lOMoARcPSD|70337540
Practice exam solutions
Corporate Finance (Universiteit van Amsterdam)
i
i
, lOMoARcPSD|70337540
CORPORATE FINANCE 2022
PRACTICE EXAM
ALL QUESTIONS AND SOLUTIONS
QUESTION 1: (20 points)
Imagine that we do not live in the Modigliani & Miller world.
A.The impossibility of writing a complete financial contract between managers and financiers leads to
moral hazard problems: managers may not always act in the best interests of shareholders. Can you
describe some of the ways in which managerial moral hazard may present itself?
Please provide at least three possibilities. (10 points)
B. Can you name two more negative consequences for investors of the fact that we cannot write
complete financial contracts? (10 points)
Please explain and justify your answers.
Tip: In order to answer this question, please think about the lecture handouts and the readings. We are not
looking for you to name specific papers, but to provide an analysis based on the ideas we developed in the
course.
Solution:
A. In the real world, there are a number of ways managerial moral hazard can present itself:
1. Insufficient effort – inattention due to overcommitment to other tasks; insufficient oversight etc.
2. Extravagant investments – pet projects and empire building
3. Entrenchment strategies – resisting hostile takeovers; focusing the business in activities where
manager has experience, even though these may not be value-enhancing; accounting manipulations
etc.
4. Self-dealing/Tunneling – self-dealing transactions that directly transfer firm assets to the benefit of the
manager and increasing manager’s ownership share via dilution, going private etc.
B. Negative consequences for investors in addition to the agency costs arising from managers
pursuing their own objectives:
1. We cannot write a perfect debt contract, therefore shareholders may abuse creditors risk shifting or
playing for time and various other investment distortions
2. It is very difficult to have a perfect bankruptcy procedure because managers/shareholders/junior
creditors, would like to play for time in order to possibly gain something in reorganization
QUESTION 2: (15 points)
Oldmont Mining, currently an all equity company, is trying to prevent a hostile takeover by Barrick Silver. The
assets of Oldmont Mining are expected to generate free cash flows of $50 million in one year’s time, with an
expected growth rate of 2% per annum beyond that year. The beta of Oldmont’s assets is 1.2, the riskless
rate is 1% and the expected market return is 6%.
1
i
Practice exam solutions
Corporate Finance (Universiteit van Amsterdam)
i
i
, lOMoARcPSD|70337540
CORPORATE FINANCE 2022
PRACTICE EXAM
ALL QUESTIONS AND SOLUTIONS
QUESTION 1: (20 points)
Imagine that we do not live in the Modigliani & Miller world.
A.The impossibility of writing a complete financial contract between managers and financiers leads to
moral hazard problems: managers may not always act in the best interests of shareholders. Can you
describe some of the ways in which managerial moral hazard may present itself?
Please provide at least three possibilities. (10 points)
B. Can you name two more negative consequences for investors of the fact that we cannot write
complete financial contracts? (10 points)
Please explain and justify your answers.
Tip: In order to answer this question, please think about the lecture handouts and the readings. We are not
looking for you to name specific papers, but to provide an analysis based on the ideas we developed in the
course.
Solution:
A. In the real world, there are a number of ways managerial moral hazard can present itself:
1. Insufficient effort – inattention due to overcommitment to other tasks; insufficient oversight etc.
2. Extravagant investments – pet projects and empire building
3. Entrenchment strategies – resisting hostile takeovers; focusing the business in activities where
manager has experience, even though these may not be value-enhancing; accounting manipulations
etc.
4. Self-dealing/Tunneling – self-dealing transactions that directly transfer firm assets to the benefit of the
manager and increasing manager’s ownership share via dilution, going private etc.
B. Negative consequences for investors in addition to the agency costs arising from managers
pursuing their own objectives:
1. We cannot write a perfect debt contract, therefore shareholders may abuse creditors risk shifting or
playing for time and various other investment distortions
2. It is very difficult to have a perfect bankruptcy procedure because managers/shareholders/junior
creditors, would like to play for time in order to possibly gain something in reorganization
QUESTION 2: (15 points)
Oldmont Mining, currently an all equity company, is trying to prevent a hostile takeover by Barrick Silver. The
assets of Oldmont Mining are expected to generate free cash flows of $50 million in one year’s time, with an
expected growth rate of 2% per annum beyond that year. The beta of Oldmont’s assets is 1.2, the riskless
rate is 1% and the expected market return is 6%.
1
i
