Question

Which one of the following is not a typical characteristic of a leveraged buyout target?

A. Low debt levels

B. Concentrated ownership (large shareholders)

C．Potential for gains from restructuring

D. Large cash flows that can be used to service the debt

Last year, company Z invested £10m to develop a new software. However, all of its customers have now switched to a different operative system that is incompatible with Z's software. It is estimated that upgrading the software to make it compatible will cost £5m. The company should upgrade the software if the present value of the future stream of cash flows generated by the project is larger than (in £m)

A.15(1+r)

B．10(1+r)

C. 10(1+r)+5

D．5

Consider the following two situations

A．An investor considering whether to buy a firm’s bond is unable to assess the risk associated with the firm's existing projects

B．A market maker is unable to observe whether its counterparty is an insider or not

The nature of the asymmetric information problem in situations A and B can be described as

1. Adverse selection in both cases

B．Moral hazard in both cases

C. Adverse selection in case A. and moral hazard in case B.

D．Moral hazard in case A. and adverse selection in case B.

An increase in the amount of goods held in inventory

A. Implies a reduction in working capital and should be accordingly considered as a positive cash flow

B．Can be seen as a sunk cost and therefore should not be considered when calculating the project’s cash flows

C．Implies an increase in working capital and should be accordingly considered as a negative cash flow

D. Reduces the opportunity cost of a project

Firm X has generated average annual profits of £Y>0 over the last 10 years. In the same period, the firm has not paid any dividend (all earnings have been retained) and its debt has been constant at £D>0. The firm’s business model and its market environment have also stayed roughly the same during the 10 year period. This implies that

A. X’s debt to equity ratio is the same as it was 10 years ago

B. The beta of firm X’s larger than it was 10 years ago

C．The beta of firm X’s equity is the same as it was 10 years ago

D．The beta of firm X’s equity is smaller than it was 10 years ago

Last year firm X was only undertaking projects with an IRR larger than 10%. This year the firm has decided to increase the hurdle rate to 12%. This decision can be justified

A. On the grounds that the risk free rate has decreased

B. On the grounds that the risk premium was previously underestimated

C. On the grounds that the new projects are expected to have a lower beta than the firm as a whole

D．On the grounds that the firm’s beta was previously overestimated

Answer 1

Leveraged buyouts are not aimed at those companies which have a large proportion of concentrated share holding. Concentrated share holding does not allow the new firm to take the control in its own hands. Hence it will need a scattered shareholding not concentrated.

Rest are the features of leveraged buyout target like low debt,high cash flows, and potential gains from restructuring.

So the correct answer would be option ( B).