CFA L2 Apostila 01 Exame 2018 - COMPLETA IMPRESSÃO

Fixed Income Investments Corporate Finance Study Session 8 Financing and Control Issues24. Corporate Performance, Governance, and Business Ethics25. Corporate Governance26. Mergers and AcquisitionsLOS 26.b Explain Mergers and AcquisitionsSchweser B2 pg 291, CFAI V3 pg 279 Merger Motivations 2  Synergies  Achieve rapid growth  Access to unique capabilities  Increased market power  Diversification  Personal benefits for managers  Bootstrapping EPS© Kaplan, Inc. ©2018 FK Partne

SS 08 - Financing and Control Issues Fixed Income Investments Corporate Finance Study Session 9 Financing and Control Issues 26. Mergers and AcquisitionsLOS 26.b Explain Mergers and AcquisitionsSchweser B2 pg 291, CFAI V3 pg 279 Merger Motivations (continued) Tax benefits Unlocking hidden value Achieving international business goals © Kaplan, Inc. 3ers - Exame CFA 1

LOS 26.c Explain/Calculate Mergers and AcquisitionsSchweser B2 pg 293, CFAI V3 pg 280 Bootstrapping Bootstrapping EPS: Increased EPS that occurs when a high P/E firm acquires a lower P/E firm  Increase in earnings per share  Real economic gains are not necessarily achieved  Point: EPS increases, but the share price may not!© Kaplan, Inc. 4LOS 26.c Explain/Calculate Mergers and AcquisitionsSchweser B2 pg 293, CFAI V3 pg 280 BootstrappingPrice Weavers, Knitters, Weavers PostEPS Inc. Inc. MergerP/E $60.00# Shares $60.00 $30.00 $4.40 $4.00 $3.00Earnings 15 10 13.64Market 125,000Cap 100,000 50,000 $550,000 $400,000 $150,000 $7,500,000 $6,000,000 $1,500,00025,000© Kaplan, Inc. shares issued (i.e., 25,000 × $60 = $1.5MM) 6 ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.c Explain/Calculate Mergers and AcquisitionsSchweser B2 pg 293, CFAI V3 pg 280 Bootstrapping Example: Weavers, Inc. is planning to acquire Knitters, Inc.  Financial data shown on next slide Calculate: 1. Weaver’s post-merger EPS 2. Determine whether the merger created economic gains© Kaplan, Inc. 5LOS 26.c Explain/Calculate Mergers and AcquisitionsSchweser B2 pg 293, CFAI V3 pg 280 Bootstrapping Post-merger EPS = $550,000 / 125,000 = $4.40 No economic value created by the merger Market cap = 125,000 × $60 = $7,500,000 Growth in EPS ($4.00 to $4.40) was result of accounting, not economic, gains New P/E = 13.64; market NOT fooled!© Kaplan, Inc. 7ers - Exame CFA 2

LOS 26.g Calculate/Interpret/Evaluate Mergers and AcquisitionsSchweser B2 pg 302, CFAI V3 pg 296 Herfindahl-Hirschman Index Herfindahl-Hirschman Index: Key measure of market power for determining anti-trust violations HHI = n )2 (MSi i=1MSi = market share of firm i (%)n = number of firms in the industry© Kaplan, Inc. 8LOS 26.g Calculate/Interpret/Evaluate Mergers and AcquisitionsSchweser B2 pg 302, CFAI V3 pg 296Herfindahl-Hirschman Index: Example 10 firms in an industry Firms 1 and 2 each have a 20% share The other 8 firms each have a 7.5% share Firms 9 and 10 decide to mergeCalculate the pre-merger and post-mergerHHI and evaluate the likelihood of anantitrust challenge.© Kaplan, Inc. 10 ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.g Calculate/Interpret/Evaluate Mergers and AcquisitionsSchweser B2 pg 302, CFAI V3 pg 296 Herfindahl-Hirschman IndexPost Merger Industry Change Antitrust HHI Concentration in HHI Action < 1000 Not Any No action concentrated amount Between Possible1000 & 1800 Moderate 100 or more Virtually > 1800 High certain 50 or more© Kaplan, Inc. 9LOS 26.g Calculate/Interpret/Evaluate Mergers and AcquisitionsSchweser B2 pg 302, CFAI V3 pg 296Herfindahl-Hirschman Index: ExamplePre-merger HHI = [(0.075 × 100)2 × 8] +[(0.20 × 100)2 × 2] = 1,250Post-merger HHI = [(0.075 × 100)2 × 6] +[(0.20 × 100)2 × 2] + (0.15 × 100)2 = 1,362.5 Industry Concentration: moderate Pre to Post = 1,362.5 – 1,250 = 112.5 > 100  Point: Possible antitrust action 11© Kaplan, Inc.ers - Exame CFA 3

LOS 26.i Calculate/Estimate Mergers and AcquisitionsSchweser B2 pg 304, CFAI V3 pg 299 Valuing a Target Company 12 Your job: Compare and contrast three methods 1. Discounted cash flow method  Determine FCF and discount (like FCFF) 2. Comparable company analysis  Use relative value metrics + premium  Start with minority interest values 3. Comparable transaction analysis  Same, only start with majority prices© Kaplan, Inc.LOS 26.i Calculate/Estimate Mergers and AcquisitionsSchweser B2 pg 304, CFAI V3 pg 299DCF Method Step 3: Calculate FCF X Net income + Net interest after tax = Unlevered net income + Increase in deferred tax Lia = NOPLAT + Net noncash charges +/– Changes in net working capital – Capital expenditure = Free cash flow (FCFF)© Kaplan, Inc. 14 ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.i Calculate/Estimate Mergers and AcquisitionsSchweser B2 pg 304, CFAI V3 pg 299Approach #1:Discounted Cash FlowStep 1: Determine which FCF model to use  Two-stage or three-stage?Step 2: Develop pro forma financialsStep 3: Calculate free cash flowsStep 4: Discount FCFs back to the presentStep 5: Determine terminal value and discount it back to the presentStep 6: Add discounted values for each stage© Kaplan, Inc. 13LOS 26.i Calculate/Estimate Mergers and AcquisitionsSchweser B2 pg 304, CFAI V3 pg 299DCF Method Step 3: Calculate FCF Alternatively using formula from SS12: FCFF = NI + NCC + [Int (1 – T)] – FCInv – WCInv Result is the same © Kaplan, Inc. 15ers - Exame CFA 4















