University of Delaware

Lerner College of Business and Economics

FINC 312– Intermediate Financial Management

Midterm Examination 2, Fall 2020

Duration: 90 minutes

Aids allowed: Financial or Scientific calculator, double-sided crib sheet

Please answer questions on this exam paper

Name: ___________________________________________________________

Student #: ___________________________________

Question Grade
Conceptual and Theory Questions /4.5
M&A /3
Financial Distress /2.5
Credit Risk /1
Total: /10+1 bonus

I hereby certify that I will follow the Code of Student Conduct as defined by the
University, the Department and this specific course (states in the course syllabus),
that I will not cheat nor will I condone cheating.

Signature:________________ Name:________________________

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Conceptual and Theory Questions (0.5 mark each)

1) In a tender offer acquisition what does the “hold out” problem refer to?

2) If a firm has a stock based insolvency in both book and market value terms would the
shareholders push for Chapter 7 resulting in a settlement according to the APR? Why?
Briefly explain your reasoning.

3) A _______ permits shareholders, except for the acquirer, to purchase additional shares
at a discount. This provides investors with instantaneous profits which also dilutes
shares held by the acquiring company, making the takeover attempt more expensive
and more difficult.

4) A ______________ is an individual or company that acts as a savior of a company by

acquiring the corporation on the verge of being taken over by a force deemed
undesirable by company officials.

5) Empirical evidence suggests that upon announcement of a new equity issue, current
stock prices generally _________ (fall or rise)? Why? Briefly explain your reasoning.

6) If a group other than management solicits the authority to vote shares to replace
management, a _____ is said to occur.

7) Which of the following statements is true?

a) Dividends paid to preferred shareholders are fixed in advance which is different from
bond coupons.
b) Omission of dividend payment to preferred shareholders constitute default.
c) In the case of default common shareholders have priority in their claim on firm’s assets
over preferred shareholders.
d) Preferred shareholders do not have the right to vote in directors’ election even when
the firm skips preferred dividend payments.
e) Dividends paid to preferred shareholders are due before the common shareholders
receive their dividends.

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 8) Why do firms with high level of cash flow volatility avoid issuing public debt (i.e.,
corporate bonds) and prefer bank loans?

9) Which theory of capital structure predicts that firms that have more tangible assets
maintain a low leverage ratio?

Mergers and Acquisitions

Two firms are competing to acquire Sanctuary Ltd, a firm with 20 million shares outstanding that
are currently trading at $20. Underground Excavators (UE) has a market value of $1 billion and
100 million shares outstanding, while Gnosis Inc. has 500 million shares trading at $15. UE has
offered to pay to $600 million cash for the firm while Gnosis has offered to issue 40 million new
shares as a payment.

a) Assuming synergies are perpetual and the discount rate is 10% for both companies,
what is the minimum yearly synergy benefit created by the merger that would justify
each offer? (1 mark)

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b) If Sanctuary's shareholders believe that a merger with either suitor would create
perpetual yearly synergies of $35 million, which offer are Sanctuary's shareholders most
likely to accept and why? (1 mark)

c) Assuming an efficient market, if Sanctuary's shareholders accept Gnosis' offer, what

should happen to the share price of Sanctuary AND Gnosis immediately after the
announcement that the offer was accepted? Consider both cases: synergies of $20 million
and $35 million for both firms - a total of 4 prices should be reported (1 marks – bonus!)

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Financial Distress and Underinvestment Problem

Lerner Inc. is facing financial distress. There is a 40% chance that the firm’s assets will be
worth $15 million and a 60% chance that the assets are going to be worth $100 million next
year. The firm also has a debt claim outstanding with a face value of $45 million due next year.
The cost of equity and debt capital is equal to 10%. Lerner Inc. is facing an investment
opportunity that requires $20 million upfront and will result in a safe cash flow of $25 million
next year. The firm has no internal funds available to finance the project.

a) Will Lerner Inc.’s shareholders inject new equity to finance this project? Why? (1 marks)

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b) Suppose Lerner Inc. proposes a deal to its creditors. The creditors are asked to write down
$10 million in debt face value to $35 million, and shareholders will have to inject new
equity to fund the project. Will shareholders agree? Will creditors agree? Why? (1 mark)

c) What is the “minimum amount of debt forgiveness” required to make both shareholders and
creditors agree and fund the investment project? (0.5 mark)

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Credit Risk
Company XYZ needs to borrow $3 million for 1 year. Next year the assets of XYZ are worth either
$5 million (with the likelihood of 95%) or $2 million (with the likelihood of 5%). Moreover, the
cost of selling assets in the state of default is $100,000. Creditors required rate of return is 10%.
The 1-year treasury rate is 6%. What is the yield spread required by the creditors? (1 mark)