...American Finance Association Limited Arbitrage in Equity Markets Author(s): Mark Mitchell, Todd Pulvino, Erik Stafford Source: The Journal of Finance, Vol. 57, No. 2 (Apr., 2002), pp. 551-584 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2697750 Accessed: 08/01/2010 15:26 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association...
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...viewed as a result of an investment decision because if the current assets are less than its liabilities, the company may have a negative net worth (Block, Hirt, & Danielson, 2010). The degree of operating leverage or DOL is defined as the percentage change in the operating income that occurs as a result of a percentage change in the units sold (Block, Hirt, & Danielson, 2010). When a company is highly leveraged, they will have an increase in income as their volume expands. When the DOL is computed close to the break-even point it will result in a higher number because of the increase in the operating income (Block, Hirt, & Danielson, 2010). There are leveraged firms and conservative firms. The DOL for a leveraged firm is higher than of a conservative firm. This means that in this example, the Hi Tech Manufacturing Company would be considered to be more leveraged than that the Old School. Financial leverage is the amount of debt used in the capital structure of the firm (Block, Hirt, & Danielson, 2010). The text pointed out that it is helpful to remember that the operating leverage primarily affects the left-hand side of the balance sheet and the financial leverage primarily affects the right-hand side of the balance sheet. The degree of financial leverage or DFL is defined as the percentage...
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...Sensitivities? What happened to the gross margins? Willing to use these projections for valuation? Car Wash Partners Management Tom Curtis – successful entrepreneur from the past. Credible? Curtis capable of leading major change in this industry? No further management team as yet Investors Cabot Brown (Brown & McMillan) Start up-VCs? First deal Who are their investors? Bill Burgin (Bessemer Partners) Experienced VC Investing with a friend? Does the investment fit their needs? Car Wash Partners Valuation Who puts up the money? (BMC, Bessemer; total of $6.6) How much is Curtis’ contribution worth at this stage? The “pre-money” value ($1.1; “post-money” value ($7.7, see Exh 9). VCs had 86% of capital) P/EBITDA 1997 (Exh 6); assuming 50% leverage P = $7,700 EDITDA = $629 Ratio = 12.2x In 2001: EBITDA = $50,192 (Increase due to 45x growth in revenues; 1.8x growth in CF margins) ROI = $18.8/$142 = 13.2% (after $135 of new equity financing) In 2001, at Exit via IPO at EBITDA x 12 = $600 million X 15% = 90 4yr ROI = EBITDA x 10 = 500 75 P/E of 25 = 470 70 P/E of 15 = 282 42 85% 77 74 53%...
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...book ratio where investors value Pepsi's balance sheet structure more than Coke. Pepsi is priced 5.5x of equity value compared to Coke which is priced only at 5x. Having a higher operating and profit margin, Coke is more likely to be able to sustain any shocks in the market (eg. from lower sales). The sustainability of Coke’s earnings are also helped by more efficient tax structure seen from lower effective tax rate compared to Pepsi. Its Selling General Administration expenses are also within the industry norm (compared to Pepsi). Coke’s has room to further improve its efficiency by improving its balance sheet structure. This includes a more efficient use working capital (eg. reducing receivables and inventory days), using higher leverage to attain higher return on equity and optimizing/sweating the assets more to generate higher asset turnover. Coke’s acquisition is substantially cashless. It exchanged $3.4bn of equity investment it had in CCE and assumed $9.5bn in debt and obligations to control CCE’s North American bottling operations. This will impact Coke’s financials in a few ways: i) With the acquisition, there could possibly be synergies and cost reduction which would benefit Coke’s bottom line. The resultant Coke’s earnings could improve with the consolidation of North American bottling earnings. This will then improve EPS....
