Corporate Finance

A. Gibbons 1. Gibbons timeline a. 1968: 86% tender offer - $53/sh b. 1971: Squeeze out of minority shareholders $35/share c. 1974: $43.87/share appraisal/appeal d. 1975: second appraisal - $33.86/share 2. Court appointed appraiser: a. 3. Trial court: a. 4. Remember our earnings formulae a. Earnings/discount rate = value b. Multiplier * earnings = value c. Appraiser's capitalized earnings: X * Y = 52.78 d. Chancellor's capitalized earnings: X * Y = 39.79

1. Appraiser's capitalized earnings: a. 14 * $3.77 = $52.78 (per share value using CAPM) b. $3.77 / $52.78 = 0.071 c. ("14" is the multiplier; 7% is discount rate) 2. Chancellor's capitalized earnings: a. X * $2.38 = $39.79 b. 16.7 * $2.38 = $39.79 c. $2.38 / $39.79 = 0.060 d. ("16.7" is the multiplier; 6% is discount rate)

1) The good part of this: you can get rid of 10m recalcitrant shareholders. You've enhanced 2) This is not a poison pill, bc you take poison pill IF the company is acquired. They've just taken on harm to protect themselves. 3) This is different from poison pill: repositioning co, saying that they think co is worth iat least 57/50 4) 87% of he 33m shares are tendered. Not a vote of confidence tha shares are worth more than 57.50. means that the shareholders think this is a great deal, 5) Do hey owe fiduciary duty to note holders? No, don't old fidcuary duty to creditors. Covenants are waivable. BUT; noteholders are still shareholders. You do owe a fudicuary duty tot hem as shareholders; co has put themselves in a bad spot 6) Bergerac then offers 42 for 90%. Reasoning: co is worth less after you've harmed the company with the 10m repurchase for the shares, and the notes. But this is basically tongue in cheek - nobody will buy for 42, because they want to wait and get 65. 42 is saying they'll only pay when 10% of the company is getting 65/share. Way of signalling that Bergerac has done to the company's value. 7) After they sell 10m shares, took on 100m preferred, 475m in debt. Capital structure changed bc of notes. NOT showing hat thaty're now sharing the pie with a lot fewer shareholders. See how much each share is now worth

1) Greenmail motive: want to just get a payout from board to go away 2) Board has now shifted to wanting to get the best price. 3) Long-term shareholder interests: what will be the long term effect of Perleman as head of co 4) They look for other buyers, geta favorably acquirer, Forstmann. 5) Terms of deal struck with Forstmann is not a poison pill 6) Now all Perlan has to do is offer more than 56, 7) Redeem rights: rights have to be redeemed as long as you're offering less than 65 for your offer to make sense. 8) Waive covenants: co will argue they have fiduciary duty to shareholders to waive covenants if it's in their best interest 9) Golden parachutes: for board members, Bergeron - either keep heir jobs or get a nice windfall when they leave 10) Another fiduciary breach: they gave Forstmann more info than Pantry 11) Once you give the info to someone, you're saying you've decided that the info isn't so confidential it can't be used by a buyer. But needs to be accessible to all buyers 12) One problem: discriminatory providing of information. That's a breach in an auction scenario 13) Perleman wans also to appoint three out of 14 directors. Way for him to jumpstart control of the board. 14) At this point, Perleman has the most valuable offer 15) Notes crash in value bc everybody knows covenans will be waived. 16) Forstman cuts another deal to go higher. No-shop: not allowed to negotiate with anybody else behind Forsman's back. No shop is ok for a period, but not a permanent no shop. One year is probably too long; here week no shop is probably ok, not a fiduciary breach. 17) Lockup: lockup of particular divisions of Revlon so he can buy them at a specific price. Can buy at a huge discount. This will only happen though if FOrstmann loses. Wants assurances the deal will close. 18) Cancellation fee: an explicit penalty check if the deal doesn't go through. Cancellation fee is permissible. It's only riggered if someone buys 19.9%. so: triggered if they sell to somebody else, his deal falls through. Buy then why have both a lockup and cancellation fee? 19) Note price support: he note holders have been hreatening to sue the board. Board needs to get them to pay for price support for the notes, maintain them at their par value. 20) Immediate approval - says sign deal today, or we walk. In this scenario, it's probably a breach of fiduciary duty - need to give Perleman a chance to offer you. 21) Withnotes: get x shares out of rotation, indicate what you think shares are worth.

1. Snowy, Incorporated, was organized by the majority stockholder of Ziebarth Corporation, for the express purpose of consummating an option agreement involving the possible sale of all the outstanding stock of the latter corporation. The option agreement could not otherwise be effectuated due to the opposition of Matteson, a minority stockholder of Ziebarth Corporation. There is nothing in the uniform business corporation act to indicate that this is not a "lawful business purpose." Nor does appellant cite any authority to that effect. We therefore conclude that Snowy, Incorporated, was a kind of corporation which might, under the statute, merge with Ziebarth Corporation. 2. "The merger statute authorizes the directors of the two corporations to draft the details of the merger. " a. Can callable preferred shares be issued in exchange for a corporation's common shares? Yes. 1) "There are no restrictions concerning the nature of the stock to be issued. The directors may agree to allocate to the stockholders of the absorbed corporation whatever stock interest in the surviving corporation appears proper under the circumstances. The statute does not proscribe an allocation of callable preferred stock in the surviving corporation, even though it may result in the ultimate ouster of the recipient of such stock from any interest in the business."

1. "Whether that feature of the merger plan, though conforming to statutory requirements, introduces an element of unfairness or fraud sufficient to move a court of equity, is an entirely different question." a. Can the merger be challenged on grounds of unfairness or fraud? No. 1) "We are of the view that, under our own act, the statutory remedy is likewise exclusive as to unfairness or breach of fiduciary duty short of actual fraud. This is subject to the qualification, however, that the statutory remedy is not exclusive unless the facts concerning such unfairness or breach of fiduciary duty were known to the aggrieved stockholder at the time of the stockholders' meeting at which the corporate action was approved." 2. Dissent a. [Ziebarth] caused Snowy to be incorporated, not to engage in any 'lawful business' as contemplated by statute, but merely to have a paper corporation with which Ziebarth Corporation might merge, and thus, by the machinery provided by statute, force Matteson to sell his stock or lose his investment. It does not seem to me the statute authorizing a merger of corporations contemplates such a transaction as the one Ziebarth is trying to carry out. If we say the Ziebarth Corporation and Snowy, Incorporated can be merged in order to carry out the contemplated sale to Gold Seal, we open the way to a new method of freezing out minority stockholders merely because they disagree with the majority on questions of corporate policy. 3. Takeaways a. Ziebarth: Only a right to appraisal absent 1) fraud or 2) HIDDEN unfairness

1. Privately held Widget Inc.'s cash flow for last 3 years was, starting with the most recent year, $350 million, $300 million and $250. Its earnings for last 3 years were, starting with the most recent year, $500 million, $250 million and $200 million, which reflects a one-time shift in the depreciation schedule that substantially decreased expenses in the most recent year. What income stream would you choose to value Widget and why? a. Assume the facts in (5) above. The annual return of the S&P 500 was 5.00% over the last year, 10% over the last five years, 13% over the last ten years, between 14% and 2.4% for the rolling 20-year periods from 1950 to 2010, and 8.22% since 1926. The investment return of the Widgets Index has been 12% over the last year, 36% over the last five years, -30% over the last ten years, and 18% over the last twenty years. The average cash flow of companies in the S&P is $300 million, and Widget's beta with respect to that index is 4. The average cash flow of companies in the Widget Index has been $14 million, and Widget's beta with respect to that index is .8. What you choose for the market return and why? Issues: extreme beta; difference in cash flows; name of index; can't use a negative return; most recent return most indicative of present but stock returns are volatile and the most recent may be an outlier; high negative 5-year and high positive 10- years means stock price must have been very volatile, which increases risk of outliers; last 10 years probably more indicative than last 100 The beta of .8 does not suggest that the Widget Index is not a good match, but the beta of 4 indicates that Widget's stock price has been far more volatile than the S&P 500 has been, which favors choosing the Widget Index, as does the fact that the name of index suggests that its constituents are comparable. However, Widget's cash flow of [$300m - $350m] is many multiples of the cash flow of companies in the Widget Index, while it is fairly to that of the S&P 500 companies, which favors the latter. If you choose the S&P 500: The most recent year may be most indicative of the current situation, but it may be an outlier, as stock return returns vary greatly from year-to-year. The one-year, 5% return may be an outlier, which may be reflected by it being at the low end of the 20-year rolling period returns, the 10-year return of 10% and the long-term return of 8.22%. The latter two are close, but the 10-yr is more recent, so I would choose that. If you choose the Widget Index: A negative return is not useable, and the most recent is most reflective of the present but may be outlier given the volatility of stock returns. A 5-year 36% return and a 10-year -30% return means that Widget's stock price must have been extremely volatile, with both potentially representing an outlier. The 20-year return may be best as 20 years will smooth outliers and be most representative of the true market risk premium for the Index. With cash flow of $300 million and discount rate - beta of 10% - 4 or 18% - .8, and assuming an risk free rate of 4%, Widgets is worth: 300/(.04 + 4*(.1 -.04) = 300/(.04+.24) = 300/.28 = $1.071 billion 300/(.04 + .8*(.18 -.04) = 300/(.04+.112) = 300/.152 = $1.974 billion

6: the returns - widgets index has plus 36% over five years, and negative 30% over last ten years: we know it's very volatile. Another reason why we think widgets index is v volatile: percentages are jumping around. BUT consider the volatility of stock prices - way more volatile than earnings or CF. consider again that most recent year is preferable. But here, we won't put a lot of stock in the 12% bc of volatility. Also: Widget index has CF of 14 million, our company has CF of 100m+. S&P has cash flows more comparable to our company. Also: Betas. .8 is much more in line than a beta of 4. So even though other widget cos are tiny, and ours is huge, it experiences the same volatility that they do.

A. Value Chart 1. 1/2 = 0.5 2. 1/3 = 0.333 3. 1/4 = 0.25 4. 1/5 = 0.2 5. 1/6 = 0.167 6. 1/7 = 0.143 7. 1/8 = 0.125 8. 1/9 = 0.111 9. 1/10 = 0.10 10. 1/11 = 0.091

1. 1/12 = 0.083 2. 1/13 = 0.077 3. 1/14 = 0.071 4. 1/15 = 0.067 5. 1/16 =0.0625 6. 1/17 = 0.059 7. 1/18 = 0.056 8. 1/19 = 0.053 9. 1/20 = 0.05 10. Applicable questions a. If the multiplier is 7, then the discount rate is: 14.3% b. If the discount rate is .083, then the multiplier is: 12 c. An acquiror expects a company to generate a 11.1% return. What is the discount rate? 11.1% What is the multiplier? 9 d. In valuing company, Acquiror A applies a 12.5% discount rate, e. and Acquiror B applies a multiplier of 6. Which one believes the company is riskier? B: 1/6 = 16.7% Discount Rate

1) Black letter rule from Revlon: if a bidding war breaks out, there's essentially an auction, board has a duty to get the highest value for the company. Is bd on the hook if people are making unsolicited offers, for making the auction: no. AN auction is one created by the board - you don't have an obligation to get the best value if you never solicited it in the first place. so: you take a risk if you search out a "white knight;" they can turn into a raider, have to take whatever is the best offer. What you should do from the beginning: don't start an auction. And if you have a threat identified, it's v difficult for Perleman to come in and prove that wrong. That's not what Revlon did - said they should receive at least 65/share that's triggered by 20% acquiring. Should paper the file stating all the bad things Perleman would do, in terms of what their view was stating what would bring the most long-term value to the company. Then they can use whatever defensive measure they want. 2) In Revlon: If giving everyone a 65 note, that means they think the shares are at least worth 65. If there's an offer out there for 65, then you're not going to take anything less than 65. Disingenuous in the sense that they don't expect this to happen - they're forcing the other party to come to the table. What else might bd do if they thought 54.20 was inadequate: create the 65/share note; anybody that coughs up their share gets that note.

1) If Twitter was going to use poison pills, should have put them into place a long time ago, which mean that they would be subject to the lower standard of the BJP. What's the standard when a tender offer is actually made: BJP. 2) If you put out this note for 65, what are you saying is the threat, you've been offered 54.20: 54.20 is adequate, only 65 and up is adequate. 3) Could the board buy out Musk at 100% premium to make him leave the board and shut up: Perot. Green-mail offer. 4) If Musk does a 51% tender offer, what may unfold is Paramount machinations. Diff tween it an Revlon: Revlon was a 100% tender offer

A. There are two kinds of dilution: ownership dilution and economic dilution B. Ownership dilution 1. Usually occurs when new shares are issued and can affect control of the company. 2. Shareholders' voting power is reduced. 3. Issuing new stock carries risk bc it can affect who has control of the company 4. Ex: a. Business starts with net asses worth $10, is issued ten shares. Each share is initially worth one dollar. b. Company sells five new shares for a total of five dollars. Here are now 15 shares outstanding, company is worth fifteen dollars. Owners of the original ten shares have been diluted, because hey now own a smaller percentage of the company than before. Instead of 100%, only have a 2/3 stake. New shareholders have 1/3 stake. c. This is esp problematic if the original 10 shares are owned by more than one shareholder. 1) Assume that one shareholder owns 3, another owns 3, and another owns 4. If you represented last shareholder, you'd be afraid that the new shareholder could work with one of the older shareholder to take control of the company. Could trigger a change of control of the business.

A. Economic dilution 1. Occurs when an incorrect pre-money valuation is used and can result in an economic loss. 2. Value of shareholders' stake is reduced 3. Ex: a. Business starts with net asses worth $10, is issued ten shares. Each share is initially worth one dollar. b. Company sells five new shares for a total of five dollars. Here are now 15 shares outstanding, company is worth fifteen dollars. In this instance, no economic dilution has occurred. Everyone is in the same financial position they were in prior to the sell of new stock. the old shareholders stock is still worth a dollar per share, overall are still worth 10 dollars 4. What if a new shareholder pays too little for their shares: a. Imagine the same scenario, except the new shareholder pays just $2 for five shares. The total value of company is $12, of which she has contributed 1/6. However, she owns 1/3 of the stock. 1) New shareholder has seen her shares jump in value; they're now worth $4/share. The old shareholders, since make up 2/3 of shares, have experienced dilution; now worth just 8$/12$ (2/3). That's a two dollar loss. 5. What if new shareholder pays too much for her shares? a. Same scenario, except she pays $14 for five shares. She has contributed more than half of the assets, but owns only 1/3 of the shares. Her stake would be worth only $8, whilst he older shareholders' would be worth $16. b. This is called "watered stock" - stock sold for more than what they're worth 6. Reason why you'd pay too much or too little: inaccurate valuation of the company. a. Ex: company's management claims the co is worth $28 instead of $10. The new shareholder pays $14 for five shares. Co is now worth 42$, if the pre-transaction value is right. 1) But if co is actually worth ten dollars: her five shares are only 1/3 of the company, although she has contributed 7/12 of its value. b. Ex: company is undervalued at $4, new shareholder pays $2 for her five shares. She owns 1/3 of the company, and her stocks are actually worth $4. The older shareholders' stake though is now worth just $8. c. This is why pre-transaction value is so important. Preventing economic dilution depends on an accurate pre-money valuation.

I. Debt A. What are the advantages of debt? 1. Tax deductible interest 2. Lower cost of capital 3. Leverage 4. No sacrifice of control 5. (almost) no fiduciary duty 6. Amount generally not limited

A. Remember: when interest rates rise, bond prices falle 1. Prevailing interest rate Bond price Interest payment 2. 20% 250 50 3. 15% 333 50 4. 10% 500 50 5. 5% 1000 50

A. Paramount. 1. The state of defensive tactics a. Unocal 1) Hreat 2) Reasonable response b. Williams Act 1) Same price + all holders c. Moran: 1) Pre-planning = BJR 2) Fresh look d. Carmody/Quickurn 1) No hand, dead hand e. Revlon 1) Applied Unocal or 2) An auction is an auction 2. Timeline a. 1988 1) Poison pill repurchase plan: 2) 15% acquisition/30% T-O trigger 3) Buy 400/share for 200 4) Bylaws: 80% merger requires boar approval b. 7/93 1) Tentative deal - 60.86 Value 2) Tentative deal: 1 Paramount for .1/.9 A/B Viacome. 13.50 cash. 65/share ceiling. c. 7-8/93 1) Discussions breakdown d. 8/93 1) Discussions breakdown

a. 9/7 - 12/93 1) New deal: 69.14 2) New deal: 1 for .1/.9. 9.10 cash. 100m termination. Stock option (69.14/share. 19.9% shares (23.7m). $1 + sub. Notes. No limit.), no shop, poison pill exemption, amend 80% requirement b. 9/20 1) QVC Offer: 80/100% c. 9/21 1) AT App. d. 9/27 a. QVC Offer: 83.80 value. b. Viacom offer; 65.45 value c. Board: Fin. Req. d. No comms e. 10/5 1) QVC - $$$ f. 10/11 1) Board: Comms authorized g. 10/21 1) QVC sues and tender: 80/51% 2) Tender: 80 cash 51%. 1.42857 QVC 49%. h. 10/24 1) Viacom: 80 for 51% approved i. 11/6 1) Viacom: 85 j. 11/12 1) QVC: 90; cash for 51% 2) QVC's 90 tender: 90 cash for 51%. 1.43 CS/.32 PS QVC 49%. No stock option. No $$$ condition k. 11/15 board meeting l. 11/16/93 1) Chancery court hearing m. 11/24 1) 51% at 85/share to close at midnity n. 11/24 1) Preliminary injunction o. 12/9 1) Supreme Court affirms p. 12/22 q. Jan. 1) Viacom buys blockbuster r. 1/8.94 1) Board chooses Viacom s. Feb. 1) 76.4% vote for viacom

a. Revlon 1) Once you're in an auction, you have to get the best price - you can't discriminate against one particular buyer. You have a duty to shareholders to get the best price. 2) This begins with meeting between acquirer and CEO. CEO will always rebuff a hostile acquisition. Purpose of the meeting: Bergerac says no, not interested. After meeting, they adopt a poison pill. Standard that applies to this pill: Unocal, bc there's a threat to the board - they see their positions at risk, which raises Unocal. 3) Under Unocal, you have to identify the threat. 4) One characteristic of poison pill getting triggered: a certain amount of shares are acquired. 5) When someone hits owning 20% of shares, poison pill is triggered. 6) What will happen at trigger: everyone is given 65$ one year note per share. What does this tell us about what they perceive the threat to be? Value of the note is 65. This is setting a fair share. This means Perlman has to offer a minimum of 65/share. This is benchmarking what the value of the shares is. 7) Why does the board need to make sure the rights are redeemable: as threat unfolds, they'll need to update it. The threat is that someone will buy it for less. Why is it that nobody can now buy the company for less than 65/share: there's no way they can buy the co, bc everybody will take the deal and get 65/share; nobody will sell for less han 65/share, will wait to purchase at 65/share. So every shareholder is hoping every other shareholder will accept the offer below 65.

1) Is there any problem with this poison pill? Yes, the "excludes purchaser" part. Today, we have the all holders rule. You can't have discriminatory offers under modern law. 2) This satisfies Unocal. If it didn't, BJP would apply. 3) This tells us that one hreat the board clearly sees is failing to get 65/share. Is there any other threat we see here? 4) Unocal is an extremely lenient standard. You can threaten to blow up the whole company, basically - no dead hand here, either. 5) Here, can hreaten to blow up company if someone buys more than 20%. 6) Why do they have to be redeemable: they've given shareholders this right. Redeemable for .10/share so the hands of future boards' hands won't be tied. If they need to change the price up or down from 65, they need to be able to do so. also: shows they'll take a "fresh look" via Moran every time the situation changes. 7) This is stage 1. 8) First offer is 47.50/share, contingent upon redemption of rights. Now, the board can keep the shareholders from taking an offer that they might want. 9) Now they implement a second round of poison pills 10) Buying 10m shares. Turn in your share, get a 47.50. indicates the lowest they'll take for the shares is 47.50. eliminated 10m common shares, created 1m preferred. So we've changed capial srucure a little bit. Replaced the 10m shares with a lot of debt. The new PS has a 9$ dividend preference. What this is saying: we'll let you out at 47.50. AND you can participate in any higher price that comes down the road. They don't even have to give up participatin in the acquisition, price shooting up as a result of a bidding war. Can read into this hey're essentially giving he shareholder 57.40/share.

1. In-class notes a. All holders rule: applies to discriminatory tender offers. ASK ABOUT THIS b. Add to problems doc: control premium/minority discount c. Ct enters a preliminary injunction stopping the deal from happening. Kicks bidding war back into overdrive. d. Go back to 1988. Poison pill is first put into place. bc here's no threat, if challenged, it is challenged on BJP. This is a flip-up. Allows anoyone who owns one of he rights at the point the rights are issued can buy a share at a hugely diluted price. e. The bylaws also have an 80% merger approval. If you do a two-step acquisition, to get control of 100% of the shares, you'll have to get a follow up vote. And at that vote, there's usually at lease 49% of shares that are owned by min. f. Five years later: there's a negotiated transaction between Redstone and Paramount. Moving arget: the value of the shares being acquired, the value offered. There is a ceiling on the amount that may be paid under this deal, which is a function of Viacom's price rising, thereby increasing the value of the deal for Paramoun. g. Ceiling = no matter what value Viacom's share reach, the value of can't go above 65/share. Who does this benefit: the acquiror - limits how much acquirer might pay. What's the other side of this risk, that the arget is confronted with: if the share price of Paramount jumps, gets more valuable, then there is no number of Paramount share that would make the deal too sweet for P to agree to. Argument: if board is going to agree to a ceiling, it should also agree to a floor below which Viacom won't go. h. If you wanted to manipulate the value of the deal to make it look better, which co's shares would you buy to make the deal look like it's worth more? Buy Viacom. That's exactly what Redstone was doing. i. Next: Viacom share price rises from 46 o 57. But remember: only allowing 60.85 deal to go to 65. j. Paramount's Davis knows that QVC is a threat. Asks QVC to stay away. k. A no shop, for a certain limited period of time, is common and perfectly reasonable. l. Question: flip-in/flip-up v. selective share

a. When it is stock: not really a consideration problem. If it is debt: consideration problem. b. Back end issue: bd has duty to protect back-end shareholders, in second part of this deal. Squeeze out will happen of shareholders that don't sell their shares in the first part of the offer. The offer for the second stage will be different because the acquirer's shares will have gone up or down. Main issue with stock as compensation: it's a moving target. And if it's stock for stock, you have tow moving targets. c. One approach: will be based on its average trading price over the past 90 days; aka, remove affect of tender offer on the price. Another approach: say you're just going to fix the price. d. Ct will view PS as lower value than common. Esp if it's PS that was just issued. if PS is basically just debt, ct might view it as an inferior type of consideration, as just a form of deb. e. Winner's curse: Viacom paid way more than they should bc they got in a macho-man bidding war with QVC. f. Covered: utility of a no shop; terms that cover no shop. Cts don't like stock options as parts of deals, though they're arguably just a awy of rewarding the first person to enter into negotiations - way to reward: i will only talk to you, nobody else. g. lock ups in theory are admissible if th'y're an inducement to get somebody to agree to a great deal for the co, and lock-up doesn't prevent the co from getting a new deal. But if lock up essentially destroys the possibility of somebody coming along and buying the co, harder to defend. Can agree if you realistically think nobody will offer more than that. h. No shop, lockup, the idea of stock and cash and how that combo works. Then we've got the type of offer made in Revlon, the flip up Apply Unocal from the start. First stage involves something that threat isn't entirely clear. in every stage, tell him the Unocal standard applies (way of elocuting a FD in respect to defensive tactics)

A. Discount Rate and Multiplier 1. Business: $100 annual earnings. 50% is the "discount rate" or "capitalization rate" for the business. a. Why is the purchase price often described as a multiple of income (the "multiplier?") 1) 50% = ½. Multiplier = 2/1 b. IF 50% is the "discount rate" or "capitalization rate" for the business, THEN 2 is the multiplier for the business 2. Higher discount rate = higher risk = less you'll pay 3. 100$ = income stream 4. Price of stock/price of earnings per stock = discount rate. When PE ratio really high, share price/earnings, paying more for the dollar earnings, which means that investors are getting more confident they'll get their money back. If share price goes up = people are thinking earnings are more likely to not be risky. The financial press calls discount rate: multiplier. The discount rate is the inverse of the PE rate. Multiple of five times earnings = discount rate of 20% (multiplier is 5/1, so discount rate is 1/5 = 20%).

A. Capital Asset Pricing Model 1. E(PR) = RF + Beta * (E(RM) - RF) a. E(PR) = discount rate b. RF = risk-free rate c. Beta = a company's risk relative to the market d. (E(RM) - RF) = risk premium: the risk of the market minus the risk free rate 2. Notes a. What we're trying to figure out is the premium ABOVE the RF rate b. Note that more recent nos, esp for RF rate, are preferable.

A. Example: 1. Value: $1000 bond at 5%. 2. Suppose rates decline to 2.5%: value of bond is now 2000 (because 50 is 2.5% of 2000) 3. Suppose rates rise to 10%: value of bond drops to 500 B. Now consider: 100m 5% bond is used in 1986. 1. Prevailing rate in 1996 is 1%. Bond matures in 2016. 2. Value of the bond will decline to 100m over twenty years. Will it trade at 500m in 1996?

A. Example: 1. 1000 5% bond is issued. Bond is callable at 1500. Remember now that if rates decline to 2.5%, bond is valued at 2000. 2. If interest rates decline to 3.3%, company calls bond: 50 is 3.3% of 1500. 3. If the issuer borrowed 1500 and called, what would it pay each year in interest? 50. 50 is 3.3% of 1500. 4. Is it worth borrowing 1500 at 3.3% to pay 50/year and 1500 at maturity? No. 5. Suppose now that interest rates decline to 2.5% a. 12.50 is 2.5% of 1500. b. If the issuer borrowed 1500 and called, what would it pay each year in interest: 12.50 c. Is it worth borrowing 1500 at 2.5% to pay 12.50/year and 1500 at maturity? Maybe. d. With 10 years remaining until maturity? Yes. Six years? No. 1) NOTE: tradeoff between reduced interest payment and increased payment at maturity.

A. "Public" PS Characteristics 1. Public companies 2. Like debt; dividend preference always paid 3. $1,000 face value 4. Fixed dividend preference (nonparticipating) 5. Cumulative 6. Convertible / Callable A. "Public" PS: 1. Common stock with no upside 2. Debt with no promise to pay

B. "Private" PS characteristics 1. Venture capital investors 2. Convertible 3. Registration right 4. Meaningful voting/board rights 5. Liquidation preference 6. Dividend preference not as important 7. In-class breakdown a. "Private' PS = companies that aren't public. VCs want convertible stock bc they're eventually wanna get their money back, get out, and then go invest in the next big thing. Registration right: what you can use to form business to go public. b. Private cos won't be paying dividends bc they're rapid growing, putting all profits back into the business c. Why would you ever buy preferred? Essentially debt with no promise to pay. Only advantage: you're getting paid a little more than you would if you buy a bond.

