BBA 2011

CORPORATE FINANCIAL MANAGEMENT

MICHELLE CHIA KAR YAN

930609-14-5906

200170

MR CHONG

APRIL

2013 SEMESTER

Page 1 of 17

1.0 CONTENT

1.0 CONTENT.................................................................................2

2.0 TASK 1......................................................................................3

3.0 TASK 2......................................................................................4

4.0 TASK 3......................................................................................6

5.0 TASK 4......................................................................................7

6.0 TASK 5......................................................................................9

7.0 REFERENCES........................................................................13

8.0 COURSEWORK.....................................................................14

Page 2 of 17

2.0 TASK 1

In 2012 Pfizer had 12,000 million shares stock authorized. 8,863 million in issue, and

6,746 million outstanding (figures rounded to the nearest million). Its equity account

was as follows.

$

Common stock 443

Additional paid-in capital 70,283

Retained earnings 44,148

Treasury shares (57,391)

1.1 What is the par value of each share?

443million8,863million

=0.05

1.2 What was the average price at which shares were sold?

443million−70,283million8,863million

= 7.98

1.3 How many shares had been repurchased

8,863 million – 6,746 million

= 2,117 million

1.4 What was the average price at which the shares were repurchased?

Page 3 of 17

57,391million2,117million

= $ 27.11 per share

Type equation here.

1.5 What was the net book value of Pfizer’s common equity?

443 million + 70,283 million + 44,148 million – 57,391 million

= 57,483 million

3.0 TASK 2

Inbox software was founded in 2010. Its founder put up $2 million for 500,000

shares of common stock. Each share had a par value of $10.

2.1 Construct an equity account (like the one in Table 14.2) for inbox on the day

after its founding. Ignore any legal or administrative costs of setting up the

company

The day after the founding of Inbox: $ Common

shares ($0.10 per value) 50,000

Additional paid-in capital 1,950,000

Retained earning 0

Page 4 of 17

Treasury shares at cost 0 Net

common equity 2,000,000

2.2 after two years of operation, Inbox generated earning of $120,000 and paid no

dividends. What was the equity account at this point?

After two years of operation: $

Common shares ($0.10 per value) 50,000

Additional paid-in capital 1,950,000

Retained earning 120,000

Treasury shares at cost 0 Net

common equity 2,120,000

2.3 After three years the company sold 1 million additional shares for $5 per

share. It earned $250,000 during the year and paid no dividends. What was the

equity account?

After three years of operation: $

Common shares ($0.10 per value) 50,000

Additional paid-in capital 6,850,000

Retained earning 370,000

Treasury shares at cost 0 Net

common equity 7,270,000

Page 5 of 17

4.0 TASK 3

In shareholders of the Pickwick Paper Company need to elect five directors.

There are 200,000 shares outstanding. How many shares do you need to own to

ensure that you can elect at least one director if

3.1 The company has majority voting?

x=(200,0002 )+1

=100,001

3.2 if has cumulative voting?

200,000×5=1,000,000

x=(1,000,000−x5 )+1

x−1=( 1,000,000−x5 )

5 x−5=1,000,000−x

5 x+ x=1,000,000+5

6 x=1,000,000

x=(1,000,0006 )

=166,667.5

Page 6 of 17

( 166,667.55 )

= 33.333 (share holder)

= 33.334

5.0 TASK 4

4.1 Large businesses spend millions of dollars annually on insurance. Why? Should

they insure against all risks or does insurance make more sense for some risks

than others?

Insurance companies have the experience to assess routine risks and to advise

companies on how to decrease the frequency of losses. Insurance company

experience and the very competitive nature of the insurance industry result in

correct pricing of routine risks. However, BP, for example, has concluded that

insurance industry pricing of coverage for large potential losses is not efficient

because of the industry’s lack of experience with such losses. Consequently, BP

has chosen to self insure against these large potential losses. Effectively, this

means that BP uses the stock market, rather than insurance companies, as its

vehicle for insuring against large losses. Other than that, large losses result in

reductions in the value of BP’s stock. The stock market can be an efficient risk absorber

for these large but diversifiable risks.

Page 7 of 17

Insurance company expertise can be beneficial to large businesses because the

insurance company’s experience enable the insurance company to correctly price

insurance coverage for routine risks and to provide advice on how to minimize the

risk of loss. Furthermore, the insurance company is able to pool risks and thereby

minimize the cost of insurance. Rarely does it pay for a company to insure

against all risks, however. Typically, large organization self-insure against small

potential losses.

4.2 On some catastrophe bonds, payments are reduced if the claims against the

issuer exceed a specified sum. In other cases payments are reduced only if

claims against the entire industry exceed some sum. What are the advantages

and disadvantages of the two structures?

If payments are decreased when claims against one issuer exceed a specified

amount, the issuer is co-insured above some level, and some degree of on-going

viability is ensured in the event of a catastrophe. The disadvantage and cons is that,

knowing this, the insurance firm may over-commit in this area in order to

gain additional premiums. If the payments are reduced based on claims against

the entire industry, an on-going and viable insurance market may be assured but

some firms may under-commit and yet still enjoy the benefits of lower payments.

