Investments FINC 6399Quiz 2Note: All questions worth 3 points each except as noted. Please complete using template provide inBlackBoard. Questions also include the reading posted in BB Kaplan and Stromberg (2010).1. The private equity model of ownership has the potential to improve returns due toA. concentrated ownership.B. all of these reasons.C. stronger oversight and governance.D. incentive based compensation for managers of portfolio companies.E. highleverage imposing greater discipline on the portfolio company’s management.2. The prediction that the LBO or private equity form of ownership model would be the dominant form ofcorporate organizational ownershipA. has come true.B. has not come true.3. The private equity industry has displayedA. a steady upward trend in terms of its growth.B. cycles of boom and bust due to availability of debt capital and market conditions.C. cycles of boom and bust due to nonavailability of target companies.D. a constant growth in terms of number of private equity firms listing themselves on public stockexchanges.E. absence of bankruptcy and failures in the past.4. In a private equity structure the limited partners (select all that apply)A. provide most of the capital.B. take an active role in the management of the private equity firm.C. take an active role in the management of the portfolio companies.D. can exit any time from their investment.E. can sell their investment to general partners after providing the required notice period.5. Usually the life of a fund raised by a private equity firm isA. unlimited.B. ten years which can be extended by three years.C. thirteen years.D. five years.E. anywhere between three years and thirty years.6. When a private equity firm buys a portfolio company the transaction is funded byA. equity only.B. equity and senior secured debt.C. equity and a mix of senior secured and subordinate debt.D. equity and junk bonds.E. a mix of senior secured and subordinate debt only.© 2015 Ray Sant PhD CFA CMA 7. A private equity firm has raised $1.5 billion as investment funds for a pool with terms of 2/20. This meansthat the general partners of the private equity firm will be paid 2% per year in the form of managementfees and will earn 20% of the increase in the value of the fund at the time of exit. If the expected life ofthe fund is ten years and the net liquidation value of its equity holdings is $2.25 billion what will be thetotal fees earned by the general partners during the life of the fund? (6 points)A. $300 millionB. $450 millionC. $150 millionD. $180 millionE. $750 million8. US private equity activity until 2007 hasA. generally remained above 5% of the total value of the stock market.B. generally remained between 1% and 3% of the total value of the stock market.C. generally remained between 5 % and 10% of the total value of the stock market.D. shown some periods of peak activity but generally remained below 1% of the total value of the stockmarket.E. been highly volatile and has consistently ranged between 1% and 3%.9. Private equity firmsA. engage primarily in taking large public firms private with the help of debt.B. have displayed resilience by buying mid size private firms when debt markets have undergoneturmoil.C. only buy manufacturing and retail firms.D. have never faced any situation where their portfolio companies have defaulted on debt obligations.E. engage in shortterm market arbitrage.10. Based on current research exit data shows that the largest single category of buyers of private equityportfolio companiesA. are companies in the same industry.B. financial buyers.C. public investors through IPOs.D. investment banks.E. hedge funds.11. Research shows that median holding period for an investment in a portfolio company by a private equityfirmA. is about six to seven years and has appeared to have lengthened over time.B. is about two years and is shrinking.C. is ten years.D. is thirteen years.E. varies anywhere from five to fifteen years.12. In the private equity industry a secondary buyout meansA. sale of a portfolio company to an investment bank.B. listing of a portfolio company on a public stock exchange.C. sale of a portfolio company to a strategic buyer.D. repossession of a portfolio company by the lenders in the event of a default.E. sale of a portfolio company to another private equity firm.