SS 08 - Financing and Control IssuesLOS 26.j Estimate Mergers and AcquisitionsSchweser B2 pg 309, CFAI V3 pg 305 Step 3: Estimated Stock Value for Roslovic Restaurants SolutionTarget RR Mean Estimated Stock RVM Value (a × b)Statistic Stats. (a) RVM (b) $22.55 $32.54EPS 2.05 P/E 11.00 $24.49 $29.76BV/S 16.35 P/B 1.99 $27.33CF/S 2.95 P/CF 8.30Sales/S 32.00 P/Sales 0.93 Mean estimated stock value =© Kaplan, Inc. 29LOS 26.j Estimate Mergers and AcquisitionsSchweser B2 pg 309, CFAI V3 pg 305 Calculation of Takeover Premium Solutions Company Pre- Deal Price Takeover Target 1 Takeover (b) Premium Target 2 [(b) – (a)] / (a) Target 3 Price $31.25 Target 4 (a) 13.7% 23.0%© Kaplan, Inc. $27.50 10.0% 14.6% $13.70 $16.85 15.3% $87.65 $96.40 $52.25 $59.90 Mean premium: 31ers - Exame CFA 8

LOS 26.j Estimate Mergers and AcquisitionsSchweser B2 pg 309, CFAI V3 pg 305Comparable Company Analysis Example Step 5: Estimate takeover price = stock value based on comparables + takeover premium Estimated stock value based on comparable firms = $27.33 Estimated takeover premium = 15.3% Estimated takeover price for Roslovic = $27.33 × 1.153 = $31.51© Kaplan, Inc. 32LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid Gains accrued to the targetGainT = TP = PT – VTwhere:GainT = gains accrued to targetTP = takeover premiumPT = price paid for targetVT = pre-merger value of target© Kaplan, Inc. 34 ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid Post-merger value of an acquirer: VAT = VA + VT + S – C where: VAT = post-merger value of combined firm VA = pre-merger value of acquirer VT = pre-merger value of target S = synergies created by the merger C = cash paid to target shareholders© Kaplan, Inc. 33LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid Gains accrued to the acquirer GainA = S – TP = S – (PT – VT) where: GainA = gains to acquirer’s shareholders Note that gains accrued to the target shareholders + gains accrued to the acquirer = synergies© Kaplan, Inc. 35ers - Exame CFA 9

LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid Adjustment for stock paymentPT = (N × PAT) Important point!where:N = number of new shares target receivesPAT = price per share after merger announced© Kaplan, Inc. 36LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Merger Evaluation InputsPre-merger stock price Home Tool Town# shares (mil) HardwarePre-merger value (mil) $15 $25 26 35 $390 $85 million $875Estimated NPV of synergies© Kaplan, Inc. The hard part: Given on Exam! 38 ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid: ExampleHome Hardware acquiring Tool Town:  Scenario 1—Cash: $18 per share of Tool Town ($18 × 26 million shares = $468 mm)  Scenario 2—Stock: 0.6 shares of Home Hardware for each share of Tool Town Calculate: 1. Post-merger value of the combined firm 2. Gains accrued to the target 3. Gains accrued to the acquirer© Kaplan, Inc. 37LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger Bid: SolutionScenario 1: Cash offer  Post-merger value of combined firm = VAT = VA + VT + S – C VAT = $875 + $390 + $85 – $468 = $882© Kaplan, Inc. 39ers - Exame CFA 10

LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310Evaluating a Merger Bid: SolutionScenario 1: Cash offer Gain to target = GainT = TP = PT – VTGainT = $468 – $390 = $78 Acquirer and target Gain to acquirer = GainA = S – TP split the = S – (PT – VT) synergies of $85GainA = $85 – ($468 – $390) = $7© Kaplan, Inc. 40LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger BidScenario 2: Stock offer  Gain to target = GainT = TP = PT – VT VAT New shares outstandingPAT = $1,350 / (35 + 15.6) = $26.68PT = (N × PAT) = 15.6 × $26.68 = $416.21© Kaplan, Inc. Price paid for target 42 in stock deal ©2018 FK Partne

SS 08 - Financing and Control IssuesLOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger BidScenario 2: Stock offer  # new shares = 26 × 0.6 = 15.6 million  Post-merger value of combined firm = 41 VAT = VA + VT + S – C VAT = $875 + $390 + $85 – $0 = $1,350 Note: Stock deal so C = $0© Kaplan, Inc.LOS 26.k Estimate Mergers and AcquisitionsSchweser B2 pg 317, CFAI V3 pg 310 Evaluating a Merger BidScenario 2: Stock offer  GainT = $416.21 – $390 = $26.21  Gain to acquirer = Acquirer and target split the synergies of $85 GainA = S – TP = S – (PT – VT) GainA = $85 – ($416.21 – $390) = $58.79© Kaplan, Inc. 43ers - Exame CFA 11

LOS 26.m Describe Mergers and AcquisitionsSchweser B2 pg 322, CFAI V3 pg 314 Distribution of Merger Benefits Short-term effect on stock price  Target average gain approximately 30%  Acquirer loses between 1% and 3%  “Winner’s curse”  Managerial hubris Long-term effect on stock price  Acquirers tend to underperform  Failure to capture promised synergies© Kaplan, Inc. 44 Fixed Income Investments Corporate Finance Study Session 8 Discussion Questions CFA Institute Program curriculum, Level II, Volume 3, page 320 Questions 7–12 ©2018 FK Partne

SS 08 - Financing and Control Issues Mergers and Acquisitions Other LOS For SS8These LOS are not covered in live class: Reading 24: All LOS Reading 25: All LOS  LOS 26.f Distinguish LOS 26.a Explain  LOS 26.h Compare LOS 26.d Explain  LOS 26.n Distinguish LOS 26.e Contrast  LOS 26.o Explain© Kaplan, Inc. 45 Discussion QuestionsThe following information relates to Questions 7–12 Kinetic Corporation is considering acquiring High Tech Systems. Jim Smith, the vice president of finance at Kinetic, has been assigned the task of estimating a fair acquisition price for High Tech. Smith is aware of several approaches that could be used for this purpose. He plans to estimate the acquisition price based on each of these approaches, and has collected or estimated the necessary financial data. © Kaplan, Inc. 47ers - Exame CFA 12

Discussion Questions High Tech has 10 million shares of common stock outstanding and no debt. Smith has estimated that the post-merger free cash flows from High Tech, in millions of dollars, would be 15, 17, 20, and 23 at the end of the following four years. After Year 4, he projects the free cash flow to grow at a constant rate of 6.5 percent a year. He determines that the appropriate rate for discounting these estimated cash flows is 11 percent. He also estimates that after four years High Tech would be worth 23 times its free cash flow at the end of the fourth year.© Kaplan, Inc. 48 Discussion QuestionsValuation Variables Alpha Neutron Techno High TechCurrent stock price ($) 44.00 23.00 51.00 31.00Earnings/share ($) 1.68 2.52 1.98Sales/share ($) 3.01 14.22 18.15 17.23Book value/share ($) 20.16 7.18 11.15 10.02 15.16The relevant data for the three recently acquired companies aregiven below: Valuation Variables Quadrant ProTech Automator 24.90 43.20 Stock price pre-takeover ($) 28.00 52.00 29.00 1.40 2.10 Acquisition stock price ($) 10.58 20.41 34.50 Earnings/share ($) 8.29 10.14 2.35 Sales/share ($) 15.93 Book value/share ($) 9.17© Kaplan, Inc. 50 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Smith has determined that three companies—Alpha, Neutron, and Techno—are comparable to High Tech. He has also identified three recent takeover transactions— Quadrant, ProTech, and Automator—that are similar to the takeover of High Tech under consideration. He believes that price-to-earnings, price-to-sales, and price-to-book value per share of these companies could be used to estimate the value of High Tech. The relevant data for the three comparable companies and for High Tech are as follows:© Kaplan, Inc. 49 Discussion Questions While discussing his analysis with a colleague, Smith makes two comments. Smith’s first comment is: “If there were a pre-announcement run-up in Quadrant’s price because of speculation, the takeover premium should be computed based on the price prior to the run-up.” His second comment is: “Because the comparable transaction approach is based on the acquisition price, the takeover premium is implicitly recognized in this approach.”© Kaplan, Inc. 51ers - Exame CFA 13

Discussion Questions Question 77. What is the present value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the constant growth model to determine terminal value? A. $39.38. B. $40.56. C. $41.57.© Kaplan, Inc. 52 Discussion Questions Solution 77. What is the present value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the constant growth model to determine terminal value? A. $39.38. B. $40.56. C. $41.57.© Kaplan, Inc. 54 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Solution 7 DCF valuation with constant growth 15 + 17 + 20 + 23 = 57.09 1.11 1.112 1.113 1.114 Terminal value 23(1.065) = 544.33 (0.11 – 0.065) PV Terminal value 544.33 = 358.57 1.114 Value = 57.09 + 358.57 = 415.66/10 = $41.57 per share© Kaplan, Inc. 53 Discussion Questions Question 88. What is the present value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the cash flow multiple method to determine terminal value? A. $35.22. B. $40.56. C. $41.57.© Kaplan, Inc. 55ers - Exame CFA 14

Discussion Questions Solution 8DCF valuation with terminal cash flow multiple 15 + 17 + 20 + 23 = 57.091.11 1.112 1.113 1.114Terminal value 23×23 = 529PV Terminal value 529 = 348.47 1.114Value = 57.09 + 348.47 = 405.56/10 = $40.56 per share© Kaplan, Inc. 56 Discussion Questions Question 99. The average stock price of High Tech for the three relative valuation ratios (if it is traded at the mean of the three valuations) is closest to: A. $35.21. B. $39.38. C. $40.56.© Kaplan, Inc. 58 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Solution 88. What is the present value per share of High Tech stock using the discounted cash flow approach if the terminal value of High Tech is based on using the cash flow multiple method to determine terminal value? A. $35.22. B. $40.56. C. $41.57.© Kaplan, Inc. 57 Discussion Questions Solution 9Average Relative ValuationRatio Alpha Neutron Techno Mean High Valuation TechP/E 14.62 13.69 20.24 16.18 $1.98 $32.04P/S 2.18 1.62 2.81 2.20 $17.23 $37.91Mean Valuation = (32.04 + 37.91 + 35.67)/3 = $35.21P/BV 2.90 3.20 4.57 3.56 $10.02 $35.67© Kaplan, Inc. 59ers - Exame CFA 15

Discussion Questions Solution 99. The average stock price of High Tech for the three relative valuation ratios (if it is traded at the mean of the three valuations) is closest to: A. $35.21. B. $39.38. C. $40.56.© Kaplan, Inc. 60 Discussion Questions Solution 10Comparable Company ApproachTakeover Premiums (28.00 – 24.90)/24.90 = 12.45% (52.00 – 43.20)/43.20 = 20.37% (34.50 – 29.00)/29.00 = 18.97%Mean = (12.45 + 20.37 + 18.97)/3 = 17.26%Value = $35.21×1.1726 = $41.29© Kaplan, Inc. 62 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Question 1010.Taking into account the mean takeover premium on recent comparable takeovers, what would be the estimate of the fair acquisition price of High Tech based on the comparable company approach? A. $35.22. B. $40.83. C. $41.29.© Kaplan, Inc. 61 Discussion Questions Solution 1010.Taking into account the mean takeover premium on recent comparable takeovers, what would be the estimate of the fair acquisition price of High Tech based on the comparable company approach? A. $35.22. B. $40.83. C. $41.29.© Kaplan, Inc. 63ers - Exame CFA 16

Discussion Questions Question 1111.The fair acquisition price of High Tech using the comparable transaction approach is closest to: A. $35.22. B. $40.86. C. $41.31.© Kaplan, Inc. 64 Discussion Questions Solution 1111.The fair acquisition price of High Tech using the comparable transaction approach is closest to: A. $35.22. B. $40.86. C. $41.31.© Kaplan, Inc. 66 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Solution 11Comparable Transaction ApproachRatio Quadrant ProTech Automator Mean High Valuation TechP/E 20.00 24.76 14.68 19.81 $1.98 $39.22P/S 2.65 2.55 2.17 2.46 $17.23 $42.39PM/BeVan =3.3(839.22 5+.143 2.39 3+.7640.98)/34.=09 $40$.1806.02 $40.98© Kaplan, Inc. 65 Discussion Questions Question 1212.Are Smith’s two comments about his analysis correct?A. Both of his comments are correct.B. Both of his comments are incorrect.C. His first comment is correct, and his second comment is incorrect.© Kaplan, Inc. 67ers - Exame CFA 17

Discussion Questions Solution 12Comment OneIf there was a pre-announcement run-up in Quadrant’sprice because of speculation, the takeover premiumshould be computed based on the price prior to the run-upComment Two Because the comparable transaction approach is basedon the acquisition price, the takeover premium is implicitlyrecognized in this approach.© Kaplan, Inc. 68 ©2018 FK Partne

SS 08 - Financing and Control Issues Discussion Questions Solution 1212.Are Smith’s two comments about his analysis correct?A. Both of his comments are correct.B. Both of his comments are incorrect.C. His first comment is correct, and his second comment is incorrect.© Kaplan, Inc. 69ers - Exame CFA 18

Questions – SS08 - Corporate Finance Financing and Control IssuesQuestion 1 - 6Gazelle Bancorp was formed 11 years ago to address what its founders deemed unmet consumerneeds. Apparently, they were correct in their assessment, and Gazelle has grown rapidly as a nicheplayer. This has attracted the attention of the other banks in its market, and rumors are swirlingthat two of its competitors are contemplating takeover bids for Gazelle. The firm's management hasapproached Omega Financial for advice on strategies it can employ should the firm become atakeover target.Ionnias Padras, CFA, has been assigned as the lead advisor to Gazelle's management. In advanceof their initial meeting, he has prepared a list of questions and discussion points. With thisinformation he hopes to built a coherent strategy either to fend off the potential suitors or to realizemaximum value for Gazelle's shareholders, should atakeover be consummated.During the course of his meeting with management, Padras asks the bank managers a series ofquestions, and the answers he received are provided below each question.Q1: What is your growth rate, and how does it compare to your potential acquirers?A1: Our profits have been growing at a rate of approximately 10% per year, while our potentialacquirers' profits have been growing in line with the overall economy, which is about 3 to 4% peryear.Q2: Do you have any takeover defenses in place, and, if so, what are they?A2: We have established a set of compensation arrangements to enhance management's security. Ifa merger were to occur, our top 7 management personnel would each be paid 4 years salary.This is contingent upon the managers agreeing to remain in their jobs until the merger is completed.Q3: How many banks are operating in the market, and what are their market shares?A3: There are 11 other comparable financial institutions in our market. 8 of these institutions havea market share of 6% each, 3 of them have a market share of 15% each, and we have a share of7%. Potential acquirer 1 has a share of 15%, while potential acquirer 2 has a share of 6%.Q4: Do you consider any of your current competitors similar to Gazelle? Were there other bankspreviously present in the market that have been taken over recently?A4: None of the current competitors have business models or growth rates that are comparable toGazelle. There are three previously independent institutions that have business models and growthrates similar to ours, and are our direct competitors. These banks were taken over by other bankswithin the past 3 years.Q5: What is Gazelle's current market price and how many shares are outstanding? If your firm wereto merge with either of its potential suitors, what is your estimate of the synergies available? Isthere any chance that your board would agree to a takeover if the price were right?A5: Our current share price is $43, and there are 50 million shares outstanding. We estimate thatthe present value of potential cost reductions and revenue enhancements for an acquirer would beapproximately $500m. The board can probably be convinced to accept an offer it believes to beadequate.Q6: Describe the structure of your banking operations. Is there any other course of action that youwould consider that might make the bank less attractive as a takeover target?A6: Gazelle is a combination of a traditional, full service bank, and a 24/7 provider of personalfinancial services. For example, we have been able to obtain exclusive agreements with the 2 largestgrocery chains in our market to open branch offices in their stores. We have similar agreementswith other 24/7 retail establishments, and consumers have found the ability to bank at any time ofthe day extremely attractive. We believe that this is the part of Gazelle that our prospective suitorsare seeking.Question 1Based upon the information provided to Padras does it appear that the potential suitors are seeking tobootstrap their earnings? What stage of the industry lifecycle is Gazelle most likely in?Bootstrap Earnings Industry Life CycleA) No Mature growthB) Yes Rapid growthC) No Rapid growthQuestion 2 1 ______________________ ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

