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
By REUTERS
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 |
Revenues |
|
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) |
EBIT |
|
1,300,000 |
1,417,000 |
1,544,530 |
1,683,538 |
1,835,056 |
1,890,108 |
Interest |
|
(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 |
|
|
|
|
|
|
|
|
|