© 2015 Ray Sant PhD CFA CMA 13. Management ownership in a portfolio company belonging to a private equity firmA. is typically less than that in public companies and averages around 5%.B. is typically equal to that in public companies and averages around 15%.C. is typically nonexistent.D. is typically greater than that in public companies with median around 1516%.E. is frowned upon by lenders and is barred by securities laws.14. Empirical research based on 1980s data shows that in general after a company has been acquired by aprivate equity firm and “operational engineering” has been implementedA. operating margin increases 510%.B. cash flow to sales remains constant.C. operating margin increases by 10 20% and cash flow to sales increases by 40%.D. operating margin increases by 40% and cash flow to sales increases by 1020%.E. operating margin and cash flow to sales increase by about 10%.15. Based on global studies of private equity portfolio companies it may be concluded thatA. gains in value possibly arise from hardtovalue tax savings.B. operational efficiencies.C. higher productivity and better wage management.D. reduction of agency costs.E. all of these reasons.16. More recent empirical evidence suggests that despite modest improvements in financial performance ofportfolio companies private equity firms generate high investment returns for themselves because ofA. trading on inside information.B. paying a lower price when buying a portfolio company.C. selfdealing.D. raising equity cheaply.E. cutting labor aggressively.17. A private equity firm has raised $1.5 billion as investment funds for a pool with terms of 2/20. This meansthat the general partners of the private equity firm will be paid 2% per year in the form of managementfees and will earn 20% of the increase in the value of the fund at the time of exit. If the expected life ofthe fund is ten years and the net liquidation value of its equity holdings is $2.25 billion what will be theminimum total amount available for investment in portfolio companies? (6 points)A. $1.5 billionB. $1.2 billionC. $1.8 billionD. $750 millionE. $1.05 billion18. Kaplan and Stromberg (2010) present evidence thatA. limited partners in private equity firms earn net returns equal to the return on the S&P 500.B. private equity firms’ investment returns gross of management and performance fees lag those onS&P 500.C. while limited partners earn net returns exceeding those on S&P 500 portfolio firms underperformS&P 500.D. gains if any from private equity investing accrue to the limited partners.E. gains if any from private equity investing accrue to the general partners.© 2015 Ray Sant PhD CFA CMA 19. Empirical research show thatA. private equity market activity in the U.S. is driven by yield on junk bonds relative to EBITDA yields(based on enterprise value).B. leveraged buyout capital structures are most strongly related to prevailing debt market conditions atthe time of the buyout.C. the amount of leverage available seems to affect the amount that the private equity bids to acquire aportfolio company.D. debt used in a given leveraged buyout transaction may be driven more by the conditions in the creditmarkets than by the relative benefits of leverage for the firm.E. All of the above.20. Empirical research seems to suggest thatA. private equity fund returns tend to decline when more capital is committed to this asset class.B. capital commitments to private equity tend to increase when realized returns increase.C. private equity fund returns tend to increase when more capital is committed to this asset class.D. both A and B.E. both B and C.21. Private equity includes all of the following exceptA. venture capital firms.B. leveraged buyout transactions.C. management buyout transactions.D. hedge funds.E. mezzanine funding.22. In a typical LBO transaction debt is used toA. increase operating margins of a portfolio company.B. increase cash flow discipline on part of the management of the portfolio company.C. increase the return on equity so long as the return on assets exceeds the cost of borrowing.D. increase the return on assets of the firm.E. B and C above.23. If a portfolio company does not perform according to private equity fund’s expectations A. its CEO or management may not be replaced since they hold a significant stake.B. the portfolio company is sold to another private equity firm.C. the lenders call in their debt to reduce their risk exposure.D. its CEO or management is likely to be replaced quickly.E. B C and D are true.24. Companies that are acquired by private equity firms must haveA. leverageable balance sheet and low capital expenditure requirements.B. experienced loss making quarters prior to being acquired.C. must have skipped dividends to their preferred stock holders.D. leverageable balance sheet low capital expenditure requirements and quality physical assets.E. all of the above.