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...appeal to the core readers. The very foundation of the business is therefore neglected * Rationale for the diversification strategy was a mitigate to cyclicality, but this clearly did not pay off. No clear evidence of alternative synergies between the businesses. Moreover, restructuring charges are substantial * Additional investment in declining trading cards business through the acquisition of SkyBox, while Marvel was already showing signs of distress * Drafting an unconvincing reorganization plan, which among others includes an additional acquisition (which raises new risk and debt in the short term). Selling off unsynergetic business units may have made more senses Bad execution * High leverage using overpriced shares as collateral. Given the this leverage in combination with relatively high coupon rates, debt service became problematic * Structuring debt based on collateral shares instead of others assets and cash flows makes a company highly dependent of debt providers in case of a covenant breach * Cash flow in a declining market is used for investments instead of deleveraging. Through SkyBox acquisition additional debt was taken on. Besides that,...
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...solid foot by 1980. The four year plan included steps to introduce fiscal discipline and maintain certain limits on debt to capital ratio, rating and fund raising activities. Also growth in hotel management fees and cash inflows from selling stakes in low return operations generated an excess amount of cash for the firm. The firm strongly believed in investing its cashflows as it believed in the operating model and the fact that investors would gain higher returns than if dividends were paid out. This higher cash inflow led to reduced need to raise debt. Also this excess cash could be used to pay down outstanding debt (expected to be $125 million by 1883). On the other hand the firm’s equity value was rising and this led to a declining leverage ratio. The management of the company believed that its expertise was in hotel development and management and not in long term hotel ownership. The strategies they designed were based on these factors and they started producing excellent results. In 1980 the growth prospects looked great, especially when compared to its competitors. While its peer companies had stopped growing in businesses they owned and grew very selectively in those they managed without owning, the independent companies weren’t even able to obtain financing for their planned expansion. Marriott wanted to make use of their advantage in position to accelerate their hotel room growth to 20%-25%. Their management contracts earned them a minimum constant percentage of...
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...ACCT 7340 Fall 2013 Professor Lin Solution to Individual Assignment 8 (1) The cost of equity is calculated as follows. Whirlpool: ........................... IBM: ..................................... Target Stores: ...................... 3.5% + (2.27 x 5.0%) = 14.85% 3.5% + (0.78 x 5.0%) = 7.40% 3.5% + (1.20 x 5.0%) = 9.50% (2) We use the book value of the debt and the market value of the equity as the proxies for the intrinsic values of debt and equity, respectively. Whirlpool 2,597 46.7% 2,959 53.3% 5,556 100% IBM 23,925 17.7% 110,984 82.3% 134,909 100% Target Stores 21,752 49.1% 22,521 50.9% 44,273 100% IVd IVe IVf Weighted Average Cost of Capital: Whirlpool: ........................ IBM: .................................. Target Stores: ................... (.467 x .65 x 6.1%) + (.533 x 14.85%) = 9.76% (.177 x .65 x 4.3%) + (.823 x 7.40%) = 6.58% (.491 x .65 x 4.9%) + (.509 x 9.50%) = 6.40% Note that Whirlpool has the highest weighted average costs of capital because it has the highest cost of both debt and equity. However, this does not mean firms with higher cost of debt and higher cost of equity will always have higher WACC. Look at the comparison between IBM and Target. IBM has the lower cost of debt and equity than Target. However, IBM has least leveraged capital structure (Debt-to-Equity ratio= .177/.823 = 0.216) while Target has the most leveraged capital structure with Debt-to-Equity ratio = 0.966. The extremely high portion of equity capital in IBM...
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...developed when e-commerce was in an infancy stage. This gave Amazon the opportunity to create and expand on the platform that we know today. It would prove to be very difficult if a similar firm were to try and duplicate the same success as Amazon. A similar firm would need to develop the credibility and reputation that Amazon has taken years to develop. Then it would need to establish a large client base that can bring together both buyers and sellers. One of the second major tools that a new firm would need to be competitive with Amazon is large amounts of capital. If a firm was to borrow capital the result would cause the company to become highly leveraged, which would mean that the margin of error would have to be very slim. High leverage a slim margin for error, thus in turn reduces pricing power and lowers profit margin. Within the past decade investment capital for online companies has become extinct sense the great boom of the .com era (Smith, 2015). This has left the playing fields wide open for venture capitalist seeking an opportunity for the next big thing. Within this paper we will...
