what can i say

3b)

There are several reasons why local borrowing is generally preferred:

1.    It provides a natural currency hedge. if a company is generating a

cash flow in foreign currency but has to service a debt in pounds sterling then it has substantial 'transaction exposure' currency risk. If the debt is in the foreign currency, the problem disappears.

2. If a company is not filly consolidated into the parent's accounts then local borrowing will not appear as a liability in the patent's accounts. The finance director will prefer this. It will make the parent look stronger financially with a lower gearing (or 'leverage') ratio.

3. The interest on local debt will usually be tax-deductible from local taxes. If there is significant inflation in the foreign country, interest rates there are likely to be high and tax-deductibility can be very valuable.

4. If there were major political change in the foreign country and the government decided to nationalize the tile factory, the government would take over the debts at the same time that it took over the assets. if the borrowing for the project had taken place outside the foreign country this would not be the case.

5. If restrictions are imposed on currency convertibility, the ability to service local debt will not be affected. The ability to pay interest or dividends to the parent or foreign banks might be.

3(c) 

(i)            This project is subject to transactions currency exposure. This risk arises where a company has agreed to pay out or receive specific amounts in foreign currencies at agreed dates or within agreed periods in the future. The exposure of the company is the net position in each currency. If agreed payments match agreed receipts in a currency they cancel each other out. An important Treasury function in multinational companies is to establish the net currency exposures of the whole company by aggregating the positions of the divisions and subdivisions. An unusual type of transaction exposure arises when a company makes a quotation for a major project in a foreign country, or when it sets a price in a foreign currency without knowing exactly how much it will sell. It is difficult to protect against this type of risk.

(ii) This deal generates transaction exposure of $3501000 for a six-month period. Borrow dollars from a bank, promising to repay $350,000 in six months’ time. The amount borrowed will be a little less than $350,000, since the repayment must include both principal and interest. Exchange the borrowed dollars for pounds at the spot rate, and deposit the pounds in the bank. When the customer pays the $350,000, this money is used to repay the dollar loan. The pounds on deposit can be regarded as the 'proceeds' of the customer's payment, and these proceeds will be independent of any changes in the exchange rate over the six- month period.

6 a)

The assumptions underlying MM1 are as follows:

• Capital markets have no frictions (including no taxes and transaction costs);
• Investors have perfect information and homogeneous expectations;
• Investors care only about their wealth;
• Financing decisions do not affect investment outcomes.

The key result is that financing decisions do not affect investment outcomes.

Hence, two firms with identical investment policies will derive identical returns regardless of their financing.

As their investment proceeds are the same, they should have the same value.

MM I tells us that the firm value is independent of leverage.

Another key point is that none of their cash flow goes to anyone outside those

who own debt and equity.

b)

Another way to see MM proposition is to use the Black -Scholes option pricing

analysis.

The pay-off profile for equity in a levered -firm is precisely the same as that of

a call option with exercise price equal to the face value of the firm's debt.

The pay-off profile for debt can be replicated by a risk -free investment paying

B and simultaneously write a put option struck at B. Given put-call parity, the sum of the values of debt and equity must be equal to the value of firms assets. The sum of debt and equity is a position consisting of a call option less a put option (both struck at B) plus lending B/(1+rD). This holds whatever the specific value taken by B. Hence, as the face value of debt varies, firm value is unchanged. The Black-Scholes analysis of the MM proposition also gives us a simple way in which to value debt and equity claims on firms.

7

a)

Pre-bid - This stage involves the development of the acquisition strategy.

The exploration of the logic behind the way in which value will be created by the merger or acquisition and the acquisition criteria. Then the search begins for

potential targets which are screened (again using a set of criteria) and the final

selection of target or targets identified. This stage concludes with the evaluation

of the target in terms of strategic fit to justify the acquisition.

Bidding stage - In this stage of the process, the target has been chosen and

bidding management must determine a bidding strategy. The target is then valued using an appropriate valuation model (e.g. PER, Tobrns Q. etc) and a bid price for the target determined. Finally during this stage the negotiations are

undertaken, finance must be arranged and the deal closed. Discussion on hostile -v- negotiated takeover.

Post-bid - The final stage involves the evaluation of the organisational and

cultural fit of the merging companies. The integration strategy must be decided

upon. The strategy, organisation and culture of the merging companies must be

matched.

b)

The choice is cash, debt or equity.

Methods of payment include: Cash; Share exchanges; Cash underwritten by a share offer (vendor placing); Loan stock; Convertible loan stock or preferred stock; Deferred payment.

Factors affecting the choice include: relative costs of the two methods i.e. cost of debt capital, cost of equity (stock price) and the cash the company has in reserve.

Cash: For the shareholder, certainty of payment and value but likely to trigger tax liability, portfolio rebalancing and no longer own shares in the company. For

company, no dilution of stock, retain full control of target, avoids using undervalued equity and target shareholder do not become shareholders in the company but may stretch resources or require new issue, and may pay too much cash which is bad for bidder. Debt financing has similar characteristics to cash.

Equity: For the shareholder, delays tax liability, avoids transaction costs, ongoing ownership of company but uncertainty over performance and equity may be overvalued. For the company, useful currency usage if stocks are highly rated and initial cash flow cost is low but depresses stock price, expensive form of capital, maybe additional cash flow commitment in terms of dividends, dilutes former shareholdings and will reduce gearing.