WILLIAM MITCHELL COLLEGE OF LAW

FINAL EXAMINATION

CORPORATE FINANCE

Professor Niels Schaumann

Wednesday, December 14, 1994 - 6:30 p.m.

2 Hours

STUDENT TEST NO.

1. For anonymity, use your assigned test number which was mailed to you.

2. Put your test number on this page and on all bluebooks.

3. If you do not know your test number, you may obtain it at the Communication Center or in the Records Office (Cindy Egeness) during the first 30 minutes of the exam period.

4. If you do not use your test number, you will be deemed to have waived your privilege of anonymous grading.

5. TURN IN YOUR BLUEBOOKS AND THIS EXAM AT THE END OF THE PERIOD.

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STUDENT CONDUCT CODE

IT IS A VIOLATION OF THE CODE:

1. To use any sources which are forbidden by the instructor to complete an exam.

2. To submit as one's own work the work of another.

3. To engage in any conduct which tends to give an unfair advantage to any student in any academic matter.

Knowledge of any violation should be promptly reported.

VIOLATION OF THE STUDENT CONDUCT CODE MAY RESULT IN EXPULSION

OR SUSPENSION FROM THE COLLEGE OR DISMISSAL FROM THE CLASS.

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GRADUATING SENIORS: If you are a graduating senior, note this fact on all bluebooks and this exam paper. DO SO CONSPICUOUSLY.

TYPING AREA: If you are going to type your examination, the typing area is located in the old Boardroom. You must return the exam to this room at the conclusion of the exam period.

GENERAL INSTRUCTIONS

MATERIALS PERMITTED FOR THIS TEST: Hamilton, Corporation Finance (2d Ed. 1989). In addition, you may use class notes, outlines and other materials prepared by you or by other students, and any material distributed by the instructor. NO OTHER MATERIAL IS PERMITTED.

This examination consists of two Parts, numbered I and II. Below the heading for each Part there appears, in parenthesis, the percentage of the total test score attributable to that Part. Keep in mind that no matter how long you spend on a question, you can earn no more than the specified percentage of the total test score for your answer.

Write in INK ONLY. Do not answer any part of this examination in pencil!

Instructions for Essay Questions

1. WRITE ON ONLY ONE SIDE OF THE PAGE. WRITE ON EVERY OTHER LINE.

2. Try to write legibly. I cannot give credit for an answer I cannot read.

3. Citations to specific cases are not necessary. You should, however, cite relevant statutes and rules.

4. Take some time to organize your answer. All other things being equal, a coherent response will earn more credit than one that rambles aimlessly.

Part I--Essays

(60%)

In February 1988, Allison, Bob, Cathy, Donna and Elvis incorporated their business (a retail camera shop) under the name "F Stop, Inc." F Stop was located in New City, in the state of Grace (which has adopted the Model Business Corporation Act in its entirety). The only shareholders in F Stop were the five above-named persons, and each made an identical investment in F Stop: $10,000 cash, for which each received 1000 shares of F Stop's common stock, par value $1 per share. Each of the five served as a director of F Stop, and Allison served as the Board chair and chief executive officer.

In late October 1988, Allison found herself short of cash. Although F Stop had done well in its first months of operation (relative to other brand-new businesses), it was barely breaking even and had not yet turned a profit. However, F Stop did have on hand about $35,000 in cash, all of which represented proceeds from the issuance of its common stock in February. In order to meet her immediate need for cash, Allison proposed that F Stop pay a dividend of $2 per share on its common stock.

Question 1. Can F Stop pay the dividend proposed by Allison? Explain. (Take into account only the facts stated so far; disregard, for this question, the facts stated immediately below.)

The question of Allison's proposed dividend was shelved when, at the November 1988 F Stop board meeting, Bob stated that he had been contacted by a group of physicians who were seeking an investment and had expressed interest in F Stop. Bob reported that the physicians suggested to him that they might be interested in purchasing preferred stock of F Stop, if the terms of the stock were favorable and included, in the physicians' words, "reasonable protections for us."

Before the board meeting was over, the F Stop board had resolved to offer the physicians F Stop preferred stock, and authorized Bob to negotiate with the physicians over the terms of the preferred stock.

Question 2. Part (a): Describe briefly the advantages and disadvantages, from F Stop's perspective, of issuing preferred stock to the physicians as an investment. Your description should compare and contrast preferred stock with common alternatives, e.g. common stock and debt.

Part (b): Outline briefly, for F Stop's benefit, the kinds of protection that the physicians might request in negotiating with Bob over the terms of the preferred stock.

Part II--Multiple Choice

(40%)

Instructions for Multiple-Choice Questions

1. For each question in Part II, choose the most accurate answer (whether or not you think it fits perfectly). Print (do not write in script) the letter for your answer on the examination paper in the space provided immediately to the left of the question.