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...Seagate Technology Buyout - Case Study Question 1: Why is Seagate undertaking this transaction? Is it necessary to divest the Veritas shares in a separate transaction? Who are the winners and losers resulting from the transaction? Answer: Seagate Technology was badly undervalued as far asSTOCK MARKET is considered, and due to this, the company decided to go for leverage buyout option. A large stake of VERITAS Software Corporation's stocks is owned by Seagate Technology, because of which its stock price is doubled (from its original price), however, the share price of Seagate Technology hardly changed for a long time. Therefore, the reason that the attempts and efforts of senior management were useless, made them decide to engage in Leverage Buyout (LBO). As a result, Seagate went for two fold transaction, i.e. the first is to sell out all of the company's disk drive manufacturing assets including $ 765 million of cash to the acquirer “Silver Lake”. On the other hand, the most crucial thing for Seagate Technology is to take care of the large stake of VERITAS Software Corporation's stocks. Therefore, it was essential for Seagate Technology to go for a separate transaction in order to evade paying large amount of taxes. The transaction of shares among VERITAS and Seagate is taken into account as reorganization of asset, while not applying any corporate taxes. Thus, by using two-fold transaction, Seagate Technology became able to liquidate its undervalued shares...
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...Homework 1: Part 1: H Partners and Six Flags Case Study. Following questions are based on the case study. 1. Briefly describe the reasons for Six Flag’s deteriorating performance. Do you believe the core business is sound? (Note-I am not looking for a very long answer. The reasons for bankruptcy will play a big role in your decision to invest or not invest in a company. For instance: a business cycle downturn vs new research that shows company’s products are harmful for people (think asbestos)) Due to the volatile state of Six Flags between 2003 and 2009, one could conclude that Six Flag’s business model was not financially sound. In looking at comparable firms such as Disney or Universal Studios, the amusement parks are not their only component in their business model. In addition to being poorly diversified, Six Flags sold tickets at steep discounts and heavy promotions, which drove the average ticket price to $21.10 in 2008. Unlike their competitors, the parks are marketed to consumers within 100 miles of the park. Firms like Disney and Universal have both domestic and international tourists, the majority of which come from more than 100 miles away. This leaves Six Flags with limited same-park growth because they are limited to the population within driving distance to the park. Furthermore, an unfortunate sequence of events hit the company in 2009. The outbreak of the H1N1 (swine flu virus) caused the Mexico City park to shut down and negatively impacted...
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...L. The data given in column L matches most with that of Electric and gas utility. A notable feature here would have to be their low inventory which is quite low (2%) meaning they do not need many goods for their line of business. This is mainly so because their revenue comes from electricity and natural gas sales which are a form of natural emissions in one way or another. Plant and equipment tends to be high in this industry as there is heavy machinery in power plants used to convert natural gas into electricity/ transform energy into usable power. It happens to be 60% of total assets. Another figure that leads to our decision is long-term debt of 32%, which is quite high compared to other industries, which makes sense given their high plant and equipment percentage. This tells us most of their financing comes from borrowings, making this a highly leveraged industry. Also, their inventory turnover ratio of 2.3 correlates with their low inventory percentage of 3%, which essentially tells us, they are not incurring many costs of goods sold. Moreover, the profit margin here is at .09, which is higher than most of the other industries, and it is safe to say that is due to the fact there is not much competition within this industry. A. Column A gives us data matching that of an Online Retailer. To begin, their inventory is at 19% of assets, which is higher than majority of the other industries mentioned. This can be easily explained by the fact that they are selling products to...
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...Workshop 4 Problems Kevin Rock MBA 465 Strategic Management BSA 555 November 1, 2011 David R. Gray, Ph.D 1. Why are acquisition strategies popular in many firms competing in the global economy? Because of globalization; deregulation of multiple industries in many different economies and favorable legislation; the number and size of domestic and cross-border acquisitions continues to increase; especially from emerging economies 2. What reasons account for firms’ decisions to use acquisition strategies as a means to achieving strategic competitiveness? To increase market power; overcome entry barriers to new markets or regions; avoid costs of developing new products and increase the speed of new market entries; reduce the risk of entering a new business; become more diversified; reshape their competitive scope with different portfolio of businesses; and enhance their learning. 3. What are the seven primary problems that affect a firm’s efforts to successfully use an acquisition strategy? Difficulty of effectively integrating the firms involved; incorrectly evaluating the target firm’s value; creating debt loads that preclude adequate long-term investment; overestimating the potential for synergy; creating a firm that is too diversified; creating an internal environment in which managers devote increasing amounts of their time and energy to analyzing and completing the acquisition; developing a combined firm that is too large (thereby necessitating extensive...