What type of take-over defense does Gazelle have in place, and is this likely to be sufficient to fendoff a potential suitor?Take-Over Defense Defense Sufficient?A) Golden parachute YesB) Greenmail NoC) Golden parachute NoQuestion 3If both of the prospective acquirers were to make bids, what are the probable antitrust ramificationsfor potential acquirer 1 and potential acquirer 2, respectively?D) Good chance of antitrust action because change in HHI is greater than 100; small chance of antitrust action because change in HHI is less than 100.E) No chance of antitrust action because change in HHI is less than 100; no chance of antitrust action because change in HHI is less than 50.F) Antitrust action virtually certain because change in HHI is greater than 100; small chance of antitrust action because change in HHI is less than 50.Question 4Based upon the information provided, what type of valuation methodology is most likely to be usedby the potential acquirers?A) Comparable transaction.B) Discounted cash flow.C) Comparable firm.Question 5What is the probable price range for an offer for Gazelle? If one of the acquirers makes an offer of$55, should the board accept it? Price Range AcceptA) $43 to $63 YesB) $43 to $53 NoC) $43 to $53 YesQuestion 6If Gazelle were to separate itself into two parts, the traditional bank and the 24/7 bank, and to selloff the 24/7 bank in a public offering, what would the action be called from the standpoint of thesale and from the standpoint of a takeover defense? Sale Takeover DefenseA) Equity carve-out Leveraged recapitalization defenseB) Split-off Crown jewel defenseC) Equity carve-out Crown jewel defenseQuestion 7 - 12Samantha Zillner, CFA is evaluating corporate governance issues at Peabody Systems Inc. Recently,Peabody has been under market scrutiny as the firm has announced restatements of financialstatements for the past three years. Additionally, the Chairman and CEO has resigned amidallegations of improper self-dealings and the company is under review by the SEC.Zillner notes that:I. Corporate governance systems will vary according to the legal environment, culture and industry in which the firm operates; however, there are core attributes that all effective corporate governance systems share. ______________________ 2 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

II. The Board of Directors of a corporation is an important determinant of the effectiveness of corporate governance systems acting as a check and balance between management and shareholders. It is a necessary task for the analyst to assess the effectiveness of the Board.III. One of the key objectives of good corporate governance is to try and avoid the potential conflicts of interest that can occur amongst the various stakeholders of the business. IV. There are three major business forms, Sole Traders, Partnerships and Corporations. Each of these three business structures is thought to suffer to some degree from potential conflicts of interest amongst stakeholders. V. The strength and effectiveness of a corporate governance system has a direct impact on the value of a business. A number of studies have been undertaken to assess the impact. VI. The existence of a weak or ineffective corporate governance system increases the risk to the investor. This increased risk will reduce the value of the company and in extreme cases deficient corporate governance canVII. cause a company to go bankrupt.Question 7Which of the following is least likely to be a core attribute of an effective corporate governancesystem? Effective corporate governance systems:A) Lay an integral and leading role in determining the strategic long term direction of the company.B) Provide for fair and equitable treatment in all dealings between managers, directors and shareholders.C) Define and communicate to stakeholders the oversight responsibilities of managers and directors.Question 8Which of the following statements would be evidence of a corporation that had not adopted globalbest practice with regards to the Board of Directors?A) The composition of the Board is made up of 75% of members who are independent.B) Has not adopted staggered elections for appointment to the Board of Directo rs.C) A Board that has a number of independent members who serve on several other Boards, in order to bring a variety of business experience to the Corporation.Question 9Looking at the relationship between Directors and Shareholders, which of the following would leastlikely be regarded as a significant potential conflict of interest for those Directors with non -operational responsibilities?A) Directors receiving high levels of compensation.B) Growing the size of the business to receive increased job security, power and compensation.C) Interlinked Boards.Question 10Which of the following statements in respect of these three types of business is least likely to becorrect?A) Due to the lack of a Board of Directors and a Management team, sole proprietors face conflicts of interest only with their creditors and suppliers.B) Partnerships solve their internal conflicts of interest with the existence of partnership agreements that clearly spell out the roles and responsibilities of partners.C) Since stockholders in a corporation have limited liability and can only lose the amount invested and no more, corporations face little or no conflict of interest.Question 11Which of the following statement is least likely to be correct with respect to the findings of studiesevaluating the impact of corporate governance on firm value?A) The best governed companies generate an ROE that exceeds poorly governed firms by ______________________ 3 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