2. Each question in this Part is worth the same number of points (1.38 points).

3. Although an incorrect answer will not earn any points, no points will be deducted for an incorrect answer. This means that if you are unsure of the correct answer, it is to your advantage to guess. An answer left blank counts as an incorrect answer.

4. Although I have tried to make the questions as clear as possible, objective questions are very difficult to write. Moreover, law students under exam pressure are extraordinarily adept at spotting lurking ambiguities.

For these reasons, below each question there are three lines. If you consider it necessary to qualify your answer, you may use those lines to write in any additional information that you believe I should have.

The foregoing should not be construed as encouragement to qualify your answer. No "extra credit" will be given for material written in these spaces. Similarly, no points will be deducted for incorrect statements made in a qualification. If, however, students identify a material flaw in a question, I may allow more than one answer or, if necessary, not score the question at all.

NOTE: References to the "RMBCA" or to the "Revised Model Act" are to the Revised Model Business Corporation Act.

References to the "MBCA" or the "Model Act" are to the Model Business Corporation Act.

____ 1. The price at which a willing buyer and a willing seller would close a transaction, assuming that neither is under any compulsion and each has all relevant information, is usually referred to as the:

A. Salvage value.

B. Market value.

C. Liquidation value.

D. Book value.

E. Real value.

A. Liquidation value.

B. Real value.

C. Market value.

D. Book value.

E. Salvage value.

A. Book value.

B. Salvage value.

C. Liquidation value.

D. Asset value.

E. None of the above.

A. Market value.

B. Capitalized earnings.

C. Salvage value.

D. Asset value.

E. Capitalized cash flow.

A. Taking a weighted average of the earnings.

B. Restricting or expanding the period of time over which earnings are measured.

C. Utilizing a different present value formula for years in which the earnings are abnormally low.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. To determine the value of the payment stream as a capital (i.e., a lump) sum.

B. To utilize the payment stream in a way that is economically efficient.

C. To utilize the payment stream in a way that maximizes the user's personal benefit.

D. All of the above.

E. None of the above.

A. Calculates the value of the enterprise as if it were on a hypothetical auction block.

B. Calculates the value of the enterprise "brick by brick, and block by block."

C. Calculates the value of the enterprise by several different techniques, and then assign a percentage weight to each to determine the final value.

D. Calculates the value of the enterprise by taking a walk around the block while thinking really hard about the problem.

E. None of the above.

A. Is void for all purposes.

B. Is void for most, but not all, purposes.

C. Is voidable at the instance of any shareholder of the corporation.

D. Is voidable at the instance of any creditor of the corporation.

E. None of the above.

A. Is void, because legal services are not lawful consideration for the issuance of corporate stock.

B. Is void, because the payment to Sue exceeded the real value of the services she provided.

C. Is valid only if the Xenon board can prove that it reasonably believed the value of Sue's services to be at least $1000.

D. Is valid, as long as neither the Xenon board nor Sue was acting fraudulently.

E. None of the above.

A. Issue shares of a single class of common stock, with a nominal (low) par value.

B. Issue shares of a single class of common stock, with a par value equal to the sale price of the stock.

C. Issue shares of a single class of common stock, with no par value.

D. Issue shares of one class of common stock, with a nominal (low) par value, and a second class of preferred stock, with a dividend preference over the common stock.

E. None of the above alternatives has any particular advantages or disadvantages over the others.

A. The directors who voted to declare the dividend may be jointly and severally liable for the amount of the dividend paid to shareholders in excess of the amount that could properly have been paid under the Model Act.

B. A director who relied in good faith on financial statements of the corporation, certified to be correct by the president of the corporation, is not liable on account of the dividend.

C. A director who abstained from the vote to declare the dividend is presumed to have assented to the dividend.

D. All of the above are true.

E. Both A. and B. above, but not C. or D.

A. No certificate may be issued for any share of stock until that share is fully paid.

B. A shareholder may be liable to the corporation for the full purchase price of the shares of stock she holds.

C. The stated capital of a corporation may not be reduced.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. The price at which George could sell the bond has most likely increased.

B. The price at which George could sell the bond has most likely decreased.

C. The net present value of the cash flow generated by the bond has most likely remained the same.

D. Both A. and C. above, but not B.

E. None of the above.

A. The prices of bonds with a shorter time to maturity are more volatile (i.e., the magnitude of changes is greater) than the prices of bonds with a longer time to maturity.

B. The prices of bonds with a longer time to maturity are more volatile than the prices of bonds with a shorter time to maturity.

C. The prices of bonds with a shorter time to maturity change more frequently than the prices of bonds with a longer time to maturity.

D. Both A. and C. above, but not B.

E. None of the above.

A. The effective interest rate on the bond, taking into account only the coupon rate and the price.

B. The effective interest rate on the bond, taking into account the coupon rate, the price and the principal.

C. The net present value of the principal, taking into account the time to maturity and the current market rate of interest.

