1st Semester 2020 / 2021

RESIT EXAMINATION

Time allowed: 3 hours

Course : ADVANCED CORPORATE FINANCE - FI502E

Instructors : Saqib Aziz, Tipu Sultan, Raoul Grosset

STUDENTS INSTRUCTIONS

ANSWER Answer in English

DOCUMENTATION Open book Exam

APPENDIX Solutions in PDF for Part 1 and EXCEL for part 2

INTENDED LEARNING OUTCOMES (ILOs) TESTED BY THE EXAM

This exam broadly covers all ILOs of the Advanced Corporate Finance module by focusing on theoretical
and analytical aspects relating to overall objective of corporate finance, investment decision rules in
particular capital budgeting, capital structure decision, payout policies, valuation with leverage, and
market of corporate control dominated (i.e. mergers and acquisitions).

100 MARKS IN TOTAL, AWARDED ACCORDING TO THE FOLLOWING TABLE:

Part 1 30 points
Part 2 70 points
Total 100 points

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 RESIT EXAMINATION
ADVANCED CORPORATE FINANCE - FI502E

PART 1: CASE STUDY (30 points)

Case: Trade Vs Cross-Border Mergers And Acquisitions: Complement Or Substitute –

The Case Of TECHNO

In 2017, while talking to TheStreet TECHNO Systems Inc. CEO – Adam Rotensky stated,
“[We] intend to continue to use smart M&A as a way to seize market transactions in new
markets as well as extend our leadership in our current business."

Further, he added that "Our M&A approach will strive to remain balanced -- maintaining
discipline in light of market conditions while making key strategic moves that cement
TECHNO's competitive differentiation for the future."1

Introduction:
TECHNO Systems Inc. is a US technology company with its operations spread across the world
and is mainly known for the computer-networking product. The company is headquartered in
San Jose, California, in the heart of Silicon Valley. Charles H. Robbins, 52 years old, is the
Chief Executive Officer (CEO) of the company who assumed this position in July 2015 and
became board member in May 2015. He is associated with the company since December 1997.

TECHNO manufactures and sells Internet Protocol (IP) based networking products and services
in information technology (IT) and communication sector. The major focus of the business is
on the networking products which aims at helping their consumers to use technology for their
important business operations and addressing the growth opportunities, and attaining cost
reduction, reducing risk, business growth and competitive advantage in the market. Their
products are grouped into several categories such as:
(1) Switching
(2) Next-Generation Network (NGN) Routing
(3) Service Provider Video;
(4) Collaboration;
(5) Data Center;
(6) Wireless;
(7) Security;
(8) Service Provider Video; and
(9) Other Products

Besides the products, they are also engaged in providing services to their consumers including
but not limited to the support services. They mainly sell their products to the businesses in every
industry and is one of the largest companies in the United States. Their customer base is huge
and is not limited to any specific industry, geography and product. During the period 2014 -
2017, TECHNO did not have a single customer with purchases accounting for more than 10%
of company’s sales. The company conducts its businesses around the world and manages its
operations in three different geographic segments:

1
https://www.thestreet.com/story/14279045/1/cisco-ceo-here-is-our-acquisition-strategy.html
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(1) The Americas,
(2) Europe, Middle East and Africa (EMEA) and
(3) Asia Pacific, Japan and China (APJC).

The financial accounts of the companies are also maintained by geographical segment.

Background:
Two Stanford computer scientists, Sandra Lerner and Leonard Bosack, in December 1984,
started a company “TECHNO” in San FranTECHNO, California. Lerner was managing the
computers of Stanford Graduate School of Business and Bosack was in charge of computer
science department of Stanford. Both of them designed a device that could connect the
computer networks of these two different departments and identify a router technology. In 1985,
the company began a site dedicated for customer support where the consumers could download
the software over File Transfer Protocol (FTP). Until 1986, the two scientists continued their
job and then they resigned and started working full time for the company. By November 1986,
TECHNO already started earning sales of $250K and after the initial success; they started to
organize the company and hired Bill Graves as Chief Executive Officer (CEO) and Lloyd
Embry as Chief Financial Officer (CFO) in 1987. Sequoia Capital, a venture capital firm also
provided financing of $2.5 million in the same year. This investment proved very beneficial for
the company. TECHNO succeeded in attracting customers’ attention and received considerable
orders. Moreover, lack of competition in the industry at that time was also favoring the
company. Thus, it documented a sale of $5.5 million and net income of $555 thousands. John
Morgridge became new president and CEO of the company in October 1988 and TECHNO
went public in 1990 under his leadership. After successfully leading the company until 1995,
John T. Chambers succeeded him who continued his term until 2015 when current CEO, Chuck
Robbins, replaced him.

