestion2.

C.YesforSuggestion1andNoforSuggestion2.

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Answer

Aiscorrect.Bothsuggestionsarebad.Invaluingprojects,expectedcash

flowsshouldbediscountedatrequiredratesofreturnthatreflecttheirrisk,

notatarisk-freeratethatignoresrisk.Eventhoughbothoptionscannotbe

simultaneouslyexercised,theycanbothaddvalue.Ifdemandishigh,you

canexercisethegrowthoption,andifdemandislow,youcanexercisethe

abandonmentoption.

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6.Shouldthecapitalbudgetingcommitteeaccepttheinternalauditor’sthirdand

fourthsuggestions,respectively?

A.NoforSuggestions3and4.

B.YesforSuggestions3and4.

C.NoforSuggestion3andYesforSuggestion4.

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Answer

Biscorrect.Bothsuggestionsaregood.ChoosingprojectswithhighIRRs

mightcausethecompanytoconcentrateonshort-termprojectsthatreduce

theNPVofthecompany.Whenevertheprojectriskdiffersfromthecompany

risk,aproject-specificrequiredrateofreturnshouldbeused.

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Case2

ThefollowinginformationrelatestoQuestions7—9

McConachieCompanyisconsideringthepurchaseofanew400-tonstamping

press.Thepresscosts$360,000,andanadditional$40,000isneededtoinstallit.

Thepresswillbedepreciatedstraight-linetozerooverafive-yearlife.Thepress

willgeneratenoadditionalrevenues,butitwillreducecashoperatingexpenses

by$140,000annually.Thepresswillbesoldfor$120,000afterfiveyears.An

inventoryinvestmentof$60,000isrequiredduringthelifeoftheinvestment.

McConachieisinthe40percenttaxbracket.

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7.WhatistheMcConachienetinvestmentoutlay?

A.$400,000.

B.$420,000.

C.$460,000.

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Answer

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8.McConachie’sincrementalannualafter-taxoperatingcashflowisclosestto:

A.$116,000.

B.$124,000.

C.$140,000.

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Answer

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9.Whatistheterminalyearafter-taxnon-operatingcashflowattheendofyear

five?

A.$108,000.

B.$132,000.

C.$180,000.

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Answer

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Case3

ThefollowinginformationrelatestoQuestions10—15

HennessyInc.,locatedinUnitedStates,isahigh-qualityproductsmanufactureranddistributor

withlonghistoryspecializinginaccessoriesandbags.TheindustrywhereWilliamsisoperating

entersintomaturitystagewithstableearnings.Williams’sboardofdirectorsiswonderinghow

toboostthestockprice.

MaxVerstappen,theCEOofHennessy,answerstotheboardthatbyacquiringanothercompany

using100%stockpaying,thecompanycanincreasetheearningpershareifthepricemultiple

doesnotdeclineafterthemerger.VerstappenaskesDanielRicardo,thechieffinanceofficerto

screenforpotentialtargetswhichareproperforthepurposeofincreasingEPS.

KateInc.andMichaelInc.aretwosmallercompetitorswithshorterhistorieswithinthesame

industry,whicharerecommendedbyRicardotoVerstappen.

Tofurtherexaminethepotentialeffectofacquisition,Ricardoputtheinformationrelatedto

KateandMichael,togetherwithHennessy’s,asisindicatedinExhibit1.

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Exhibit1:InformationRelatedtoHennessy,KateandMichael

Hennessy

3.20

Kate

Michael

3.10

Pre-mergerearningspershare(in$)

Sharesoutstanding(inmillions)

Pre-mergerpricepershare(in$)

8.50

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150

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66

61.50

66.20

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JohnstonHorneristhechairmanoftheboard.Hornersaysinadditiontotheprice

appreciationintheshortrunitisalsoimportanttogainrealbenefitfrombusiness

combinationinthelongrun.Hemakesthefollowingstatementsdescribingmergers

thatcanbenefitthecompany:

Statement1:Byacquiringacompetitor,wecangainmarketpowertorisetheselling

priceofourproducts.