Basis risk will be highest in the first case due to the larger firm specific risk.

Page 8 of 17

4.3 List some of the commodity futures contracts that are traded on exchanges. Who

do you think could usefully reduce risk by buying each of these contracts? Who

do you think might wish to sell each contract?

The list of commodity futures contracts is long, and includes:

Gold Buyers include jewelers.

Sellers include gold-mining companies.

Sugar Buyers include bakers.

Sellers include sugar-cane farmers.

Aluminum Buyers include aircraft manufacturers.

Sellers include bauxite miners.

6.0 TASK 5

Consider the commodities and financial assets listed in Table. The risk-free

interest rate is 6 percent a year, and the term structure is flat.

5.1 Calculate the six-month futures price for each case.

To calculate the six-month futures price, we use the following basic

relationships for commodities and for financial futures, respectively:

Ft = S0 (1 + rf + storage costs − convenience yield)t

Page 9 of 17

Ft = S0 (1 + rf − y)t

Thus, the six-month futures prices are:

Magnoosium: 2,800 × (1.03 – 0.04) = $2,772 per ton

Oat Bran: 0.44 × (1.03 – 0.03) = $0.44 per bushel

Biotech: 140.2 × 1.03 = $144.41

Allen Wrench: 58.00 × [1.03 – (1.20/58.00)] = $58.54

5-Year T-Note: 108.93 × [1.03 – (4.00/108.93)] = $108.20

Ruple: * 3.017 ruples/$

237

*Note that, for the currency futures (i.e., the Westonian ruple), the spot currency

quote is an indirect quote (i.e., ruples per dollar) rather than a direct quote (i.e.,

dollars per ruple). If I buy ruples today in the spot market, I pay ($1/3.1) per ruple

in the spot market and earn interest of [(1.120.5) –1] = 0.0583 = 5.83% for six

months. If I buy ruples in the futures market, I pay ($1/X) per ruple (where X is

the indirect futures quote) and I earn 6% interest on my dollars. Thus, the futures

price of one ruple should be:

1.0583/(3.1 × 1.03) = 0.33144 = 1/3.017

Therefore, a futures buyer should demand 3.017 ruples for $1.

5.2 Explain how a magnoosium producer would use a futures market to lock in

the selling price of a planned shipment of 1,000 tons of magnoosium six

months from now.

Page 10 of 17

The magnoosium producer would sell 1,000 tons of six-month magnoosium

futures.

5.3 Suppose the producer takes the actions recommended in your answer to

(5.2), but after one month magnoosium prices have fallen to $2,200. What

happens? Will the producer have to undertake additional futures market

trades to restore its hedged position?

Because magnoosium prices have fallen, the magnoosium producer will

receive payment from the exchange. It is not necessary for the producer to

undertake additional futures market trades to restore its hedge position.

5.4 Does the biotech index futures price provide useful information about the

expected future performance of biotech stocks?

No, the futures price depends on the spot price, the risk-free rate of interest,

and the convenience yield.

5.5 Suppose Allen Wrench stock falls suddenly by $10 per share. Investors

are confident that the cash dividend will not be reduced. What happens to

the futures price?

The futures price will fall to $48.24 (same calculation as above, with a spot

price of $48):

Page 11 of 17

48.00 × [1.03 – (1.20/48.00)] = $48.24

5.6 Suppose interest rates suddenly fall to 4 percent. The term structure

remains flat. What happens to the six-month futures price on the five-year

Treasury note? What happens to a trader who shorted 100 notes at the

futures price calculated in part (a)?

First, we recalculate the current spot price of the 5-year Treasury note.

The spot price given ($108.93) is based on semi-annual interest payments

of $40 each (annual coupon rate is 8%) and a flat term structure of 6% per

year. Assuming that 6% is the compounded rate, the six-month rate is:

(1 + 0.06)1/2 – 1 = 0.02956 = 2.956%

Incorporating similar assumptions with the new term structure specified in

the problem, the new spot price of the 5-year Treasury note will be $118.16.

Thus, the futures price of the 5-year T-note will be:

118.16 × [1.02 – (4.00/118.16)] = $116.52

The dealer who shorted 100 notes at the (previous) futures price has lost

money.

5.7 An importer must make a payment of one million ruples three months from

now. Explain two strategies the importer could use to hedge against

unfavorable shifts in the ruple—dollar exchange rate.

The importer could buy a three-month option to exchange dollars for ruples,

or the importer could buy a futures contract, agreeing to exchange dollars

Page 12 of 17

for ruples in three months’ time.

