Sample Final Exam
Corporate Financial Restructuring

Prof. Ian Giddy, New York University

A 2-hour, open-book, open-notes exam. Calculators allowed (no laptops). 100 points.

Question 1 (15 points)

What is a "flip-over pill," and how does it typically work in hostile takeover situations? Give an example.

Question 2 (15 points)

In the context of financial restructuring, what are "exchange offers?" Give typical examples. According to research studies, some types of exchange offers result in negative returns, while others produce positive net returns. What factors influence which effect prevails?

Question 3 (10 points)

Under what circumstances would a company consider doing a leveraged ESOP? Be brief and specific.

Question 4 (10 points)

Read the mini-case study below. Why do you think a billionaire investor owns 85% of XO's debt?

XO Communications Ends Forstmann Deal

Oct 15, 2002

RESTON, Va. (Reuters) - XO Communications Inc.on Monday said it has agreed to release buyout firm Forstmann Little & Co. and its partner from a deal to infuse $800 million into the troubled telecommunications provider.

Under the settlement, which is subject to bankruptcy court approval, Forstmann Little and Mexican telecommunications firm Telefonos de Mexico will each pay XO $12.5 million. The deal has the support of billionaire investor Carl Icahn, who currently controls about 85 percent of XO's senior secured debt.

XO intends to seek bankruptcy court approval for the deal in mid-November and will move forward with its stand-alone plan of reorganization filed with the court earlier this year. 

Reston, Virginia-based XO, which provides telephone and data services to businesses in 65 U.S. markets, filed for bankruptcy in June under the weight of $8.5 billion in debt as the discussions with Forstmann began to unravel. XO was one of several telecommunications upstarts to file bankruptcy after borrowing billions of dollars in recent years to build new communication networks that failed to attract enough traffic and customers. Other bankruptcies include Global Crossing Ltd., WorldCom Inc., and Williams Communications. Under XO's stand-alone reorganization plan, the company has said $1 billion worth of bank debt would be converted into stock, and it would issue $250 million worth of new equity in a rights offering to bondholders. It also would issue $500 million in new junior secured debt.

XO, which said it had more than $500 million in cash and cash equivalents as of Sept. 30, said it provides service to more than 100,000 business customers. It said it continues to add new customers, as well as cut costs and improve its operations.

Question 5 (50 points)

4ests 4ever Inc

Giddy Partners is considering the leveraged buyout of a small private forestry company.                       
The cost of the buyout including expenses is estimated at $6,500,000    
The company's revenue in the current year is $3,600,000    
Current operating expenses before depreciation are $2,200,000    
Revenue and operating expenses are projected to grow at 9.0%
per year for the next 5 years and after that, at a steady rate of 3.0%
In the current year, capital expenditures are $125,000        
and depreciation is $100,000                
Both are expected to grow at the same rate as revenue for five years, and to                       
be equal to one another after that.                       
Working capital change as a percentage of revenue is 4%   

Discussions with lenders suggest that the LBO can be financed with this capital structure:                       
    Debt     $4,500,000                
    Equity    $2,000,000                
The debt would be provided in the form of a fixed-rate amortizing term loan from banks,                       
while the equity would come 10% from management and 90% from the LBO firm.                       
The interest rate on the debt would reflect a rating of    B   
(See rating table below)                       
The intent of Giddy Partners is to pay down the debt at the annual rate of  $300,000 during the next 5 years, after which the remaining debt will be refinanced.                       

The post-LBO beta of the firm is estimated to be 3       
The risk-free rate of interest is 4.5%       
The market risk premium is assumed to be 5.50%       
The firm's overall marginal tax rate is 35%       

In estimating its weighted-average cost of capital, the firm uses                       
its target debt-to-equity ratio of $1 of debt for each dollar of equity       

The firm makes the projections shown in the table below. Based on these,                       
1. Calculate the free cash flow to equity holders and to the firm
2. Calculate the unleveraged beta                      
3. Calculate the cost of capital                       
4. Calculate the terminal value of equity                       
5. Will the buyout generate sufficient cash flow to cover contractual payments?                       
6. At what price can Giddy Partners expect to sell their stake if the firm                       
is sold in 5 years?
7. Does "mezzanine financing" make sense for this LBO?

Table 1 Rating Table

If interest coverage ratio is

greater than
Rating is
Spread is

-100000 0.500 D 14.0%

0.5 0.800 C 12.7%

0.8 1.250 CC 11.5%

1.25 1.500 CCC 10.0%

1.5 2.000 B- 8.0%

2 2.500 B 6.5%

2.5 3.000 B+ 4.8%

3 3.500 BB 3.5%

3.5 4.500 BBB 2.3%

4.5 6.000 A- 2.0%

6 7.500 A 1.8%

7.5 9.500 A+ 1.5%

9.5 12.5 AA 1.0%

12.5 100000 AAA 0.8%

Table 2 Financial Projections

    Year 1 Year 2 Year 3 Year 4 Year 5 Terminal Year r
  3,600,000   3,924,000   4,277,160   4,662,104   5,081,694   5,234,145
Operating expenses  (2,200,000)  (2,398,000)  (2,613,820)  (2,849,064)  (3,105,480) (3,198,644)
Depreciation   (100,000)   (109,000)   (118,810)     (129,503)     (141,158)   (145,393)
  1,300,000   1,417,000   1,544,530     1,683,538    1,835,056   1,890,108
  (495,000)   (462,000)   (429,000)     (396,000)     (363,000)   (330,000)
Tax     (281,750)   (334,250)   (390,436)     (450,638)     (515,220)   (546,038)
Net Income
       523,250        620,750        725,095          836,900          956,836     1,014,070

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