Statement2:Reducingcostbycontrollingthekeydistributionchannelisalsoa

benefitofmerger.

Verstappensuggeststhat,NewWorld,afurproductsmakerwhoseproductsdirectly

competeswithHennessy’soneproductlineforyearsmightbeagoodchoiceforthe

merger.HethinksthatbyacquiringNewWorld,evenifthecompany’sprice

multipledecreases,Hennessy’sshareholderscanalsobenefitfromtheeconomicsof

scalegainedfrommoreeffectiveoperatingandhighersellingpriceinthelongrun.

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Forthefurproductsindustry,thecurrentHerfindahl-HirschmanIndex(HHI)is

1000.IfHennessytakeoverNewWorld,theHHIwillincreasesto1080.

Verstappenconcludesthat,theindustryismoderatelyconcentratedandthe

companyispossibletobechallengedbyanti-trustlawregardingthetakeoverof

NewWorld

VerstappenputstogethertheinformationofNewWorldandtheestimation

regardingthemergerinExhibit2andpresentsthemtotheboard.

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Exhibit2:InformationRelatedtoMergerofNewWorld

SharesofNewWorldoutstanding(inmillions)

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Pre-mergerpricepershareofNewWorld(in$)

Post-mergervalue(in$millions)

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12,350

ThepaymentforeachshareofNewWorldistobemadewith$30

cashand0.5shareofHennessy.

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Onameetingoftheboardofdirectors,AdrianNewey,oneoftheboardmembers,makesthe

conclusionthatthemergermightbenefitthemanagementwithoutcreatevalueforthe

shareholders.

Neweyisalsoconcernedwiththatthereishugeriskthatthesynergywillnotberealizedafter

themerger,whichwillbeassumedbythecompany’sshareholders.

WithregardtotheriskconcernedbyNeweyandthevaluecreatedfortheHennessy’s

shareholders,Hornermakesthefollowingtwosuggestions:

Suggestion1:Ifwearenotsoconfidentwiththemerger,wecanincreasethecashpayingto$40

andreducethestockpayingcorrespondingly.

Suggestion2:Weshouldkeepthemergerplansecretetoavoidattractingattentionoftheother

companies,soastoreducethenumberofbidders.

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10.AccordingtotheinformationinExhibit1,toachievethegoalofincreasing

EPS,Hennessywillmostlikelytoacquire:

AKateonly.

BMichaelonly.

CeitherKateorMichael

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Answer

Aiscorrect.

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11.WhichofthefollowingisthetypeofmergerthatisdescribedbytheHorner

in:

Statement1

Statement2

AVerticalmerger

BVerticalmerger

Horizontalmerger

Verticalmerger

CHorizontalmergerVerticalmerger

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Answer

Ciscorrect.

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12.Verstappenismostlikelycorrectin:

Adescribingtheconcentrationoftheindustryonly.

Bforecastingthepossibilityofanti-trustactiononly.

CbothAandB.

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Answer

Aiscorrect.

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13.BymergingNewWorld,Hennessy’sshareholdersarelikelytogain:

A$1,360.72million.

B$364.28million.

C$1,725million.

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Answer

Aiscorrect.

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14.Newey’sconclusionisleastlikelytobesupportedbythefactthat:

Athemanagement’scompensationishighlycorrelatedtothecompanysize.

Bthemanagementownstockoptionsofthecompany.

Cthepricemultiplewilldecreaseafterthemerger.

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Answer

Ciscorrect

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15.WhichofthesuggestionmadebyHorneris/aremostreasonable?

ASuggestion1only.

BSuggestion2only.

CBothsuggestion1andsuggestion2.