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...California Choppers: - turndown in profitability in 2005 - high-end motorcycle manufacturer for wealthy older motorists - had tv show by same name starring doakes and daughter - generated revenue on logos for t-shirts and posters - owner has luxurious lifestyle – didn’t put much profit back into company prior to 2000 - sales only in parts of US - 2001 company expanded to develop rest of US market - production processes found to be inefficient, Operating costs excessive, and financial leverage too high - 2001 Doakes steps down and hires Jane Heathcliff – respected business woman - also organized corporate advisory board (Doakes still owns the company) - Heathcliff developed US market by encouraging dealerships to carry CCs - Also got new factory equipment to increase volumes and efficiency - First, she was careful noy yo incur any overhead costs and focused on debt reduction - 2004 and 2005 – new office headquarters and product development facility - advisory board said to expand to Europe and Canada despite how expensive the work abroad is - before 2000 – workforce (non-unionized) continued to receive above-average wage rates (Doakes was sympathetic and wanted to treat them well) - he had refused to outsource to cheaper places (mexico, china) – felt choppers should be MADE IN USA - 2003 – large increase in workforce wages and benefits (sharing new success with workers) - past – company stretched its payables to generate cash flow – Heathcliff wanted to...
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...Unit 6 Assignment GB550: Financial Management Alberto Silveira Kaplan University Prof: Ana Machuca April 11, 2011 Chapter 13: Problem 13-5: How is it possible for an employee stock option to be valuable even if the firm's stock price fails to meet shareholders' expectations? Solution: Employees are given the option of buying stocks at a specified time at a specified price without investing any money. For example, if the price of stock is $10 today and the employee is given the option to buy 1000 shares at the price of $10 per share two years from now. If the stock price increases to $12 per share in two years, then the employee will gain $2,000 ($2 x 1000) from these stock options. Let’s say that the expected capital appreciation was 20%, the value of the stock would have increased to $14.4 per stock. Even though the stock price fell short of the expected value, it still created additional income of $2,000 for the employee. The options pay off if, at the time of option expiration, the stock price is higher than the option’s strike price, even if the company failed to meet shareholders’ expectations. Chapter 15: Problem 15-8: The Rivoli Company has no outstanding debt and its financial position is given with the following data: Assets (book=market) $3,000,000 EBIT $500,000 Cost of equity, rs 10% Stock price, P0 $15 Shares outstanding n0 200,000 Tax rate, T (federal plus...
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...Mr. Loewen – After some careful consideration and examination, I recommend that we accept SCI’s bid of $43 per share. My recommendation is based upon my assessment of four things: * Our position after the Mississippi case settlement * Our financial situation * Our business model * SWOT and Industry Analysis First, the Mississippi case has somewhat damaged our company’s image and may portray us as a company that does not honor legal agreements. Not only was a contract broken that brought the case originally, but so was the settlement as a number of the “subject to” provisions were not met. If this be the case, then it could stand to reason that we may be viewed as untrustworthy in other agreements. Being that acquisitions are based more so on the intangibles and our reputation as “the preferred acquirer” is key to our ability to attract high quality acquisitions this sullying of our image may hamper our efforts at quality growth. This case has also put us in a precarious financial situation. The settlement has necessitated that we undertake a refinancing of the company to cover the cash portion of the agreement. While we were able to ease investor nerves and regain some share price, after losing more than 50% of share value, that confidence is tentative and dependent upon us maintaining our acquisition pace and operational profitability. This will be a hard feat as our acquisitions costs growth rate has averaged 80% over the last three years and to...
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