Scribd
Upload
126 views3 pages

Corporate+Finance Tutorial 06 Exercises

This document contains an exercise set from a corporate finance course on capital structure and managerial incentives/asymmetric information. It includes 3 tasks: 1) Analyzing the agency costs of leverage for a biotech start-up considering 3 research strategies and 2 levels of debt due. 2) Examining agency costs and trade-off theory for a company considering empire building, risk shifting, and 4 levels of debt due. 3) Discussing whether it would be wise for an Internet company CEO to use overvalued stock to acquire non-Internet companies during the late 1990s Internet boom.

Uploaded by

strategy.inform
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
126 views3 pages

Corporate+Finance Tutorial 06 Exercises

This document contains an exercise set from a corporate finance course on capital structure and managerial incentives/asymmetric information. It includes 3 tasks: 1) Analyzing the agency costs of leverage for a biotech start-up considering 3 research strategies and 2 levels of debt due. 2) Examining agency costs and trade-off theory for a company considering empire building, risk shifting, and 4 levels of debt due. 3) Discussing whether it would be wise for an Internet company CEO to use overvalued stock to acquire non-Internet companies during the late 1990s Internet boom.

Uploaded by

strategy.inform
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 3

INSTITUTE FOR CAPITAL MARKETS AND CORPORATE FINANCE

Corporate Finance
(Summer Term 2021)

Exercise Set 6: Capital Structure and Managerial Incentives /


Asymmetric Information

Task 1: Agency Costs of Leverage

Zymase is a biotechnology start-up firm. Researchers at Zymase must choose one of three
different research strategies. The payoffs (after-tax) and their likelihood for each strategy are
shown below. The risk of each project is diversifiable.

Strategy Probability Payoff (million $)

A 100% 75

B 50% 140

50% 0

C 10% 300

90% 40

a) Which project has the highest expected payoff?

b) Suppose Zymase has debt of $40 million due at the time of the project’s payoff.
Which project has the highest expected payoff for equity holders?

c) Suppose Zymase has debt of $110 million due at the time of the project’s payoff.
Which project has the highest expected payoff for equity holders?

d) If management chooses the strategy that maximizes the payoff to equity holders,
what is the expected agency cost to the firm from having $40 million in debt due?
What is the expected agency cost to the firm from having $110 million in debt due?

Corporate Finance / Summer Term 2021 Exercise Set 6: Capital Structure and Managerial Incentives / Asymmetric Information
-2-

Task 2: Agency Costs and Trade-Off Theory


If it is managed efficiently, Remel Inc. will have assets with a market value of $50 million, $100
million, or $150 million next year, with each outcome being equally likely. However, managers
may engage in wasteful empire building, which will reduce the firm’s market value by $5 million
in all cases. Managers may also increase the risk of the firm, changing the probability of each
outcome to 50%, 10%, and 40%, respectively.

a) What is the expected value of Remel’s assets if it is run efficiently?

Suppose managers will engage in empire building unless that behavior increases the likelihood of
bankruptcy. They will choose the risk of the firm to maximize the expected payoff to equity
holders.

b) Suppose Remel has debt due in one year as shown below. For each case, indicate
whether managers will engage in empire building, and whether they will increase
risk. What is the expected value of Remel’s assets in each case?

i. $44 million
ii. $49 million
iii. $90 million
iv. $99 million

c) Suppose the tax savings from the debt, after including investor taxes, is equal to
10% of the expected payoff of the debt. The proceeds from the debt, as well as
the value of any tax savings, will be paid out to shareholders immediately as a
dividend when the debt is issued. Which debt level in part (b) is optimal for
Remel?

Corporate Finance / Summer Term 2021 Exercise Set 6: Capital Structure and Managerial Incentives / Asymmetric Information
-3-

Task 3: Asymmetric Information and Capital Structure


During the Internet boom of the late 1990s, the stock prices of many Internet firms soared to
extreme heights. As CEO of such a firm, if you believed your stock was significantly overvalued,
would using your stock to acquire non-Internet stocks be a wise idea, even if you had to pay a
small premium over their fair market value to make the acquisition?

Corporate Finance / Summer Term 2021 Exercise Set 6: Capital Structure and Managerial Incentives / Asymmetric Information

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy