题目内容
The chief executive officer (CEO) of Faoilean Co has just returned from a discussion at a leading university on the ‘application of options to investment decisions and corporate value’. She wants to understand how some of the ideas which were discussed can be applied to decisions made at Faoilean Co. She is still a little unclear about some of the discussion on options and their application, and wants further clarification on the following:
(i) Faoilean Co is involved in the exploration and extraction of oil and gas. Recently there have been indications that there could be significant deposits of oil and gas just off the shores of Ireland. The government of Ireland has invited companies to submit bids for the rights to commence the initial exploration of the area to assess the likelihood and amount of oil and gas deposits, with further extraction rights to follow. Faoilean Co is considering putting in a bid for the rights. The speaker leading the discussion suggested that using options as an investment assessment tool would be particularly useful to Faoilean Co in this respect.
(ii) The speaker further suggested that options were useful in determining the value of equity and default risk, and suggested that this was why companies facing severe financial distress could still have a positive equity value.
(iii) Towards the end of the discussion, the speaker suggested that changes in the values of options can be measured in terms of a number of risk factors known as the ‘greeks’, such as the ‘vega’. The CEO is unclear why option values are affected by so many different risk factors.
Required:
(a) With regard to (i) above, discuss how Faoilean Co may use the idea of options to help with the investment decision in bidding for the exploration rights, and explain the assumptions made when using the idea of options in making investment decisions. (11 marks)
(b) With regard to (ii) above, discuss how options could be useful in determining the value of equity and default risk, and why companies facing severe financial distress still have positive equity values. (9 marks)
(c) With regard to (iii) above, explain why changes in option values are determined by numerous different risk factors and what ‘vega’ determines. (5 marks)
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Vogel Co, a listed engineering company, manufactures large scale plant and machinery for industrial companies. Until ten years ago, Vogel Co pursued a strategy of organic growth. Since then, it has followed an aggressive policy of acquiring smaller engineering companies, which it feels have developed new technologies and methods, which could be used in its manufacturing processes. However, it is estimated that only between 30% and 40% of the acquisitions made in the last ten years have successfully increased the company’s shareholder value.
Vogel Co is currently considering acquiring Tori Co, an unlisted company, which has three departments. Department A manufactures machinery for industrial companies, Department B produces electrical goods for the retail market, and the smaller Department C operates in the construction industry. Upon acquisition, Department A will become part of Vogel Co, as it contains the new technologies which Vogel Co is seeking, but Departments B and C will be unbundled, with the assets attached to Department C sold and Department B being spun off into a new company called Ndege Co.
Given below are extracts of financial information for the two companies for the year ended 30 April 2014.
Other information
(i) It is estimated that for Department C, the realisable value of its non-current assets is 100% of their book value, but its current assets’ realisable value is only 90% of their book value. The costs related to closing Department C are estimated to be $3 million.
(ii) The funds raised from the disposal of Department C will be used to pay off Tori Co’s other non-current and current liabilities.
(iii) The 7% unsecured bond will be taken over by Ndege Co. It can be assumed that the current market value of the bond is equal to its book value.
(iv) At present, around 10% of Department B’s PBDIT come from sales made to Department C.
(v) Ndege Co’s cost of capital is estimated to be 10%. It is estimated that in the first year of operation Ndege Co’s free cash flows to firm will grow by 20%, and then by 5·2% annually thereafter.
(vi) The tax rate applicable to all the companies is 20%, and Ndege Co can claim 10% tax allowable depreciation on its non-current assets. It can be assumed that the amount of tax allowable depreciation is the same as the investment needed to maintain Ndege Co’s operations.
(vii) Vogel Co’s current share price is $3 per share and it is estimated that Tori Co’s price-to-earnings (PE) ratio is 25% higher than Vogel Co’s PE ratio. After the acquisition, when Department A becomes part of Vogel Co, it is estimated that Vogel Co’s PE ratio will increase by 15%.
(viii) It is estimated that the combined company’s annual after-tax earnings will increase by $7 million due to the synergy benefits resulting from combining Vogel Co and Department A.
Required:
(a) Discuss the possible reasons why Vogel Co may have switched its strategy of organic growth to one of growing by acquiring companies. (4 marks)
(b) Discuss the possible actions Vogel Co could take to reduce the risk that the acquisition of Tori Co fails to increase shareholder value. (7 marks)
(c) Estimate, showing all relevant calculations, the maximum premium Vogel Co could pay to acquire Tori Co, explaining the approach taken and any assumptions made. (14 marks)
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