Competition:
The company operates in technology market and the changes within the markets are taking
place very rapidly. They are also venturing into foreign markets through various modes and
therefore, the company has not only to face the competition from the domestic market but also
in the foreign markets. The intensity of the competition is very high, for example, sometime the
companies with whom TECHNO has established a strategic alliance for one line of product,
becomes competitors in another product line. Then, they also face competition from their
customers. Their major competitors include but not limited to Arista Networks, Inc., Amazon
Web Services LLC, Huawei Technologies Co., Nokia Corporation, Microsoft Corporation, Dell
Technologies Inc. and Symantec Corporation.

Sources of Innovation:
TECHNO systems operate in an industry in which the success of a player is based on
innovation. The company must meet the dynamics of changing environment of the industry.
Their strategy for the continuous innovation is based on following five components:
(1) Build – in-house research and development
(2) Buy – either acquire or divest
(3) Partner – strategic partner within US and outside US
(4) Invest – investing into domains that are at their infancy
(5) Co-develop – development of new solutions with the huge network of customers,
partners, soft-ware houses and academic researchers.

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Mergers and Acquisitions at TECHNO:
TECHNO has been engaged in mergers and acquisitions (M&A) for last several years and has
acquired many companies since its inception. The figure 1 plots M&A activity of the company
over the period 1993 – 2016. The bars indicate the dollar transaction value of M&A and lines
indicate the number of M&A. The figure presents the domestic and cross-border merger
activity, separately. The company made its first domestic acquisition of Crescendo
Communications in 1993 and acquired 3 more companies in 1994, 6 companies in 1995, and
became very active in market for corporate control afterwards. Between 1989 and 2016, the
company made more than 217 mergers and acquisitions2 deals out of which 37 acquisitions
were across the border. The company made its first cross-border acquisition in 1996 by
acquiring an Australian company Metaplex. Until now, the company has been very active in
global M&A market. As an acquisition strategy, they have been mainly focusing on the start-
up companies dealing with the new technologies. This pace of acquisitions has significantly
helped the company to meet its growth strategy of coping with the market transitions.

The company spent huge amount of capital on mergers and acquisitions in 1999 and 2000 (see
figure 1), and reported loss of $1 billion over the same period. Apart from other domestic and
global market forces, analysts attributed this huge loss mainly to the investments in mergers
and acquisitions. However, TECHNO slowed down their investments in mergers and
acquisitions for the next few years and after recovering from internal financial constraints, the
company resumed its investments in mergers and acquisitions.

TECHNO follows mainly three steps while making any acquisitions. In a first step, the
executive identifies the potential target and convincing the management about the potential
benefits of the acquisition. Next, the company moves on evaluating whether the target company
is a best fit with the TECHNO. Once the deal is signed upon agreement between both the
acquiring and target companies, next step is integration of acquired companies within the
TECHNO to yield the maximum benefits.

Figure 1:

The figure presents the domestic as well as cross-border Mergers and Acquisitions activity of
TECHNO over the period 1993 – 2016
2
Source: Thomson Reuters
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Export Sales of TECHNO:
TECHNO has its presence in international market since the very beginning and became a global
leader in the network industry. Before estabilishing its M&A footprints across borders, the
company gained access to the foreign markets by exporting their products abroad. The company
started selling their product all over the world soon after its inception. During the first few
years, the company observed a steady growth in their exports but then it experienced an increase
of almost 60% in their export sales3 (See sub-figure A of Figure 2).

The sub-figure B of figure 2 graphs the domestic as well as cross-border mergers over the same
period for TECHNO. As discussed earlier and we can see in this figure as well, initially the
company engaged in mergers and acquisitions domestically before starting to acquire abroad
and, in parallel, the company also kept exporting their products.

Figure 2:
Sub-figure A graphs the trade-flows of TECHNO company over period (1989 – 1997) and sub-
figure B graphs the M&A of TECHNO over same period.
Sub-figure A – Trade Flows

Sub-figure B – Mergers and Acquisitions

3
The data on export sales is only available until 1997.
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Questions:

A. Provide anlysis of this case that should not exceed one page. (15 pts)

B. Answer the following:

Q-1: What is the growth strategy of TECHNO? (05 pts)

Q-2: How did TECHNO mergers and acquisitions activity help it in achieving the its growth
strategy and what benefits could acquisitions bring to TECHNO? (05 pts)

Q-3 How would you speculat about the association between exports and M&A at TECHNO?
(05 pts)

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 PART 2: ANALYTICAL QUESTIONS (70 points)

Question 1:HSY Packaging is considering expanding its production capacity by purchasing a new
machine, the JB-007. The cost of the JB-007 is $2.75 million. Unfortunately, installing this machine will
take several months and will partially disrupt production. The firm has just completed a $50,000
feasibility study to analyze the decision to buy the JB-007, resulting in the following estimates:

■ Marketing: Once the JB-007 is operating next year, the extra capacity is
expected to generate $10 million per year in additional sales, which will
continue for the ten-year life of the machine.

■ Operations: The disruption caused by the installation will decrease sales by $5

million this year. As with HSY’s existing products, the cost of goods for the
products produced by the JB-007 is expected to be 70% of their sale price. The
increased production will also require increased inventory on hand of $1
million during the life of the project. The increased production will require
additional inventory of $1M, to be added in year 0 and depleted in year 10.

■ Human Resources: The expansion will require additional sales and

administrative personnel at a cost of $2 million per year.

■ Accounting: The JB-007 will be depreciated via the straight-line method in

years 1–10. Receivables are expected to be 15% of revenues and payables to be
10% of the cost of goods sold. HSY’s marginal corporate tax rate is 35%.

a. Determine the incremental earnings from the purchase of the JB-007.

b. Determine the free cash flow from the purchase of the JB-007.

c. If the appropriate cost of capital for the expansion is 10%, compute the NPV of
the purchase.

d. While the expected new sales will be $10 million per year from the expansion,
estimates range from $8 million to $12 million. What is the NPV in the worst
case? In the best case?
e. What is the break-even level of new sales from the expansion? What is the
break-even level for the cost of goods sold?

f. HSY could instead purchase the JB-900, which offers even greater capacity.
The cost of theJB-900 is $4 million. The extra capacity would not be useful in
the first two years of operation, but would allow for additional sales in years 3–
10. What level of additional sales (above the $10 million expected for the JB-
007) per year in those years would justify purchasing the larger machine?

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 Tax rate 35.00%
Cost of goods as a % of sales 70.00%
First year sales value 10,000.00

(40 points)

Question 2: PenGo Corp plans to make a $50 million investment, initially funded completely with debt.
The free cash flows of the investment and PenGo Corp’s incremental debt from the project are shown
below:

Year 0 1 2 3
Free cash flows -50 40 20 25
Debt 50 30 15 0

PenGo Corp’s incremental debt for the project will be paid off according to the predetermined
schedule shown. PenGo Corp’s debt cost of capital is 8%, and its tax rate is 40%. Syntec also
estimates an unlevered cost of capital for the project of 12%.

a.
Use the APV method to determine the levered value of the project at each date and its
initial NPV.

b.
Calculate the WACC for this project at each date. How does the WACC change over
time? Why?

c. Compute the project’s NPV using the WACC method.

d.
Compute the equity cost of capital for this project at each date. How does the equity
cost of capital change over time? Why?

e. Compute the project’s equity value using the FTE method. How does the initial equity
value compare with the NPV calculated in parts (a) and (c)?

(30 points)

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