D. The likelihood that the obligor on the bond will default in less than one year.

E. None of the above.

A. Many leveraged transactions popular at that time required bondholders in the target corporations to make large cash payments to corporate raiders.

B. Bondholders in the target corporations, in an effort to be recognized as major players in the takeover markets, frequently paid too much for shares of target corporation stock.

C. Many leveraged transactions popular at that time caused the credit ratings of the target corporations to decline precipitously, because the bidders pledged the target's assets in order to secure loans used to acquire the target's equity.

D. Both A. and C. above, but not B.

E. None of the above.

A. Is bound by fiduciary duties to the bondholders as long as any bonds remain outstanding.

B. Is prohibited from transacting any business with the issuer of the bonds as long as any bonds remain outstanding.

C. Is prohibited from transacting any business with a bondholder as long as any bonds remain outstanding.

D. All of the above.

E. None of the above.

A. The issuer is completely discharged from all obligations under the terms of the defeased bonds.

B. The issuer is permitted, under applicable accounting rules, to recognize income in an amount equal to the difference between the face value of the bonds and the cost of defeasance.

C. The bondholders still bear some degree of risk arising from their ownership of the bonds.

D. All of the above.

E. Both B. and C. above, but not A. or D.

A. The amount of preferred stock the enterprise has issued.

B. The amount of common stock the enterprise has issued.

C. The ratio of long-term debt to equity in the enterprise.

D. The ratio of short-term debt to long-term debt in the enterprise.

E. The ratio of short-term debt plus long-term debt to equity in the enterprise.

A. Are owed a fiduciary duty by the issuer's board of directors.

B. Are viewed as shareholders for purposes of corporation law.

C. Are not entitled to receive any payments until all stock dividends validly declared have been paid in full.

D. Both A. and B. above, but not C.

E. None of the above.

A. Is a dividend, but only if the CEO is required by the terms of the Plan to own shares of Beta common stock in order to be qualified for the CEO position.

B. Is not a dividend (whether or not the CEO is required to own shares), but is a distribution, because the transaction consists of the issuance of shares to a shareholder.

C. Is neither a dividend nor a distribution, because it is paid as compensation.

D. Is both a distribution and compensation.

E. None of the above.

A. Involves a larger number of shares than a stock dividend.

B. Is accounted for by transferring an amount equal to the par value of the issued shares from capital surplus to stated capital.

C. Often has the effect of "squeezing out" small stockholders.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. A stock dividend.

B. A cash dividend.

C. A repurchase by the issuer of its shares, on the New York Stock Exchange.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. Gamma stock will begin to trade "ex-dividend" on the date that is four business days before the record date.

B. The shareholder on the record date is presumed to be entitled to the dividend.

C. The parties to a sale and purchase transaction of Gamma stock cannot negotiate which of them will be entitled to receive the dividend, but must rely on the Stock Exchange's conventions to determine this issue.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. Only one corporation can survive a statutory merger.

B. In general, shareholders of both the target corporation (which will be extinguished) and the surviving corporation have the right to vote on a statutory merger.

C. A statutory merger cannot take place between more than two corporations, with one surviving and the other being extinguished.

D. All of the above.

E. Both A. and B. above, but not C. or D.

A. Is a technique for accomplishing a merger without the approval of the shareholders in the surviving corporation.

B. Is illegal in most states.

C. Has essentially the same consequences as a consolidation.

D. Is a technique for accomplishing a merger without the approval of the shareholders in the target corporation.

E. None of the above.

A. Is a technique for accomplishing a merger without the approval of the shareholders in the surviving corporation.

B. Is illegal in most states.

C. Has essentially the same consequences as a consolidation.

D. Is a technique for accomplishing a merger without the approval of the shareholders in the target corporation.

E. None of the above.

A. Must be approved by the board of directors of the buyer(s).

B. Must be approved by the shareholders of the seller, unless it is in the ordinary course of the seller's business.

C. Must be approved by the shareholders of the seller, whether or not it is in the ordinary course of the seller's business.

D. Need not be approved by the shareholders of the seller, whether or not it is in the ordinary course of the seller's business.

E. None of the above.

A. Theoretically, the buyer assumes all liabilities of the seller (except those expressly disclaimed), although in practice courts often decline to find the buyer liable.

B. Theoretically, the buyer assumes no liabilities of the seller (except those assumed expressly), although in practice courts often find the buyer liable.

C. Theoretically, the buyer assumes all contract liabilities of the seller (except those expressly disclaimed), although in practice courts often find the buyer liable in tort as well.

D. Theoretically, the buyer assumes all tort liabilities of the seller (except those expressly disclaimed), although in practice courts often find the buyer liable in contract as well.

E. None of the above.

HAPPY HOLIDAYS TO ALL!