© 2015 Ray Sant PhD CFA CMA 25. A financial sponsor does all of the following exceptA. identifies and selects the takeover target.B. negotiates the purchase price or makes a bid.C. controls the board and appoints the management of the acquired company.D. provides debt financing.E. provides equity financing.26. Limited partners in a private equity fundA. have lock up periods that are medium term and extend up to five years.B. do not have lock up periods.C. have lock up periods that extend up to ten to twelve years.D. have highly liquid securities.E. have to register with the SEC in the U.S.27. “Carried interest” for general partners means the latterA. get annual management fees.B. get a share generally 20 percent of the profits.B. have to invest their personal money at least equal to the investment by general partners.C. have to guarantee the loans taken out by the portfolio companies.D. have to carry insurance to protect the losses to limited partners.28. Invested capital in a private equity fund equalsA. contributed capital minus life time management fees paid to the fund.B. contributed capital plus lifetime management fees paid to the fund.C. contributed capital minus cost basis of exited investments.D. net contributed capital minus cost basis of exited investments.E. market value of all portfolio companies.29. Deal and monitoring feesA. are fees charged to the limited partners.B. are fees paid to investment bankers.C. are paid to the government regulators.D. charged to portfolio companies by the fund and split with limited partners.E. are deducted from the price paid to the selling shareholders of the target company.30. A private equity firm improves the net income margin of a portfolio company to 105 percent of itsoriginal margin and doubles its financial leverage from thirty percent of total assets to sixty percent oftotal assets. All else being equal if the original ROE of the portfolio company was eleven percent thenew ROE will be (6 points)A. 15%B. 20%C. 25%D. 11%E. 22%© 2015 Ray Sant PhD CFA CMA 31. The average equity contribution as a percentage of total acquisition price in LBO dealsA. has remained the same over the years.B. has declined over the years.C. has increased over the years.D. has been under ten percent since the 1980s.E. has been above thirty percent since the 1980s.32. Over the period 2004 to 2011 leverage multiples as measured by total debt to EBITDAA. have remained constant.B. peaked in 2009.C. were greater for larger deals (EBITDA greater than $50 million) than smaller deals (EBITDA under $50million).D. were lower for larger deals (EBITDA greater than $50 million) than smaller deals (EBITDA under $50million).E. Both B and C are true.33. After the debt crisis of 2007 A. senior debt as a proportion of total debt was greater for larger deals (EBITDA greater than $50million) than smaller deals (EBITDA under $50 million).B. senior debt as a proportion of total debt was lower for larger deals (EBITDA greater than $50 million)than smaller deals (EBITDA under $50 million).C. senior debt as a proportion of total debt was about the same for larger deals (EBITDA greater than$50 million) and smaller deals (EBITDA under $50 million).D. access to senior debt was completely shutoff for private equity companies.E. the spread over LIBOR went down on debt available to private equity industry.34. Data from a survey in 2011 shows that the biggest number of contributors to private equity funds aslimited partners were asset management firms withA. AUM between $20 and $50 billion.B. AUM greater than $50 billion.C. AUM between $5 and $10 billion.D. AUM between $10 and $20 billion.E. AUM under $5 billion.35. Based on available research it may be concluded that private equity portfolio firmsA. were able to borrow funds for LBOs at more favorable covenants than most other entities.B. experienced lower default rates on average than other corporate borrowers.C. were able to leverage up more during periods of low cost debt.D. were subject to strong governance policies.E. all of the above.36. In an LBO transaction stub equityA. refers to equity held by the management of a portfolio company.B. refers to equity held by a public shareholder most likely to be a large shareholder or founder.C. may be used to facilitate the transaction by overcoming opposition to the deal.D. both B and C above are true.E. A B and C above are true.