Review the two case-studies illustrated below, and on behalf of the reading; respond to the following questions.
Cephalon, Inc
Primary Teaching Objective:
This case is designed to give students a chance to consider how a firm can use equity derivatives to finance a possible purchase.
Students will see how equity derivatives can be used as part of a risk management strategy, to examine the application of cash-flow hedging in a corporate context, and to examine issues associated with the pricing of a derivative security.
Case Study Questions:
1. Describe the situation that existed at Cephalon during the time of writing of the case. Be sure to discuss the objectives of management and the possible solutions they were considering.
2. Use the data in the case to determine your best estimate of the net present value of the Myotrophin project TO CEPHALON. Be careful to document how the probability of likelihood of FDA approval is incorporated in your calculation.
3. The case describes SBC’s proposal as “2.5 million capped call options” on Cephalon’s own stock. What is a capped call option? Draw its payoff and profit diagrams and discuss its potential use in a financing strategy.
4. Is the SBC proposal fairly valued?
5. Exhibit 5 in the case shows that the market had a negative reaction each time Cephalon issued new stock to finance future projects. However, the market had a positive reaction when Cephalon issued convertible debt in 1997. How do you explain the difference in market reaction?
6. This case demonstrates how a company could use equity derivatives to hedge its future cash flow. Do you think Cephalon’s management should accept SBC’s proposal? Or should they wait until the FDA makes its announcement and seek financing if they need it?
7. Use the internet to find out the fate of Myotrophin. Did the FDA approve it? Does your answer affect your evaluation of the decision facing Cephalon’s management during the time period of the case?
Times Mirror:
Primary Teaching Objective:
The case allows students to explore the use of functionally equivalent financial strategies to carry out a tax-efficient disposal of appreciated stock; to deconstruct and value a simple derivative security; and to calculate the sources of value for this transaction.
Case Study Questions:
1. Describe the key features of the PEPS proposal.
2. Describe the PEPS in terms of simple “building block” contracts (e.g. calls, puts, etc.).
3. Draw the payoff diagram of the PEPS security.
4. Determine the fair value of the PEPS security. What are the key sensitivities of your pricing analysis? What assumptions have you made? What aspects of the contract have you ignored, and how might they affect your valuation? Does the pricing proposed by Morgan Stanley appear to be “fair” from the perspective of potential investors?
5. How large is Times Mirror’s net benefit from issuing the PEPS as compared to its other alternatives? Calculate the sources of value (and costs) to Times Mirror of issuing the PEPS transaction instead of selling its Netscape shares privately.
6. What should Times Mirror do?
7. Does everyone “win” in this case? If so, how can that be? Can you identify a loser?
Attachment:- case study.rar