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Answer

Biscorrect

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Case4

ThefollowinginformationrelatestoQuestions16—21

ModernElectronicInc.isaleadingmanufacturerofhouseholdappliancewith

itsownstores.RainZhang,theCEOofModernElectronic,recognizestheusage

ofsmart-hometechnologywillseeexplosivegrowthindemandinthefollowing

oneortwodecades.Thecompanywantstoenterthisindustryby100%

acquiringacompanythathasalreadydevelopedrelevanttechnologies.

ZhanghiresSmartAdvisor,aconsultingfirmspecializinginconsumptiongoods

sector,toestimatethefairvalueofpotentialmergertargets.RedStarElectronic

isamongthecompaniesbeinganalyzed.RedStar’smanagementisalreadyin

contactwithModernElectronic.RedStarspendsalotinresearchbuthasnot

beenabletoexploititsresearchresultsyet.RedStarhasrecentlyprovidedits

financialstatementstoModernElectronic,whichisindicatedbelowinExhibit1.

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Exhibit1:SelectedInformationfromtheProFormaFinancialStatementsofRedStar

Electronic(in$thousands)

IncomeStatement

2018

2019

2020

2021

Revenue

101,346

107,025

129,432

164,254

COGS

68,347

26,122

1,533

5,343

1,641

1,481

2,221

70,190

26,827

1,658

8,350

1,689

2,664

3,997

82,166

31,404

1,786

14,077

1,715

4,945

7,417

109,889

38,276

1,901

Selling,generalandadministrativeexpenses

Depreciation

Operatingincome

Netinterestexpense

Incometax(40%）

Netincome

14,188

1,855

4,933

7,400

BalanceSheet

Cashandcashequivalent

Othercurrentassets

Netfixedassets

Totalasset

Accountspayable

Short-termdebt

Currentliabilities

Long-termdebt

Totalliabilities

43,521

23,866

26,657

94,044

15,183

12,997

28,180

14,360

42,540

47,560

25,305

27,556

100,421

18,033

13,441

31,474

15,256

46,730

46,582

26,549

28,078

101,209

20,601

13,165

33,766

15,530

49,296

48,177

29,951

26,531

104,659

23,654

14,878

38,532

16,036

54,568

Owners’equity

51,504

53,691

51,913

50,091

Freecashflowsin2018is$3,577thousand.

Datafor2019,2020and2021areestimated.

Discountrateis10.4%.

Growthrateofcashflowfortheyearsafter2021is4.5%.

Therewasnofixedassetsold.

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TheCFOofModernElectronic,TomLiu,saysitismoreappropriatetouse

comparabletransactionmethodtoevaluatethetargetcompany.Hegivestwo

reasons:

Reason1:Thereisnoneedtoestimatetakeoverpremiumseparatelybecauseitis

impliedinthecomparabletransactionprice.

Reason2:Discountedcashflowmethodrequiresmanyassumptionandestimates,

whichisnotthecaseforcomparablecompanymethod.

Liucollectsinformationoffivemostrecenttakeovertransactionswhichare

comparablewithModernElectronic’smergerofRedStar.Theinformation

relatedtothesetransactionsisgivenbelowinExhibit2.ModernElectronichas2

millionsharesoutstanding.

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Exhibit2:InformationRelatedtoComparableTransactions

P/B

P/E

P/FCF

1.55

23.00

15.1

TargetA

TargetB

TargetC

TargetD

TargetE

1.78

1.65

1.66

1.62

25.00

22.60

20.05

25.25

17.5

15.5

17.6

15.2

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Anothertwocompanies,WulianTechnologyandBrookstone,arealsoanalyzed

bySmartAdvisor.Thefollowingobservationsarerelatedtothesetwocompanies.

Observation1:AccordingtoWulianTechnology’sbylaws,thechangeofcontrol

requiresvoteof80percentorsharesoutstanding.

Observation2:ModernElectronictriedtoacquireBrookstonethreeyearsago

throughatenderoffer.Athirdpartypurchasedsubstantialminoritystakesof

BrookstonewhichdeterredthetakeoverbyModernElectronic.

Zhangal