1. In-class quiz (Callability Quiz - 3/1/22) a. Recall that in Morgan Stanley the plaintiff purchased a bond at a price well above the price at which one would expect it to be called. How would we know that price? It depends on prevailing interest rates and the bond's remaining maturity. The question is whether savings on interest payments exceed the additional amount paid at maturity. More accurately, it is whether the present value of interest payment savings exceeds the present cost of the greater balloon payment at maturity. Let's assume that a 30-year 5% bond is callable for $1,100. That means that the issuer must borrow $1,100 to call the bond, and the issuer will pay an additional $100 at maturity. If there are still 10 years left until maturity, should the issuer call the bond if interest rates have declined to 4%? Will the savings on interest payments make up for the extra $100 payment? Let's assume an 8% discount rate. b. 1) What is the present cost of the additional payment of $100 ten years from now? (Hint: The "present cost" of $1 received in X years" is the same as the "present value of $1 received in X years" - except it's negative). 1) Based on the present value table below, the present value of a $100 payment received in 10 years at an 8% discount rate is $46.32 ($100 * 0.4632). So the present "cost" is -$46.32. a. 2) How much would the issuer save in interest payments each year? $6. $50 - ($1,100 * 0.04) = $50 - $44 = $6 b. 3) What is the present value of total savings on interest payments? $40.26. 1) Based on the annuity table below, the present value of a $1 payment received each year for 10 years at an 8% discount rate is $6.71 (i.e., I would pay $6.71 today for the right to receive $1 at the end of the year for 10 years). The present value of a $6 payment would be $40.26 ($6 * $6.71). c. 4) What is the net present value of the additional balloon payment and total savings on interest payments? -$6.06 ($40.26 - $46.32). d. 5) Should the issuer call the bonds? If not, should the issuer call the bonds if interest rates are 4.5%? If they are 2%? 1) No, because the present value of calling the bonds is negative (-$6.06; the present cost of the additional balloon payment exceeds the present value of the savings on interest payments). No, because if the answer is No at 4%, then it will be No at any higher rate. 2) Yes, because it's so close at 4%, you can guesstimate that this will make sense at 2%. Or you could calculate the present value of the interest rate savings of $28 ($50 - $22) over ten years at 8% -- $187.88 ($28 * $6.71) - and subtract $46.32 to get a present value of $141.56. e. 6) Assuming the same facts above, what is the interest rate (to the nearest one tenth of one percent) below which calling the bonds makes sense? 3.8%. 1) You know that that it will be the interest rate at which the present value of the interest payment savings equals $46.32 (the present cost of the extra $100 balloon payment). We know that the present value of $1 received each year for 10 years at 8% is $6.71. What times $6.71 equals $46.32? About $6.90. That is the savings amount that makes calling the bond a breakeven proposition. If the interest rate savings are $6.90 each year, what is the implied interest payment? $43.10 ($50 - $6.90 = $43.10) What is the implied interest rate? 3.9% ($43.10/$1,100 = 3.9%). 3.9% makes sense as the breakeven interest rate because we were so close at 4.0%.

a. In-class breakdown 1) In-class quiz 2) 1: bonds are issued at 1000, so it pays 50. 3) Note that if the interest rate has stayed the same, or gone up, there should be no question at all whether you should call a bond - the answer is no. 4) If the answer is no for 10 years, it's definitely no for any shorter period of years. Question 6): 3.8% is he answer. 3.9% is your break-even point. Breakdown: Value (46.32) of savings must exceed how much exra you pay at the end (100). x * 7.71 = 46.32 = 6.9 is how many dollars you must save per year in investment payments. 50 - x + 6.9 = 43.1. 43.1/1100 = 3.9%

I. Valuation A. The idea of valuation is this question: what is the value of a business? Answer: the value of is income stream. B. Present value of future income stream - old man and the tree exs (understanding the deficiencies of different approaches. The problems of the first five will have their problems solved by using the discount rate method): 1. Scrap value - income? a. Maj problem with scrap method, value of wood chopped up and sold: ignore profits of the years leading up to the scrap. Scrap value is really just something you tack onto last year of profits - you're ignoring income otherwise. Another problem: for cos, we don't calculate scrap value bc we assume co can live forever. 2. One year's income - future income? a. One year's income: first, you ignore scrap value. Second issue: you ignore the income for the next, following year. Doesn't take ino account each year's income 3. 15 years * one year's income - present value? Risk? a. Fifteen year's income = this year's income times fifteen. Prob: doesn't take into account risk, only uses one year's income - the further we go out, the more that value is reduced bc of inflation. Risk = how are we going to vary this depending on how likely it is he tree will continue to make applies

1. Other offers - liquid market? Speculative component? Control premium? a. Other offers (someone else has offered to buy for x amount): this assumes there are other offers. Liquid market = assumes there are enough offers to give you a good sense of price, can trust the value. One offer alone isn't enough - but if you have a stock market for trees, thousands of trees sold a day, that's good. Speculative component - stock prices not necessarily indicative of real value of the tree. Control premium - what someone might pay over the price of the tree for control of the tree. The market we're imagining is only for a single share - but we, in our case, are wanting control of the company, which means we'll pay more than the stock price times the no of shares. (two things are the benefit of control premium: you can increase profits of co; can decide what happens to the assets. 2) also lets you hire your lazy uncle - self dealing. Two things: self dealing (which you hope is only a big office, control of assets). Market depth - there's always a gap between stock bid and stock ask; that doesn't mean you can buy at that price, bc that bid might be for 800 shares, but you might want 1000 lower. How many shares could you actually trade at that amount. Need to know what you can buy at huge amounts - what can you actually buy at that price). 2. Book value - cost? Depreciated asset? Goodwill? Human capital? a. Book value = the value of the assets. Prob with valuing assets: you're using accounting. Prob: a lot of assets aren't kept on the books at the market value. Like real estate - are kept on their books as "at cost," not at market price. Also: books can be unreliable. Also: the asset may not have been properly depreciated. Also: good will isn't properly reflected on books unless it is the result of an acquisition (aka: good will = brand name, value of Coke AS Coke). Another prob: book value doesn't include human capital. 3. Discounted cash flow Capitalized earnings

1. Remember that there are different threats we can identify under Unocal: a. Inadequacy of offer b. Nature and timing of offer 1) If company was going out of business in a year, suspicious c. Questions of illegality 1) One reason to name as a threat: afraid you'll run afoul of the SEC d. Impact on non-shareholder constituencies 1) Ex in Revlon: the note holders e. Risk of non-consummation 1) Esp true if buyer hasn't go financing f. Quality of consideration g. Greenmail motive 1) What the "purchaser" really wants is the company to give them a payment to make them go away h. Long-term shareholder interests 1) Ex: Perlman has run other companies into the ground, if he gets his hands on the company, it'll go down 2. 9/24: board seeks other buyers; "break-up of the company was inevitable" 3. 9/27: Pantry offers 50 4. 10/1: Pantry offered 53

1. 10/3 a. Forstmann LBO b. Specifics of Forstmann deal: 1) 56/share 2) Redeem rights 3) Co has to waive covenants 4) Sale of Revlon's Adler division for 905m (a huge discount_ 5) Golden parachutes for the board, CEO (can either keep their job or will get a windfall if they quit) 2. 10/7 a. Pantry offers 56.25/share, on these conditions: 1) Nullify rights 2) Waive covenants 3) Gets to appoint three of the four directors (gets a jumpstart on acquiring control of the board) b. Pantry's offer is, on the surface, more valuable than Forstmann's. 3. 10/8: Notes' value crashes because now everyone knows the co is going to waive the covenants 4. 10/9: Pantry will beat any offer by Forstmann

A. Revlon 1. Firstly, remember the Unocal rule: a. Threat b. Reasonable response c. Question: why is the Unocal test failed in Revlon 2. In June, there is a Perlman-Bergerac meeting. Does not go well 3. 8/19 a. As a first step, they adopt a poison pill: redeemable rights/repurchase plan 1) 20% acquisition trigger 2) $65 12%, one-year note per share. Excludes purchaser (not permissible today) 3) Redeemable at $0.10/share 4) Repurchase up to 5m shares 4. 8/22: Pantry offers 47.50/share. Is contingent up redemption of rights. 5. 8/29 a. Second protective measure is taken: notes and preferred for notes exchange 1) 10m repurchase for: 1) 47.50 10-year 11.75% Sr. Sub. Notes; 2) 1/10 9$ cumulative convertible preferred shares 2) Ultimately: 87% of the 33m shares are tendered b. Notes have (waivable) covenants 1) Lazard: will trade at face value 2) Covenants were limiting: future debt, dividends, sales of assets 3) Issue: to whom do he directors owe a fiduciary duty with respect to the covenants? Not the noteholders - no fiduciary duty to creditors. Do have a fiduciary duty to stockholders, to waive the covenants asap if it's in their interest

1. 9/16 a. Pantry offers 42/share for 90% of the shares 1) Why did he do this? To show "this is what Bergerac, with this issuance of notes, has done to the value of the company" 2) Before: 33m common. 47.40*33m = 1.57b 3) After: 23m common + $100m preferred + +475m in debt 4) Adjusted value afer: 992m (1.57 - 475 - 100) b. Remember: at this point, 23m shares still have the right to 65$, 12%, one-year note per share 1) Before: 23m common left + 100m preferred + 475m in debt 2) After: 20.7m common left + 100m preferred + 625m debt 3) 2.3m * $65 = 150m c. Suppose: 90% after 1) 20.7m common 2) 100m preferred 3) 625m debt 4) 90% at 42/share = 869 d. Suppose: what if 70% purchased? 1) 992m - 450m (plus 54m in interest) = 542m 2) 70% at 42 = 676m 3) 16.1m common left 4) 100m preferred 5) 1075m debt

1. Stock option a. 69.14/share b. 19.9% shares (23.7m) c. $1 + 68.14 Sub. Notes d. No limit e. 246m dilution at 90/share 2. No-shop a. Cannot solicit, discuss other deals except if they are unsolicited, noncontingent. Fid. Requires (fiduciary out)

1. Details on the QVC Offer: a. .893 QVC for 1 Paramount b. $30 cash c. Fin provided d. No rights, termination fee, supermajority or stock option

1. Final Viacom deal: a. 107 cash 50.1% b. 49%: 1) .93065 CS/.93065 CVRs 2) .5 3-year warrants 3) .3 5-year warrants 4) 17.50 bond 2. Effect of option on Paramount a. Before: 118m shares, 69.14/share. 118m shares * 69.14/share = 8.2b b. This is Paramount assuming a 69.14/share value. c. What will happen if an option to buy 19.9% of the shares at 69.14/share is exercised? 1) The pie will increase by 23m shares (.199 * 118m) and 1.6b (23m * 69.14) d. Before: 1) 118m shares at 69.14/share. 118m * 69.14/share = 8.2b e. After: 1) 141m shares at 69.14/share. 2) Total value: 9.8b (8.2b + 1.6b) f. What will happen if an option to buy 19.9% of the shares at 69.14/share is exercised? 1) The pie will increase by 23m shares (.199 * 118m) and 1.6b (23m * 69.14) g. Before: 1) 118m shares * 90/share = 10.6b h. After 1) Total value: 12.2b (10.6b + 1.6b) 2) Is there dilution: Yes. Goes down to 86.52/share i. Assuming there is no option, how many shares must be purchased to own 51% 60.2m shares j. Assuming there IS an option, how many shares must be purchased to won 51%? .51 * 141m shares = 70.5m shares. k. Assuming there IS an option, what will happen if QVC buys only 60.2m shares? .51 * 141m shares = 70.6m shares

1. Ex: assume that QVC only buys 60.2m shares. a. No option: 118m shares 1) 90/share 2) QVC: 51% 3) Other: 49% b. Option: 141m shares 1) 43% QVC 2) 41% other 3) 16% Viacom 2. Ex: assume that QVC buys 70.6m shares a. No option: 118m shares a. 90/share * 60.2m = 5.4b b. 51% QVC c. 49% Other b. Option: 141m shares 1) 90/share * 70.6m = 6.4b 2) 51% QVC 3) 16% Viacom 4) 16% other 3. Effect of option on Paramount a. Before: 118m shares, 90/share 1) 118m shares * 90/share = 10.6b b. After: 141m shares at 86.52/share 1) Total value: 12.2b (10.6b + 1.6b) c. Is there dilution: Yes d. What does option cost QVC? 1) Diluted value is 86.52 2) 90 - 86.52 = 3.48 3) 70.6m shares * 3.48 = 246m 4) Is there dilution: yes

1. 10/12: Forstmann lockup a. He now offers 57.25/share b. Asks for a no-shop provision (if you're negotiating with someone, can' go and negotiate with someone else for a set period - a year is too long, fiduciary breach, but three weeks is probably ok) c. Lockup of Revlon's different divisions (this has a 40% trigger) d. 25m Cancellation fee (19.9% trigger) e. Note price support f. Immediate approval 2. 1.32b at 57.25/share a. Forstmann: 1.32b (less the cost of the notes support). Or: b. Pantry: 1.32b - (100m to 175m) - 25m = 832 - 907m 3. Ct found that Revlon "no longer faced threats to corporate policy and effectiveness, or to the stockholders' interests, from a grossly inadequate bid." 4. Consider: weren't noteholders outside constituents? What about the lock-up? Termination fee and exclusive info access? 5. Revlon (at 830): "when the 'break-up' --- was inevitable --- the directors' role changed from defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company." 6. Md. § 2-405.1(f) No higher acquisition duty. - An act of a director relating to or affecting an acquisition or a potential acquisition of control of a corporation may not be subject to a higher duty or greater scrutiny than is applied to any other act of a director.

1. Summary a. Unocal: 1) Threat 2) Reasonable response b. Moran 1) Pre-planning = BJR 2) Fresh look c. Williams act 1) Same price + all holders d. Carmody/Quickturn 1) No dead hand, no hand provisions e. Revlon 1) Applied Unocal; or 2) An auction is an auction 2. In-class notes a. Threat must be a threat to corporate policy. Reasonable response = reasonable to threats you've identified. Be careful - if you've identified one threat, threat goes away, you can't go and identify new threats without ct thinking that's not a credible claim. Line up your threats up front. b. When you do a poison pill, you want to make sure that there's a way to get rid of them when he threat has ended

A. Cumulative PS Cases: Wouk and Hayes 1. Wouk a. If a corporation has a lot of cash, can it avoid paying dividends to cumulative PS by dissolving? b. In dissolution, preferred holders are entitled to payment of "any arrearage of dividends to which the holders of the PS may be entitled" 1) The PS holders are "entitled" to cumulative dividends "as and when declared" 2) So . . . "entitled" = "declared" 3) Redemption provision: PS entitled to "any accumulated dividends thereon" c. Under Wouk, what does a corporation that has (1) a lot of cash and (2) a pile of unpaid cumulative dividends have an incentive to do? d. Dissent: Majority view "might encourage the use of dissolutions as a device to wipe out dividend rights."

1. Hay a. The value of the owed arrears to the PS was equal to the value of the company's assets. It had not made money ever. b. Contrast to Wouk, in which: In dissolution, PS entitled to payment of " any arrearage of dividends to which the holders of the PS may be entitled 1) The PS "entitled" to cumulative dividends "as and when declared" -- so . . . "entitled" = "declared" 2) In Hay, in contrast: upon liquidation the PS will be entitled to "all accrued unpaid dividends" 2. Simplification: a. Dohme/Sanders: If there were earnings, dividends could have been paid and must be paid b. Hay: If there were no earnings, dividends could not have been paid and must be paid c. Burton: If dividends could someday be paid . . .

A. Time Value of Money 1. Present value of a future payment a. IMAGE ON OUTLINE 1) n/I of 1 = PV of receiving $1 at the end of one year 2) n/I of 3 = PV of receiving $1 in three years 3) what is the PV of receiving $1 in 6 years at a 4% discount rate: 0.7903 4) what is the PV of receiving $1 in 7 years at a 3% discount rate: 0.8131 5) PV of future payment (table page 65) 6) This chart represents only a single payment of a dollar. Stream of payments = an annuity

a. chart on slide 12 of Valuation #2 Slideshow 1) PV of receiving $1 at the end of 1 year: $0.970874 2) PV of receiving $1 at the end of one year and two years: $1.913470 3) What is the PV of receiving $1 each year for five years at a 4% discount rate: $4.451822 4) What is the PV of receiving $2 each year for four years at a 5% discount rate: $7.09 ( 2* $3.545951) 5) Annuity table: the payments represent what you'd pay today to get one dollar today, another dollar next year, another dollar third year, etc. 6) If you were investing two million: get annuity chart, look up the right number, multiply it by two million. 7) What chart represents: if you invest 96 cents and there is a 4% risk, you'll still receive a dollar at the end of the year. 8) If you have a separate value per year: use the first chart, then multiply the appropriate number times eh value you'll get that year. Then you'll just add them together.

1. In-class notes a. Yield, coupon rate are the same thing. b. If you issue callable bonds, the whole point is that you're betting interest rates will go down, so you can replace those bonds with a borrowing at a lower rate. But here, the rate is at 1%, not a lot of room for it to go down. So they must be thinking that the value of the company will go up, that their discount rate of 6% will go down and be more similar to the 1% of the feds; esp if comparable companies have a rate of 4 or 5%. More likely in that case to pay bonds back. Aka, how much risk above the treasury rate does gamestop represent. Thinks it will get its cash worthiness (aka, credit rate) better, can get a better loan in a few years. c. Metlife is about: I'm lending money to this company bc I think it won't be issuing junk bonds soon. That puts enormous pressure on the co to generate cash to make interest payments, value of bonds go down. d. Shift now from interest rates deciding everything to instead credit worthiness being more of a factor e. Why would Gamestop redeem the notes at 106.75% of face value? That's exactly one year's interest. Will pay interest that has accrued up to that date. f. May gamestop redeem the notes with proceeds of a debt offering? yes, if redemption does occur within 120 days of an equity offering (stock offering, as opposed to bond offering or loan). Contrast this to Morgan Stanley, where the whole argument was that the payment was done with stock offering - this was confusing bc there was no time definition of what counted as the stock proceeds

a. Why would gamestop redeem the notes at 106.75% of face value? b. May gamestop redeem the notes with proceeds of a debt offering? Not clear. If you want to make this clear, say something like "cannot have been a debt offering within x days of equity offering." c. Loophole: company can just go onto the market and buy those bonds back. d. May gamestop redeem the notes with proceeds of a debt offering? real issue - can there be a contemporaneous debt offering with an equity offering? Probably no, not at least under (b). is implied that only under (b) and (c) circumstances can you redeem. There has to have been enough in an equity offering to cover the redemption. That's the bottom line, at least here. Equity offering has to cover full amount of redemption. e. (c) doesn't impose the requirement that the callback be redeemed with equity f. Does the declining redemption price after March 15, 2018 benefit gamestop or holder? You'd probably think, over time, that gamestop's credit-worthiness will get better over time. If the buyback price is going down, that's a boon for gamestop; you'd expect it to go up, since credit-worthiness has also gone up. It's weird and counter-intuitive, bullard doesn't understand it. GS only redeemed once, when the interest rates DID crash because of COVID.

A. Perot 1. Flowchart for making a demand on the board a. Is demand made 1) No; is demand excused? (must ask if particularized facts alleged support reasonable doubt that 1) directors, aka here the special litigation committee, are disinterred and independent OR 2) transaction was product of a valid exercise of business judgment 2) Yes: settlement 3) No: case dismissed 2. Deal prohibitions: a. Public criticism of GM management (or pay 7.5m) b. Purchase of GM stock c. Proxy contest for five years d. Competition with EDS for three years e. Recruiting EDS employees for 18 months 3. "Unless the presumption of the BJF is overcome by the pleadings, questions of fairness play no part in the analysis." 4. BJR - "legitimate purpose...to rid itself of the principal cause of the growing internal policy dispute over EDS' management and direction." 5. Grobow - the enhanced duty of care that the Unocal directors were found to be under was triggered by a struggle for corporate control and the inherent presumption of director self-interest associated with such a contest. Here there was no outside threat to corporate policy of GM sufficient to raise a Unocal issue of whether the directors' response was reasonable to the threat posed.

1. In-class notes a. If demand was excused, must show that directors were either not independent or not disinterested. OR 2) decision was so bad it was bad faith or completely uninformed (bad faith - nobody couldn't thought the decision was a good idea) b. Deal prohibitions - what Perot can't do. Which are the best self dealing arguments: proxy contest (self interest issue: this refers to a shareholder vote in which he'd get shareholders proxies to elect new board members. This goes directly to the self interest of the board). Criticism (argument: this would include public criticism of the board). Need to make an argument why those provisions are in bets interest of co. 1) One argument: Perot left, took insider info that he knew with him. So it's good for the co to shut him down

I. Capital asset pricing model A. Question: what is the value of a business? 1. Answer: the value of its income stream B. P/E Ratios 1. What is P/E: Price per share divided by earnings per share (multiplier or "capitalization factor") a. What is P/e? P = price. E = earnings. b. P means you're paying a certain amount for a dollar of earnings. If you only pay five dollars for one dollar of earnings: v risky, not worthy as much

1. P/E Rations (multipliers" and discount rates a. 20/1 = 5% b. 10/1 = 1-% c. 5/1 = 20% 2. Ex: 50/1 = 2%. Why might P/E no reflect he value of he 4$ in case flow? a. 50/1 ex: you must be expecting the earnings to change, go up. Particularly when you see a P/E, esp for a young company, that's 50/1, that tells you a big bet is being made for massive growth, not how risky people actually think the co is. In appraisal proceeding, want to make sure you locate these aberrations. Don't use a beta with this P/E

1. 16% bonds callable at $1,139.50. Rates fall to 12.8%. Should you call with remaining maturity of: a. 1 year? 1) Borrow $1,139.50 at 12.8% and call § Pay $145.86 in interest; $1,139.50 at maturity b. Do nothing § Pay $160 in interest; $1,000 at maturity c. 10 years? 1) Borrow $1,139.50 at 12.8% and call § Pay $1,458.56 in interest; $1,139.50 at maturity 2) • Do nothing § Pay $1,600 in interest; $1,000 at maturity d. 25 years? 1) Borrow $1,139.50 at 12.8% and call § Pay $3,646.40 in interest; $1,139.50 at maturity 2) Do nothing § Pay $4,000 in interest; $1,000 at maturity

1. Timeline for Morgan Stanley a. 1981 1) 125m bond offering b. 1982 1) 51m bond offering c. 1/83 1) 146m stock ovverings d. 3/83 1) 86m bond offering e. 5/83 1) MS purchases bonds at 1252.50 f. 6/83 1) Call announced at 1139.50 2) 146m stock offerings g. 8/83 1) Bonds recalled 2. Issues a. Breach of contract, failure to disclose b. Problem is that the k included this language: "At...any...time."

1) In the case, the maj sold 47% of his stake. No longer have maj control over the 85%. Take your 85%, stick it into another pie, then you can sell up to 49% of that pie and still will control all of the 85%. Aka, make a subsidiary with your 85%, can sell up to 49% of the subsidiary 2) Economic interest has lessened, but not the actual control 3) This is the perfect self-dealing structure: you totally control the bottom pie, but feel almost none of the economic loss from the smaller pie, even though you own such a small percentage of the interest 4) In ahmanson, they only do this once. 5) Put all of 85% in a parent they create. The empty entity has the 85% stake in it; can sell off 47% of those shares and keep control of US&L. 6) UF is the created co. UF owns the 85% stake of USL. What does UF have to give up in return for the 85% slice: a lot of shares. Gives the Ds 250 shares for each USL share. 7) Next step: they wanna go public. Sell 60k units for 7.2m. so what does the 7.2m represent, given that one unit = 2 UF shares and 5% callable, subordinated 100 bond: the bond component = 6m. so what are we implying about the value of each of the shares: they're worth 1.2m. so 600k would be the proceeds from just selling one share. Implied value of the shares: 10/share. 8) So why do you think you have to thrown in these bonds, why not just sell shares at 10/share? If you just sell the shares, it's a lot riskier; clumping it with the bonds makes it less risky. The bonds will be convertible into common stock. will they be convertible at a price below 10? No. the thinking is you wanna intro this new company, and your units are a way of intro-ing it. Selling off a tiny portion of UF's outstanding shares. They're not selling off 47% right now - just giving the public a little teaser. It's a way to market the stock. 9) How much with 5% subordinated 100 bond pay per year: 5$. 10) After this transaction: ther are 1.52 outstanding UF shares. 11) UF takes 7.2m, distribute it to themselves. Do the Ps get to sell their shares? No. and obviously they don't get any of the 7.2m. UF also is getting 300,000 they pay in interest payments. And right now, no money is coming into UF; will only get money if USL declares a dividend. UF has a reason, tehreofre, to want to show the market that tons of money is going into UF. So there's an incentive to make USL pay more dividends, and to pay more IN dividends. Dividend policy therefore changes. The incentive is to change dividends a lot to get UF share price up.

1) Go from three or four dollars per dividend to 70. Advantage to the minority. Is it to the detriment to the Ps? No, it's a benefit. (the though: if you want to make the minority sell out, you want to starve them out with low dividends, tell them they might as well sell out). 2) The issue: once UF has their stock price where they want it, they'll go from the 70 dividend payments back to 3 or 4 dollars. The minority is being hurt again. And right after they go back, they start offering o by the Ps/Mins shares at a low price. This is abuse, egregious. 3) Is it also to the benefit of the maj that they created UF? Yes. Is it to the detriment of the min? Not immediately. How would it be to their detriment? 4) Ahmanson poses two legal questions/issues: 1) created a market for their shares that the minority doesn't have access to. 5) There's no public market for minority USL shares. They've effectively been left out of the market. 6) Two potential detriments to the min: 1) they've been excluded from the public market; 2) whether the benefit of changing the dividend policy was to the detriment of the minority. 7) Without a market to sell your shares, only way you can have an economic benefit is by getting a dividend. 8) Argument: if dividends aren't paid to min, maj is also not getting a dividend. Not just a detriment to min. 9) BUT: maj has the advantage of public market. 10) What doesn't look good: they take 6.2 million from the 7.2 million of sharing UF shares and dumped it straight into their personal pockets. 11) How would you get cash from USL to the parent, UF: you pay dividends. You'd have to convince the market by getting a big check from UF. 12) Argument: UF is offering them way less than the stocks are worth to buy out the min; but argument is that they should be worth a little less than 250*25, because they don't have a control premium, they have a minority discount. 13) What's the detriment to the min (one way to read the fiduciary duty): if the maj goes public, they have to bring along th emin. 14) Questionable whether just going public would, today, count as a breach of fiduciary duty. 15) But here, the "minority discount" is ridiculous. Make an offer of 47 when trading at 173. 16) Maj did something totally to their benefit and detriment of min. some degree of minority discount is acceptable, but don't want to go too far. 17) In exam question: min is offered the opportunity to go public. Do you think min has to go along if think it'll blow up in heir faces? Should they really be able to argue later that they should be offered the opportunity again? They just want to wait, say what happens, and the ones that go public ake all the risk it's a flop, but then it goes really well, min wants a piece of the pie. It's not K (if I don't have the money to buy shares, you don't have the right to steal my money). But if you're just not taking a chance, good argument that you don't get to go in later. But if some aren't offered that opportunity, they're in the Ahmanson situation. In that case, what you'd want to see is some other egregious bhavior: lowballing them almost to ¼ of the trading value for their shares, manipulating the dividend policy. 18) UF was just creted as a way of going public without bringing along the min. What if the percentage that goes public is exactly 50%? Undercuts the min's argument against the maj - they could go, take their half, create their own public entity.