23.8%. B) US and International Companies with strong corporate governance have been shown to have higher measures of profitability and generate higher returns to shareholders. C) Portfolios of companies with strong shareholder rights protections were found to outperform companies with weaker protections by 25% per annum.Question 12Which of the following is least likely the description of one of the risks of poor corporate governance? A) The directors of the firm invest in assets that are inherently risky and therefore cause volatility in the earnings stream of the business. This is asset risk. B) Information that investors use to make investment decisions about the company is incomplete, misleading or materially misstated. This is financial disclosure risk. C) Management may enter into transactions that may not be in the best interest of shareholders but will provide benefits to managers. This is strategic policy risk.Question 13 - 18World Beaters, a maker of electric mixers and other kitchen appliances, is considering a hostiletakeover of Gadgets N' More, a catalog retailer specializing in products for the kitchen. World Beatersis planning to use its own stock for the acquisition.Lars Clausen, deputy chief financial officer for World Beaters, is preparing a report on the potentialmerger for senior management.After a review of financial literature on mergers and extensive interviews with managers of bothWorld Beaters and Gadgets N' More, Clausen submits a report recommending against the merger.The reasons for his disapproval are listed below:Gadgets N' More's stock price reflects a higher growth rate than World Beater's, and aquisition willincrease per- share profits.Shareholders will not benefit from World Beater's new lower financing rates post acquisition.Because the merger must be an acquisition of assets, World Beaters will need shareholder approvalfrom Gadgets N' More.Regardless of the recommendations to the board, Clausen sets out to compute a fair price for theacquisition of Gadgets N' More. He analyzes the recent acquisition of Tera Inc by King Inc at a priceof $34 per share of Tera Inc. Prior to media reports about the acquisition, Tera's stock was tradingat $28 per share. However, when the pending acquisition was leaked in the popular media, Tera'sstock price jumped to $38.Clausen then evaluates Gadgets N' More's corporate governance. He notes that the company's oncorporate governance practices include the following statements:Statement 1: Senior management assesses the board's performance annually. Statement 2: Atleast 75% of the audit committee of the board should be independent.Gadgets N' More has 78 million shares outstanding while World Beaters has 223 million sharesoutstanding. Gadgets N' Mores stock was trading at a price of $20 per share pre-announcementwhile World Beater's stock was trading at $43 per share. Clausen estimates the total present valueof cost savings due to the merger to be $200 million.Question 13Which of Clausen's arguments against the merger is least valid?A) Because the merger must be an acquisition of assets, we will need approval from Gadgets N' More shareholders.B) Gadgets N' More has a higher growth rate than World Beater's, and a purchase will increase per-share profits.C) Shareholders will not benefit from World Beaters' new lower financing rates.Question 14World Beaters's proposed purchase of Gadgets N' More is best described as a:A) Vertical merger. 4B) Conglomerate merger.C) Horizontal merger. ______________________ ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Question 15The acquisition premium paid under the Tera acquisition is closest to: A) -11% B) 21% C) 58%Question 16Gadgets N' More's corporate governance practice referred to in Statement 1 is most likely to be: A) Ineffective because the board should be allowed to self-asses their own performance. B) Ineffective due to the frequency of the assessment. C) EffectiveQuestion 17Statement 2 of Gadgets N' More's corporate governance practices is: A) Unlikely to be an effective corporate governance practice because a higher percentage of board members should be independent. B) Likely to be an effective corporate governance practice. C) Unlikely to be an effective corporate governance practice because a lower percentage of board members should be independent.Question 18If World Beaters's board accepts a 1:2 stock exchange offer (1 share of World Beaters per 2 sharesof Gadgets N' More), the takeover premium paid to shareholders of Gadgets N' More is closest to: A) 7.5% B) 11% C) 8.3%Question 19 - 24Clothing Tree is a Milan-based holding company. The holding company comprises individual firmswith unique brands that produce and sell products ranging from infant and children's clothing, tofashion wear, to work uniforms, to undergarments. The firm's founder and chairman, Romano Nocci,says that \"since we assume that people will continue to wear clothes, we continue to believe thatthis is a good business for the long haul.\"However, in spite of his overall belief in the soundness of the clothing market, he realizes that tastesand fashions change, and believes that the firm should constantly be on the lookout for suitablecandidates to add to the Clothing Tree empire. He also believes that it may make sense torestructure the firm by creating a new holding company, Family Tree, to own the Clothing Tree plustwo new divisions-Food Tree and Drug Tree.The Food Tree would be a holding company formed to acquire companies in all phases of the foodbusiness. The Drug Tree would be a holding company formed to acquire companies in all phases ofthe non -prescription pharmaceuticals market. Both of these product lines are necessary goods, soNocci believes that they would fit well with the firm's existing clothing businesses.To help implement this acquisition strategy, Nocci has hired Zurich Investment Advisers. ArmandoPalocci, CFA has been assigned to be the lead advisor in this effort. When Palocci and his team metwith Nocci and other key Tree managers, they discussed a wide-ranging set of subjects relating tothe nascent acquisition plans. These discussions are summarized in the paragraphs below.Palocci asks whether additions to the Tree empire will continue to maintain their identities. Forexample, if Food Tree were to purchase Parma Foods, would the company be operated as asubsidiary and maintain its identity, or would it be combined with other acquisitions and rebrandedas Food Tree? Nocci indicates that this would likely depend upon the value of maintaining the brandversus the efficiencies that could be gained from combining acquisitions.Does the Tree want to avoid firms that have takeover defenses in place? If so, which types ofdefenses? Nocci responds that he \"would prefer to avoid firms that have pre-offer defenses, suchas poison pills and pac-man defenses in place because these make the cost of an acquisition ______________________ 5 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

