UNIVERSITY OF ROCHESTER Name William E. Simon Graduate School of Business Administration Finance 423 Professor G. William Schwert Corporate Financial Policy & Control CS3-110L, 585-275-2470 Fall 2006 Fax: 585-461-5475 email: schwert@schwert.simon.rochester.edu Midterm Exam: October 18, 2006 Instructions: Exams are individual assignments, so do not collaborate with anyone else on this exam. Write your name at the top of each odd numbered page, and then stop to read all of the questions before starting to answer any of them. You need to write your answers in the space provided in this exam. Good luck!!! 1. (25 points) Read the article below from the Wall Street Journal and then answer the question below it. Sevin Rosen Scuttles New Fund To Re-Evaluate Venture Climate By REBECCA BUCKMAN October 9, 2006; Page C4 Another venture-capital firm, Sevin Rosen Funds, is aborting efforts to raise more money amid a tough environment for early-stage, high-tech investing. Sevin Rosen, a 25-year old firm with offices in Dallas and Palo Alto, Calif., sent a letter to investors Friday saying it had stopped fund raising for its 10th investment fund and would take the "radical step" of returning $250 million to $300 million in commitments already received. The fund was to have closed on initial commitments this week, said Steve Dow, a Sevin Rosen general partner. The move by the firm was reported Saturday by the New York Times. In an interview over the weekend, Mr. Dow said his firm concluded the venture industry was suffering from structural, fundamental issues -- including too much money funding too many companies, as well as a lackluster market for initial-public offerings of small companies' stock -- and needed to rethink its investing approach. Sevin Rosen's letter to investors noted that "overall returns for the venture industry are way too low" and are "insufficient" even for firms in the upper quartile of performers. "We're not going out of business," Mr. Dow said, adding that Sevin Rosen was still actively working with investments in a $300 million fund raised in 2004. A larger fund raised in 2000 remains underwater, he said. Mr. Dow said he and his partners were "cautiously optimistic" the firm would "come back next year sometime" with a new investing model, possibly a smaller fund. Sevin Rosen has $1.87 billion under management. In recent months other well-known Silicon Valley venture outfits, including Mobius Venture Capital and Worldview Technology Partners, also decided not to raise new funds as returns for venture investors have lagged behind historical levels and some firms have suffered staff turnover. Venture capitalists take stakes in small start-ups, hoping for a big payout later if those firms go public or are acquired by another company.
Mr. Dow said he hoped Sevin Rosen's move would spark a broader discussion about whether too much money is being invested in venture capital, and whether the old investing model still works. "I'm waiting for someone to call me and tell me our analysis of the problem is wrong," he said. Based on what you have read and learned in FIN 423 and this WSJ article, do you think that this would be a good time to consider seeking venture capital funding if you were the CFO of a private firm seeking to grow? Why, or why not?
FIN 423 -- Corporate Financial Policy & Control 3 Name Professor G. William Schwert -- Midterm Exam 2. (25 points) Read the article below from the Wall Street Journal and then answer the questions below it. Wall Street Journal. Aug 14, 2006. pg. A.2 By DENNIS K. BERMAN US LEC Corp. and closely held Paetec Communications Inc., two survivors of the telecommunications boom and bust, are planning to merge to form a company with an indicated equity value of about $450 million, the companies said yesterday. Both US LEC and Paetec are relatively small actors in the telecommunications realm, each fighting to control a niche amid industry giants such as AT&T Inc. and Verizon Communications Inc. There was a flowering of such players in the late 1990s, after Congress deregulated the telecom industry to allow entrants to challenge the nation's dominant phone companies with new services and pricing. Investors committed billions of dollars to these companies, and most eventually ended up in bankruptcy proceedings or were quietly swept up in consolidation years afterward. That now is the course for US LEC, based in Charlotte, N.C., and Paetec, based in Fairport, N.Y., both of which provide medium-size and larger businesses with voice and data services. Under the plan expected to be announced today, Paetec shareholders will control about two-thirds of the new company, with US LEC holders getting the rest at no premium to their current market price. The company will continue to trade under US LEC's existing Nasdaq Stock Market symbol, but will use the Paetec name. In Nasdaq Stock Market composite trading Friday, US LEC shares rose 31 cents, or 7%, to $4.77. The equity value of the deal is about $450 million, based on US LEC's current stock market value of almost $150 million. The company will also carry an additional $850 million in debt. Combined, the company will have annual revenue of almost $1 billion and $187 million in earnings before interest, taxes, depreciation and amortization. The company hopes to save $25 million in costs in the first year after the merger closes and $40 million annually thereafter. By comparison, AT&T has revenue of $55 billion and a market value of more than $117 billion. In a joint interview, US LEC Chairman Richard Aab and Arunas Chesonis, Paetec chairman and chief executive, said that competitors to the biggest telecom franchises enjoy better prospects today than they have had in a long time. That is because the large phone players are in the midst of integrating some historic mergers of their own: Verizon purchased MCI Corp., for example, while SBC Communications Inc. purchased AT&T and took on AT&T's name. "It's almost been a reverse of the last few years," Mr. Chesonis said. "Our toughest competitors were AT&T and MCI. They're going through a transition, with a dislocation of employees and policy changes. It's tough for them to stay focused on their customers. People are worried about their jobs. They have different priorities." Now, adds, Mr. Chesonis: "We've been tripping all over each other for their business." Deutsche Bank AG, Houlihan Lokey Howard & Zukin and law firm Skadden, Arps, Slate, Meagher & Flom LLP advised US LEC. Merrill Lynch & Co., Blackstone Group, Capitalink LC and law firm Hogan & Hartson advised Paetec.
(a) In August 2005, Paetec withdrew its planned IPO because of market conditions. Compare the two transactions from the perspective of Paetec. (b) Given your analysis of this transaction from the perspective of Paetec, what do you think Paetec s primary motivation was in seeking an IPO in the first place?
FIN 423 -- Corporate Financial Policy & Control 5 Name Professor G. William Schwert -- Midterm Exam 3. (25 points) Compare and contrast the advantages and disadvantages of different methods of selling seasoned equity: (a) an underwritten firm commitment offering; (b) a rights offering; (c) a private placement of stock;
(d) a stock purchase plan connected with a dividend reinvestment plan. 4. (25 points) The evidence in Asquith and Mullins' paper indicates that the stock market doesn't like it when firms sell stock, and the evidence in Eckbo's paper indicates that the market doesn't seem to mind sales of debt. Given these facts, answer the following questions: (a) Does this evidence imply that the corporate tax shield is a dominant factor in determining the optimal capital structure? (b) Why do any firms sell equity, when it makes the old stockholders worse off?
FIN 423 -- Corporate Financial Policy & Control 7 Name Professor G. William Schwert -- Midterm Exam (c) Why doesn't the stock market react positively to debt sales, given that it reacts negatively to stock sales? (i.e., Is there a profitable trading rule here?) (d) How would you as the CFO choose between stock and bond issues to maximize the value of the firm?