I. Preferred Stock A. Valuation Quiz 1. Setup a. Recall that in Technicolor the experts valued the company's income stream for each of years 1 through 5 and then assumed a perpetual income stream thereafter. Assume that Company A's income stream in each of the next three years will be: Year 1: $1 million; Year 2: $2 million; Year 3: $3 million. In year 4 and every year thereafter, Company A's income stream will be $4 million. You're asked to value the company assuming a 10% discount rate using the present value table below. The tables show the present value of $1 received in X number of years at a given discount rate and the present value of an annuity of $1 ($1 received each year) over x years at a given discount rate. 2. 1. What is the present value of year 1's income stream? $909,100 a. Present value table, row 1, column 10% = .9091 * 1,000,000 = $909,100 3. 2. What is the present value of year 2's income stream? $1,652,800 a. Present value table, row 2, column 10% = .8264 * 2,000,000 = $1,652,800 4. 3. What is the present value of year 3's income stream? $2,253,900 a. Present value table, row 3, column 10% = .7513 * 2,000,000 = $2,253,900 5. 4. What is the total present value of the first 3 years of income? $4,815,800 a. 909,100 + 1,652,800 + 2,253,900

1. 5. What is the present value of $4 million received every year forever? $40,000,000 a. $4,000,000/0.10 = $40,000,000 2. 6. What is the present value of $4 million received each year for 3 years? $9,947,600 a. Annuity table: row 3, column 10%: 2.4869 is present value of $1 received each year for 3 years; $4,000,000 * 2.4869 = $9,947,600 3. 7. What is the present value of $4 million received every year forever after subtracting the present value of $4 million received each year for 3 years? $30,052,400 a. $40,000,000 (the answer to #5) - $ 9,947,600 (the answer to #6) = $30,052,400. This is value of an annuity of $4 million paid each year beginning in year 4, which is what we need to know for our valuation. 4. 8. What is the value of Company A? $34,868,200 a. $ 4,815,800 (the answer to #4) + $30,052,400 (the answer to #7) = $34,868,200 5. In-class breakdown a. Figure out present value of year 1, 2, and 3 separately. b. In our problem, we'll assume that value of fifth years will be the same as the fourth year. c. We want to know the value of the co in perpetuity. Don't count the first four years twice in this calculation d. Ordinarily, to find value: income stream divided by discount rate e. If we just say 4m divided by 10%, get 40m, that 40m includes the values of the company's first, second, and third years of income. So you'll need to get rid, subtract the first three years

1. Wouk a. AOI provided that on dissolution, assets were first to be distributed to preferred stockholders. This included "any arrearage of dividends to which the holders are entitled." But AOI also provided that preferred stock were entitled to cumulative dividends as and when declared. b. Majority said that "cumulative" dividends were the only dividends to which preferred were entitled. Construe the arrearage of preferred dividends on dissolution refers only to declared dividends which weren't paid. So, as to undeclared dividends, the preferred stockholders never became entitled to them, and they did not accumulate. c. This means: in the case of dissolution, stockholders are restricted to arrearages of dividends, not accumulated dividends d. Peck's dissent: sees no difference between the two 2. Hay a. Cited by dissent in Wouk. b. Corporation had never declared dividends, never had any surplus profits from which dividends might have been paid. Yet the trial court held that the preferred shareholders were entitled to receive on liquidation an amount equal to the par value plus the six percent dividend for each year from the date of issuance to the date of liquidation. c. Majority said that they should go ahead an pay dividends on those years when, originally, the corp hadn't had the money to pay them. Minority said no. d. Can think of cumulation and contingent voting rights as close substitutes for one another

1. 626 - 33 (Burton) a. Two types of preferred stock. Exon owned 100% of the First preferred and 26.5% of the second preferred, and 90.9% of the common stock. b. Burton owned 10 shares of Second Preferred stock. there were 1945 shares of Second Preferred total c. AOI said that when accrued dividend arrearages on the preferred stock remained unpaid the exclusive right to vote for the directors is vested in first and second preferred, voting as one class. As a result: for more than 40 years, because the corp failed to paid dividends, and Exxon owned more than 80% of preferred, Exxon has controlled the corp. d. During 1977-80, board took several actions that Burton claimed was a breach of fiduciary duties. Contended that payments of dividends to Exxon, the First Preferred stockholder, were self-dealing and constituted a breach. Ct disagrees. e. In 1981, board decided that here should be a vote for dissolution. Required a 2/3 of both Second and First, each voting as a separate class. f. On dissolution, only First would be paid, because the value of assets were worth less than the arrearages actually due to First. g. In the vote, 4284 votes of Second weren't voted; abstentions were counted as "nos." so vote didn't pass. Burton wanted an injunction preventing dissolution, Exxon wanted dissolution. h. Corp had previously declared a dividend only to First, ie Exxon. None went to Second. i. Ct used the intrinsic fairness test. Said then that it would have been unwise for corp to not pay Exxon. There was substantial uncertainty with regards to future payments.

I. Dilution A. Dilution quiz 1. A company has 100 shares outstanding and is worth $10 million. It proposes to issue another 100 shares, so there will be 200 shares outstanding. To avoid dilution of the interests of existing shareholders and purchasing shareholders, how much should the purchasing shareholders pay for the 100 shares? a. 10m b. 1m c. 5m a. 2m b. Answer: 10m. Correct: Dilution occurs when either the existing or new shareholders' wealth is reduced by the recapitalization. Before the transaction, each share is worth $100,000, so the existing shareholders' stake is worth $10 million. In order to prevent dilution of the existing and new shareholders' interests, the new shares should be sold for $100,000/share. Another way to think about this question is to match the ratio of the existing and new shares to the ratio of the corporation's value and the purchase price. Here, the existing/new shares ratio is 1:1. The value/purchase price ratio therefore should be 1:1, so the purchase price must equal $10 million. To check your answer, compare the existing and new shareholders' pre-recapitalization wealth to their post-transaction wealth to ensure that they are equal.

1. A company has 100 shares outstanding and is worth $5 million. It proposes to issue another 100 shares, so there will be 200 shares outstanding. To avoid dilution of the interests of existing shareholders and purchasing shareholders, how much should the purchasing shareholders pay for the 100 shares: a. 10m b. 1m c. 5m d. 2m e. Answer: 10m. Correct: Dilution occurs when either the existing or new shareholders' wealth is reduced by the recapitalization. Before the transaction, each share is worth $50,000, so the existing shareholders' wealth is $5 million. In order to prevent dilution of the existing and new shareholders' interests, the new shares should be sold for $50,000/share. Another way to think about this question is to match the ratio of the existing and new shares to the ratio of the corporation's value and the purchase price. Here, the existing/new shares ratio is 1:1. The value/purchase price ratio therefore should be 1:1, so the purchase price must equal $5 million. To check your answer, compare the existing and new shareholders' pre-recapitalization wealth to their post-transaction wealth to ensure that they are equal.

1. A company has 900 shares outstanding and is worth $9 million. It proposes to issue 100 new shares. What total price should the purchasing shareholders pay for the new shares: a. 10m b. 9m c. 1m d. 81m e. Answer: 1m. Correct: Dilution occurs when either the existing or new shareholders' wealth is reduced by the recapitalization. Before the transaction, each share is worth $10,000, so the existing shareholders' stake is worth $9 million. In order to prevent dilution of the existing and new shareholders' interests, the new shares should be sold for $10,000/share, or $1 million. Another way to think about this question is to match the ratio of the existing and new shares to the ratio of the corporation's value and the purchase price. Here, the existing/new shares ratio is 9:1. The value/purchase price ratio therefore should be 9:1, so the purchase price must be $1 million. To check your answer, compare the existing and new shareholders' pre-recapitalization wealth to their post-transaction wealth to ensure that they are equal.

1. A company has 400 shares outstanding and is worth 8 million. It proposes to issue 100 new shares. What total price should the purchasing shareholders pay for the new shares: a. 10m b. 1m c. 2m d. 80m e. 5m f. Answer: 2m. Correct: Exp: Dilution occurs when either the existing or new shareholders' wealth is reduced by the recapitalization. Before the transaction, each share is worth $20,000, so the existing shareholders' stake is worth $8 million. In order to prevent dilution of the existing and new shareholders' interests, the new shares should be sold for 20,000/share, or $2 million. Another way to think about this question is to match the ratio of the existing and new shares to the ratio of the corporation's value and the purchase price. Here, the existing/new shares ratio is 4:1. The value/purchase price ratio therefore should be 4:1, so the purchase price must be $2 million. To check your answer, compare the existing and new shareholders' pre-recapitalization wealth to their post-transaction wealth to ensure that they are equal.

1. What is a preemptive right: a. A shareholder's right to be bought out by the majority shareholders before the corporation issues new shares. b. A shareholder's right to be bought out by the majority shareholders before the corporation pays dividends. c. A shareholder's right to purchase the number of shares in a new issue as necessary to maintain the shareholder's proportionate interest in the corporation. d. A shareholder's right to demand that the corporation purchase his shares at the same or better price as that paid to a majority shareholder e. Answer: Preemptive rights protect a minority shareholder against dilution by ensuring that, if new shares are issued, the shareholder will be able to purchase the number of shares necessary to maintain his proportionate voting and economic interests in the corporation.

1. A minority shareholder owns 10 of Corporation A's 100 outstanding shares. In which circumstances would you advise a minority shareholder that his economic interests may be diluted if he does not exercise his preemptive rights (mark all that apply) a. 1. Corporation A is worth $10 million and it issues 50 new shares for $100,000/share. b. 2. Corporation A is worth $5 million and it issues 50 new shares for $75,000/share. c. 3. Corporation A is worth $20 million and it issues 100 new shares for $100,000/share. d. 4. Corporation A is worth $20 million and it issues 50 new shares for $200,000/share. e. Answer: 3. The minority shareholder's interest in Corporation A will be diluted if new shares are issued at a discount to their market value. The minority shareholder will not be harmed if new shares are issued for at least $50,000/share, $100,000/share, or $200,000/share when the company is worth $5 million, $10 million, or $20 million, respectively. Only in answer C are the shares issued at a discount to their value ($20 million value, $100,000/share purchase price). In this example, the value of the minority's shares would decline by $1.5 million, from $200,000/share to $150,000/share (10/200 share * $30m = $1.5 million = $150,000/share). By exercising preemptive rights to purchase 10% (10 shares) of the new offering for $1 million, the minority shareholder's interest would be worth 10% of $30 million, or $3 million. This equals the sum of his interest before the recapitalization (10 * $200,000 = $2 million) and his new $1 million investment.

A. Farris 1. Contrast: a. Ziebarth: Only a right to appraisal absent fraud/hidden unfairness b. Farris: ANY right to appraisal? 2. Questions to consider a. Can appraisal right triggered by merger be circumvented by an asset purchase (do indirectly what you can't do directly)? b. Is appraisal right triggered by fundamental change in nature of ownership interest? 3. Glen Alden originally has 85m in assets, 5m in debt. a. List originally owns 31m of the assets, of 39%. Other GA shareholders own 49m, 61%. 4. What we have here is a minnow, GA, swallowing a whale, List. a. GA sends 31m, or 39% of its assets, in GA stock to List. List sends its stocks to GA. b. Question: Why not have List buy all of GA assets? 1) Pa. transfer tax 2) Loss carryovers c. Why not have List merge with (acquire) GA for List stock? 1) Appraisal right

1. Before and after this transaction a. Before: 1) GA has 85m in assets, 5m in debt. 2) GA shareholders own 61%, List shareholders own 39%. b. After: 1) GA has 169m in assets, 38m in debt 2) GA shareholders own 24%; List shareholders own 76% c. Has there been a sale of control? 1) 85m - 5m = 80m. 80m * .61 = 49m 2) 169m - 38m = 131m. 131 * .24 = 31m. 3) Yes; the whole idea is that the shareholders' stake in the company should be worth the same thing that it was before. Ownership dilution may be impossible to avoid, but they've been economically diluted, and that's preventable. 2. DE sections a. Section 311: No vote required for issuance of stock for assets b. Section 908: No appraisal right for asset purchase 1) We "will not blind our eyes to the reality of the transaction." 2) What would Ziebarth court say?

1. In Litwin, bond had a return of $55 annually. That means that it was issued at 5.5% interest rate on $1000. a. How would you calculate the prevailing rate if the bond were trading at $1060? In other words, what interest rate would an annual $55 payment reflect if paid on a loan of $1060? 55/1060 = __%. Answer: the prevailing rate = 5.2% (55 is 5.2% of 1060). b. 55 annually = 5.5% on 1000 c. 55 annually = 5.2% on 1060 d. How would you calculate the prevailing rate at the time that the bond was trading at 810? Remember, the bond is still paying 55 annually. 1) 55/810 = 6.8%. this would be the prevailing rate. 2. Recall now that when interest rates rise, bond prices fall 1) Prevailing interest rate Bond Price Interest (coupon) payment 2) 6.8% 810 55 3) 5.5% 1000 55 4) 5.2% 1060 55 5) 3.6% 1528 55 3. In this case, rates rose. Could they have increased instead?

1. Bond pays $100 annually, coupon rate = 10% The bond sells for $2,000: What is the prevailing rate? 5% a. Interest rates double from the date the bond was issued: What is the bond worth? $500 b. Would you buy a $1,000 bond with a 10% coupon rate for $500 assuming a prevailing rate of 15%? Yes (the bond's yield is 20%! ($100/$500)) c. Would you buy a $1,000 bond with a 5% coupon rate for $2,000 assuming a prevailing rate of 2.4%? Yes (2.5% yield) 2. Opportunity Cost: What could the bank have earned on a similar 1000 bond? The prevailing 5.2% rate a. Mo. Pacific = 55 annually b. Similar bond = 52 annually c. MoPac is trading at 1060 because that price turns it into a bond paying 5.2%

1. Market return? a. NASDAQ Biotechnology Index. The annual return of the S&P 500 was 0.00% over the last year, 0.07% over the last five years, 3.2% over the last ten years, between 14.4% and 2.4% for 20-year periods from 1950 to 2010, and 8.22% since 1926. The investment return of the NASDAQ Biotechnology Index has been 12.08% over the last year, 36.91% over the last five years and -30.72% over the last nine years and four months (since the inception of the index on 9/25/03). b. Market return = (he just chose this number, we can choose almost any, as long as have a good argument) 8.1% 1) S&P: 0% 1 yr; .07% 5 yr; 3.2% 10 yr; 2.4% to 14.4% over rolling 20yr; 8.22% since 1926 2) • Bio: 12 / 1 yr, 37 / 5 yr, -31 / 10 yr c. 200m * (1/4% + (Beta * (8.2% - 4%))))) 2. Beta? a. Its stock price has risen and fallen twice as much as the S&P 500, and half as much as the NASDAQ Biotechnology Index. b. 2x volatility of S&P: beta is 2 c. ½ volatility of biotech index: beta is .5

1. Calculation a. 200m * (1 / (4% + (2 * 4.2%) b. $200m * (1 / (4% + 8.4%) c. $200m * (1 / 12.4%) d. $200m/12.4% = $1.6b e. So what is biotech's value: 1.6 billion

A. Valuation sample exam question 1. Text a. Privately held Biotech Inc.'s cash flow last year was $300 million, with $100 million coming from the one-time sale of an office building. Its stock price has risen and fallen twice as much as the S&P 500, and half as much as the NASDAQ Biotechnology Index. The annual return of the S&P 500 was 0.00% over the last year, 0.07% over the last five years, 3.2% over the last ten years, between 14.4% and 2.4% for 20-year periods from 1950 to 2010, and 8.22% since 1926. The investment return of the NASDAQ Biotechnology Index has been 12.08% over the last year, 36.91% over the last five years and -30.72% over the last nine years and four months (since the inception of the index on 9/25/03). The ten-year treasury bond rate is currently 1.9% and has averaged approximately 4.0% over the last ten years. What is Biotech's value?

1. Cash flow? a. Privately held Biotech Inc.'s cash flow last year was $300 million, with $100 million coming from the one-time sale of an office building. b. 300m - 100m = 200m. c. 200m * (1/(RF + (Beta * (E(RM) - RF)))) 2. Risk free rate? a. The ten-year treasury bond rate is currently 1.9% and has averaged approximately 4.0% over the last ten years. b. Treasury: 1.9% now, 4% over ten years c. 200m * (1/4% + (Beta * (E(RM) - 4%))))

1. The term watered stock refers to (mark the best answer: a. Stock held by existing shareholders when a corporation issues new shares at a price that is below their market value. b. Stock issued to new shareholders at a price that is higher than the stock's market value c. Stock held by existing shareholders when a corporation issues new shares at a price that is higher than their market value d. Stock issued to new shareholders at a price that is below the stock's market value. e. Answer: The phrase "watered stock" derives from the practice of have cattle drink water to artificially increase their weight immediately before they are sold. Similarly, watered stock is artificially inflated in value at the time of sale. There is no comparable term for the dilution that occurs when stock is sold at a discount to its market value and the interests of existing shareholders are diluted. In this course, both the issuance of watered stock and discounted stock are referred to as resulting in "dilution." 2. The CEO owns 1% of a corporation's outstanding shares. How might the CEO receive a financial benefit as a direct result of causing the corporation to issue new shares at a price that is below their market value? a. When new shares are issued at a discount to their market value, the value of the CEO's current shares are diluted along with the shares held by other shareholders. The CEO might benefit from the issuance of watered stock, however, if: (1)he is one of the purchasers of the newly issued shares, and (2) the dollar amount of the discount of the shares he purchases exceeds the dollar amount of the dilution to his existing shares.

1. Corporation A has 1,000 outstanding shares, of which the CEO owns 10%. The value of Corporation A is $1 million. Under which circumstances would the CEO be better off financially (mark all that apply): a. Corporation A issues 500 new shares for $2.5 million, and the CEO purchases 50. 1) A: The CEO is not better off. The new shares are sold for $5,000/share -- a $4,000/share premium above their value. Thus, the new shares are "watered stock" the sale of which increases the value of the CEO's 100 shares. But the CEO loses money on each of the 50 shares purchased at $5,000 each. His 150 stake is worth $350,000, but this $250,000 increase is consumed by the loss on the watered stock. He breaks even. b. Corporation A issues 500 new shares for $2.5 million, and the CEO purchases 25. 1) The CEO is better off. The new shares are sold for $5,000/share -- a $4,000/share premium above their value. Thus, the new shares are "watered stock" that increase the value of the CEO's 100 shares. The CEO spends $125,000 on the 25 shares purchased, leaving him with 125 shares in a company now worth $3.5 million. His stake grows to about $167,000 for a $67,000 net gain.

A. In-Class notes 1. 608 - 26 (Guttman, Wouk, Hay (n.1)) a. The types of stock, rights associated with them must be set out in articles of incorporation b. Different types of rights associated with preferred stock: dividend rights, liquidation rights, voting rights, redemption rights, conversion rights, protective provisions c. Dividend rights: provide a fixed rate of return that must be paid in any year before any divided may be paid on the common. Amount may be fixed in dollars per share of preferred or as a percentage of face value. d. Liquidation rights: preferred stock typically carries preference in the liquidation of the corp. amount of the liquidation preference may be based on the par value of the preferred shares, the original issue price, or some stated amount. e. Voting rights: preferred stock is usually non-voting, but they may carry contingent voting rights triggered by nonpayment of dividends. f. Redemption rights: preferred stock is usually made redeemable by the corp at a predetermined price, which is usually based on the par value or original issue price, often including a premium. often the right of the issuer to redeem is referred to as a righ to call the stock and the stock itself is said to be callable. By the same token, right to require the corp to redeem is called a put option, stock is said to be put-able. g. Conversion rights: many issues of preferred stock grant the holder the right to convert into common shares at a predetermined ratio. h. Protective provisions: in many cases, the AOI provisions defining the rights of preferred stock also include a variety of protective provisions. They may limit the right of the corp to issue additional shares with superior or equal rights or limit the distributions that may be made to common stock. i. The rights of preferred stock are strictly limited to what's in the AOI j. In many ways, secured interest is like debt. However, unlike debt, no security interest is possible with secured shares. k. A corp may issue more than one class of preferred stock - "senior" vs "junior" securities l. Dividend may be paid on preferred stock only if assets would be at least equal to liabilities after giving effect to the dividend and the corp would remain able to pay its bills as they come due.

1. Dividend rights - Guttman a. ILCR issued 186,457 shares of 6% noncumulative convertible preferred stock in 1922. AOI said that stock had right to dividends on surplus income or net profits, not exceeding 7%, before any dividends are paid on common stock. no dividend can be paid on common stock unless preferred stock is paid first b. No dividends on preferred were declared between 1932-48. Between 37-48, however, the net income exceeded the amount needed to satisfy the annual dividend requirement of the preferred. c. Ct assumes that the standard of discretion in weighing the non-declaration of dividends for preferred is much stricter than in the case for common. d. Here, they think that the directors made an appropriate decision, adopted a "reasonable attitude of reluctant pessimism about the future." e. The issue is whether the directors could declare a dividend on common stock in 1950 without directing that there should be paid arrears of preferred dividends that had been earned in 42-47. Aka: did 1) directors have the power to declare such arrears and b) did they abuse their discretion in declaring any dividend on common stock without paying those arrears. f. Ct looked at Wabash case, which held that "if no dividend is declared within the year, the claim for that year is gone and cannot be asserted at a later date." g. Ps tried to distinguish Wabash from the present case by arguing Wabash only applied to instances where net earnings are used on capital improvements. Ct declines this argument, say that "a contract is a contract." h. NOTE: this approach (NJ) is not followed by a majority of js, who say that they have a "Definite interest" in net earnings.

I. Transactions A. there are two types of acquisitions: friendly and hostile 1. Friendly a. Process 1) Negotiations between acquirer and target 2) Negotiations are successful 3) Merger approved by target board 4) Acquirer creates sub 5) Dissenting target shareholders have appraisal right 6) 100% of target's shares go to the new sub, new sub sends money and acquirer securities 7) Target is dissolved b. Breakdown 1) Friendly acquisitions begin with negotiations. Often are friendly. Acquirer often owns a large chunk of target stock aready. Board will approve deal. Then will have to go to shareholders of the target to get the deal approved by shareholder vote. Approved by shareholders; those who disset have appraisal rights, which means that they go to ct, litigate what their shares are worth. Acquirer now gets the whole company, dissenters are squeezed out. Acquirer will drop down a new sub, will send money and securities to target, shares will go to sub. Target is dissolved.

1. Hostile a. Stage 1 1) Negotiations between target and acquirer 2) Negotiations fail; target board takes defensive measures against tender offer 3) Dissenting target shareholders do not tender 4) Acquirer sends target board money and securities 5) Target board sends acquirer greatly than 50%, but less than 100%, of target shares. b. Stage 2 1) Acquirer has greater than 50, less than 100% control of subsidiary 2) Dissenting shareholders' stake is less than 50% 3) Negotiations between acquirer and subsidiary 4) Negotiations are successful, merger approved by board 5) (No proxy solicit in short-form merger) Proxy solicit 6) Subsidiary goes into new sub, new sub sends subsidiary money and acquirer securities. 7) Money and acquirer securities go to dissenters c. Breakdown 1) Negotiations where the acquirer knows the target board won't go along. Target board will incorporate defensive measures to stop you from selling stock at a price you'd like to take.

1. You borrowed $300,000 to purchase a $500,000 house. You do not pay your real estate taxes and the government places a $50,000 lien on your house. What is your debt-equity ratio? (Lien: a security interest in a home or other property that secures an obligation.) a. 1. 1.7:1 b. 2. 2:1 c. 3. 3:1 d. 4. 1:3 e. 5. 3.5:1 f. Answer: Your debt is $300,000. Your debt would not include the amount of the lien because a lien would not be considered the kind of long-term financing that constituted debt for purposes of evaluating a business's capital structure. Your equity would equal the $500,000 value of the home, minus both the outstanding balance of the loan ($300,000) and the lien ($50,000), or $150,000. In other words, if you sold your house, the bank would receive $300,000, the IRS would receive $50,000, and you would receive $150,000. Your debt-equity ratio would be $300,000/$150,000, or 2:1. 2. If Widget A opportunity has a 60% chance of earning $100 million and a 40% chance of losing $100 million, then what is the expected value of the opportunity a. 1. $20 million b. 2. $0 c. 3. $40 million d. 4. $100 million e. 5. -$40 million f. 6. -$60 million g. Answer: The expected value would be calculated as follows: (60% * $100 million) + (40% * (-$100 million)) = $20 million.

1. If Widget A opportunity has a 75% chance of earning $80 million and a 25% chance of losing $40 million, then what is the expected value of the opportunity? a. 1. -$20 million b. 2. $20 million c. 3. $60 million d. 4. $50 million e. 5. -$10 million f. 6. $40 million g. The expected value would be calculated as follows: (75% * $80 million) + (25% * (-$40 million)) = $50 million. 2. If Widget A has a 30% chance of earning $90 million, a 25% chance of earning $10 million, and a 45% chance of losing $20 million, then what is the expected value of the opportunity? a. 1. $10.5 million b. 2. $20.5 million c. 3. -$15.5 million d. 4. $23.5 million e. 5. -$23.5 million f. Answer: Correct: The expected value would be calculated as follows: (30% * $90 million) + (25% * $10 million) + (45% * (-$20 million)) = $20.5 million

A. Moran 1. Trial court: "while fending off Moran's advances, Clark took the lead in securing advice concerning takeover defenses." 2. Timeline: a. 2/84: concern about takeover vulnerability b. 3/84: Board decides against fair price amendment c. 5/84: request for meetin from investment company d. From 02/84 to 05/84, there are Moral "discussions" regarding the LBO. e. ISSUE: is there really a threat? 3. Law of defensive tactics a. Unocal (at 798): 1) "directors must show...reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another person's stock ownership." 2) "defensive measure...must be reasonable in relation to the threat posed." b. Moral (at 807, 813): 1) "pre-planning for...hostile takeover might reduce risk that...management will fail to exercise reasonable judgment." (BJP) 2) "ultimate response to an actual takeover bid must be judged by the directors' actions at that time." ("fresh look") 4. Carmody/quickturn (at 815-6): a. Dead and no hand provisions are impermissible 5. Summary: a. Unocal: 1) Threat 2) Reasonable response b. Moran: 1) Pre-planning = BJR 2) Fresh look c. Carmody/Quickturn: 1) No dead hand

1. In-class notes a. If Unocal test doesn't apply (aka, don't have a threat), we're back to the BJP. b. In exam, where would you identify Moran: if there's just a rumor. Not clear if defenseive measures out of response to a rumor is enough to trigger Unocal. Little more tangible if it's about a specific acquiror, or it's started by a phone message. c. This case is all about whether they KNEW there was a threat. d. If no threat, BJP applies. e. Another part of Moran: Fresh Look doctrine: you est that there's a threat, take reasonable defensive measures, but if they change their offer, you have to reconsider everything. You have to revisit it, give it a fresh look. f. You cannot have a provision that says future boards cannot change it (dead hand provision) (implied by fresh look doctrine, anyway. Dead hand says you're not allowed to take a fresh look) g. You can do basically anything else, besides dead hand provisions, exclude other shareholders

A. Discount rate 1. Chart for discussion a. US gov bond - prevailing rate is 5% - annual interest payment is $100 - what would you pay for the bond? 1) You'd pay $2000 b. Large US co - prevailing rate is 10% - annual interest payment is $100 - wha would you pay for the bond? 1) You'd pay $1000 c. Small internet co - prevailing rate is 20% - annual interest payment is $100 - what would you pay for the bond? 1) You'd pay $500 2. Discussion a. US bond ex: (prevailing rae = what market thinks is a fair price) you'd pay 2000. 100 is 5% of 2000. Convert the dollars you'll get from the percentage of what you've paid. You expect them to pay 5% - 100 per year will represent 5% of your 2000. This is a risk free rate of return. b. Large US company: more risky than US. Will demand a higher return for your money, bc riskier. Demand a higher expectation, higher return for your money. You'd pay: 1000. This is less than US bc it's riskier, even though you're getting the same payment. c. Tiny intent company: you'd pay $500. If it wants to buy your money, it'll have to pay you a lot more.