prohibitive. However, if a firm has shown a willingness to pay greenmail in the past, he would notbe averse to testing the management again on this count.\"Some of the acquisition targets will likely have business interests in the U.S. and Canada, as wellas Europe. Palocci describes to Nocci how industry concentration is measured in the U.S., and whatmight cause an acquisition to be challenged on antitrust grounds. Nocci indicates that whether ornot it makes sense to run the risk of an antitrust challenge will depend, in part, on the potentialgains from the merger. Thus, they must be evaluated on a case by case basis.Palocci and Nocci conclude their discussions with a review of acquisition target valuation methods,the evidence concerning the distribution of merger benefits, and strategies that the firm mightemploy if it were to purchase a firm with several divisions, some of which it does not wish to keep.Question 19If Food Tree is successful in purchasing a food company for which it maintains the firm's existingidentity and brands, the first such purchase would be classified as a:A) Subsidiary, conglomerate merger.B) Subsidiary, horizontal merger.C) Statutory, conglomerate merger.Question 20With regard to Nocci's description of the types of takeover defenses he would prefer to avoid, he is:A) Incorrect with respect to the poison pill defense, and incorrect with respect to the pac - man defense.B) Correct with respect to the poison pill defense, and correct with respect to the pac -man defense.C) Correct with respect to the poison pill defense, but incorrect with respect to the pac-man defense.Question 21With respect to antitrust challenges in the United States, Palocci should have told Nocci that thedecision to challenge is based upon a:A) Quantitative measure of industry concentration, but that the issue is not clear-cut.B) Qualitative measure of industry concentration, but that the issue is not clear -cut.C) Quantitative measure of industry concentration, and that the issue is clear-cut once the change in the measure is known.Question 22Food Tree is likely to have to evaluate potential acquisition targets that are temporarily experiencingfinancial distress or earnings problems that can be solved with an application of the Tree's financialstrength and management expertise. That said, the food industry, by and large, consists of firmsthat have relatively predictable revenue and cost patterns, and the level of investment risk is well-understood. All else being equal this set of circumstances would seem to argue for which of thefollowing valuation approaches?A) Comparable transaction.B) Comparable company.C) Discounted cash flow.Question 23Suppose that Drug Tree has identified three comparable companies relative to a target underevaluation. The valuation metric is price to sales (P/S). The three comparable companies have P/Sratios of 2.17, 1.98, and 2.09. The target has sales of 600m. What value of the P/S should beapplied to the target, and what is the estimated value? P/S Estimated ValueA) 1.98 1188mB) 2.08 1248mC) 2.17 1302m ______________________ 6 ©2018 FK Partners Todos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Question 24Palocci advises that if the Food Tree purchases a firm that includes a division that does not fit theTree's strategic plan, the firm can sell the division via divestiture, equity carve-out, spin-off, or split-off. However, he tells Nocci that only the divestiture will provide Food Tree with cash aftercompletion, because the others all involve the distribution of stock in the division. Palocci's adviceis: A) Correct with respect to the alternatives, and correct with respect to the provision of cash. B) Correct with respect to the alternatives, but incorrect with respect to the provision of cash. C) Incorrect with respect to the alternatives, and incorrect with respect to the provision of cash. ______________________ 7 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

______________________ 8 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio.

Answers – SS 08 - Corporate Finance Financing and Control IssuesQuestions 1 - 6Questions 1The correct answer was A) No Mature growthIn order for bootstrapping to occur, a high price-to-earnings (P/E) firm needs to acquire a low P/Efirm. In this case, based upon the relative growth rates, the opposite is likely to be true. Gazelle i smost likely in the mature growth stage. In this stage, competition is present, but there is stillopportunity for above average growth. During the rapid growth stage, competition is more limitedthan appears to be the case for Gazelle.Question 2The correct answer was C) Golden parachute NoThe company has a golden parachute package in place. If the compensation for the top 7 managersaveraged$500,000, the total cost of the golden parachute is $14m. This is probably not sufficient to deter abidder. Conversely, to the extent that it helps keep management in place during the acquisition, itmay make Gazelle more attractive as an acquisition candidate.Question 3The correct answer was A) Good chance of antitrust action because change in HHI is greater than100; small chance of antitrust action because change in HHI is less than 100.Based upon the market share data provided, the initial HHI value is:If acquirer 1 were successful, the new HHI = 1222 (an increase of 210). This indicates a goodchance of an antitrust challenge.If acquirer 2 were successful, the new HHI = 1096 (an increase of 84). This indicates a small chanceof an antitrust challengeQuestion 4The correct answer was A) Comparable transaction.Since there are no comparable direct competitors in the market, comparable firm analysis is unlikely.Discounted cash flow analysis is a viable possibility. However, given that there have been 3comparable transactions over the past 3 years, this argues strongly in favor of a comparabletransaction valuation methodology.Question 5The correct answer was C) $43 to $53YesThe probable price range is the current market price to the current price + the value of thesynergies. That is, $43 to$43 + 500m / 50m = $53. If they receive an offer greater than $53, the board should accept.Question 6The correct answer was C) Equity carve-outCrown jewel defenseA public offering of a subsidiary as a stand-alone enterprise is called an equity carve-out. Using thistechnique to fend off a merger is known as a crown jewel defense.Questions 7 – 12Question 7The correct answer was A) lay an integral and leading role in determining the strategic long termdirection of the company.This would not be a core attribute of the corporate governance system - this is rather somethingfor the senior management of the business to decide upon, with help and input from the board.Question 8The correct answer was C) A Board that has a number of independent members who serve on several _________________________ 1 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

other Boards, in order to bring a variety of business experience to the Corporation.Best practice recommends that Board Members should not serve on more than two or three boards.Staggered boards are not recommended as they limit the ability of shareholders to alter thecomposition of the board quickly.Question 9The correct answer was B) Growing the size of the business to receive increased job security, powerand compensation.This would normally be a conflict of interest that would be associated with a manager of the businessnot a Board Member with non-executive responsibilities.Question 10The correct answer was C) Since stockholders in a corporation have limited liability and can only losethe amount invested and no more, corporations face little or no conflict of interest.Corporate shareholders have limited liability but this does not preclude the existence of a conflictof interest between the shareholders and the management and/or directors.Question 11The correct answer was C) Portfolios of companies with strong shareholder rights protections werefound to outperform companies with weaker protections by 25% per annum.A slightly excessive claim - the study only found the excess to be 8.5%. The other statements areall correct.Question 12The correct answer was A) The directors of the firm invest in assets that are inherently risky andtherefore cause volatility in the earnings stream of the business. This is asset risk.Asset risk arises when managers and directors use company assets inappropriately. Examples wouldinclude paying excess compensation and perks.Questions 13 – 18Question 13The correct answer was B) Gadgets N' More has a higher growth rate than World Beater's, and apurchase will increase per-share profits.For major acquisition of assets (in this case 100%), shareholder permission would be needed. Whena high -growth firm purchases a low-growth firm, per-share profits are temporarily boosted, thuslowering future growth prospects on a per-share basis. Since Gadgets 'N More has a higher growthrate than World Beaters, the effect will be just the opposite, depressing EPS in the near term. Whilethe acquisition could boost the growth rate going forward because of the depression of currentearnings and the integration of a faster-growth business, this could indeed be used as an argumentagainst a merger, as in some cases, any one-time decline in EPS is unacceptable. As such, thisargument is somewhat valid. Lower financing rates benefit the company, but usually notshareholders, because the company's price likely reflects the fact that shareholders of bothcompanies end up guaranteeing each other's debt.Question 14The correct answer was A) vertical merger.In a vertical merger, the acquiring company moves up or down the supply chain. In this case, WorldBeaters wants to buy a retailer that sells its products, moving up the supply chain toward consumers.Question 15The correct answer was B) 21%Takeover premium = Acquisition price/pre-announcement price - 1 = 34/28 - 1 = 21.4%Question 16The correct answer was A) ineffective because the board should be allowed to self-asses their ownperformance. _________________________ 2 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

Effective corporate governance practices call for board to perform self-assessment (rather thanmanagement assessing the board). The process of periodic self-assessment by the board allowsdirectors improve not just their own performance but also to initiate any changes needed in thecorporate governance struc ture.Question 17The correct answer was A) Unlikely to be an effective corporate governance practice because a higherpercentage of board members should be independent.✓Effective corporate governance practices calls for 100% of the members of the audit committee ofthe board to be independent.Question 18The correct answer was C) 8.3%TP = PT - VT where PT = N x PAT for a stock acquisition.PAT = VAT / # of sharesVAT = (223 million x $43) + (78 million x $20) + $200 million = $11,349 million.# of shares post-merger = 223 million + 78/2 million = 262 millionPAT = $11,349 / 262 = $43.32PT = 0.5 x 43.32 = 21.66TP = 21.66 - 20 = $1.66 per share or 1.66/20 = 8.3%Questions 19 – 24Question 19The correct answer was A) subsidiary, conglomerate merger.The first food company, being in an entirely different business from clothing, would have to beconsidered a conglomerate merger. The fact that the firm intends to maintain the target's identityafter it is acquired indicates that it would be considered a subsidiary merger.Question 20The correct answer was C) correct with respect to the poison pill defense, but incorrect with respectto the pac-man defense.Nocci is correct with respect to the poison pill defense. It is a pre-offer defense that can make anacquisition prohibitively expensive. The pac-man defense is a post-offer defense. It involves theacquisition target turning the table and attempting to acquire the firm that is making the offer.Question 21The correct answer was A) quantitative measure of industry concentration, but that the issue is notclear-cut.Palocci should have told him that the decision to challenge is based upon a quantitative measure ofindustry concentration, but that the issue is not necessarily clear-cut.Question 22The correct answer was C) Discounted cash flow.If a firm is in financial distress or experiencing earnings problems, this will make it difficult to applythe comparable company or comparable transaction approaches. However, if the firm can berestored to health and future cash flows and risks are fairly predictable, this implies that discountedcash flow valuat ion may provide the best results.Question 23The correct answer was B) 2.081248mThe appropriate value to apply to the target is the average, or P/S = 2.08. If sales = 600m thensolving for P = 2.08 × 600m yields an estimated target value of 1248m.Question 24The correct answer was B) correct with respect to the alternatives, but incorrect with respect to theprovision of cash.Palocci's list of methods is correct for a going concern (liquidation is also an option if the firm is in _________________________ 3 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

financial distress, which is assumed not to be the case here). However, he is incorrect with respectto the provision of cash. An equity carve-out will also generate cash, via the public offering of sharesin the division. A spin -off or split-off will not generate cash for Food Tree. _________________________ 4 ©2018 FK PartnersTodos os direitos reservados – É proibida a reprodução total ou parcial, de qualquer forma ou por qualquer meio

Fixed Income Investments EquityStudy Sessions 9, 10, 11 Equity Investments Topic Weight: 15‒25% Fixed Income Investments Equity Equity Valuation 28. Return Concepts ©2018 FK Partne

SS 09 - Equity Investments Fixed Income Investments Equity Study Session 9 Equity Valuation: Valuation Concepts 27. Equity Valuation: 28. Applications and Processes Return ConceptsLOS 28.b Calculate/Interpret Return ConceptsSchweser B3 pg 15, CFAI V4 pg 58 Equity Risk Premium (ERP) Equity Risk Premium—additional return above the risk-free rate investors require for holding (risky) equity securities  Think: Required return – RFR The risk-free rate should be equal to the investor’s investment horizon  T-Bills for short horizons  T-Bonds for longer holding periods© Kaplan, Inc. 3ers - Exame CFA 1