© 2015 Ray Sant PhD CFA CMA 37. Which of the following statements is FALSE?A. Presence of stub equity increase disclosure and reporting burden of a portfolio company to SEC.B. Rollover equity refers to equity offered to management in the postLBO company.C. A controlling shareholder is defined as someone who owns 50 percent or more of a target companyprior to its takeover.D. Teaming up with a company’s management to acquire a company usually triggers takeover defensemechanisms and issues of fairdealing.E. In practice stub equity is limited to thirty percent or less of the equity of a portfolio company afterthe LBO transaction.38. When it comes to secondary markets for private equity investments A. any limited partner can sell his or her share easily at a fair price.B. it has been found that transactions are few and in general have fetched up to forty percent less thantheir original net asset value.C. efforts are being made to create a publicly traded stock exchange devoted to private equity.D. individual investors can participate and buy smaller stakes than what is available through directplacement.E. they represent a large proportion of the total invested funds by limited partners in the private equityindustry .39. Based on recent research reports it can be said thatA. private equity investments have consistently underperformed broader stock market indexes sincethe debt crisis.B. private equity investments have consistently outperformed broader stock market indexes since thedebt crisis.C. private equity investments have performed about as well as the broader stock market indexes sincethe debt crisis.D. private equity investments have shown a mixed performance in comparison with the broader stockmarket indexes since the debt crisis.E. private equity investments cannot be compared to broader stock market indexes due to their nontradeable nature.40. Based on available data it can be claimed thatA. acquisition and debt multiples (x EBITDA) were at historic lows just prior to the debt crisis.B. acquisition and debt multiples (x EBITDA) held steady at historic averages just prior to the debt crisis.C. acquisition and debt multiples (x EBITDA) were at a historic peak just prior to the debt crisis.D. acquisition and debt multiples (x EBITDA) are unrelated to availability of debt capital to finance LBOdeals.E. acquisition and debt multiples (x EBITDA) only reflect future operational efficiency gains fromportfolio companies.41. Based on published data it can be concluded that the debt crisis of 2007 led to aA. sharp reduction in the size of an average LBO deal.B. led to a sharp increase in the share of equity required to complete an LBO transaction.C. led to a significant drop in LBO debt multiples (x EBITDA).D. led to a large reduction in the number of LBO deals.E. all of the above.© 2015 Ray Sant PhD CFA CMA 42. When acquiring a portfolio company the private equity fund’s emphasis is on all of the following exceptA. improving free cash flow to the enterprise in order to service its debt obligations.B. cost cutting and improving margins.C. increasing capital expenditures.D. relying on debt to finance the acquisition.E. improving incentives for the management to perform at their best.43. Free cash flow to the firm can be defined asA. net operating profit plus depreciation and amortization plus changes in net working capital asmeasured by accruals and deferrals minus capital expenditures and plus sales of assets bothtangible and intangible.B. net income plus depreciation and amortization plus changes in net working capital as measured byaccruals and deferrals minus capital expenditures and plus sales of assets both tangible andintangible.C. net operating profit plus depreciation and amortization plus changes in net working capital asmeasured by accruals and deferrals minus capital expenditures plus sales of assets both tangibleand intangible and minus debt service payments.D. net income plus depreciation and amortization.E. net income plus depreciation and amortization plus changes in net working capital as measured byaccruals and deferrals.44. free cash flow to shareholders of a firm can be defined asA. net operating profit plus depreciation and amortization plus changes in net working capital asmeasured by accruals and deferrals minus capital expenditures and plus sales of assets bothtangible and intangible.B. net income plus depreciation and amortization plus changes in net working capital as measured byaccruals and deferrals minus capital expenditures and plus sales of assets both tangible andintangible and minus debt principal paymentsC. net operating profit plus depreciation and amortization plus changes in net working capital asmeasured by accruals and deferrals minus capital expenditures plus sales of assets both tangibleand intangible and minus debt principal payments.D. net income plus depreciation and amortization.E. net income plus depreciation and amortization plus changes in net working capital as measured byaccruals and deferrals.45. A private equity firm requires a minimum return of fifteen percent on its equity investment. It expects toimprove the EBITDA of a portfolio