1. If a business has $100 in annual earnings and a US bond is trading at a 5% interest rate, would you pay $2000 for the business? NO: $100 represents 5% return on $2000. YOU CAN GET THAT WITH A GOV BOND!!! RISK FREE a. What WOULD you pay for the business, and what would you need to know to make that decision? 1) You'd need to know the rate of return you expect from the investment 2) What do you need to know in order to figure out what you'll pay for that business: risk, which we'll measure by market premium (how much more than the RF do you expect your investment, your 100$, to represent) b. Why should there never be a PE greater than 20/1: that's the risk free rate, that's basically US. You could get that same 5% bond from the government, not some random co. you should demand a premium, bc there's always going to be more risk than you'd take with the gov. If gov starts paying you more for bonds, stock prices go down. This is one of the ways that the gov can affect the stock market. 2. If the business had $100 in annual earnings, and you required a 50% rate of return (the business is high risk), you would determine the purchase price by solving for X: a. $100/X = 50% (expected annual return = 50% of investment) 1) $100/$200 = 50% (earnings = 50% of investment) i.How much MORE than the risk free rate are you demanding from the business?45%. 45% is the PREMIUM paid by the business.

1. The CEO expects the company to sell a a multiplier of three to four. What does this statement mean? a. The company's sale price will equal three to four times its earnings b. The company's sale price will equal 3 to 4 times its earnings per share c. The company will sell at 3 to 4 times its capitalization d. The discount rate for the company is 25% or below e. The discount rate for the company is 25% or above f. The company presents a greater risk than a company that'd sell at a multiplier of 4 o 5. g. Answer: 1, 5, 6 2. As a company's discount rate increases, its value: decreases A higher discount rate means greater risk and a lower placed on for $1 of earnings. 3. As a company's multiplier increases, its value: increases.

1. If a company earns $3.15 per share and its share price is $12.6, then what is its discount rate? 4.25. The discount rate equals inverse of the price-to-earnings ratio. The p/e here is $12.60/$3.15, or 4. Its inverse is 25%. 2. In an appraisal proceeding, the D company prefers a discount rate that is: Higher. In an appraisal proceeding, the plaintiffs are minority shareholders who seek a higher payment for their shares. The company is the defendant and wants to pay the shareholders as little as possible. A higher discount rate means a lower price (to reflect greater risk), so the company prefers a higher discount rate. 3. The capital asse pricing model: a. Uses a company's earnings, as opposed to its cash flow, to calculate the company's value b. Uses beta to reflect the risk of the market in which a company's securities trade c. Provides a formula for determining a company's discount rate d. Doesn't incorporate market prices e. Generates an appropriate estimate of the value of the company f. Answer: 3.

I. Perot, Litwin, Bonds, and Capital Structure A. Review questions 1. If a 1000 face value US government bond is used at a 5% coupon rate, what will be he value of the bond if interest rates on similar US government bonds rise to 10% a. $500. If newly issued $1,000 face value government bonds are paying 10% annually in interest, then purchasers will require that any similar bond also pay 10% annually. That's the going rate. This means that the $50 annual interest payment on the original bond will have to reflect a 10% return. $50 is 10% of $500. The bonds will sell for $500. Interest rates rise. Bond prices fall. 2. If a 1000 face value US government bond is used at a 10% coupon rate, what will be the value of the bond if interest rates on similar US government bonds rise to 5%? a. Needs Grading: $2,000. This is the reverse of the preceding question. Now the market is satisfied with only 5% interest on a government bond. The original bond that pays $100 each year need reflect only a 5% return. $100 is 5% of $2,000. The bonds will sell for $2,000. Interest rates fall. Bond prices rise.

1. In Litwin, the Missouri bonds had a coupon rate of 5.5%. They traded a $106 at the time of the deal. What was the approximate prevailing interest rates for similar bonds at that time? a. 5.2%. The bonds paid $55 annually. If the market was willing to pay $1,060 for $55 in annual interest payments, then the market was satisfied with a 55/1060 annual interest rate, or 5.2%. Interest rates had declined to 5.2%. The value of the bonds rose. 2. In Litwin, the Missouri bonds had a coupon rate of 5.5%. They traded at $81 six months after the deal. What was the approximate prevailing interest rates for similar bonds at that time? a. The bonds paid $55 annually. If the market was willing to pay only $810 for $55 in annual interest payments, then the market was demanding a 55/810 annual interest rate, or 6.8%. Interest rates had increased to 6.8%. The value of the bonds fell 3. In Litwin, what was the potential benefit to the bank in buying the bonds at $100? Or was there no prospect of a positive return

I. Hostile Acquisitions A. Key question: by what standard do we evaluate the board's response to a hostile tender offer? The Unocal standard. Ask: 1. Does the board have the legal authority to implement defensive measures? a. Answer to this will almost always be yes 2. What standard applies? BJP? a. Answer: It depends B. Unocal 1. Unocal (at 1107-08): a. 1."directors must show . . . reasonable grounds for believing that a danger to corporate policy and effectiveness existed because of another b. person's stock ownership." c. 2."defensive measure . . . must be reasonable in relation to the threat posed." d. THESE ARE: The two steps to the Unocal standard. 2. Exs of Unocal threats (at 1108): a. Inadequacy of offer b. Nature and timing of offer c. Questions of illegality d. Impact on nonshareholder constituencies e. Risk of nonconsummation f. Quality of consideration 3. May offeror be excluded from a selective repurchase, as in Unocal? Timeline: a. Unocal court: "reasonably related to the threat posed" b. Other federal courts disagree, applying state law c. Each state overrules federal court decision d. SEC adopts all-holders rule (Unocal partly overruled)

1. In-class notes a. Almost no black letter law with hostile acquisitions b. The legal question is: by what standard do we evaluate the board's response to a hostile tender offer c. Question one: does the board have the legal authority to impelement defneseive measures" answer is almost always yes. So this will never be the issue. d. Question two: what standard applies? BJP? e. Unocal: takeaway is the two-part Unocal standard. 1. There has to be a threat to corporate olicy and effectiveness. One way to do this: lookit identity of acquirer, lookit their past deals, say they're bad at deals, will end up harming the company. 2. If there's a threat, you can take defensive measures that are reasonably tailored to the threat. Gotta make sure when you first face the threat you get ALL the threats down on paper so they can just be picked off. f. Risk of nonconsummation: they're looking for financing, don't quite have it. g. Illegality: antitrust issues. Merger might have to be approved by justice dept, you think it won't come out h. Quality of consideration: if they're going to pay you in stock or bonds. Esp true when: in a two step acquisition, second step they offer bonds instead of stock i. Can you be excluded from a selective stock purchase (if you buy the stock that the acquirer already owns of your company, you're helping the purchaser, just giving away money). The SEC rule: if you make a repurchase, it has to be given to all holders, including the enemy. j. What can't you do: all holders rule requires a repurchase be for ALL holders. Test: threat; reasonably related defenses. Black letter rule: can't have selective stock purchases.

1. Shareholder would have stock "taken away from him and the stock of a new company thrust upon him in its place," would be "projected against his will into a new enterprise under terms not of his own choosing." 2. Appraisal is required when transaction causes entity "to lose its essential nature and alter the original fundamental relationships of the shareholders among themselves and to the corporation." 3. Does transaction "fundamentally change the corporate character of Glen Alden," "in reality force [the shareholder] to give up his stock in one corporation and against his will accept shares in another?" 4. Takeaways a. Ziebarth: only right to appraisal unless fraud b. Farris: Appraisal right for fundamental changes (de facto merger doctrine) 1) This was overturned in Pa. 2) Del: Per ZIebarth, no de facto merger doctrine 3) But doctrine may apply in other states

1. In-class notes a. Farris confronts the question: is there even a right to appraisal: ct says yes. You have a right to appraisal. b. How did they avoid appraisal: an asset purchase. Asset purchase doesn't trigger for a dissenting shareholder the right to vote. c. Answer is you cannot do indirectly what you can't do directly. d. Is appraisal right triggered by fundamentl change in nature of ownership interest? Ct has to look at the transaction, say that it's really a merger, have some basis for saying so. e. Glen Alden is owned 39% by List. Other shares are widely owned. That means List has working/de facto control. List is much bigger than GA. But List is selling its assets to GA, this smaller company. A much small company is swallowing List. Who's really acquiring whom, who will end up having majority control after the deal? The List shareholders. When a minnow swallows a whale, the whale is really in change, will become maj shareholders of the arget. f. Why not have List buy all GA assets? This is what would happen, really, with an asset purchase. Bc wouldn't triggered a PA transfer tax. Another reason: GA has a lot of tax loss carryovers, which we want to preserve, can't do that if List, a profitable company, acquires GA. g. What would be a practical arguemn as to why you wouldn't want to trigger appraisal if you think a significant no of shareholders will demand appraisal? You'll have to pay out, might not have cash on hand to pay all of them. And you do have to pay them in cash, not in stock. h. Why not merge with List stock: that would trigger vote, vote goes along with an appraisal right. i. How would you analyze this transaction: look at percentage of stocks owned by List before, after the transaction. List has greatly increased their percentage (bc they had to issue shares to acquire List's assets, which List shareholders bought). j. If you had paid th right amount for the acquired assets, GA shareholders should still have 61%. Economic dilution can be avoided, even if ownership can't, if you pay the right amount. k. Has there been a sale of control? We've gone from working control to outright maj control, so yeah. l. Key for us: the idea that after the transaction, your stake should be WORTH the same as it was before. m. Under DE law, no vote required for issaucne of stock. actors to consider if this is really an appraisal: essential nature....og fundamental relationships (when arguing for de facto merger)

A. MetLife 1. Plaintiff claims that RJR "breaches the duty [or implied covenant] of good faith and fair dealing by . . . destroying the investment grade quality of the debt and transferring that value to 'buy-out' proponents and to the shareholders." (776) 2. "Under plaintiffs' theory, bondholders might ask a court to prohibit a company like RJR Nabisco not only from engaging in an LBO, but also from entering a new line of business — with the attendant costs of building new physical plants and hiring new workers — or from acquiring new businesses such as RJR Nabisco did when it acquired Del Monte." 3. "That agreement [with Del Monte] restricted [its] ability . . . to incur the sort of indebtedness involved in the RJR Nabisco LBO. . . . [Subsequently], MetLife and [RJR] entered into a guarantee and amendment agreement . . .. Pursuant to that agreement, . . . MetLife thus 'gave up the restrictive covenants applicable to the Del Monte debt ... in return for [the parent company's] guarantee and public covenants.'" 4. Bond "represents a contractual entitlement to the repayment of a debt and does not represent an equitable interest in the issuing corporation." 5. Extrinsic evidence? "Second Circuit has established a different rule for customary, or boilerplate, provisions of detailed indentures used and relied upon throughout the securities market, such as those at issue." 6. "Plaintiffs also remain free to assert their claims based on the fraudulent conveyance laws . . ." a. Aka: a common law claim

1. In-class notes a. What's the effect of a co taking on a huge amount of debt at the high interest rate: drive way down the value of the company, the likelihood you'll get paid just went down. b. You could have a change of control provision (if there's a change of control, bond holder has a right to be bought out; gives you option if sketchy characters come around, you get bad vibes, think they'll take the company under), a provision that prevents the issuer from taking on new debt in this type of situation, if you hold jukn bonds c. You want people with junior loans to you to come in - you might get paid off with money that they give the company. You wanted STs to get out, because with them gone, you have a better chance of getting paid in bankruptcy. d. Argument in Met Life: I would be protected from what would happen if co issued junk bonds, destroyed investment value of co. ct's viewpoint: this argument could keep company from entering into any type of risky business. If you want to protect yourself, you have to put it into writing. e. Another problem: this type of covenant was previously in the covenant, but MetLife had already taken it out. That drives home the point that this is a k issue. This was a credit worthiness case. Credit worthiness was brought down because co was issuing bonds at a very high interest rate.

A. Basic issues he could raise on an exam question: 1. Cash flow distortions a. One time purchase/sale of building b. Reduction in accounts receivable by 50% with no change in sales c. Increase in accounts payable by 50% with no change in expenses 2. Earnings distortions a. One time large write-off b. Non-recurring tax benefit c. Non-operating pension gains d. Non-recurring legal expenses 3. Time: a. Longer period smooths extremes in recent years b. Older data less representative of today's conditions 4. Risk-free rate a. 1-, 5- or 10-year T-bills

1. Index a. Extreme beta? Probably not a good fit b. How handle negative returns c. Number of stocks in index (less than 20? suspect usefulness) d. Similarity of line of business 2. Beta a. Function of index b. Shouldn't include price effect of announced acquisition c. Inclusion/exclusion of extreme periods of volatility 3. In-class notes a. Last CAPM slide: list of issues that he might raise in an exam problem. List of CF, earnings distortions 1) Legal expenses: deflation 2) Pension gains: deflation 3) Tax benefit: inflation 4) If have just 20 stocks, vs SP 500, you know that a corp with 500+ stocks will be a better indicator than a corp with just 20.

A. Joy v. North 1. Basically about lending money to a failing company: Joy v. North. 2. Claim is being brought in respect to Citytrust. Citytrust is wholly owned by CFSC. People bringing a claim aren't shareholders of Citytrust. But they still have standing bc there's a 100% parent - doesn't matter that they're not a direct shareholder, just shareholders of the holding company - idea is you should be able to pierce all the way through (double derivative claim). You're suing CItytrust for not bringing a claim against its board and its directors. 3. Recall that to bring a derivative claim: you have to be harmed pro rata along with other shareholders - harm has to be to the corp. 4. We have Citytrust making 1972 loans to Katz. Includes a mortgage on an office building. Series of more and more loans, as Katz becomes more and more desperate. 5. Is Citytrust still responsible for the loan even though Lincoln "buys" it from them? Yeah, they keep the obligations. The seller of the asset hasn't been relieved of responsibility 6. Note that Citytrust is a bank. We have a strong illegality argument here bc when made the loans, they exceeded the legal limit of loans they could make to a single borrower. 7. Demand is made on the board. The board appoints a special litigation committee. Note that judges disagree on what standard should be applied to the SLC - are they entitled to the same BJR as the board, or different standard? Also consider - the board appointed the SLC, they're no likely to argue against the board. SLC suggests a settlement but indicates if they can't reach a settlement, they still won't bring the case.

1. Issue: given the SLC's potential conflicts and biases if they should be given a lower standard they have to meet bc they're "independent" or whether we should be second-guessing their decision and evaluating it like any other. Joy v. North says no, they don't get the BJR. But NOW in DE the rule is that they DO get the BJR. So consider whether, fi they'd been afforded the BJR, they would've gotten the same outcome 2. SLC may not in reality really be independent, but the ct is going to say that they are. 3. If a co is going bankrupt, can't afford its insurance, should bank give a loan to cover the insurance and protect the assets: yes. This is an exception to the idea that you don't want to throw good money after bad. 4. Diversification issue: board hadn't given money to other places aside from Katz (?) 5. If you invest in more than one co, you're not betting on one outcome - you're betting on hundreds of outcomes; you'll eventually end up with something of value, average out at five. And the more you bet, the closer you'll get to five. 6. If you invest in just one co, then half the time you'll lose. But if you have lots of cos, lots of coin tosses, you'll end up even if what you're paying is the expected value of five dollars. 7. If something has an expected value of five, what would be reasonable to invest: anything less than five will cause this to have a positive expected value. 8. Winters is thinking: we want boards and cos to make a lot of risks because we have diversified portfolios, we'll be alright, and we want to have more profit so we want more gutsy moves. 9. Here is what's happening: board is investing 8 for an expected value of 5 on what is essentially a coin toss. The board "could" win - theoretically they could get 10$, make 2. Even though it's a very bad idea, they're not going to get sued for that. But according to Winters: they should be liable. 10. Chart - equal chance of getting, losing five dolalrs: expected value of 0. So there'd be no reason o invest in that opportunity, you'd just break even. 11. Look at the middle of your two values. That will be your expected value. Expected value of 8 and -2: 3. Expected value of 2 and -8: -3. NEVER choose a negative expected value. 12. Which one does winters say, between 9 and -1 and 8, -2: 4. Because an expected value of 4 is greater than an expected value of 3. According to Winters. 13. White page slide: choose A, higher expected value. B, though, is less risky - so might be better for a small closely held business because there's no risk you'll lose money. Bc you're not diversified, you've only got one shot. 14. BUT: If you do 200 As, 20% of them will lose 13. But that's ok because 80% will have a profit, for a total value of 3.8. 15. But we don't want to hold the boards of the investing companies liable everytime they're having to choose between A and B - both have positive overall values. We want people to take risks. 16. Winters approach is harsh. He would hold you liable for choosing a negative expected value, even if it turns out ok. 17. For which portfolio owner is Winter writing the rules: 2, bc it's more diversified. His rules don't work well for the one coin flip investor, the closely held family business. 18. This opinion is an anomaly, saying that A is definitely the best interest. BUT it is important to discuss the concept of throwing good money after bad, whether you had a good reason to invest (like to pay insurance, plug a hole in the tanker) or not

A. Lerner 1. Facts a. This is a dispute between brothers, Lawrence (L) and Theodore (T). b. T owned 74% of the company, L owned 26%. 1) Consider: Would Wolfson from Smith have wanted this structure? i. Here, T is like Wolfson; doesn't want dividends paid. Top tax rate: § 1988 - 90: 28% § 1991 - 02: 39.6% § 2003 - 12: 35% § 2013 - 17: 43.4% § 2018 - 2021: 40.8% c. Deal for L: 1) Preemptive right 2) Right to distribution of proportionate share of income before development activity expenses i. What do we call a distribution to shareholders that's proportionate to their ownership stake? A dividend d. L: 26% * $100 = $26 1) Income before development expenses = $100 2) Development expenses = $20 3) Net income = $80 4) Contrast then to T: 74% * $80 = $59.20 e. We know L rec'd a $805,325 distribution (26% of prev-dev. Expenses income) + $121,124 in interest. 1) Lawrence: $805,325 = 26.4% * $3,050,473 (+ $121,124 in interest = $926,449)

1. Issue: was the payment to Lawrence a priority distribution a. "If paragraph 10 of the settlement agreement is interpreted as creating a priority distribution in favor of Lawrence E. Lerner, it is our opinion that the company will not satisfy the "one class of stock" requirement of Section 1361(b)(1)(D) and, therefore, will cease to qualify as an S corporation, with the resulting loss of the company and its shareholders of the federal and Maryland income tax benefits conferred by its status as an S corporation." b. "share of accumulated but undistributed income" c. What created this problem for Lawrence? Settlement terms. Theodore must also receive a pro rata distribution

A. Fiduciary duties now are fading, k duties are coming to the forefront 1. Common stockholders aren't promised anything. Preferred shareholders are subject to a much more k view of the world than a fiduciary duty view of the world. Preferred stock essentially stands between liabilities and common stock in the case of liquidation. Will virtually always have a liquidation preference. Usually is the amount they invested in the co. Preferred, in this way, operates a lot like debt. In bankruptcy, preferred will be paid before common gets anything.

1. Key characteristics of preferred: a. liquidation preference, dividend preference (means that before common gets anything, preferred get their dividend preference (whatever that is. If 6%, means that they get 6% per preferred before any common dividends) reliant on whether dividends ARE paid). Participating/non-participating (means: you get your dividend preference, and you also to "participate" in the upside; aka, you get you 6% first, then maybe you participate equally with the common stock). cumulative/noncumulative - what Gutman is about (cumulative = every year that I don't get my 6%, it gets added onto the next year. Noncumulative: if don't get 6% this year, it expires. Never buy noncumulative). Convertible/callable (convertible = the right of the holder to convert the preferred to common stock. Caallable - co has option to call back the preferred. Works like callable debt). 1) Liquidation preference: usually in respect to face value. 2. Which will pay more, bonds or preferred stock interest rates? Interest rates. The preferred stock is taking on more risk than a lender bc dividends, unlike loans, don't have to be paid. Taking on more risk than the other that they won't be paid.

A. Morgan Stanley 1. 125m, 30-year bond offering at 16%. Bond issued in 1981. 2. 16% * $1000 = $160/year. 3. Bond is callable at $1139.50 4. What percentage of 1139.50 is 160? 14%. At 14%, ADM can borrow 113950 and pay $160 and 1139.50 at maturity. 5. Bonds are called at 1139 at 14%. 6. What percentage of 1139.50 is 160? 14%. 7. At 14%, ADM can borrow 1139.50 and pay 160 and 1139.50 at maturity. 8. What will the bond be worth if interest rates fall to 10%? a. What amount is 160 10% of? 1600. b. At 10%, ADM can borrow 1139.50 and pay 113.95/year and 1139.50 at maturity 9. What will the bond be worth if interest rates fall to 10%? a. What amount is 160 10% of? 1600 b. At 10%, ADM can borrow 1139.50 and pay 113.95 per year and 1139.5 at maturity. 10. More specific facts. a. ADM is the borrower. Issues bonds to earlier lender at 16%: $160 payments, $1000 at maturity. b. With later lender: gets a rate of 10%. 113.95 payments, 1139.50 at maturity.

1. Let's illustrate this issue verbally a. 16% bonds callable at $1,139.50. Rates fall to 14% Should you call with remaining maturity of: 1) 1 year? § Borrow $1,139.50 at 14% and call v Pay $160 in interest; $1,139.50 at maturity § Do nothing v Pay $160 in interest; $1,000 at maturity 2) 10 years? § Borrow $1,139.50 at 14% and call v Pay $1,600 in interest; $1,139.50 at maturity § Do nothing v Pay $1,600 in interest; $1,000 at maturity b. 16% bonds callable at $1,139.50. Rates fall to 10%. Should you call with remaining maturity of: 1) 1 year? § Borrow $1,139.50 at 10% and call v Pay $113.95 in interest; $1,139.50 at maturity § Do nothing v Pay $160 in interest; $1,000 at maturity 2) 10 years? § Borrow $1,139.50 at 10% and call v Pay $1,139.50 in interest; $1,139.50 at maturity § Do nothing v Pay $1,600 in interest; $1,000 at maturity 2. What was the prevailing rate when MS purchased? MS buys for 1252. They have option to call at 1139. 12.8% yield. Why was it trading at 1252?

A. Ziebarth 1. Consider these questions: a. Can a 100% approval needed to acquire stock be circumvented by a merger (do indirectly what you can't do directly)? • Is creating a corporation for the purpose of squeezing out Matteson a "business purpose"? • Is appraisal the only remedy for a squeezed-out shareholder? b. Can you be forced out (yes), and if so, what are you entitled to? Do you get an appraisal? Why might you not get an appraisal? c. Here, we're dealing with friendly acquisitions - if anybody is squeezed out, it's the minority. 2. Initial allocation when company was founded: Ziebarth (Z) owns 7600 shares, 68%. Matteson (M) owns 3600 shares, 32%. 3. After 1950 allocation: Z owns 27500 shares, 81%. M owns 3600 shares, 11%. Other random shareholders own 2751 shares, 8%. 4. The ziebarth company needs to find a company to market its bleach. Enters into a deal with Gold Seal (GS) whereby, if GS is successful in marketing the bleach, GS will have the option on 100% of Ziebarth shares. a. Marketing effort is successful, GS exercises option. In addition, makes a 16k payment to Robert Ziebarth.

1. M is a holdout, wants a quarter of that 16k payment. Z needs to find a way to squeeze M out. a. Ziebarth Inc. creates a new company, Snowy. b. At the time Snowy is created, Ziebarth Inc. is organized as follows: 1) Other shareholders own 2751 shares, 8%. Z owns 27500 shares, 81%. M owns 3600 shares, 11%. c. 100% of Ziebarth shares to into Snowy. In return, Snowy issues 20 cent callable preferred stocks to Ziebarth shareholders. M's shares are then called, the other shareholders essentially pay themselves twenty cents per share. 1) In Snowy, Z then owns 27399 shares, 91%. Other shareholders own 2751, 9%. And M owns zero shares, 0%. 2. Snowy then gives GS an option on 100% Ziebarth shares. 3. Legal issues: a. Not contemplated by law b. Substantively unfair 4. "A corporation may be formed, under the act, 'for any lawful business purpose' with certain exceptions not here in point." a. Is squeezing out Matteson a lawful business purpose?

1. June 1960 a. UF before: 1.4m shares outstanding b. UF after: 1.52m shares outstanding; sold 8%/120k of the shares. 1) Sold 60,000 units. 2) 6m for bonds 3) 1.3m for 120,000 shares (10/share) 2. Feb. 1961 a. There are now 1.57m shares. Minority now owns 47%/738k shares. Majority owns 832k shares/53% 1) Public, before, owned 8%. 2) Public then owned 47%. 3) 568k old shares sold - 14.2m, 25/share. 3. UF share price goes from 5/share in 1959 to 25/share in February 1961. 4. UF Financial situation a. +6m for bonds (June 1960) b. +1.2m for 120,000 shres (June 1960) c. -500,000 offering expenses (June 1960) d. -6.2m distribution (June 1960) e. -300,000 annual % f. +1.25m for 50 shares (Feb. 1961) g. = 200,000 June 1961 - 1.45m h. = 100,000 June 1962 - 1.15m

1. Majority starts paying US&L dividends at 75/share in 1959 a. Lowers to 57/share in 1960 b. From 1959 to June 1960, 170 US&L shares per year are traded c. June 1960, IPO @ 10/share. 1) 1100/share offer for less than or equal to 350 shares ( = 4.40/UF share, trading @ 14.80/share) d. Dec. 1960 - majority to minority: 4/share dividend in the future e. 1961: 2400/share offer ( = 47/UF share, trading @ 173/share) 2. UF Financial Situation a. + 6m for bonds (June 1960) b. +1.2m for 120,000 shares (June 1960) c. -500,000 offering expenses (June 1960) d. -6.2m distribution (June 1960) e. -300,000 annual % f. + 1.25m for 50 shares (Feb. 1961) g. + 500,000 1959 dividend h. + 375,000 1960 dividend i. = 1.45m May 1961 - 2.325m j. = 1.15m May 1962 - 2.025m

A. Guttman 1. Issue is upon the "irrevocable destruction" of potential cumulative rights by the k terms 2. The "rights of the preferred stockholders are determined by the precise language of the certificate in question" a. Is this just an "undesirable" deal or grossly unfair? Fiduciarily unfair? b. Are noncumulative PS without any control rights a rational investment? c. Would it matter if the PS had been convertible? 3. Contrast to Wabash: Cumulative dividends not payable...BECAUSE profits used for capital improvements? 4. Guttman: enough net income to pay PS full dividend from 37 to 48. 5. Gutman presents the tension between cumulative and non-cumualtive stock. here, we're dealing with non-cumulative. P is saying we should treat it as cumulative bc the problem of the incentives created when you issue non-cumulative. This co hadn't paid dividends for seventeen years. What's the return on your investment then if you own preferred? Nothing,r eally. No pressure on management - can wait til cash piles up, in year four pay huge dividend. If non-cumulative, in year four: get 60$. If cumulative: 240. So gives co a huge incentive to just not pay dividends. 6. So: it makes no sense to buy non-cumulative preferred. Preferred needs to be cumulative.

1. Noncumulative: in the past, had voting rights that were triggered if dividends cont to not be paid. So this would fix the noncumulative problem, essentially makes it cumulative. 2. There's a fiduciary duty to these people that is owed once they own stock. (NOTE: you don't owe lenders a fiduciary duty, only shareholders). 3. It sounds like you've breached your fiduciary duty if the preferred stock is essentially worthless. 4. But ct here looks at the situation, says we just have k agreement. 5. Guttman refers to this idea of the "irrevocable destruction." This is basically just a one-off case, doesn't set black letter law. 6. Would it matter if the PS had been convertible to common? How would that have changed this case? PS could convert to common, so they would have the same righ to earnings as someone else. As soon as common looked like a better deal than not getting paid dividends, PS can do that. Keeps co honest. If you were negotiating the terms, you would wanna make sure that you negotiate for a large enough no of shares that you make the co play nice. Co knows they have to feed PS stock to keep them from converting. In his case, the existing common would be diluted. They could then sue for breach of fiduciary duty. What's the k argument her ein favor of the common? The board has a duty to protect their investment, to give people the deal that they struck. Note, then, that you're going to hurt one when you help the other. What you want to do is not write terms that put the directors in that position. Wabash: heir reason for not paying dividends was because the co was reinvesting them; this case says that it's ok to not pay dividends as long as you're using them for something, not just having the cash lying around.

