Divestments: sales and spin-offs — MCQs

Norvale Manufacturing is considering replacing a labor-intensive production line with automated equipment. The investment committee asks corporate finance analyst Elena Ruiz to estimate the project's incremental cash flows and a risk-appropriate discount rate. The project will operate for three years, and all cash flows occur at year-end except the initial investment. Norvale already owns the land required for the project. The land is not currently used in operations and could be sold immediately for the after-tax amount reported in Exhibit 1. Management commissioned a feasibility study last year and has already paid the consultant. The expenditure cannot be recovered regardless of whether the project proceeds. Net working capital must be committed when the equipment is installed and is expected to be recovered fully when the project terminates. Ruiz assumes the annual operating cash flows shown in Exhibit 1 are incremental, after tax, and exclude both depreciation tax benefits and financing costs. The stated salvage value is also after tax. For an initial screening calculation, the investment committee instructs Ruiz to use a 10.0% annual project discount rate. Ruiz separately estimates Norvale's company-wide weighted average cost of capital using the information in Exhibit 2. Norvale's debt is publicly traded, and the quoted debt and equity values are current market values. The cost of equity was estimated with a standard market model, while the debt cost is a pre-tax yield. Norvale can use the full interest tax deduction. Because the automated process differs materially from Norvale's existing operations, Ruiz identifies a publicly traded pure-play comparable. She assumes the comparable's debt beta is zero and that both companies face the same 25.0% corporate tax rate. She plans to remove the effect of the comparable's leverage from its equity beta and then incorporate the project's target leverage. The project is expected to maintain its target debt-to-equity ratio throughout its life.

Northbridge Holdings operates industrial and consumer-products divisions. The company has accumulated excess cash and is considering alternative ways to distribute it. Management believes the shares are fairly valued at the current market price and has no material nonpublic information concerning future operating performance. Unless otherwise stated, the analyst assumes frictionless capital markets, no personal taxes, and no signaling effect from the payout method. One alternative is an open-market share repurchase at the current market price. If cash is distributed, Northbridge will no longer earn the investment return generated by that cash. The analyst is therefore instructed to incorporate the after-tax reduction in interest income when estimating post-repurchase earnings per share. The repurchase will not otherwise affect operating earnings, financing costs, or the tax rate. A second alternative is a special cash dividend using all available excess cash. The board asks whether the dividend itself creates shareholder wealth or whether the share price simply adjusts for assets leaving the company. The analyst is instructed to assess the immediate mechanical effect under the stated frictionless-market assumptions rather than infer a signaling effect. Northbridge is also evaluating a spin-off of its consumer-products division. The two divisions currently share only centralized reporting and treasury services. The board believes investors may value the businesses more accurately if they are separately listed, but it wants the analyst to identify an operating or governance benefit supported by the facts rather than assume that every spin-off creates value. Finally, a director proposes replacing the open-market repurchase with a tender offer at a premium to both the market price and estimated intrinsic value. The offer would use existing cash, and participation would be voluntary. The analyst is asked to assess which shareholder group would bear the economic cost of paying more than intrinsic value. The analysis does not assume any future performance improvement that would justify the tender premium.

Ardent Systems is a publicly listed technology company founded by its current chief executive officer. Its charter authorizes Class A shares with one vote per share and founder-held Class B shares with ten votes per share. Both classes have equal economic rights to dividends and liquidation proceeds. The ownership and board structure is summarized in Exhibit 1. The founder has proposed that Ardent enter a five-year supply agreement with a privately held company controlled by the founder's sibling. The proposed prices are 8% above those available from an unrelated supplier, although the founder argues that the related supplier offers more reliable delivery. Under Ardent's current governance procedures, the full board approves material contracts by simple majority vote. The founder and the sibling have not offered to abstain from the contract review. Minority shareholders have asked the board to establish a process that evaluates the contract's fairness and protects Ardent from self-dealing. The board's audit committee has authority to oversee financial reporting, internal controls, and external auditor appointments. The CFO currently serves on that committee. Ardent's listing rules require all audit committee members to be independent, but the company has not yet corrected the committee's composition following the CFO's recent appointment to the board. Ardent also holds excess cash and is considering the repurchase described in Exhibit 2. The company would repurchase only publicly held Class A shares; neither the founder nor any other Class B shareholder would tender shares. The repurchase would be funded entirely from cash and would not change operating income. The stated income forgone is the after-tax return currently earned on the cash and is the only effect of using cash that must be reflected in pro forma net income. Management states that the repurchase will increase earnings per share and may also consolidate the founder's voting control. An analyst assessing the proposal notes that an increase in EPS does not, by itself, establish that the transaction creates economic value. The analyst separately evaluates the transaction's effect on reported EPS and voting rights.

Helix Systems is a listed technology company whose founder retains enhanced voting rights through a dual-class share structure. An equity analyst is assessing whether the separation between voting rights and economic ownership increases governance risk. The ownership structure in Exhibit 1 has remained unchanged during the year, and no additional voting agreements, options, or convertible securities are outstanding. The analyst notes that the founder can exercise voting control despite owning a minority of the company's total shares. This structure can support a long-term strategic focus, but it may also weaken the market for corporate control and increase the risk that decisions benefit the controlling shareholder at the expense of minority shareholders. These concerns are particularly relevant because Helix is considering leasing a warehouse from a private company owned entirely by the founder. The proposed lease is material to Helix, and applicable law does not prohibit the transaction if it is properly reviewed and approved. The board has a majority of independent directors, but the founder currently presides over all board meetings. The governance committee is considering whether the related-party transaction should be delegated to directors who have no financial or personal relationship with the founder. The external auditor will audit the financial-statement presentation of the lease but does not have statutory authority to approve commercial transactions for Helix. The analyst also reviews the operating and restructuring information in Exhibit 2. Helix's subscription business generates cash before all related services are delivered, creating a source of operating financing through contract liabilities. Customer prepayments are non-refundable unless Helix fails to provide the contracted service. For capital-budgeting purposes, management has instructed analysts to include environmental effects only when they produce measurable incremental cash flows attributable to the project. The contractual emissions fee described in Exhibit 2 meets that condition; general reputational claims that cannot be linked to project cash flows do not. Finally, Helix is reviewing alternatives for its data-centre subsidiary. Management does not want to surrender control or distribute the subsidiary directly to existing Helix shareholders. It seeks a transaction that generates immediate cash proceeds and establishes a separately traded market value for part of the subsidiary.

A company has 52 inventory days, 38 receivable days, and 31 payable days. If inventory days fall by 6 and receivable days rise by 2, the new cash-conversion cycle is closest to:

A company with net income of USD 12 million and 1 million shares uses USD 6 million of cash to repurchase 200,000 shares. The cash earned 4% before tax, and the tax rate is 25%. The calculated value of post-repurchase EPS is closest to:

An analyst reviews a limited liability company (LLC) in which several members actively participate in day-to-day management decisions. Which conclusion is most accurate?

A company has market values of USD 600 million common equity, USD 100 million preferred stock, and USD 300 million debt. Their costs are 11%, 8%, and 6%, respectively, and the tax rate is 25%. The calculated value of WACC is closest to: