Practice Quiz 1: Corporate Finance

Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam.

1. In any firm, the balance of power between stockholders and managers is a function of a number of factors — internal as well as external. Events can cause the power to shift towards managers or towards stockholders or leave the balance unchanged. Evaluate how each of the following events would alter the balance of power. (1/2 point each)

a. The firm decides to expand its board of directors from 11 members to 22 members and allows the CEO to pick the additional directors.

  • Stockholder Power increases
  • No Effect

    • b. An activist investor manages to get three of his nominees elected to the board of directors at the expense of management nominees.

  • Stockholder Power increases
  • No Effect

    • c. The state passes a law restricting hostile takeovers.

  • Stockholder Power increases
  • No Effect

    • 2. You are told that Land’s End, a catalog retailer, earned an excess return (Jensen’s alpha), in annualized terms, of 32% over the last 5 years and that it had a beta of 1.50 during the same period. Assuming that this estimate came from a quarterly regression of stock returns against a market return, and that the average annualized riskfree rate during the period was 4.8%, estimate the intercept on the regression. ( 3 points)

    3. You subscribe to a beta estimation service. The service provides you with an adjusted beta estimate of 1.70 for Service.com, the firm that you are interested in. Assuming that the service uses weights of 0.70 (for the raw beta estimate) and 0.30 (for the market average of 1.00), and that the standard error in the beta estimate is 0.35, provide a range for the raw beta estimate, with a 67% confidence interval. ( 2 points)

    4. Acopalypse Now Inc. is a company that manufactures products for the New Age market (Crystal balls, Nostradum predictors, Tarot cards etc.). The firm has 10 million shares outstanding trading at $ 10 per share, no debt outstanding and a cash balance of $ 25 million. The stock’s current beta is 1.20. The firm decides that it should prepare for the millennium by borrowing $ 40 million, and buying back $ 40 million of its own stock. Estimate the beta after the transaction. (The corporate tax rate is 40%) (3 points)