A. Burton 1. Setup a. There were three classes of shares: First Preferred ("A"), Second Preferred ("B") and Common. b. Exxon 100% owned A and 90.0% of Common. Owned only 26.5% of B. c. Issue: 1) Would there ever be any incentive for Exxon to pay more than A's dividend preference, but not enough to trigger its common rights? No.

1. Numbers: a. In 1997, A's arrearages were 6.5m (+2.3m liquidation). b. Payments made from 1977-90: 4.1m (rec'd 6.9m) c. A's arrearages in 1981: 3.2m (+2.3m liquidation) d. Available in liquidation in 1981: 2.8m

1. Over a 100-year period, what will probably be the aggregate net earnings of Corporation A if, in each year, it has a 70% chance of earning $100 million and a 30% of losing $90 million? a. 1. -$2 billion b. 2. $430 million c. 3. -$1.35 billion d. 4. $4.3 billion e. 5. $2.15 billion f. 6. $200 million g. Answer: The Corporation is likely to earn $100 million in each of 70 years and lose $90 million in each of 30 years, bringing its net earnings to $4.3 billion (70 * $100 million) + (30 * (-$90 million)) = $4.3 billion. Alternatively, the expected value of the Corporation's annual earnings would be $43 million, which would generate $4.3 billion in net earnings over 100 years. This assumes 70 years of one outcome and 30 years of the other (this may be the best assumption, but it will not be the outcome far more often than not). This also assumes that the Corporation will not have a run of down years that bankrupt it, thereby preventing it from recovering (reverting to the mean) in the ensuing years. John Maynard Keynes made a comment that is relevant here: Markets can remain irrational longer than you can remain solvent. 2. If you had a portfolio of 100, $1 million investments, and each year each investment in your portfolio has a 70% chance of earning $100 million and a 30% of losing $90 million, then what will probably be the aggregate net earnings of your portfolio in any given year? a. 1. $2.7 billion b. 2. $4.3 billion c. 3. $413 million d. 4. -$27 million e. 5. $100 billion f. Answer: This is the same question as posed earlier, except that the 100-year time frame has been replaced by a 100-investment portfolio. About 70% of your investments will earn $100 million, and the remainder will lose $90 million. In any given year, your portfolio is most likely to earn $4.3 billion.

1. Over a 100-year period, what will probably be the aggregate net earnings of Corporation A if, in each year, it has a 40% chance of earning $100 million, a 30% chance of losing $5 million, and a 30% of losing $90 million? a. 1. $900 million b. 2. $1.15 billion c. 3. -$1.15 billion d. 4. $2.85 billion e. 5. $115 million f. Answer: Correct: The Corporation is most likely to earn $100 million in each of 40 years, lose $5 million in each of 30 years and lose $90 million in each of 30 years, bringing its net earnings to $1.15 billion (40 * $100 million) + (30 * (-$5 million)) + (30 * (-$90 million)) = $1.15 billion. Alternatively, the expected value of the Corporation's annual earnings would be $11.5 million, which would generate $1.15 billion in net earnings over 100 years. 2. In which of the following investments would you be more inclined to invest $100 million of borrowed funds for one year? a. 1. An investment that has a 40% chance of earning $100 million and a 60% chance of losing $70 million. b. 2. An investment that has a 30% chance of earning $100 million and a 70% chance of losing $40 million. c. Answer: A. These are the same investments as in the preceding question, but your incentives are now very different. You have no risk of loss because you are investing someone else's money. For you, the investments have an expected value of $40 million and $30 million, respectively. The use of leverage creates an incentive to take greater risk, even if the risk has a negative expected value. Query: If you worked on Wall Street and found an investment opportunity for your firm that had a a 50% chance of earning you $5 million, and a 50% chance of earning you only your $300,000 base salary and getting you fired, what would you do?

A. In liquidation/bankruptcy, preferred stock stands between liabilities and common stock B. Preferred stock characteristics 1. Liquidation preference a. Usually face value (e.g., each preferred share ("PS") is issued for $1,000, so each PS is entitled to receive $1,000 in liquidation before common shareholders receive anything) 1) May be greater (e.g., 110% of face value) b. PS may have fixed term (e.g., after 10 years, PS redeemed & paid face value or that plus %) 2. Dividend preference a. Right to dividends before common stockholders receive b. any dividends c. Normally fixed % of $1,000 face value d. For example, 6% $1,000 PS would receive $60 every year (if dividends paid) and no more

1. Participating/non-participating a. All PS receive fixed % face value b. If participating, PS also "participate" in additional dividend payments made to common c. For example, participating PS might pay 3% of face value and then receive same pro rata dividends as common thereafter (may be after catch-up) 2. Cumulative/noncumulative a. Dividend preference for cumulative PS rolls over from year to year - if dividend isn't paid in Year 1, it is added to the dividend preference for Year 2 b. Dividend preference for noncumulative PS does not roll over - if not paid in Year 1, the preference expires 3. Convertible/callable a. Convertible PS gives the holder the right to exchange PS for other shares, usually common b. Callable PS gives the issuer the right to buy back ("call") the PS, usually in return for payment of all accrued dividends plus a premium above face value (e.g., 110% of face value)

A. Review Quiz 1. If the multiplier is 7, then the discount rate is: 14.3% 2. If the discount rate is .111, then the multiplier is: 9 3. An acquiror expects a company to generate a 8.3% return. What is the discount rate? What is the multiplier? DR: 8.3%. Mult: 12 4. Acquiror A applies a discount rate of 15% to a company, while Acquiror B applies a multiplier of 6 to the company. Which one believes the company is riskier? A's DR: 15%. B's DR = 1/6 = 16.7%. B believes the company is riskier.

1. Privately held Widget Inc.'s cash flow for last 3 years was, starting with the most recent year, $350 million, $300 million and $250. Its earnings for last 3 years were, starting with the most recent year, $500 million, $250 million and $200 million, which reflects a one-time shift in the depreciation schedule that substantially decreased expenses in the most recent year. What income stream would you choose to value Widget and why? a. Key issues to spot: (1) trend, (2) inflated earnings in most recent year and why, (3) lock-step changes in cash flow and earnings, (4) most recent year most indicative any single year b. The most-recent-year, "one-time" shift in the depreciation schedule means that earnings would be inflated for that year, but we have no idea by how much. The second and third most recent cash flows/earnings are, respectively: $300m/$250m and $250m/$200m. The CF/E totals are fairly close and show the same $50m increase. Cash flow for the most recent year is, again, $50 million higher. That's an argument for using $350 million in cash flow, as well as the fact that there's no reason to think the cash flow data are not representative. Assuming that earnings following the apparent pattern, one might guess that earnings would also have increased $50 million and estimate that earnings were $300 million in the most recent year. The most recent year is usually more indicative of the current state of affairs than any other year, which militates for using that year's CF or E. However, one could also assume a trend and estimate that the next year's CF/E would be $50 million higher. We're stuck with using one amount for the income stream, so the value of Widget would be $400m/$350m/$300m divided by the discount rate. c. 5: note the one-time shift. Note also that they each increase 50m each year, that indicates a trend. Big difference with the 500m - presumably bc of the one time change. Assumedly it should really be 300m bc of the trend. If you use earnings: talk about what you decided o use for that year, account for 500m being an inflated number. Also: note that recent numbers are always more indicative than any other individual year bc it's closest to the present situation. What does he think we should use: either 350, most recent, or average of the three years (300). Also: you could continue the trend, use 400 for cash flow.

A. There are three approaches that we need to be familiar with: Guttman, Dohme, Sanders 1. Dohme a. "When the directors of a corporation in a year when there are annual net profits available for the payment of dividends, in their discretion fail to direct such payment and add the net earnings to surplus, the inchoate right of the non-cumulative preferred stockholder is not lost, but is transferred to said surplus funds which remain available for dividends so far as they represent moneys so retained." b. Dohme applies the NJ dividend credit rule. Dohme says we're not comfortable of depriving PS of everything. c. Dohme; if there are annual net profits available, then we're going to treat the non-cumulative right as an "inchoate right" to dividends. So is this requiring dividends be paid: no, doesn't impose an affirmative duty to pay dividends. BUT: if dividends are paid, and they've let net profits pile up, non-cumulative PS go first. What if we've been reinvesting our money every year: these facts wouldn't fit the Dohme test, which only applies when cash is lying around. In that case, you would need to pay PS the arrears that you have that stockpile lying around. Treat them essentially like they had cumulative PS; they'll get paid before common get anything. d. Has a problem with the fairness of Gutman, that non-cumulative is rendered basically worthless.

1. Sanders a. Rejects "[t]he contention . . . that recent judicial expressions indicate that we have limited our dividend credit doctrine to instances where the undistributed profits have been retained in a cash or other readily convertible account and that it is not to be applied where they have been turned into working capital and have actually been used in the corporation's normal business operations." b. Sanders rule - How this differs from Dohme? Doesn't want to only look at profits that are a "pile of cash." Reject the idea that we aren't going to count cash that is turned into working capital, rejecting the idea that we limit it to left over profits. We're going to include profits that were spent. Still have to pay dividend on that money. c. In a way, then, this is the death of non-cumulative. 2. Gutman says: you get your preference, your 50$, for the year. Dohme says: you get dividends paid essentially like cumulative PS on money that is held over in a pile of cash. Sanders: you get cumulative on all profits, all is available to cover all years in which non-cumulative weren't paid a dividend.

I. Introduction A. Parts of this course: valuation, transactions, hostile acquisitions, types of interests 1. What drives the price of valuation: a. Think about corp, the amount of money it will spit out, what is the income stream you'll get if you loan this money, buy this stock B. Slideshow 1. Slide 6 a. Slide text 1) Business worth ten million, originally has 100 shares. If the business issued 100 new shares to a new investor, how much should the investor pay? There will then be 200 shares outstanding. Answer: 10 million. b. Breakdown 1) This slide introduces the concept of dilution 2) How many shares will you issue for the one million capital? Goal is that your shares will still be worth ten million. Want the valuation to be perfect. The injector knows that they will own 1/11 of the corp; so they need to won 1/11 of common stock. so your stock needs to equal 10/11. 3) If you issued 9 shares = 9/109; doesn't work. Need to get to 1/11. 4) Minority shareholders: protect yourself against the issuance of tons of tons of undervalued shares that will squeeze you out, make your ownership basically nothing. That's ownership - your percentage of shares declines. 5) Note the distinction between ownership dilution and economic dilution - just because you might have fewer votes doesn't mean you received an unfair price. NOTE: whenever there's a close call between money and power, you should always choose power. Remember that for transactions.

1. Slide 9 - Capitol asset pricing model a. E(PR) = RF + Beta * (E(RM) - RF) 1) RF = risk free rate 2) Beta = company risk relative to market 3) E(PR) = discount rate 4) (E(RM) - RF) = risk premium: the risk of the market minus the risk free rate b. Breakdown 1) Number produced: the amount of risk produced by that dollar of income. This number will tell you how risky the company is. 2) There will be a risk free rate of return (RF) - it's kind of a baseline bc no matter what a co is spitting out in income, you'll never pay more for that income than if you would if you get it from a risk free source (like, for ex, US treasury). 3) Part of this risk will be part of the intrinsic risk you accept bc it's the lowest risk for your money. That can range from 1 - 18%, depending on inflation. Bu no matter what this no is, it's the baseline on which you're willing to pay for a return on your money. If co is more risky than US, don't give them money unless get a lot of revenue stream. Shouldn't think a co will give you 20% return per year if can get it from the US for 5%. 4) Focus on what the premium above the RF is that you'll require the co to give you for investing in them. 5) Market premium: what we've seen investors demanding from companies over the years. The difference between that and what you could get from US. 6) You'll be willing to buy something a lot less reliable than the US because you get a big premium. 7) The market MATTERS. Look at the index oc cos in similar business, see what return they have produced, take out the RF rate, which gives you what people have demanded over time from that category of companies. We do that bc most of the return of a co will be driven by how its industry does. Gotta have the right index. 8) Ex: give you IBM; give you index for biotech firms and index for top 500 firms. You'll tell him that IBM's better index is the 500 index for x reasons. One reason would be "biotech inc." and he gives biotech index. The name that the co is the same as the index is a big giveaway. 9) Start with RF, take it from RM, then multiply it by beta (the amount by which the price of the target co stock goes up and down relative to the market; low beta = closely follows that amount. High beta = doesn't follow the line that much, stock price is more volatile). 2. Slide 10: illustration is of range of financial instruments, how courts treat them. a. How to distribute equity = how ct interprets fiduciary duties. In cases of debt, more like to do strict contractual interpretation

A. Smith 1. Lead-up to Lerner: Chesterton (p. 282) a. Issue: do shareholders as shareholders owe a fiduciary duty to the corporation or other shareholders b. In Chesterton, which is discussed in Lerner, you have an S corporation (in which you can't have an entity shareholder). Chesterton arose bc one of the shareholders put her shares in an entity shareholders in order to make the company fail as an S corp out of spite. This poses the question of whether shareholders can just act in their own interest if they're not a majority shareholder. Are we going to put a fiduciary duty on them to not do that: yes. As a shareholder, you can't do something for spite to harm the corp.

1. Smith a. We have a 80% supermajority. Wolfson is a minority shareholder with just 25%. b. Due to an IRS issue, corp needed to use up 10,000. Wolfson's plan was to spend it on improvements - this would not be taxed to shareholders. But the others planned to just put out the 10k as dividends, which would be taxed to the shareholders. c. Originally, the court imposes a penalty on Wolfson but doesn't order dividend. d. In-class notes 1) There's an IRS rule that says you can't just put a bunch of investments in a corp, let it sit there year after year enjoying low corp taxes, and forty years later decide to just take your money out. Need to invest the money in the business, can't pile it up as a tax shelter. Wolfson doesn't want distributions. Two options: Wolfson has a plan for improvements, no IRS payments. Everybody else has a plan to make dividends, but in this case there would be tax.

A. Ahmanson 1. US&L ownership originally: majority owned 85%, minority owned 15%. a. Question was how can the majority capitalize on the savings and loan boom? 1) What happens if the majority sells its shares? As long as they don't sell more than 51% of their shares, they retain control of US&L b. What happens if majority sells 40 out of 85%? Then the minority would own 15%, majority would own 45%, public would own 40%; all the minority would have to do would be to join with the public to get rid of the majority. c. But what if the majority takes all of its 85% and creates a new entity - NOW what happens if UF sells 47% of its shares? It has retained control of the new entity, which means it has also retained control of US&L 1) The concept here is that you can keep putting your shares into new entities; you can start with owning 85%, and at the end you might just own 5%, but still have control of the original company. 2. In Ahmanson, the majority took its 85% and created UF (which was the 85% US&L owner). a. The majority then sold 47% of UF, which meant that the public now owned 47% of UF, and the majority had control of 53% of UF, which meant it also was still in control of US&L

1. So what's the problem: There was no public market for US&L shares; UF was sells its shares publicly. 1) US&L shares went into UF, UF issues US&L 250/1 US&L share. This meant they gave away 1.4m UF shares to the defendants (who sold the US&L shares to UF) 2) UF then sold 60,000 units on the public market for 7.2m. 3) 1 unit = 2 UF shares and 5% convertible, subordinated $100 bond. 4) What is a 5% convertible, subordinated $100 bond? 5) Of the 7.2m that UF got from selling the units, 6.2m went directly to the defendants. 2. UF financial situation: a. +6m for bonds (June 1960) b. +1.2m for 120,000 shares (June 1960) c. -500,000 offering expenses (June 1960) d. -6.2m distribution (June 1960-300,000 annual % e. = 200,000 (June 1961) (after first interest payment) f. = 100,000 (June 1962) (after second interest payment)

A. Katzowitz case 1. Sulburn holding Co. originally had fifteen shares outstanding. Lasker (L), Sidler (S), and Katzowitz (K) all have five shares. The company's value was 1500, which mean that each shareholders' stocks were worth 500. a. Examples using these facts: 1) If the business is worth 1500 and it issues new shares, how much should each cost? 100. 2) If the business is worth 27,000 and it issues new shares, how much should each cost? 1800. 3) If the business is worth 27,000 and it issues a total of 50 new shares to Sidler and Lasker for 100,share, what will happen to each shareholder's stake? i. Pre-Transaction value (shares) is 27,000. The added value from the new shares is 5,000 (50 new shares were sold). The new value = 27000 + 5000 + 32000. Also, there are now 65 shares total ii. 60/65 * 32000 + 29,538. iii. 5/65 * 32000 + 2,462. b. Pre-transaction value is 2700, and here are 15 shares outstanding. S, L, and K all own five shares each. c. The added value for the issuance of 50 new shares is 5000. d. There is a new value of 32000 and 65 shares total e. S and L own 60 of the 65 total shares. 60/65 * 4100 = 37,846 f. 5/65 * 41,000 + 3,154

1. Takeaways a. "The protection afforded by stock rights is illusory in close corporations. Even if a buyer could be found for the rights, they would have to be sold at an inadequate price because of the nature of a close corporation." b. "right not to purchase additional shares without being confronted with dilution of his existing equity if no valid business justification exists for the dilution." (p. 145) 1) Black letter law: just bc you haven't exercised your PR doesn't mean you submit to being diluted.

A. Review Questions 1. The capitalized earnings method (CEM) and the discounted cash flow (DCF) method are different because: they use different income stream (CEM: earnings. DCF: cash flow) 2. If the multiplier is five, then the discount rate is: 20% 3. If the discount rate is .1, then the multiplier is: 10 4. An acquiror expects a company to generate a 20% return. The discount rate is: 20%. 5. Acquiror A applies a multiplier of 8 to a company, while Acquiror B applies a multiplier of 6. Which one believes the company is riskier? 6, paying less per dollar 6. If a company earns $3 per share and its share price is $12, then what is its per share P/E ratio? What is its implied discount rate? DR = 25% 7. When you are buying a company, would you argue for a higher or lower discount rate? Why? Higher, because you're saying you believe you should pay less because the company is risky 8. If the multiplier is 3, then the discount rate is: 33% 9. If the discount rate is .4, then the multiplier is: 2.5 10. An acquiror expects a company to generate a 12.5 return. What is the discount rate? What is the multiplier? DR = 12.5. Multiplier = 100/12.5 = 8 11. Acquiror A applies a discount rate of 20% to a company, while Acquiror B applies a multiplier of 4 to the company. Which one believes the company is riskier? B, because the discount rate is higher. 12. What would be the value today of a 10k payment in 10 years, assuming an 11% discount rate (Use the charts on pages 64-69) a. $3,522. Using the present value table on page 67, you will see that a $1 payment in 10 years, assuming an 11% discount rate, is worth $0.3522 today. The $10,000 payment therefore would be worth 10,000 * 0.3522, or $3,522, today. 13. What would be the value today of 15k received each year for ten years, assuming an 8% discount rate? a. Needs Grading: $100,651.50. Using the present value of an annuity table on page 68, you will see that $1 received each year for 10 years, assuming an 8% discount rate, would be worth $6.7101 today. Therefore, $15,000 payment received each year would be worth 15,000 * $6.7101, or $100,651.50, today (shortcut: move the decimal point to the right 4 places and multiply by 1.5). 14. If the multiplier is three, then he discount rate is: a. 33 1/3% 15. "Cost of capital" can refer to (mark all the correct answers): a. The trading price of a company's shares b. The rate of return on an equity investment in a company that investors expect c. A figure that reflects the company's risk as an investment d. A company's discount rate e. The legal and underwriting fees paid in connection with he public offering of a company's shares f. The interest rate required by purchasers of a company's debt g. Answer: 2, 3, 4, 6.

1. The capitalized earnings method (CEM) and the discounted cash flow (DCF) method are different because (Choose the best answer): a. The CEM doesn't use a discount rate, whereas the DCF does b. The DCF is based on cash flows, whereas the CEM is based on earnings c. The DCF uses a multiplier, whereas the CEM doesn't d. They use different measures of risk e. Answer: 2. Both the CEM and the DCF measure a company's value by multiplying the company's discount rate -- which is the same in both equations -- by the value of its income stream. The CEM uses the accounting concept of earnings to measure the income stream. The DCF uses the concept of cash flow. Warren Buffett prefers the DCF because he generally believes cash flow to be a more reliable measure. Indeed, the term "manipulate" is far more often found in the vicinity of the term "earnings" than "cash flow." 2. T or F: For cash flow purposes, the entire purchase price for a building paid in year X would be reflected as negative cash flow in year X, whereas earnings for year X would be reduced by a fraction of that amount a. True. Cash flow refers to the actual cash received and paid out by a company in a given year. Earnings is an accounting concept that seeks to tie the company's costs, or its expenses, in the year in which the expenditure is expected to generate revenue, as opposed to the year in which it happened to be paid for. Although a building may be paid for in year X, the revenue generated by the building will be spread out over the life of the company. By considering as an expense only the part of the building that is "used up" in a given year, investors can better determine whether the company is profitable based on its revenues for that year. On the other hand, cash flow tells you the company's capacity to pay its bills as they come due. Earnings does not.

I. Hostile Tender Offers and Other Transactions A. What I learned in selling my company for 100 million 1. My software company ChiliSoft sold for 100 million in 2000. Or 70 million. Or 28 million. a. Article begins by saying he sold it for 100m or 70m, or 28m. when you cut a deal to buy a co, deal is closed later; and that value can change in that time. In this case, the closing happened over the collapse of internet cos in early 2000s. so when you do a deal like this: you know value may decline. There are some issues here that caused probs for the seller. 2. The deal was struck at $100 million in January 2000. But the VCs insisted on fixing the number of shares, not the value of the deal. A month later, they looked like geniuses: the deal was worth $135 million. The next month, it fell to $70 million. It closed in May at $28 million, 72% down from the deal price. Tip: Fix the price, not the stock. a. Slide 14, still article: fix the price - my co will be bought for 100m, no matter what your co or its stock is worth (in cases where buyer gives x amount of stock for y of seller's stock 3. I signed the term sheet for 1.4 million... a. Slide 15 shows exactly what happened in the market. Bullard notes that the seller isn't really receiving an unfair price because everybody had plummeted, not just him or the buyer. 4. The second financing round, Series B, was nuts -- $3.7 million on $19 million pre-money valuation . . . a. Slide 16: guy was desperate bc he had gotten capitol through debt, not by getting investors. You can't make payment with debt, it's an inflexible source of capital, you're going under. So he had to cut a sweet deal with venture capitalist.

1. The second financing round, Series B, was nuts -- $3.7 million on $19 million pre-money valuation . . . (company was worth 19m before investment; it was worth 22.7 after the money, so the investors should won 16%). a. Slide 18: they would've gotten a no of shares equal to 16% after the deal. b. Pre money valuation will determine what number of shares they get. c. Ex: you tell them you need 5m, they say ok; issue will be how many shares they'll get for that 5m. the higher the value, the less of your pie you have to give up for the investment. 2. The second financing round, Series B, was nuts -- $3.7 million on $19 million pre-money valuation, and a cap on the liquidation preference. That meant if we sold for more than $42 million, those who invested in the Series B round simply got their share back. a. Slide 19: cap on liquidation preference - not common. The preference is that you'll be limited for what you can get for your shares if we sell the company. What he's saying is that people buying in are going to be limited in terms of the conversation they get when co sells - might be limited to a 4x time increase in their share, will be capped at that, even if the co goes on to be worth more than that, and owner of co might not want to go public yet. That means VCs can't sell out when they get to 4x. problem with this deal term is it makes VCs not to want to maximize the value of the co, only up to, say, 4x. if you limit somebody, they want you to sell as soon as you get to, in this case, 42m. 3. . . . from December 1999 to May 2000, my stake dropped from 40% to 15% when the deal closed (before money, the owner owned 40%, other investors owned 60%. After the investment, when value of co went to 22.7m, he just has 14%, the new investors had 16%, and other investors had 70%). a. Slide 20: one reason this happened = ownership dilution. We can see here that his dilution was partly due to new investors, also bc somebody else got a piece of his pie. 4. DFJ and another firm offered an onerous bridge: monthly escalating warrants, and a controlling board seat. I didn't really grok the meaning of the warrants. a. Slide 21: what terms were driving this deal? "bridge" = short term carry over financing. Means that financing was offered sometime Jan-May; bridge loan = loan for a very short term, to carry you over a short period. b. Warrant: a warrant is a right to buy stock at a particular price. So VCs were allowed to buy even more shares than the 3.7m than they put in. this contributed to his ownership dilution. c. Escalating warrants: first 100 you buy at a dollar, second pay two dollars, third pay five dollars. This is escalating in a way that's favorable to the owner. So the more they dilute, the more they have to pay for it. He got diluted, but got money. d. Also gave up a controlling board seat - not good, bc he gave up control. This is him essentially giving up control of his business. 5. So how did my stock drop by 62% in 6 months? Three things: escalating warrants, management shakedown, and the timing of one of the dips in Cobalt's wild ride in 2000. a. Slide 22: management shakedown. Discuss with client what can go wrong even before start looking for a purchaser. Need to lock down senior staff before doing a big payout. You don't want them all to resign at the same time, threaten to leave if they don't get what they want. You would want to lock them down with a non-compete clause. Gave up another big portion of control through this shakedown. 6. Slide 23: ex of fb's ipo. What percentage of the dollars investing in the co is represented by the 96%? 24%. They made 30x more than their original investment bc they early on. Slide 24: entire story of those investments.

A. GameStop 1. The Notes were issued pursuant to an indenture dated as of March 9, 2016 (the "Indenture"), by and among the Company, certain subsidiary guarantors named therein (the "Guarantors") and U.S. Bank National Association, as trustee (the "Trustee"). The Notes will bear interest at the rate of 6.75% and will pay interest semi-annually in cash in arrears on each March 15 and September 15 of each year, beginning on September 15, 2016. The Notes will mature on March 15, 2021. 2. At any time prior to March 15, 2018, the Company may redeem some or all of the Notes for cash at a redemption price equal to 100% of their principal amount plus an applicable make-whole premium set forth in the Indenture and accrued and unpaid interest to, but not including, the redemption date. Prior to March 15, 2018, the Company may redeem up to 35% of the Notes at a redemption price of 106.750% of the principal amount, plus accrued and unpaid interest to, but not including, the redemption date, with the proceeds of certain equity offerings so long as the redemption occurs within 120 days of completing such equity offering and at least 65% of the aggregate principal amount of the Notes remains outstanding after such redemption. 3. On and after March 15, 2018, the Company may redeem some or all of the Notes at redemption prices (expressed as percentages of principal amount) equal to 105.063% for the twelve-month period beginning on March 15, 2018, 103.375% for the twelve-month period beginning March 15, 2019 and 100.000% beginning on March 15, 2020, plus accrued and unpaid interest to, but not including, the redemption date.

1. Upon the occurrence of a Change of Control (as defined in the Indenture), unless the Company has exercised its optional redemption right in respect of the Notes, the holders of the Notes will have the right to require the Company to repurchase all or a portion of the Notes at a price equal to 101% of the aggregate principal amount of the Notes, plus any accrued and unpaid interest to, but not including, the date of purchase. 2. The Indenture restricts the Company's ability and the ability of certain of its subsidiaries to: (i) incur additional indebtedness; (ii) pay dividends or make other distributions in respect of, or repurchase or redeem, its capital stock; (iii) prepay, redeem or repurchase debt that is junior in right of payment to the Notes; (iv) make loans and certain investments; (v) sell assets; (vi) incur liens; (vii) enter into transactions with affiliates; and (viii) consolidate, merge or sell all or substantially all of its assets. . . 3. . . . . These covenants are subject to a number of important exceptions and qualifications. During any time when the Notes are rated investment grade by Moody's Investors Service, Inc. and Standard & Poor's Ratings Services and no Default (as defined in the Indenture) has occurred and is continuing, many of such covenants will be suspended and the Company and its subsidiaries will cease to be subject to such covenants during such period.

1. How does debt reduce management flexibility? How is equity differen? a. Debt reflects a fixed obligation to pay interest. When the company's profits decline, it is still required to pay interest on its loans. The obligation to use free cash to make interest payments limits management's flexibility to put cash to better uses. Equity is different because it is not entitled to dividends. When cash can be put to better use internally, management is not required to use it to pay equityholders. 2. How can deb create risk for a firm even when I maintains its profitability? a. A firm can be profitable while still experiencing cash flow problems that make it unable to make interest payments. For example, customers might be late in paying for goods. This might leave the company with insufficient funds to make its interest payments. 3. When raising capital, what incentives do firms have in communicating with potential lenders and investors? a. They have an incentive to paint an overly rosy picture of the firm's financial situation. This is the primary focus of the securities laws with respect to the regulation of raising capital.

1. What approach do the federal securities laws take o firms' incentive to exaggerate their financial health in communications with prospective lenders and investors? a. The federal securities laws take a disclosure approach rather than a merit-based approach. They focus on requiring disclosure of the information that investors need to make informed investment decisions. Otherwise, investors are left to evaluate the merits of the investments on their own. 2. If you borrow $200,000 to purchase a $300,000 house, your capital structure will be (choose the best answer): a. 1. $100,000 in equity b. 2. $200,000 in capital c. 3. $200,000 in debt and $300,000 in equity d. 4. $100,000 in equity and $200,000 in debt e. 5. $200,000 in debt f. 6. $300,000 in equity g. Answer: A business's capital structure refers to the amount of its debt and equity. In this case, the debt is the $200,000 borrowed to purchase the house, and the equity is the $100,000 that you paid out of your own funds. A and E are correct statements, but they fail to state the amount of both the debt and equity (the "capital" can be used in place of "equity" here), so D is a better answer. B and F are wrong. 3. If you borrow $200,000 to purchase a $300,000 house, your debt-equity ratio will be: a. 2:3 b. 2:1 c. 1:3 d. 1:2 e. 3:1 f. Answer: Your equity is the $100,00 that you paid toward the purchase price. Your debt is the $200,000 that you borrowed. So your debt-equity ratio is 2:1. Remember: the debt-equity ratio is not the debt-to-value ratio, which would be 2:3 ($200,000/$300,000).

1. A minority shareholder owns 10 of Corporation A's 100 outstanding shares. In which circumstances would you advise a minority shareholder that his economic interests may be diluted if he does not exercise his preemptive rights (mark all that apply)? a. Corporation A is worth $10 million and it issues 50 new shares for $100,000/share. b. Corporation A is worth $5 million and it issues 50 new shares for $75,000/share. c. Corporation A is worth $20 million and it issues 100 new shares for $100,000/share. d. Corporation A is worth $20 million and it issues 50 new shares for $200,000/share. 2. What are three ways that a controlling shareholder can mitigate or prevent dilution when a company issues shares: voting trust, shareholders agreement, or create a supervoting class. 3. What rights may protect a minority shareholder against dilution when a company issues shares: Preemptive rights that guarantee that the minority shareholder can purchase a percentage of the offering equal to his current ownership percentage.

1. What is it called when a shareholder controls a business with less than a majority of its outstanding shares: a. Managerial control b. Control premium c. Preemptive control d. Working control e. Minority control f. Answer: working control 2. T or F: Diffuse ownership of a company's outstanding shares makes it harder for management to control a business a. False. Diffuse ownership would make it easier to control the business because shareholders would be less likely to vote together to form a controlling block of shares. 3. The pre-money valuation is important because an incorrect valuation will: a. 1. Cause existing shareholders to be diluted if the valuation is too high. b. 2. Cause purchasing shareholders to be diluted if the valuation is too low. c. 3. Cause existing shareholders to give up an undue amount of control if the valuation is too high. d. 4. Cause existing shareholders to be diluted if the valuation is too low. e. 5. Cause purchasing shareholders to gain too much voting power if the valuation is too high. f. Answer: cause existing shareholder to be diluted if the valuation is too law. If the valuation is too low, existing shareholders will be diluted because the purchasing shareholders will pay to little for their shares. 4. T or F: it is likely that existing shareholders will give up more control if they sell 1/3 of their business to a single venture capital firm than if hey sold it to thousands of individual shareholders. a. True. The single shareholder will vote all of her shares the same way, which may create an opportunity to gain control if one or more of the original shareholders switches allegiances. Widely diffuse shareholders are much less likely to vote together, which will leave control in the hands of the original shareholders who control the proxy machinery.

A. Cash flow vs. earnings 1. Discounted cash flow and capitalized earnings: a. These two models in terms of the income stream that is used. Both reflect how much risk is actually with this cash flow. The more that cash flow is discounted, the less you'll pay for it. As discount goes up, purchase price goes down. Bc higher the risk, the less you'll pay for it. 2. Income stream can be two things: earnings or cash flow (diff tween cash it has at beginning and ending of year - co's bank account. Buffet says this is more trustworthy, bc earnings are more easily manipulated. This is bc earnings are based on the idea of matching up revenues and expenses - figuring out what are the revenues you should count, not count for a period. You'd like expenses and revenues to be close together, not a month apart. But there's flexibility to saying when a sale takes place - aka, when you make an agreement vs when you get the money. 3. What are the issues that arise for both cash flow and earnings, how do they affect valuation.

1. What is the present value of a future income stream? Not as much as it would be on a present basis. 2. Prob with cash flow model: If you have cash flow, looking at bank account going up and down. Wanna know how much money co will make over 20 years. If it does a one time sale, that sale causes cash flow to be substantially larger than in past years, you know something isn't right about that last year. So you know that bc of that sale, not a good way to value the company bc it's been inflated. Alt: if he gives you five years of data, it seems consistent, and then you have that sale in the last year, can ignore the final year, use the rest bc it's consistent. a. Alt for earnings: might be the same fluctuation as cash flow. In that case, wouldn't really matter. What if earnings really fluctuate, cash flow is more consistent: maybe go with cash flow bc it's more predictable. 3. But whichever you choose, always divide by he same discount rate 4. There will be a lot of litigation over whether you choose cash flow or earnings.

A. Litwin 1. Would the facts allege survive a motion to dismiss? Do the present a no-win situation? Why or why not? 2. In Litwin, the face value of the bonds was $100, but they were trading at 106. Why? a. When interest rates rise, bond prices fall 1) Ex chart: i. Prevailing interest rate Bond price Interest Payment ii.20 % $250 $50 iii.15% $333 $50 iv.10% $500 $50 v.5% $1000 $50 2) Note that the bond price ignores the issuer's credit quality. 3) What would happen to the value of a bond if the issuer started losing money: it would fall 3. What would a bond be worth if it matured tomorrow: almost exactly its face value 4. What is a bond's coupon rate? a. Coupon rate: interest payment as % of face value.

1. What is yield? a. Interest payment as % of market value (ie, prevailing rate) 1) Ex: value is 1000, 5% interest. Rates rise to 10%, value is now 500. What is the yield here? 10%, because 50$ is 10% of the market value of 500. 2) Another ex: value is 1000 at 5%. Rates decline to 2.5%, value soars to 2000. What is the yield here: 2.5%, because 50$ is 2.5% of the market value of $2000 2. What is yield to maturity? a. Yield taking into account payment at maturity 1) Look at his slides to visualize YTM. The basic idea is that over time, the interest rates will have little impact upon the value of the bond; the bond's value will always be "moving home" towards the value it was given when issued. 2) Say a bond is valued at 1000 at 5% when it is issued. Then rates decline to 2.5% and bond is worth 2000. Will YTM rise or fall as this bond approaches maturity? YTM will lessen because YTM reflects decline to 1000 3) Say a bond is valued at 1000 at 5% a the time of issue. Rates then rise to 10%, bond is now valued at 500. Will YTM rise or fall as this bond approaches maturity? Increase, because YTM reflects rise to 1000

1. You borrowed $300,000 to purchase a $400,000 house. You pay off $50,000 of the loan and the house increases in value by $100,000. What is your debt-equity ratio? a. 1. 2.5:1 b. 2. 2.5:5 c. 3. 3:2.5 d. 4. 3:5 e. 5. 1:1 f. Answer: Your debt is $250,000 after paying $50,000 of the $300,000 loan. The house is worth $500,000, which means that your equity in the house (after deducting the outstanding balance of the loan) is $250,000. Your debt-equity ratio is $250,000/$250,000, or 1:1. 2. You borrowed $300,000 to purchase a $400,000 house. You pay off $100,000 of the loan and the house decreases in value by $150,000. What is your debt-equity ratio? a. 1. 2.5:5 b. 2. 4:1 c. 3. 3:2.5 d. 4. 2:2.5 e. 5. 1:4 f. Answer: Your debt is $200,000 after paying $100,000 of the $300,000 loan. The house is worth $250,000, which means that your equity in the house (after deducting the outstanding balance of the loan) is $50,000. Your debt-equity ratio is $200,000/$50,000, or 4:1.

1. You borrowed $300,000 to purchase a $400,000 house. You borrow another $200,000 to build an addition that adds $300,000 to the value of the house. What is your debt-equity ratio? a. 1. 3:1 b. 2. 7:1 c. 3. 5:7 d. 4. 2.5:1 e. 5. 5:1 f. Answer: Your debt is $500,000 after borrowing another $200,000 to finance the addition. The house is worth $700,000, which means that your equity in the house (after deducting the outstanding balance of the loan) is $200,000. Your debt-equity ratio is $500,000/$200,0000, or 2.5:1. 2. You borrowed $300,000 to purchase a $400,000 house. You borrow another $200,000 to build an addition that adds $300,000 to the value of the house. You have increased your leverage. True or false? a. False. Leverage refers to the relationship between your debt and equity. The greater the ratio, the greater the leverage. When you purchased the house, your debt-equity was 3:1 ($300,000/$100,000). After the remodeling, your debt-equity ratio was 2.5:1 ($500,000/$200,000). Your leverage has decreased.

A. The Great Dilution A. With banks loth to lend and credit markets still in turmoil, a tsunami of defaults seems imminent, despite the fact that credit has thawed a little in recent weeks: junk-bond spreads have fallen from their dizzying peak of 22 percentage points over government debt, and firms are paying less to issue commercial paper, widely used to finance working capital. But they will still struggle to roll over much of the $518 billion of corporate bonds and more than $1 trillion in loan facilities that, according to Citigroup, must be refinanced this year-especially given increased competition from sovereign borrowers seeking to plug deficits. Worse, a growing band of investors is using a mix of short-selling and credit-default swaps (CDSs) to bet against firms with heavy refinancing exposures. As their CDS spreads widen, those companies find it ever harder to sell fresh debt. Some have already taken this last route to get lenders off their backs. Britain's Premier Foods, for instance, is planning a rights issue in exchange for banks loosening the terms of its debt covenants. Others are likely to follow. Andrew Smithers of Smithers & Co, a research firm, expects American companies to swing from being net buyers of their own equity (through buybacks) to net sellers. Mr Wilkinson predicts a "great dilution" of existing shareholders in 2009. This could drive another round of selling in stockmarkets, he argues, which have hitherto focused only on falling profits. Fear over the need for further capital-raising contributed to the decline of banks' shares.

A. Explanation 1. Say junk bonds are paying 32%; junk bonds are "last in line debt;" go after all of the other lenders, so they will have charged the highest rate, will represent the greatest risk. If the spread = diff tween junk bonds and gov treasury bonds. We expect there o be a big spread. 2. Firms are paying less to issue commercial paper: firms are paying less for loans that are really short term. Ex of commercial paper = payroll. Payroll fluctuates; might get short term loan to pay it. Interest rate for these loans are very, very low. 3. What we see here: interest rates are coming down - fallen for junk bonds. If you have a loan coming due, can get another loan, pay it off, with a much lower interest rate. This article says that we have two ends of the spectrum, both are costing cos. 4. Still struggle to roll over much of the 518 billion of corp bonds: the lower the interest rates, the lower it should be to roll over your maturing debs. Sovereign borrowers = they're competing with companies that have debt that need to be rolled over. They're competing with cos that have maturing loans hey have to pay back. Competition to buy money. 5. Competition is coming that'll make it more difficult to roll over your debt 6. Short selling and credi default swaps: credit default swpas = insurance policy; will pay off if a particular co doesn't make good on its bonds. 7. CDS spreads widen: view of how risky people see that debt - how risky it'll be to borrow. 8. A bond is a loan. A stock is a bond that you don't have to pay interest on. 9. Bond prices go up if interest rates go down. 10. "planning a rights issue in exchange...:" premier foods is going to the actual banks, say that they want the terms of the covenants loosened (ex give borrower higher priority in loan pecking order; asking banks if they'll let them borrow more money if those new loaners aren't given priority over banks. Aka, paying the bank to take a lower value on the bank's bond). His means that other stockholders will be diluted, bc they're giving them an option to buy stock. if they sell stock at too low a price: dilution.

I. Shift now to more conventional law, including the business judgment presumption A. In-class notes/breakdown 1. Shift now into more conventional law. Obligations of management and the board to duties that run to shareholders. 2. Business judgment rule: three components of that. BJR is a presumption that P must overcome to get over a motion to dismiss. Which is why these types of cases are decided at the motion to dismiss stage. a. Second part: loyalty. Has to be egregious on some level 1) Anything you see as bad faith you're essentially going to argue as a loyalty claim b. Third part: duty of care. Turns on whether you made your decision on an informed basis. You'd essentially need a smoking gun, email between directors saying tha they knew it was a bad idea. 1) If corp bought CEO's art collection: would have to have an independent assessment of the value to have an informed basis.

A. Kamin 1. Business judgment presumption: a. Presumption that (1) absent illegality, (2) self-dealing or other breach of the duty of loyalty, (3) directors acted in good faith, on an informed basis, in the honest belief that the action taken is in the best interests of the cop 1) Presumption: P must overcome the presumption for the ct to review substantive merits of decision 2) Note that (2) is much higher than a simple negligence standard b. Taking the BJR, Then, how do we view the board's decision-making process in: 1) Kamin: distribution of DLJ stock instead of sale 2) North: lending to failing company, special litigation committee 2. 2m DLJ shares for influx of 30m from AMEX. AMEX is now suffering a loss, has two options: 1) distribute DLJ stock to shareholders or 2) sell DLJ stock. a. Distributes DLJ stock to shareholders: no earnings effect; just leaves you with tax/accounting issue 1) "Powers 'unconscientiously executed?'" 2) Avoid hit to stock price? b. If decides to sell DLJ stock: charge against earnings; 8m tax savings

A. Discount Rate and Multiplier ex - Dell 1. Text a. Any attempt to take Dell (ticker: DELL) private could provoke significant opposition from large shareholders given that the cash-rich company trades for a low multiple of earnings even after the 14% gain in its shares today to $12.43. b. . . . It's understandable that Michael Dell is frustrated with Dell's share price, which hit a low of under $9 in November and trades for less than eight times projected profits of $1.66 in the company's fiscal year ending in January 2014. Dell has one of the lowest price/earnings multiples in the S&P 500. 2. Low multiple = high discount rate. Artificially low discount rate in Dell case was being used to argue for a lower price bc the company is riskier. Second part of article: Dell is frustrated bc he's a shareholder of a public company, perspective of him as a current investor.

A. Old Man and the Apple Tree 1. The woman, the buyer, uses the capitalization of earnings method. She averages together the tree's earnings to get E = 45$. Uses a discount rate of 20%. a. Would the value be lower or higher if he cap rate were 15%? Are the earnings now "riskier" or less "risky?" 2. The old man suggests a discount rate of 15%. This grants a value of $300, if we use the E = 45$ that the buyer came up with. 3. Old man uses cash flow - looks at CF over fifteen years. a. Look at the slide. He doesn't just apply fifteen percent once, or fifteen percent every year. How does he calculate the value: looks at the value TODAY of $50 received five years from today. 1) 4. Distinguishing further between the Capitalized Earnings Method a. Earnings / Discount Rate (aka, capitalization rate) 1) Discount rate is expected rate of return 2) 45 / .2 (.2 is "discount rate") = 225 b. Earnings * Multiplier (aka, capitalization factor) 1) 45 * 5 (5 is "multiplier," inverse of discount rate) = 225 2) "Apple tree was sold at 5 times earnings."

A. Preemptive rights 1. DGCL 102(b)(3) a. No stockholder shall have any preemptive right to subscribe to an additional issue of stock or to any security convertible into such stock unless, and except to the extent that, such right is expressly granted to such stockholder in the certificate of incorporation. 1) Does the corp have to opt in or opt out to give preemptive rights to shareholders? Opt in. 2. Ohio Revised Code § 1701.15 prior to 1999: a. "(A) Unless otherwise provided in the articles, the holders of the shares of any class . . . shall, upon the offering or sale for cash of shares of the same class, have the right . . . to purchase such shares in proportion to their respective holdings of shares of such class . . . " 1) Does the corporation have to opt in or opt out to give preemptive rights to shareholders? Opt out.

A. Preemptive Rights Exs 1. Originally, a company has 1000 shares worth one million. The majority owns 667 shares worth 667,000, the minority has 333 shares worth 333,000. What will happen if the majority offers 1,000 shares to itself at 500/share and the minority exercises its preemptive rights and 1,000 shares are sold? a. The majority's old 667 shares are now worth 500,000. They will get, of the new 1,000, 667 new shares that are also worth 500,000. b. The minority's old 333 shares are now worth 250,000. They have a new 333 shares that are also worth 250,000.

A. So what do we want to know to value an income stream? 1. Risk free rate of return 2. Market risk (systematic; risk premium) 3. Firm risk (nonsystematic; beta) 4. In-class notes a. Market risk - systematic risk = if all the cos in the same business line as you go down, you're going down. Risk premium = what risk you expect from every co in this line of business. b. Firm risk = how does this co differ from all other cos in the same market. That's beta. c. Why not the market price: bc it's volatile and speculative. d. How does CPM incorporate the market price: will look at market price of comparable cos.

A. Risk Premiums and beta 1. Risk premium breakdown a. Average return of S&P 500 = 10%. Return on US bond = 5%. Risk premium: 10 - 5 = 5%. 2. Beta a. Low beta = company risk closely follows the risk level of its market. High beta: doesn't. b. Illustrative betas 1) First, recall: i. RF + Beta * (E(RM) - RF) = E(PR) ii. Assumptions: Expected Return for Market (S&P 500): 10%. Risk-Free Return: 5% 2) Illustrative betas are on slide 36 of Valuation #2 slideshow 3. In-class notes a. Risk premium: difference between RF and average return of the market rate b. Beta= the amount by which we adjust the risk premium. Wan to know if the target co is more or less risky than the rest of the comparable cos. c. Beta is based on the volatility of the market co compared to the volatility of the volatility of the other cos. d. Red and blue lines: beta less than one, bc it's less volatile than S&P e. E(RM) - RF= risk premium f. Exam question: beta before a big sock opening is super consistent; afterwards, goes crazy. Need to argue why you do (if you're the company - "we're worth less"), don't include that jump (buyer - don't include, want higher value of co, so you say it is super consistent) g. Another exam tip: if the beta doesn't match he market index, can argue that that might not be the right market, if here's a beta of, say, 5.

A. Valuation Quiz 1. If you buy a flat-screen tv instead of paying your tuition, then not attending school would be an: 2. T or F, an income stream of $100/year would be worth more when promised by IBM than by the federal government: 3. If one company earns $100 in profits reflecting a 40% return on shareholders' investment, and another company earns $100 in profits reflecting only a 20% return, what would you need to know to determine which one was a better investment? 4. Why would a lender to a business demand a higher interest rate than the interest rate it demanded on a government bond? 5. Why would a lender to a business demand a higher interest rate than it demands from another business? 6. An investor offers to invest $1 million in a business in return for a 1/3 interest. Another business that generates the same annual profits wants the investor to invest the same amount in it in return for the same 1/3 stake. What argument should the business make to the investor? 7. An investor offers to invest $1 million in a business in return for a 1/3 interest. Another business that generates the same annual profits and represents the same level of risk wants the investor's capital. What are two ways the second business could offer the investor a better deal? 8. What are the seven valuation approaches discussed in the Old Man and the Tree parable:

A. Valuation Quiz 1. If you buy a flat-screen tv instead of paying your tuition, then not attending school would be an: opportunity cost 2. T or F, an income stream of $100/year would be worth more when promised by IBM than by the federal government: F. the likelihood of being paid the 100 is greater with the federal government is greater, so that income stream is worth more. 3. If one company earns $100 in profits reflecting a 40% return on shareholders' investment, and another company earns $100 in profits reflecting only a 20% return, what would you need to know to determine which one was a better investment? You would want to know how much more risk the first company took, if any, to generate the higher return. If it took the same amount of risk as the second company, for ex, then the first might be a better investment because the $100 return represented a higher return without taking additional risk. 4. Why would a lender to a business demand a higher interest rate than the interest rate it demanded on a government bond? The likelihood of default is greater with the business. The cost of capital therefore is higher. The higher interest rate compensates the lender for taking the additional risk. 5. Why would a lender to a business demand a higher interest rate than it demands from another business? The answer is the same as for the previous question. The likelihood of default is greater with the first business. The cost of capital therefore is higher. The higher interest rate compensates the lender for taking the additional risk. 6. An investor offers to invest $1 million in a business in return for a 1/3 interest. Another business that generates the same annual profits wants the investor to invest the same amount in it in return for the same 1/3 stake. What argument should the business make to the investor? It should argue that it is a less risky business than the first business. 7. An investor offers to invest $1 million in a business in return for a 1/3 interest. Another business that generates the same annual profits and represents the same level of risk wants the investor's capital. What are two ways the second business could offer the investor a better deal? The value of identical income streams reflecting an identical level of risk generally would be equal. The second business must offer the same stake at a lower price, or a larger stake at the same price. For example, it could offer a 1/3 interest for less than $1 million or more than a 1/3 interest for $1 million. 8. What are the seven valuation approaches discussed in the Old Man and the Tree parable: scrap value; one year's income; 15 years * one year's income; other offers; book value; discounted cash flow; capitalized earnings.

a. Corporation A issues 250 new shares for $1.25 million, and the CEO purchases 50. 1) The CEO is better off. The new shares are sold for $5,000/share -- a $4,000/share premium above their value. Thus, the new shares are "watered stock" that increase the value of the already owned 100 shares but impose a loss with respect to the CEO purchase of 250 shares for $250,000. The new per share value is $1,800. The CEO experiences a $20,000 net gain. b. Corporation A issues 500 new shares for $2.5 million, and the CEO purchases 100 1) The CEO is worse off. The new shares are sold for $5,000/share -- a $4,000/share premium above their value. Thus, the new shares are "watered stock" that dilute the value of the new shares that the CEO purchases for $500,000. The CEO's gain on the 100 shares already owned is exceeded by the loss on the purchase of the new stock (by about $33,000)

Answer: The CEO will be worse off if the value of his shares after the recapitalization is less than the value of shares before the recapitalization plus the amount he pays for any new shares. The CEO owns 100 shares, each of which is worth $1,000 before the recapitalization. If new shares are sold for less than $1,000/share, then his existing interest will be diluted, and he will need to buy enough new shares to offset the amount of the dilution to his existing holdings to avoid ending up worse off. This analysis is reversed if the new shares are sold for more than $1,000/share, and the CEO buys some of the new shares. Each answer is explained separately below. A. The CEO is not worse off. The new shares are sold for $5,000/share -- a $4,000/share premium above their value. Thus, the new shares are "watered stock." The CEO loses $4,000 on each of the 50 shares purchased, or $200,000. The value of the CEO's 10% interest increases by $2,000/share, for a total gain of $200,000. He neither better nor worse off. B. The CEO is not worse off. Compared with the first answer, the CEO must be better off because the original 10% interest still increases $200,000 in value, but the CEO's $4,000/share loss on 25 shares is now only $100,000. The CEO experiences a $100,000 net gain. C. The CEO is worse off. Compared with the first answer, the CEO now must be worse off because while the original 10% interest still increases $200,000 in value as a result of the sale of watered stock, the CEO loses $4,000/share on 100 newly purchased shares, or $400,000. The CEO experiences a $200,000 net loss. D. The CEO is worse off. The analysis is the same as for the first answer, except that the increase in the value of the CEO's 10% interest will be reduced. Why? Although each newly issued share still creates a $4,000 windfall for the pre-recapitalization shareholders, only 50 new shares are sold, which halves the total gain from selling the watered stock. If you halve the amount of watered stock sold, you will halve the benefit to each existing shareholder. The CEO's 10% interest now increases in value by only $100,000. The CEO's loss remains unchanged, however, because the 50 shares purchased at $5,000/share still represents a loss of $4,000/share, or $200,000.

A. Sample Exam Question 1. Text a. Privately held Biotech Inc.'s cash flow last year was $300 million, with $100 million coming from the one-time sale of an office building. Its stock price has risen and fallen twice as much as the S&P 500, and half as much as the NASDAQ Biotechnology Index. The annual return of the S&P 500 was 0.00% over the last year, 0.07% over the last five years, 3.2% over the last ten years, between 14.4% and 2.4% for 20-year periods from 1950 to 2010, and 8.22% since 1926. The investment return of the NASDAQ Biotechnology Index has been 12.08% over the last year, 36.91% over the last five years and -30.72% over the last nine years and four months (since the inception of the index on 9/25/03). The ten-year treasury bond rate is currently 1.9% and has averaged approximately 4.0% over the last ten years. What is Biotech's value? 2. Breakdown

I. Annuities and Tables A. Technicolor 1. How does the court refer to our E(PR) + RF + Beta * (E(RM) - RF) formula? a. RF = "risk-free rate for money...typically derived from government treasury obligations. b. Beta = "The relative volatility of a the subject firm's stock price relative to the movement of the market generally." c. (E(RM) - RF) = "Market risk premium...excess of expected rate of return for representative stock index...over the riskless rate." 2. Our basic issues a. Cash-Out Merger: $23/share (17.81% shares) 1) Market Price: ($9 - $11/share) 2) Dissenting shareholders (4.4%) seek appraisal b. Dueling Experts 1) Rappaport: $13.14/share 2) Torkelsen: $62.75/share 3) $49.61 difference - 4) Distinguish this from "baseball arbitration. Rappaport's number is 57% of $23. Torkelsen's number is 272% above $23 5) Using Rappaport's discount rate in Torkelsen's analysis: $20.86 difference c. Court: $21.60

1. In-class notes a. Litwin is cited by Winter in joy v. north as another no-win decision b. Bonds were issued at 100, but they were trading at 106. Why? What changed: the company could have become more credit worthy. Wha's another reason he value of a bond would go up: interest rates have gone down across the board. c. All bonds' value will go up when interest rates go down 1) When interest rates go up: the company is riskier, so the value of the go goes down. d. When a bond is issued, it has an income stream - and the income stream, the interest rate payment, doesn't change. You'll obviously want to pay more for a fifty year old bond that pays 50$ than a new bond that just pays 25. 1) What do we call the rate that is set when the bond is issued: coupon rate. If a co has an old bond and interest rates rise, hey probably feel pretty good bc they're paying a lower interest rates on those bonds 2) Bond's face value is relevant when it is issued and when it matures - is a fixed number. Coupon rate/interest rate is also a fixed rate. e. "Par" is a term used to describe face value f. Another term for prevailing interest rate: Yield. 1) Yield = prevailing rate 2) Prevailing rate will determine the bond price. Bc: you can always buy a new bond at the prevailing rate. g. What would happen to the value of a bond if the issuer started losing money: the value of the bond would go down.

a. What would value of bond be if it matured tomorrow and prevailing interest rate was 10%: 1,000. So do you think it's still worth 500 today if tomorrow you're going to get 1000? No. that's a wrinkle - we ignore when it's maturing. When it nears maturity, need to adjust that number. If interest rates have gone up, need to round up value. If rates have gone down, need to round down. b. Three things affect bond value: 1) credit quality of the company, 2) time to maturity, 3) prevailing interest rates c. If interest rates fall by half: value of bond will double. d. What is yield: the interest payment you receive on the bond. How to calculate yield: interest payment divided by the bond value. e. What is a callable: co has the ability to call back the bond. Why would a co do that: if they think interest rates will fall. 1) If we take a bond, make it callable, will the interest rates be higher or lower than when it was issued: higher, bc now buyer has lost opportunity to make money bc they know borrower has the ability to pay them off early. Bond is worth a little bit less. 2) Morgan Stanley bought a bond after interest rates had gone down even though it was callable, and it paid a price that implied it wasn't callable. Ex case we'll read in he future f. What is yield to maturity? Says look at yield AND when bond mates. Yield to maturity will adjust price upwards the closer you get to maturity date. The idea is that regardless of interest rates, the value of the bond will always be going back to coupon price. 1) Yield might say bond is worth 2000, but YTM is going to correct the value of the bond, look at how close we are to maturity. If doesn't mature for another thirty years, yild and YTM will be basically the same 2) YTM = correcting the value of the bond to take into account when you'll get the face value paymen

1. In-class notes a. Ziebarth and Farris review 1) Your purpose doesn't have to be a business purpose - it can include the purpose of squeezing someone out. 2) The alternative to Ziebarth: when you have facts where you won't even get appraisal. Does might = right apply when you don't even have appraisal? In an asset purchase, you don' get to vote, so don't even have appraisal. Courts are much less comfy with Z when you don't get appraisal. If you do a merger, you can squeeze out minority, but they have appraisal. If you have an asset purchase, a minnow can swallow a whale and avoid the appraisal. Farris, GA therefore want to inject some fairness, say that if there's a fundamental change in the type of business, you have a right to appraisal 3) Fact exs for "fundamental changes:" 1) if co is in a different industry/the business is v different (ex going from a coal co to a software co supports a Farris argument); favors minority 2) assets to debt ratio is different (debt equity difference) - ex minnow has no debt, whale has a lot of debt, under Farris can argue that would change the nature of the business, minnow shareholders have a right to appraisal. Favors minority as a fundamental change. 3) loss carryovers: note that loss carryovers can only be take advantage of if the co with them survives. This is a legit business approval. This is a factor in favor of the company, not the minority shareholders. 4) Whale has v little cash. This is an argument in favor of List, the whale, bc if you choose to do an asset purchase, allows them to circumnavigate appraisal - and a the end of appraisal, you have to write a check. You want to avoid appraisal so you won't have to go borrow money to pay he shareholders that seek appraisal. This is a legit business justification for why you are doing the transaction in this way. 4) Ziebarth is no longer the rule in Del. But you may win this argument in other js if you make a good argument. 5) In practice: Discuss Ziebarth, and then Farris (there are other reasons than just denying the minority appraisal to do an asset purchase instead of a merger). 6) Farris is the same case as GA.

a. Ahmanson 1) If maj is in charge of the board, make a loyalty claim to get around the BJP. Ex: maj did something to its benefit that was the to min's detriment. Note: if he maj issues shares, paying themselves, not necessarily in the min's detriment, as long as they get what they are entitled. What more could you demand from the maj, is there a way the maj could abuse its discretion regarding when and how much to pay dividends? Ahmanson tells us you can be foolish enough that you can use your dividend power so abusively that ct will find that your decisions were made to the detriment to the min. 2) Abuse of dividend policy against the minority 3) If you want to get the price per share down: do a stock split. This will, though, cause people to be more interested in buying those shares, bc they think it'll be a better deal. 4) 1) need to break ourselves up in different pieces; 2) we want to isolate the "15%" of the entity (on slide illustration) 5) Want to capitalize on a boom in savings and loans. 6) What happens if maj sells its shares? That means the 15% will also have access to that market, can sell their shares. Maj wants to keep control of this pie, wanna own 51% of the whole. But they want only shares that represent 85% of the pie out there, not share that represent 15% of the pie. 7) What happens if they sell 40 of their 85%? In this case, the green majority no longer has majority control. They probably will have working control, but this is NOT the widely diffuse ownership where working control makes sense. They need to get to 51%, which means public shareholders just need 36% from maj to get control. Min now, actually, has more control and discretionary power. 8) So: if maj actually wanted to sell, they won't sell of more of their shares that would just leave them with less than 51%. 9) If you sell all the 85% to the public, all you will need is 51% of the public shares to control 85% of the company

a. Note: 1) MBCA 8.33 (a): A director who votes for or assents to a distribution in excess of what may be authorized and made pursuant to section 6.40(a) or 14.09(a) is personally liable to the corporation for the amount of the distribution that exceeds what could have been distributed without violating section 6.40(a) or 14.09(a) . . . b. What could T have done to avoid violating 6.40 at the moment the dividend was declared? Delay payment by > 120 days 1) MBC 6.40: "...the effect of a distribution under subsection (c) is measured:...(3) ...as of (i) the date the distribution is authorized if the payment occurs within 120 days after the date of authentication of (ii) the date the payment is made if it occurs more than 120 days after the date of authorization."

a. But what DID T do to avoid violating 6.40 at the time the divided was declared? Borrowed 2.6m and issued stock. 1) Issue with borrowing 2.6m: you're still in the hole 300k. 2) Selling shares will get rid of the 300k problem. But T sells them to himself. L must then exercise his preemptive rights and invest back into the business or accept ownership dilution. b. How is this different from Katzowitz? 1) "fraud/gross disparity standard" 2) "fails to show how or why the valuation was fraudulent."

1. In-class notes a. In this section of the class, we will see a conflict between k obligations and fiduciary duties. b. Participating/nonparticipating: preferred stockholders are entitled to receive more than just their dividend preference - they eat appetizer, common eats appetizer, then all sit down together and eat their meal. Unpreferred: preferred eat their appeatizer and then they're done c. Fed will sell bonds to raise the interest rate, buy them to lower them d. Callable stock is essentially like debt, just worth a little bit more, pays a little bit more interest

a. Convertible preferred will be issued to VCs. Only will buy preferred. b. Catch-up: when common eats their salad, "catches up" to preferred (on participating/nonparticipating slide) c. QUESTION: why would you ever want nonparticipating preferred stock d. You can't get away from cumulative preferred dividend preference by just not paying dividends. Bc arrears will pile up. Those arrears have to be paid before you can pay common. e. Conversion for convertible stock will usually occur in IPO. Say that x shareholders who have stock before IPO will have y amount of common. Alt: just before IPO, co is restructured so that there are two classes of common, preferred become common, that class usually has all the votes.

a. Cash flow & residual value (184 - 86): The court discusses the experts' projections of cash flow over time. What is its analysis? 1) "Torkelsen's "assumption of a 5% growth rate in cash flows after the projection period is striking when one recalls that [Torkelsen] projects growth during the 5-year explicit forecast period in the critical film processing business at 2.3%" (at 186). Why is this "striking?" i. $16.56 of difference in estimate due to 5% ii. growth assumption iii. Not "inquisitorial" 2) Cash flow and residual value: the court discusses the experts' projectison of cash flow over time. What is its analysis? Economic profits = profits above your discount rate. Question is after the first five years, what're we going to do after competitors have entered market, driven down your profits. Torkelsen assumes ___ rate of increase: perpetual. Rappaport is acknowledging that profits will go up, but so will expenses, so we'll just use a fixed number after year six to perpetuity. Torkelsen assumes 5% increase every year. Torkelsen assumes an indefinitely ability to increase this business's profits. 3) Earnings/discount rate = how to calculate an annuity into perpetuity, if there's a fixed amount you will get into perpetuity. The formula we've been working with is exactly that - assumes we'll get x return at y rate for forever. 4) What's going to happen is that they've already calculated the value for the first five years. To calculate sixth year: subtract the value of the first five. 5) Cash flow/discount rate = present value of all years. But we've messed with this, have already calculated value for first five years. So subtract that for the present value of years. 6) Use table to calculate the present value of one dollar at the end of one year at x discount rate. Do that for each year. 7) When you have your five years: value for sixth year/discount rate - added together value of first five years. 8) What we're calculating: what is the value, today, of six million for every year into perpetuity. This will give you value of an annuity of x amount per year starting in the "Y"th year.

a. Cost of capital and beta (186 - 87): The court discusses the experts' different estimates of the appropriate discount rate to use for various business lines, as well as the appropriate beta. How does the court view the strengths and weaknesses of the different approaches? 1) Rappaport: i. Discount rates: 20.4% & 17.3% ii. Beta: 1.7 for certain Technicolor divisions § "relatively stable cash flow" § includes takeover announcement period iii. Court: 1.27 beta (pre-tender offer) 2) Torkelsen: i. Discount rate: 12.5% ii.Average of: § 9.6% for MAF § 15% all manufacturing companies 3) "Striking" slide: seems like he's saying Torkelsen used a growth rate of 2.3 for at least some of the five years, and then he suddenly increased it to 5% in year six. And Rappaport doesn't even thing the 2.3 will happen. 4) My notes: i. Rappaport used the capital asset pricing model and he came up with two discount rates (which the ct refers to as the "cost of capital). One discount rate (20.4%) was used for "most of the cash flows, including film processing and videocassettes," the other (17.3%) was just used for One Hour Photo (and two related businesses) ii. Pros: the ct talks about how the CAPM is "widely used" in the field of financial analysis, used when securities are regularly traded. Also used in portfolio, budgeting decisions iii. Negatives: Ct says CAPM can't determine a "uniquely correct cost" of equity." Beta can be measured a variety of ways. iv. Rappaport's beta: to come up with his 22.7%, he used a 1.7 beta which was an estimate published by Merrill Lynch. Ct mentions that that seemed very high for a company with "relatively stable cash flows." However, also mentions that it was affected by the volatility in Technicolor stock surrounding the announcement of MAF proposal to acquire Technicolor for $23 per share (WHY: Technicolor sock had shot up rapidly to 23, when previously it had traded 9-12$. Ct says that if you applied the Merrill Lynch number to a different month, September (Rappaport was originally looking at December), the beta was a much more reasonable 1.27.

1. Final outcome: Ds paid $28.41/share (2005 WL 5755422) a. Total judgment: $51,908,955 b. Note that the total award was comprised of: 1) 4,627,600 in tender 2) $1,088,491 in added value 3) $46,192,862 in interest 2. Technicolor issues for class discussion: a. Court's decision making process (183): What does it mean when it says that the proceeding is not "inquisitorial?" 1) Court talks about how courts are supposed to be judicial, not inquisitorial: means that: (ex with baseball arbitration - arbitrator just chooses one number or the other. This causes he other sides to put in estimates tha are definitely both reasonable. Parties here did not come in with that strategy; they're both being very aggressive. Do they think this court will just pick one side over the other, not get into details: Yes. And yes, they were right). BUT: in almost every case, the ct looked at the values and made adjustmens. Cts like to think they're acting judicial, but they don't, they can't resist getting into the details. 2) 23$: what the court is probably going in looking at. If you were really doing baseball arbitration, Torkelsen probably should've come in with a number closer to, say, 30.

a. Debt (184): How is long-term debt incorporated into the valuation process? 1) Outstanding Shares: 4,567,000 2) Rappaport debt estimation: $25 million ($5.47/share) 3) Torkelsen debt estimation: $19.9 million ($4.36/share) 4) Difference (rounded): $1.12/share 5) Debt (184): how is long term debt incorporated into the valuation process? Both included debt within their estimate of the discount rate. If you have debt, how does that affect your cash flow? You will have already reduced your cash flow by the interest payments on your books. So you should have ALREADY calculated debt. So why is debt even in here, since what you're buying is the stock? what must have been true about the CF numbers they're working with? Ct's discussion is of their debt numbers? Rappaport used internal data to come up with an unaudited no (19.9 million). Torquelsen used the co's 10k. the sources, though, are close in time. So if you have an unaudited number that's very diff from the number in the 10k a month later, you should ask your expert why that number is different. Definitely don't want the co saying debt is x, then a month later telling the SEC it's y. Here it's higher in the 10k, which doesn't mean fraud because you'd want to report your debt as lower to SEC, but need to pick up on it. SO: probably shouldn't use unaudited nos when there are public nos out there

A. In-Class notes 1. Why would the majority ever issue itself shares for less than they're worth: take away minority rights, get more control. The minority, in pp ex, bear all the loss. This is Katzowitz - two owners are diluting their own stakes, squeezing out another. 2. Preemptive rights: guarantees you will not experience either type of dilution (if you have enough money to buy the stocks you're entitled to buy). Katzowitz doesn't exercise his rights within time frame they give him.

a. Does ct say if you waive this right, then are you stuck with it? No. as a general rule, you can't punish someone for not exercising their preempive rights. 1) NOTE: But there may be circumstances in which the corp might need money, Katz is just being a stick in the mud, isn't necessarily done for the purpose of diluting him, so there might be circumstances in which this is acceptable - might be good reason a person, desperate for cash, can find only a third party willing to pay a third of what they're worth. Then does it matter, since they're also not benefitting economically? Do we have this same thought if they issue shares to themselves as well? 1. Now beginning more legal part of class Equity can = stock. with stock, have fiduciary duties. With debt, there are contracts.

1. In-class notes a. Kamin: involves question of distribution of stock instead of sale of stock b. AMEX bought DLJ, a broker dealer. AMEX starts thinking they need to get rid of DLJ. What is the issue from an economic pov, what are the options for getting rid of the asset: sell it, or distribute the stocks of DLJ to the shareholders. If they sell, they'll take a hit to their earnings. Is distributing in a dividend going to give them a hit too: No. Is the economically any difference to AMEX after the transaction happens: No, there's just an accounting change, but there's no real economic effect on AMEX. c. Is there any questioning of the appropriateness of this having no effect on earnings? No, no economic diff in what AMEX was after this deal.

a. How would you argue this case as a duty of loyalty claim. Who has an incentive o avoid taking a hit to earnings: directors. Compensation plans are often tied to earnings, so might have a strong incentive to avoid taking a hit to earnings. That's a good self dealing loyalty claim. But you'd still have to get the ct to go in, second guess board's decision. Need to show there's a good argument why they should've just sold the stock, and here was some malign intent behind them distributing the stock. b. The SEC was also doubting the integrity of the earnings analysis - but note that hat still wasn't enough to persuade the ct Contrast to Van gorkom: VG took a price that was SOLELY based upon the value of the borrowing that would be needed. Bu since Kamin had papered the file, probably never going to win that case bc they were informed - doesn't matter if I was just a bad decision

1. In-class breakdown a. Interesting situation: common shareholders hold all of PS A. they can now give money to the PS, and not themselves as common, but they still get paid. The company is about to fold. PS B is desperate, looking at a situation where they're not going to get anything bc of the actions of the common. b. Incentive: pay just enough to PS A every year that the money runs out, pay nothing to B c. Unfair - owe fiduciary duty to A, B, and common. Exxon owns all of A. Exxon owes almost all of common. So what is the incentive for the common: issue dividends only up to the point of A's dividend preference. Is it ever going to pay just enough that B will get some but not common: no. But it might: pay A, Pay arrearages on B, and then pay common. That's bc common will only get money if you overcome arrearages in B. once you have, say, 100m piled up, you're going to want to go ahead an pay arrearanges bc that's the only way you, as common, can get a big chunk of change. So B will argue that if they had played their cards right, there might, in some years, be enough money left over to pay B, if you had held onto the money and invested it, they can eventually catch up to A. that's their theory.

a. If they had recd 6.9 in 1977-80, why couldn't they pay off 6.5m arrearanges and have 400k left over for B? Because the arrearages have grown. Pay out from 1977-80 4.1m. that isn't enough to even resolve the 1977 arrearanges, much less what has accumulated from 1977-90. Almost like they are holding money back. b. 1981, 3.2m payment to A. get money coming into the business for 2.3m in liquidation. Have now paid 7.3m to A, but still haven't reached the arrearages that they owe A. so still in the hole as of 1981. c. What's the theory under which B would ever get anything? B says we know that right now we're behind, but if you'd just hold onto these liquidation payments, invest them, they'd grow quicker than what the arrearages are growing. Which means that eventually we will catch up, there'll be money for B. seems like A has made a discretionary decision to not even wait a year to invest the liquidation money to get some cash in B's pockets that is self dealing. This isn't dealing anymore with the fact that B was k obligated to get money if the common is paid (even though it is technically in compliance with k's terms). d. What is it, contractually, that B should be relying on? The goal of dividends is to make sure common get money. That has gone haywire here.

1. Gibbons a. In Gibbons, the defendant, Schenley Industries, was a distiller. How might the p/e ratio of the Standard & Poor's Distiller's Index have played a role in Chancellor Marvel's analysis? b. Is it likely that the appraiser and Chancellor Marvel used the same earnings figures and discount rates (See page 140)? 1) No. See the tables on page 140 and the 2nd sentence following the first one. The appraiser's earnings value was $52.78. The Chancellor's was $37.79. At least one, if not both, had to have been different.

a. In Gibbons, the appraiser concluded the company's earnings were 3.77/share. Based on the first table on p140, what discount rate did the appraiser use? The appraiser's earnings value was $52.78. The discount rate equals earnings divided by value. The discount rate was about 7% ($3.77 / $52.78 = .071). b. In Gibbons, the chancellor reduced the appraiser's earnings estimate from 3.77/share to 2.38/share. What discount rate did the chancellor use? Based on the Chancellor's $39.79 earnings value in the second table on page 140, the discount rate had to have been about 6%. Recall from the last question that the discount rate equals earnings divided by value: $2.38 / $39.79 = .059. c. In Gibbons, did Chancellor Marvel use a higher or lower capitalization rate than the appraiser? What was the effect of this? Did it favor the majority or minority shareholders? Why or why not? 1) A lower rate (about 6% versus about 7%). A lower capitalization rate (aka discount rate) would mean that the investment was less risky and worth more, thereby favoring the minority shareholders because they want to be paid more for their shares. However, the greatly reduced earnings used by the Chancellor more than offset the benefit to the minority of the lower discount rate. A. Capital asset pricing model 1. Question: what's the value of a business? a. Answer: the value of its income stream

1. Sample chart displaying these three approaches a. No dividends were paid from 1992 to 1998. $32 million in dividends will be paid In 1999. How much must be paid to the holder of $100m noncumulative 5% preferred with a $100m liquidation preference? 1) Guttman: 5m 2) Dohme: 15m or 13m? 3) Sanders: 29m or 23m?

a. In-class breakdown 1) Common will always seek to benefit itself over PS. In the case of noncumulative stock, can just wait, not pay a dividend, til there's a huge pile of cash. 2) Guttman approach is easy 3) Dohme: if there is a surplus, then there's a potential for abuse. If cash was piling up, you weren't using it, it looks like you're just trying to keep noncumulative from getting anything. 4) Under Dohme, in year dividends are paid, what should they get for 1999: 5m. 5) How would you apply Dohme to successive years where dividends weren't paid? Give them credit for the whole 10m is one approach - look at all the surplus, give that to them bc that's the money you sort of hid away from them. Another approach: look at each year, give them what they would have been paid each year: 1, 0, 1, 1, 0, 5 (bc 5% of 100m; only can get up to 5m each year, so only give them the portion of 5m that they could've received each year). 6) What if one year there was negative surplus? Another approach would be to net out the values for the years. 7) Dohme says they're can get credit, above the 5m they're always entitled to, for the years that there was an account surplus. 8) If you have negative nos: Dohme says surplus, we're just looking at surplus Sanders: look at total net earnings. Credit now will be measured for any year in which there were profits. Can say: all of them are available. Then add up 5, 2, 3, 3, 4, 5, 2. Give them credit for 30m for the seven years if say that they're entitlted to all the profits. You'll have 27m available after you pay a dividend in 1999. That means the whole pot would be eaten up by PS. Alternative approach: add up available 5ms for each year, have credit for 27m.

a. Post-trial: in this option, take 5k off of the table, which reduces entity's value, and then divide that value three ways. This is what the ct does. What might you argue for S and L here, where, in alt, you take out the 5k and the amount of increase that's attributable to the 5k. splitting it just three ways is kinda unfair and then jus giving back S and L their 5k. Katz shouldn't get the gains that come from the money they put in; should just be put in the position he wouldn't been in if they'd put in the righ amount of shares. But if you rep Katz, say your honor, keep it simple, he owned a third before, he should own a third now. b. One interpretation: give them back their 5k, pretend the pie had just grown, split that pie three way, give S and L back their 5k (bc that's what they contributed; Katz shouldn't get that).

a. Katz takeaway: it's all about whether you have a market for your shares; if you don't, you're trapped. Aka the problem of closely held businesses. In practicaliy: this might mean you'd go to several diff VCs, see what they're willing to pay - you then can argue that the value you came up with, even if way lower than book value, is actually v reasonable. Then you'd wanna show how important the money is to the company. Then going to argue that the guy not buying has the money to buy, he has the PR and that should be all the protection he gets, he wants to ride the coattails of the people who want to save the company. b. Another takeaway: you shouldn't be punished economically jus bc you don't decide to exercise your PR.

1. Lerner Corp Assets - Liabilities = -$300,000 a. This comes about because you'll have a 300k deficit if you pay L his 926k and T his 2.6m. b. Does corporate law allow you to pay dividends that would leave less assets than liabilities? No way. 1) MBCA 6.40: "...(a) A board of directors may authorize and the corporation may make distributions to its shareholders subject to restriction by the articles of incorporation and the limitation in subsection 6.40(c). 2) (c) No distribution may be made if, after giving it effect: 3) (1) the corporation would not be able to pay its debts as they become due in the usual course of business; or 4) (2) the corporation's total assets would be less than the sum of its total liabilities plus (unless the articles of incorporation permit otherwise) the amount that would be needed, if the corporation were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution."

a. Let's do an illustration of this: 1) Assets i. Cash: 400 ii. Inventory: 50 iii. Machinery: 50 iv. Total: 400 2) Liabilities i. Loan: 200 ii. Preferred stock: 100 iii. Common stock: 100 iv. Total: 400 3) If the loan is due this week, can you pay $100 in dividends? Yes, you can cover the 200 loan and the 100 preferred. What about 200 in dividends? Nope.

a. What went wrong back in time that set up this situation where being required to give money to L then triggers a right for T to get a huge distribution himself? The settlement agreement. Was the agreement between L and the co? No, between L and T. The payment would NEED to come from T, not the company, bc the og agreement was made bc L wanted to get money from T. 1) Bullard's argument: as a practical matter, this is just L v. T, we should look at the real economics of what's going on. Treating it like a priority distribution effectively unravels the settlement, L loses the advantage of the deal he struck. b. L has a problem with the extra 2.6m being paid out to T as a result of the settlement, why does L say that's not allowed to happen: you cannot distribute money you don't have, if it's going to leave corp unable to pay their obligations. Policy reason why: don't want shareholders to pay themselves off when the corp is going down, leave SPs with nothing. So L thinks he's found a clever way to prevent the distribution from being made. Problem with this argument: then can't pay L or lose S corp status. c. Have to be able to pay divided to preferred stock along with divided if you make distribution (HAVE to pay loan first)

a. Liabilities and preferred (bc of liquidation preference) HAVE to get paid - common stock doesn't 1) NOTE: This is one of the situations where directors can be held personally liable. So L is being crafty here 2) Directors would be on the hook for 300k if paid out T - wouldn't have enough to cover liabilities b. What T could have done to avoid violating 6.4: just delay the dividend, which will cut the legs out of L's argument. But T takes a more complicated approach to not avoid 6.4: issue stock and borrowed the 2.6m. Aka, said he had a plan to cover the corp's liabilities. The problem is that you're still going to be 300k in the hole with a new loan. Next step: you need to add enough to the assets, and not the liabilities, to cover liabilities. Do that through issuing stock. The cash will add to the assets, take care of 300k without increasing liabilities. c. This ends up being a chance for T to get a huge chunk of money to buy shares which now puts the ball back into L's court. T will be necessarily ownership diluted until he exercises his preemptive rights. If you exercise preemptive rights, he has to spend the 926k he just got back. So L is forced to either accept dilution or essentially the money L just received pursuant to the settlement. d. It's also the case that T is probably issuing the share for less than they're worth, since he's buying them all, which means L is also getting economically diluted e. So for T this is all one big opportunity to economically and ownership dilute L. How is legal standard diff from Katz case? In Katz, the problem was that the dilution was egregious. Do you think T would low ball the shares to the extent we have a Katz? No, will low ball just within the reasonable range of valuations that he's had an investment banker document for him. The questionable fact/red flag here though is that T is buying the shares himself, and he is turning the settlement agreement which was supposed to be in L's favor to dilute L.

1) Small market premium question: issue here is that CAPM isn't being accurate predicting he value of small companies. Ct says that this Technicolor doesn't actually look like a small cap company. Does the value of the takeover something that needs to be factored in? do you get to take advantage of the value added by he acquirer? DE says no. which sucks, bc stockholder has an argument that they saw the inherent value in the co, which is why hey bought stocks in the first place

a. Market price (188 - 90): How does the court view the role of market price in the valuation of the company? 1) Refer to market value is "more or less the only objective indication of what the stocks are actually worth." 2) Market prices are not conclusive of intrinsic value, but ct says that they may have pertinence in attempting to estimate that value. 3) Here, ct says that in this instance, market price ofTechnicolor stock is one factor that indicates Rappaport's valuation is better than Torkelsen's: REASON: was raded on NY stock exchange, market was active one, stock price showed trends that appear related to the companies economic performance, prospects. 1. In-class notes a. Note that 17% sake COULD be worth a control premium, if the rest of the co was widely held. But in this case, the co wasn't. b. Torquelson's estimate was almost three times what stocks were trading for c. Small cap premium: the discount rate goes up when you add this premium. DCF hasn't done a good job evaluating the future return of a small co like this.

1. Explanation of multiplier and values a. Appraiser: 14.0 (multiplier) = (value) $52.78/$3.77 b. Chancellor: 16.7 (multiplier) = (value) #39.79/$23.8 c. Appraiser: $3.77 (earnings/(value) $52.78 = (Discount rate) 7.1% d. Chancellor: $2.38 (earnings)/$39.79 (value) = (Discount rate) 6.0% 2. In-class notes a. Gibbons starts with a 53/share rate; several years later, tries to squeeze out minorities at 35/share. Minority shareholders want an appraisal which says that they're worth more than 35/share. Court appointed appraiser and rial court uses two different appraisal methods. We're interested in the earnings value for these methods b. Trial court overturned court appointed appraiser

a. Market price = simply the value of an individual share (why might not be indicative: doesn't include control premium). b. Asset value: book value. c. Two ways of thinking about earnings: earnings/discount rathe OR multiplier times earnings. d. What are the two things that might explain why someone would have a lower capitalized earnings value: either/or the multiplier has to be higher, or the earnings are lower, for chancellor to get a lower value. e. Remember: higher discount rate = lower multiplier f. Appraiser's earnings: 3.77. g. Chancellor's earnings: 2.38. So now we know at least one source of the lower number. But: our math tells us that chancellor thought multiplier was higher, thought that the company was less risky than the appraiser. h. In litigation, you'll want to win both the discount rate and earnings argument i. 43/share is a win for the Ps - still doing better than the 35/share. BUT the final resolution: puts appraisal to 33/share. So, overall: shouldn't have brought suit.