firm by fifteen percent over five years compared to $65 million today.If the projected fiveyear exit value multiple is 7X (of EBITDA) and debt pay down will amount to $125million over the five year period what is the maximum amount the firm should bid for the portfoliocompany assuming it will leverage the acquisition value today with seventyfive percent debt? (9 points)A. $260 millionB. $348 millionC. $517 millionD. $694 millionE. $792 million© 2015 Ray Sant PhD CFA CMA 46. A private equity firm will finance the acquisition of a portfolio company with sixtyfive percent debt andthe rest with equity. The company will generate enough cash flow to pay down debt principal by $875million annually. Its minimum annual return requirement is twenty percent. If the exit EBITDA in threeyears is expected to be $950 million with a 6.5X valuation multiple should the company be acquired ifselling shareholders are asking an enterprise value of $5.5 billion? (9 points)A. Yes the PE firm will earn an annualized return of 25.5%.B. No the PE firm will earn an annualized return of 14.6%.C. No the PE firm will earn an annualized return of 19.7%.D. Yes the PE firm will earn an annualized return of 31.5%.E. Yes the PE firm will earn an annualized return of 28.3%.47. A portfolio company is projected to have an EBITDA of $175 million in the third year. It will have $650million in debt outstanding in debt at the beginning of the year carrying an interest rate of 5.5%. capitalexpenditures will amount to twentyfive percent of EBITDA and net working capital will increase by $12million. How much cash will be available to the portfolio company to pay down its outstanding debt if it isin the thirty percent tax bracket? Assume depreciation of $32 million for the year. (6 points)A. $60.50 millionB. $51.33 millionC. $75.00 millionD. $48.75 millionE. $68.28 million48. In order to increase its rate of return on an investment in a portfolio company a private equity fund can(select all that apply)A. increase operating cash flows.B. reduce capital expenditures.C. increase operating margins.D. reduce acquisition multiple.E. increase leverage without increasing risk.49. Private equity (financial) buyers compete for the same companies with strategic buyers. Which of thefollowing statements is TRUE?A. Strategic buyers take advantage of lower cost of capital whereas financial buyers rely on operationaland strategic synergies.B. Strategic buyers improve corporate governance of acquired companies whereas financial buyersprimarily benefit from cutting costs.C. Strategic buyers employ financial engineering techniques whereas financial buyers apply operationalengineering techniques to improve performance of acquired companies.D. Strategic buyers rely on operational and strategic synergies whereas financial buyers rely on lowercost of capital due to greater leverage in order to justify premium paid for acquiring a targetcompany.E. Strategic buyers use leverage to gain value in an acquisition whereas financial buyers useoperational financial and governance efficiencies to extract value form an acquired company.© 2015 Ray Sant PhD CFA CMA 50. Threat of an acquisition by a private equity may make an inefficiently managed companyA. increase its financial leverage.B. attempt to find a whiteknight.C. erect takeover defenses.D. sell unproductive assets.E. do all of the above.51. Historically an overwhelming percentage of merger and acquisition transactions have involved a(n)A. corporate seller and a financial sponsor buyer.B. financial sponsor seller and a corporate buyer.C. corporate seller and a corporate buyer.D. financial sponsor seller and a financial sponsor buyer.E. investment bank as a buyer and financial sponsor as a seller.52. Instead of doing an IPO a private company’s owners may prefer to sell the company to a private equityfirm due toA. ease and speed of transaction.B. potential for stub equity with improved governance and operational efficiencies.C. elimination of public reporting burden and associated costs.D. support in the form of managerial expertise and internal consulting services.E. all of the above reasons.53. In theory the private equity model seems like a perfect solution for value maximization challenge due tothe corporate governance problem in a publicly traded firm where equity is dispersed. Why has it notbecome the dominant model of ownership?A. Due to a lack of depth of management expertise.B. Due to a lack of availability of good executives who could serve on corporate boards of acquiredcompanies.C. Due to regulatory hurdles.D. Due to necessity for high levels of leverage to make it work which requires it to be virtually an errorfree operation.E. Du…