7.0 REFERENCES

1.http://search.4shared.com/postDownload/6pgXrqW7/principles_of_corporate_financ.html

2. https://www.google.com.my/#hl=en&gs_rn=12&gs_ri=psy-ab&tok=B0BOqq0hoU3FzZVag4AJHA&cp=7&gs_id=w&xhr=t&q=bradley+cooper&es_nrs=true&pf=p&output=search&sclient=psy-ab&oq=bredley&gs_l=&pbx=1&bav=on.2,or.r_qf.&bvm=bv.46340616,d.bmk&fp=7cd4b16ab95c27b7&biw=1688&bih=748

3. www.medtronic.com/corporate-governance/principles.../principles

4. www.asx.com.au/governance/corporategovernance.

5. Test Book (Corporate Financial Management Edition)

Page 13 of 17

8.0 COURSEWORK

1. Financial intermediaries contribute in many ways to our individual well-being and the smooth functioning of the economy. List out THREE example and briefly explain them.

The payment Mechanism Think how inconvenient life would be if all payments had

to be made in cash. Fortunately, checking accounts, credits cards, and electronic transfers

allow individuals and firms to send and receive payments quickly and safely over along

distances. Banks are the obvious providers of payments services, but they are not alone.

For example, if you buy shares in a money-market mutual fund, your money is pooled

with that of other investors and is used to buy safe, short-term securities. You can then

write checks on this mutual fend investment, just as if you had a bank deposit.

Borrowing and Lending Almost all financial institutions are involved in channeling

savings toward those who can best use them. Thus, if Ms Jones has more money now

than she needs and wishes to save for a rainy day, she can put the money in a bank

savings deposit. If Mr. Smith wants to buys a car now and pay a for it later, he can

borrow money from the bank. Both the lender and borrower are happier than if they were

forced to spend cash as it arrived. Of course, individuals are not alone in needing to raise

cash. Companies with profitable investment opportunities may wish to borrow from the

bank, or they may raise the finance by selling new shares or bonds. Governments also

often run at a deficit, which they fund by issuing large quantities of debt.

Page 14 of 17

In principle, individuals or firms with cash surpluses could take out newspaper

advertisements or surf he Net looking for those with cash shortages. But it can be cheaper

and more convenient to use a financial intermediary, such as a bank, to link up the

borrower and lender. For example, banks are equipped to check out the would-be

borrower’s creditworthiness and to monitor the use of lent out. Would you lend money to

a stranger contacted over the internet? You would be safer lending the money to the bank

and letting the bank decide what to do with it.

Notice that banks promise their checking account customers instant access to their

money and at the same time make long-term loans to companies and individuals. This

mismatch between the liquidity of the bank’s liabilities (the deposits) and most of its

assets (loans) is possible only because the number of depositors is sufficiently large that

the bank can be fairly sure that they will not all want to withdraw their money

simultaneously.

Pooling Risk. Financial markets and institutions allow firms and individuals to pool

their risks. For instance, insurance companies make it possible to share the risk of an

automobile accident or a household fire. Here is another example. Suppose that you have

only a small sum of invest. You could buy the stock of a single company, but then you

would be wiped out if that company went belly-up. It is generally better to buy shares in a

mutual fund that invests in a diversified portfolio of common stocks or other securities. In

this case you are exposed only to the risk that security prices as a whole will fall.

Page 15 of 17

The basic functions of financial markets are the same the world over. So it is not

surprising that similar institutions have emerged to perform these functions. In almost

every country you will find banks accepting deposits, making loans, and looking after the

payments system. You will also encounter insurance companies offering life insurance

and protection against accident. If the country is relatively prosperous, other institutions,

such as pension funds and mutual funds, will also have been established to help manage

people’s savings.

Of course there are differences in institutional structure. Take banks, for example. In

many countries where securities markets are relatively undeveloped, banks play a much

more dominant role in financing industry. Often the banks undertake a wider range of

activities than they do in the United States. For example, they may take large equity

stakes in industrial companies; this would not generally be allowed in the United States.

2. In most companies stockholders elect directors by using a system of majority voting. Please explain the voting procedures.

In most companies stockholders elect directors by a system of majority voting. In this

case, each director is voted upon separately and stockholders can cast one vote for each

share that they own. If company’s articles permits cumulative voting, the directors are

voted upon jointly and stockholders can, if they wish, allot all their votes to just one

candidate. 8 Cumulative voting makes it easier for a minority group among the

stockholders to elect directors who will represent the group’s interests. That is why some

shareholder groups campaign for cumulative voting.

Page 16 of 17

One many issues a simple majority of votes cast is sufficient to carry the day, but

the company charter may specify some decisions that require a supermajority of, say,

75% of those eligible to vote. For example, a supermajority vote is sometimes needed to

approve a merger.

The issues on which stockholders are asked to vote are rarely contested, particularly

in the case of large, publicly traded firms. Occasionally, there are proxy contests in which

the firm’s existing management and directors complete with outsiders, for effective

control of the corporation. But the odds are stacked against the outsides, for the insiders

can get the firm to pay all the costs of presenting their case and obtaining votes.

Page 17 of 17