1. In-class notes a. Issues present here: cash flow. Here, he only gave us one year of CF, and one effect that might distort the total. Easy answer: ake 100 out of the 300 million. (why might expenses be off for CF: costs were just really high one particular year). Why use 4 percent for RF rate: better representation, bc it's for he past ten years, not just one year. Eliminate potential outliers. Advantage of 1.9: that's the CURRENT risk free rate. Also, we don't know if here's been a steady decline! Can argue that this might be more reflecive of today's conditions.

a. Market return: we're looking at biggest loss and biggest gain for a year, three years, etc. take into account the betas. What about the returns: you cannot put a negative number into our formula - that's an unusable number. SP 0% is also not useful. .07 probably also not useful. That means, for SP that puts us back to the last ten years or twenty year periods. Using our beta for SP, that would mean we want a return of around 2%, which doesn't work. biotech: pretty volatile. Is the 36.1 indicative give he negative percentage over the last nine years? Well, if you've got a range, maybe shoot for the difference between them. b. Remember: validity of most recent number, validity of long-term data. c. In reality, if choose biotech, will probably be something in between 12 and 36. d. He chose 8.22 since 1926 bc gave you a nice long period. e. Prob with zero, negative returns: if you're investing in a co, you want SOME return. Looking at market to see what return you should demand - and you're not going to demand a NEGATIVE return Beta in respect to SP is 2.

1. In-class notes a. Discounted cash flow and capitalization of earnings, which differe only in how they define income, are the two best valuation options from "old man" ex b. Capitalized earning approach: have both an earnings no, and a discount rate. In old man ex: uses one year earnings of 45$, discount rate of 20%. Issue: does the 45 rep an estimate across multiple years? Yeah, this is essentially a blended no - she averaged in her head earnings over the years. NOTE: she will also want a higher discount rate, because that means she'll pay less for the tree. c. IF we are in a siuation where a company wants to present iself as risky, aka in a valuation proceeding, will argue it's really risky. In this case, they'll want a high price to buy them out. d. Would the value be higher or lower if rate were 15: higher. After valuing company, remember to DIVIDE by the discount rate. e. How to describe what she's buying using the lingo of multiplier, instead of discount rate: she's buying co at a multiplier of five times earnings (OR, if using cash flow: five times cash flow). f. Remember that you'll essentially be working backwards; you have an income stream, and you have to make that income stream equal equate a certain percentage of return (of your money; aka, the discount rate). g. Discount rate = capitalization rate. Mean same thing.

a. Multiplier = capitalization factor. DEPENDS ON WHETHER USING CAPITALIZED EARNINGS METHOD OR CASH FLOW METHOD IF YOU CALL IT CAPITALIZATION FACTOR. 1) But: you can use the term "discount rate" for both b. How old man takes his approach to the income stream: cash flow. He includes the salvage value at the end. Why will this salvage value, after taking out discount rate, be super small and insignificant? Bc the further out we go, fifteen years out, that discount rate is going to represent x amount less than it did originally (depreciation, inflation issues). He further ou you're discounting a payment, the less valuable it is today. c. Old man's approach looks at CF of each year, applies discount rate every year. Contrast to buyer, which applied rate to averaged amount. In his approach: every year you're saying that...7.37 is what you would pay for the 60 in 15 years (assuming a 15% return). WHAT AMOUNT for fifteen years would you pay to get 60 in 15 years. d. Second year's earnings: fifteen percent one year, fifteen percent second year, will get you fifty. e. We really are going to just do six diff valuations: use old man's approach fir the first five years, then use her approach for the rest of the year's of the co's indefinite life. f. What we see here: his estimate of the CF is actually more favorable to her than it is to him; she's assuming a higher income stream. g. Explanation of math 1) Each value in the column equals the payment (e.g., $50) divided by 1 + the discount rate to the power of n, with n being the number of periods. So $50 in three years would be worth 50/(1.15^3), or $32.88. Think of that as the reverse of earning a 15% return on $32.88 for three years: 2) $32.88 * 1.15 = $37.12 3) $37.12 * 1.15 = $43.48 4) $43.48 * 1.15 = $50 So I would pay $32.88 today to receive $50 in three years assuming a return of 15%.

a. Could you contractually keep Exxon in check by saying that any PS owed by Exxon will be treated as common? That's one way to do it. Make sure that if they're getting the money by not having to wait at the end of the line, you say that any money they receive before B will be treated as payments to the common as common. And that solves the problem. You've eliminated the problem of them getting paid before B. b. Another way to solve this problem: if B doesn't get paid for x years, gets control of the board. c. If you run the numbers based on the plan that B proposes, you find out that it would take a really long time indeed to pay off the arrearages of A (NOTE: you will never catch up to arrearages to B; just want to be able to get some money in B's pocket). The first, in turn, will argue opportunity cost: we're only getting a 4% return a year, that 400k in arrearages, when if we were to go out and invest in something else, the prevailing interest rate is 10%. d. Remember: this case is always going to be about getting past the business judgment presumption on self-dealing grounds.

a. PS bullard says is essentially debt without promise to get paid. Really only makes sense in the VS scenario - in that case, the idea is that the founders won't see any money until I get paid. b. Junk bonds = common stock with an obligation to pay dividends. c. Move now to debt Why we think of debt as useful: the interest on debt is tax deductable (if you give your business a loan, you will get interest on payments of that loan, interest is tax deductible from the profits of the business, will reduce your taxable profits. Cheaper than collecting capital through issuance of shares - paying the debtor will reduce the amount of tax you owe) 2) lower cost of capital (shareholders will demand a return on their money, aka the discount rate, will demand a higher return than will lenders bc in bankruptcy the lenders will go first, then shareholders) 3) Leverage (if you are collecting capital from sahreholders and they invest 1m, you make 20% of your money, they get all of it. But if instead you have 9m loaned at 10%, 1m via stock: you made 20% on total of ten million in capital. That means after you pay the interest, you've still got over a million left over. Shareholders will get 100% of their return. OR you can collect some of that capital from someone else who will only take 10%. Now if you make 20%, you'll still have some left over, have all that extra. Problem is if you make 0%: if you have all shareholders, you don't have to write them a check. But if you have loaned money, they still want their money. 4) no sacrifice of control - lenders don't have any voting rights! 5) no fiduciary duty until you've literally almost hit bankruptcy. In that case, treat lenders like basically the owners of the company. 6) amount that you can raise through debt is generally not limited by corporate law or by instruments of the entity.

1. In class notes a. Note that intangible assets don't necessarily lose value over time, unlike tangible assets. b. L, S are underselling the co bc they see an opportunity for dilution. c. If we start with 15 shares, business is worh 1,5k, and it issues new shares, each share should be worth 100. d. 15 shares, business is worth 27k, how much should each new share cost: 1800. e. L, S want to issue new stocks at 100 per share. Katz has preemptive rights - no risk of eco, ownership dilution if he exercises it. We know though that the no of shares he owns no won't end up worth less - why won't he be hurt financially: because the loss on his old shares will be made up by the gain that he gets in his new shares. The hit to his old shares will be exactly offset by the gain he realizes from buying the new shares at too low a price. The same would be true if, for ex, shares were being sold for too much. f. Katz WILL lose money if he doesn't exercise his preemptive rights. g. NOTE: There might be a legit reason to sell shares at too low a price; but the fact that they bought them up suggests self dealing. BUT: a third party bought 50 new shares. That suggests there is some legit reason. Katz's case is weaker in this instance

a. Potential benefit of not exercising your PR: you wanna wait and see whether the new investment will actually work - wanna sit back, not throw any more money into a failing company, wait and see what happens. Free-riding. b. What if you had a client come in, stocks should be worth 1800, but they wanna sell at 100 per share? Should suggest to bring the no up - a court is going to view 100/share is ridiculous. If you sell them at 1/18th the value, you'll get creamed when you get sued. You're NOT going to flat out tell them what price to sell at. Tell them there are litigation risks regardless, bc other shareholder might think they're worth more. Bu litigation risk is less if they choose a higher number. You don't want the ct to start second guessing the board, who is supposed to look out for ALL shareholders - they don't wanna go there. Sweet spot for client is somewhere between 100 and 1700. 100 is very risky; 1700 is much safer. Get info to back up that 1700. Then it's up to them to decide where on that spectrum they want to tell. If you are really greedy you'll end off much worse off than you will if you base your number on some reasonable valuation. c. Two things that have caused red and yellow bars to go up on bar chart slide: economic dilution (aka money coming out of Katz's pocket), and the new money coming in from sell of new shares. d. Liquidation: pie just got bigger by 9k.

1. In-class notes a. Start with two primary shareholds, Matteson (M) and Ziebarth (Z). b. Kind of deal they want: want a company to go out, market their bleach, if marketer is successful, cos will essentially merge. Gold Seal (GS) wants, og, to get ___ in the deal: the right to buy stock options, the option to buy a majority shares. But Gold Seal wants not just a majority, wants the option to buy the whole company. c. Issue: we have a minority shareholder that's a holdout. d. Transactionally, this is a good solution for Gold Seal, just having the option, bc they don't know if he bleach product will be a bust or not e. Z is gettins 16k side payment from GS that the other shareholders don't get. He says this was a consulting arrangement. But this probably wasn't really a consulting arragnemnt - he's the one controlling the vote. Question is how do we know if he's really getting paid for being a consultant, or if he's being paid a big chunk of change for his shares, for getting along with he deal. Could be a "payoff" for management. Aka, a bribe to go along with the deal. Sometimes that's legit - retention payments to ensure they stick around. Hard to track, then, if this fee is legit or not f. If your position is that Z is self dealing: then the 16k should be distributed to other shareholders. M ries to argue that here. His solution is that 16k is paid pro rata to all shareholders, though HE says says that HE should get 4k of the 16k, which he isn't entitled to pro rata. g. There's a conceptual problem here then: P argues that 16k is just part of the total price for the pie, and that additionally M should get his pro rata share, which would be about 1600. But M argues that this is essentially payment for everyone's shares, but then isn't consistent as to what the remedy should be. Says that if there is unjustice, he should benefit as well. h. M says unless he gets 25% of this side deal, he won't cooperate. We're going to squeeze him out i. What's being done here to get around M?

a. Set up a shell than GS can get 100% of without 100% of the vote. Circumvent M's ability to prevent this from happening. What are the steps to do this? They create Snowy. Snowy is just an empty box. It has no business purpose. Simply moving one set of assets into another box. Who owns Snowy? It's the same "other" shareholders. Have any of the shares been offered to M? No, he got zero shares. Shares are issued, nothing in it, not worth anything yet, M isn't offered any shares. No connection yet. Then what happens? (NOTE: MB says that today, with today's laws, you'd probably be able to just agree that if GS exercises the option, they've already agreed to the acquisition; board could've just agreed to have been acquired by GS, GS will buy all of their shares, with only a majority of shareholders, and M would just have to go along with it) b. Ziebarth shares go into Snowy, Snowy gives 20 cent callable preferred stock in return for all of Ziebarth shares. Switching out common stock, basically, for Snowy callable PS instead. The issue here is that it is "callable," which means they can call the PS whenever they want, just pay 20 cents per share. The moment they make the deal, they DO call all the preferred, and M is squeezed out. All of the Z shareholders, minus M, ends up owning all of Snowy. c. QUESTION: I'm CONFUSED AOBUT how 100% of Z shares got into Snowy. d. Does ct say that co has to have a business purpose? No. can you use authority to issue PS to squeeze out minority? Yes, as long as you have the authority to issue it under corporate law. e. M only had an appraisal right. He didn't exercise it, which was a mistake, bc that would've given him leverage when he did go to court. f. Can you squeeze someone out: Yes g. Do you always get appraisal in squeeze out? Maybe not h. In short: if you have the power, you can do it. You can squeeze. i. What's wrong with the argument that it's fair to give M 20/share bc all the sharesholder also get 20/share? Those shareholders are basically paying themselves 20 cents. You CAN challenge on the basis of unfairness. But here, ct says that to look to the unfairness, it can't be something that you knew about. Shareholders knew about this, approved it anyway - everybody except M was on the other side of this deal anyway.

1) Cost of capital and beta question: pretty unusual to break discount rates up along business lines. But if you can come up with a really distinct line, that might be appropriate. Torkelsen's rate is problematic: uses the acquiring company. Supposed, also, to look for companies in a comparable index - not necessary rel between an acquirer and a target. And technicolor is not a manufacturing company. So T is overbroad, and his method was inappropriate. Rappaport's baseline is more appropriate. Ct looks at betas: there can only be one beta for the index, no "choosing" of it. But beta can serve as an indicator as to the appropriateness of the index. Beta of 5 for one index, .9 for another index, that argues in favor of the other index. Problem with the beta here: Rappaport uses a beta that includes the takeover period, after the announcement; stock was way more volatile, so seems to make co way more valuable. C rejects that period, chooses a much lower beta (which R doesn't like bc it makes he co way more valuable). T calculated just NOT how you do it.

a. Small cap effect (187 - 88): The court briefly discusses the premium that small capitalization companies have paid for capital. What does that mean? What is its relevance to the court's analysis? 1) Rappaport: Increase discount rate by 4 percentage points 2) Court: Rejects small cap premium i. old company ii. stable industry iii. leader in oligopoly iv. brand name identification 3) Valuation adjustments i. Rappaport § $13.14 (starting point) § + $1.12 (more long-term debt) § + $7.34 (no small-cap adjustment and lower beta) § Total: $21.60 4) My notes i. What does this mean: it refers to the "unexplained inability of the CAPM to replicate with complete accuracy the historic reurns of socks with he same historic betas." Namely, this refers to the fact that small capitalization companies have a reurring premium, an additional return. ii. The court rejects applying Rappaport's extra four percentage points that this would add to the discount rate by noting the facts above. iii.Another way of saying what the premium is: higher equity return is demanded for small businesses than larger businesses. This is the "premium." aka, smaller businesses are expected to higher equity return that they're supposed to bring. Smaller companies are observed to generate higher returns than larger capitalized firms. iv.This is all based on the company's market value. Low market value = high premium.

1. In-class notes/breakdown a. Lerner - an inter-family squabble b. This is about showing how a maj shareholder might take advantage of a min shareholder c. Two bros: Lawrence and Theodore (L and T). d. What would Wolfson, from Smith, have thought of their respective percentage ownerships? Were dividends paid in Wolfson's case? No. but they were paid in Lerner. Why would Wolfson not have liked the S Corp as the structure, why doesn't he want dividends to be distributed: taxes. Wolfson doesn't want to pay taxes. In a C Corp, Wolfson wouldn't have gotten taxed in the first place. Wolfson is probably at a v high tax bracket, and this is a tension between Wolfson and other shareholders. How is S corp diff in respect to the desire of a shareholder to not pay dividends: there's no tax at S corp level bc the individuals ALWAYS pay taxes. So Wolfson wouldn't have liked that. 1) In S corp, we have someone who can be forced to pay taxes, but not have a right to a distribution to help pay the tax. So if you're Lawrence, wanna spend more money, you're constantly getting hit with tax liability but without any distributions to pay this: the S corp structure isn't really valuable to you. And Lerner is a v small corp, which means it's hard to bring suit to make somebody pay distributions.

a. T is offering to buy L's shares, despite the fact that he's not willing to make distributions. So he can force minority to sell bc this is a small corp, no market for min's shares. Can put squeeze on min. b. L also disagrees with the way the business is being run. The disagreement is reflected in a settlement they reach. In the settlement: L gets a preemptive right, and he has a right to distribution of proportionate share of income before development activity expenses - aka he wants forced distributions. c. There's also a disagreement regarding business expenses. T is trying to build this corp as a long-term family asset, wants to keep as much money in the business as possible, keep investing it in the corp. d. What happens when law changes, the dividend tax rate is reduced: corps will pay more dividends. So if law changes, there will be a change in dividend payments amongst corps. 1) If you pay taxes before development expenses (ex on board: 26) e. 805,325 must reflect 26% of pre-dev. Expenses f. What do we call a distribution to shareholders that is proportionate to their ownership stake: dividend. A dividend, when you pay it out as a proportionate piece of income, then what does every shareholder have the right to: a distribution proportionate to their ownership stake. You have to give those proportionate dividends to anybody, bc if you don't that must mean you have two diff classes of stock. and with an S corp, you can only have one class. g. Will we allow L to receive a distribution that will allow him to destroy the S corp status? No. so what's the solution to that: you give a proportionate amount to T, so now they've each gotten a proportionate distribution, we're back to having one class of shares. h. Key issue here: is the payment to L a priority distribution. Do the lawyers address this? Not really. Don't analyze whether this is a priority distribution, which is what really needs to be answered.

1. TWEN Quizzes: Preferred Stock a. What does it mean for preferred stock to be cumulative? 1) The dividend preference is carried over from year to year 2) The dividend preference is extinguished at the end of each year. 3) Preferred shareholders are entitled to receive only the amount of the dividend preference for the current year before the common stockholders can receive dividends, even if no dividends have been paid for years. 4) Preferred shareholders are entitled to receive the amount of the dividend preference for each year that it has not been paid before the common stockholders can receive dividends. 5) Answer: 1 and 4 b. Cumulative Preferred Stock A, with a face value of $1,000, has a 4% dividend preference. If dividends are not paid for three years, how much would have to be paid in the fourth year to the holder of ten shares of Preferred Stock A before any dividends could be paid to the common stockholders? 1) $1,200 2) $160 3) 1,600 4) $120 5) $900 6) None 7) Answer: referred Stock A would be entitled to receive $40/share in dividends before any dividends were paid to common stockholders. Each year that the dividend preference was not paid, the unpaid amount would carry over to the next year. In this case, the dividends for three years in which no dividends were paid would carry over to the fourth year, and the dividend for each prior year and for the fourth year would have to be paid before dividends could be paid to the common stockholders. Thus, a total of $160/share ($40 * 4 years) would have to be paid on the Preferred Stock A, or a total of $1,600 on ten shares, before dividends could be paid to the common stockholders.

a. T or F, all things being equal, cumulative preferred should trade at a lower price than noncumulative: 1) False. Cumulative preferred should trade at a higher price because it has a stronger claim on corporate assets than noncumulative preferred. Each year that dividends are not paid, the noncumulative preferred stock's dividend preference is extinguished, whereas the cumulative preferred stock's dividend carries over until it has been completely satisfied. Noncumulative preferred therefore would typically have some rights that were designed to ensure that dividends were paid on an ongoing basis. For example, noncumulative preferred might have the right to elect a specific number of directors if the dividend preference is not satisfied for two consecutive quarters. b. What does it mean for preferred stock to be noncumulative: 1) The dividend preference is carried over from year to year. 2) The dividend preference is extinguished at the end of each year. 3) 3. Preferred shareholders are entitled to receive the amount of the dividend preference for each year that it has not been paid before the common stockholders can receive dividends. 4) 4. Preferred shareholders are entitled to receive only the amount of the dividend preference for the current year before the common stockholders can receive dividends, even if dividends have not been paid for prior years. 5) Answer: 2 and 4

1. In-class notes a. Issue in Wouk: wanted to get money to common without paying dividends so we can evade payment to the PS. b. In Wouk: what does "entitled" mean? Ct held that this wording meant that it only applied to declared dividends that were not paid. If hadn't declared a dividend, weren't entitled to them. This is a literal interpretation. c. There's a motivation, then, to liquidate a profitable company so that we can circumnavigate the arrearanges, not declare a dividend, but still get the money to the common d. Dissent: "entitled" here should mean the same thing it does in the redemption provision (where, here, it doesn't matter if dividends were declared or not). Argument is that in both of these situations, you get to extinguish the preferred. ISSUE is accumulated the same thing as cumulative. K argument here. This was probably due to a drafting mistake e. Hay: again asking how to deal with arrearances in the case of liquidation f. Say you have a co that's not profitable, never paid any dividends. As a matter of public policy, we want that co to end, sell assets to someone else.

a. They'll never liquidate if the value of the assets is exactly the value of the arrearages. They won't get any money. b. If they don't liquidate, PS is getting hurt. c. In practicality: you'll be arguing how much fo the value of the assets the common will get to agree to liquidate. d. NOTE: Preferred get liquidation preference no matter what!!!! This case is JUST about whether they get their arrearages e. Hay rule: you're entitled to arrearages. f. Company will be liquidated only if they agree to share some of the value of the assets with the common. g. Problem with Wouk: you don't have negotiating leverage if you're the PS. h. Common shareholders win in Wouk. Arguing that entitled = declared. So: PS gets liquidation preference, but don't get arrearanges bc there has been no declaration of dividends. In Hay, common loses. Why, irl, they'd want to negotiate with PS.

a. What does it mean for preferred stock to be callable (aka, redeemable) 1) 1. Holders of the preferred have the right to put their shares to the corporation at a discount to par value. 2) 2. The corporation has the right to reset the dividend preference based on a decline in prevailing interest rates. 3) 3. Holders have the right to receive common stock based on the number of preferred shares that they own under specified circumstances. 4) The corporation has the right to repurchase the preferred under specified circumstances. 5) Answer: 4. Callable, or "redeemable," preferred is subject to the corporation's option to repurchase the shares under specified circumstances. For example, the preferred might be callable at the discretion of the corporation at $100 above its par value (par value = face value of $1,000) as of a specific date after issuance. This is a disadvantage because it means that the corporation will be able deprive the preferred shareholders of gains above a certain value. b. T or F: all things being equal, callable preferred stock will trade at a lower price than non-callable preferred stock 1) True. Callable, or "redeemable," preferred is subject to the corporation's option to repurchase the shares under specified circumstances. For example, the preferred might be callable at the discretion of the corporation at $100 above its par value as of a specific date after issuance. All things being equal, this feature would make it less valuable than non-callable preferred. If the value of the preferred increased above $1,100 for any reason (e.g., due to a decline in prevailing interest rates), the corporation may repurchase the preferred, thereby depriving the holder of the benefit of further increases in value. In contrast with non-callable preferred, callable preferred is effectively subject to a ceiling on its potential value.

a. What does it mean for preferred stock to be convertible? 1) The corporation has the right to convert the preferred to debt under specified circumstances. 2) 2. When the corporation reaches specific performance targets, the limit on the preferred's dividend preference is removed and preferred holders participate equally with common in dividend distributions. 3) The preferred holder has the right to exchange preferred shares for common shares under specified circumstances. 4) 4. The corporation has the right to convert the preferred to common stock to under specified circumstances. 5) Answer: 3. Convertible preferred carries the option to exchange preferred shares for a specific number of common shares under specified circumstances. For example, convertible preferred might carry the right to receive one common share for each preferred share if the common share price reaches a certain level. Convertible preferred has the advantage of giving the preferred holders the ability to participate in the corporation's success while still retaining their preferential status as to dividends and liquidations in bankruptcy b. True or false: all things being equal, when preferred stock is convertible, its dividend preference will be lower True. Convertible preferred carries the option to exchange preferred shares for a specific number of common shares under specified circumstances. For example, convertible preferred might carry the right to receive one common share for each preferred share if the common share price reaches a certain level. Convertible preferred has the advantage of giving the preferred holders the ability to participate in the corporation's success while still retaining their preferential status as to dividends and liquidations in bankruptcy. All things being equal, the purchaser of the preferred should have to give up something in return for the added benefit of the conversion right, such as accepting a smaller dividend preference

a. What does it mean for preferred stock to have a liquidation preference? 1) The holder has the right to demand, in specified circumstances, that corporate assets be liquidated to satisfy the stock's dividend preference. 2) 2. The corporation is required to maintain a specified amount of liquid assets (e.g., short-term bonds) as to which preferred stockholders have a prior claim. 3) 3. The holder is entitled to special voting rights as to a decision to liquidate the corporation. 4) The holder is entitled to receive the amount of the preference before payments in liquidation of the corporation are made to common stockholders. 5) Answer: 4. The term "liquidation" refers, in this context, to the liquidation of the corporation and the distribution of its assets, such as pursuant to an involuntary bankruptcy or voluntary dissolution. As a general matter, the order of preference in liquidation will be: (1) secured creditors, (2) unsecured creditors, (3) preferred stockholders, (4) common stockholders. Preferred stockholders are entitled to receive the amount of their liquidation preference before any payments are made to the common stockholders. The liquidation preference generally equals the "par value" of the preferred. For example, if there were 1,000 outstanding shares of $1,000 Preferred Stock A, its holders would be entitled to receive $1,000,000 pursuant to their liquidation preference before common stockholders were paid anything. Common stockholders therefore are often referred to as owning a "residual claim," that is, a claim that is residual to all other corporate stakeholders.

a. What does it mean for preferred stock to be participating? 1) The holder has a contractual right to receive dividends each year that the corporation has positive net income. 2) 2. The holder is entitled to elect directors in certain circumstances. 3) The holder is entitled to receive dividends in addition to dividends received pursuant to a stipulated dividend preference. 4) 4. The holder must contribute additional capital up to specified limits if the corporation's shareholders equity falls below a specified per share value. 5) Answer: 4. Preferred stock generally entitles the holder to a dividend preference. For example, preferred stock might entitle the holder to receive $50 per share in dividends before the common shareholders can receive any dividends. Participating preferred stock typically would receive dividends beyond that $50/share preference under specified terms. For example, participating preferred stock might entitle the holder to a $50/share dividend preference plus the right to receive $1/share for each $2/share paid in dividends on common stock.

a. Bond pays 55 annually. So we know the prevailing rate for when the bond was issued: 5.5%. 1) Why do we know from the fact the prevailing rate has changed: value of bond had gone up, which mean that interest rates had gone down. What's the fraction you would build, knowing that it was trading at 1060: 55/1060. That'll be slightly smaller than 55/1000 (5.25%) b. The rate has gone down, but they're allowed to buy the bond at 1000. That's a good deal, because you'll be getting 5.5 percent return on investment instead of 5.2. what is the catch on this purchase: the bond can be repurchased for a period of six months at 1000. So what has the buyer of the bond gained in those six months: interest payments. They make 1.5$ per bond. Do they have the right to force the other party to buy it back at 1000? No. So if interest rates go up, value of bond goes down. No incentive to buy it back if it falls below 1000. Who gets the upside if raes keep going down: the repurchaser. Who bears the downside if interest rates shoot up: the og buyer, who's stuck with the bond. So they made a deal where if interest rates go down, they'll buy it back, and if they rise, the buyer bears all of the risk. Is this a total no win situation then? No, not if there a 100% certainty that interest rates will stay at 5.2% for six months. in this instance, it's nothing buy a win for the buyer.

a. What happens if the bond is trading a 810? The prevailing rate is 55/810. This means that rates have gone up. 6.8%. but is there a chance rates could have gone down instead? Yeah. There is still a positive expected value here. Wasn't a no-win situation. They just got it wrong. The issue here: the 528 gain would have never been realized bc the other party would've repurchased it at 1000. Your job would be to make sure your client papers their file so that they thought there was no way interest rates would rise. They could argue that they relied on an expert who told them that there was no way they'd lose money.

A. Dilution Exs 1. If a business worth 1m with 1,000 outstanding shares issued 1,000 new shares, what should it receive: 1m. a. What will happen if 1,00 shares are sold for 500/share: old investors' 1,000 shares are now worth 750,000, new investors' new 1,000 shares are also worth 750,000.

a. What will happen if the majority issues 1,000 shares to itself at 500/share? 1) The majority originally had 667 shares worth 667,000. Minority originally had 333 shares worth 333,000 2) With the new shares: the minority's 333 shares are now worth 250,000. The majority's old 667 shares are now worth 500,000. And the majority's new shares are worth 750,000. b. What will happen if 1,000 shares are sold for 2,000/share? 1) The old investors' 1,000 shares were originally worth 1m. 2) After the new shares, the old investors' 1000 shares are worth 1.5 million. The new investors' 1000 shares are worth 1.5 million.