Pace University
MBA 648: Managerial Finance
Prof. P.V. Viswanath

Spring 2014


  1. (21 points) Read the article below and answer the following questions:
    1. You may already know that the vote at the Chattanooga plant went against the union. While the concept of a union to battle for workers rights fits in with the usual adversarial model of stockholders against employees, this particular union vote was supported by VW management as a necessary step to establish a works council. From one opint of view, this is very unusual. Stockholders contribute capital, in return for residual claims to firm cashflows and thus have an indirect say (through board of directors elections) in the employment of the firms' managers who have a fiduciary responsibility to shareholders; employees, on the other hand, have a contractual relationship with the firm - they provide labor and they get compensated for it. Managers, as shareholder representatives, decide how the firm is run. Why would a firm establish a council that would seem to usurp shareholder rights by allowing employee representatives to share in "managerial" decision-making prerogatives?
    2. You may or may not have been able to justify the concept of workers councils in part (a). Still, workers councils only discuss staffing schedules and working conditions. What would you say to allowing workers to elect representatives to the board of directors? Would this be going too far? Could this be justified?
    3. Propose and justify participation in the board of directors for another group, that does not legally have such representation, currently.

    "Why Volkswagen is helping a union organize its own plant," by Lydia DePillis, Washington Post, February 10, 2014.

    This week at Volkswagen's plant in Chattanooga, Tenn., 1,570 workers will vote on whether to join the United Auto Workers. It's a big deal: While the big three American carmakers are all unionized, so far the foreign companies have avoided it by locating in Southern states with strong Right to Work laws. From their perspective, unions usually just mean work stoppages, expensive benefit plans, and the inability to fire people at will.

    That's what's weird about the VW vote: The German company is campaigning for the UAW, not against it, in a kind of employer-union partnership America has seldom seen. What gives?

    Well, VW is kind of different, as automakers go. It understands how having a union can boost productivity and allow it greater flexibility in adjusting to downturns. It should know: The rest of its plants are unionized too.

    This would also be something new for the United Auto Workers. They wouldn't have the same relationship with VW as they do with Chrysler, General Motors, and Ford. Rather, the idea is to create something called a "works council," which are widespread across Europe and enjoy tremendous influence over how plants are run. In America, that kind of body can't be established without a union vote -- but crucially, the works council would be independent of the union, meaning the UAW would give up some control as soon as it gained it.

    While the details of the arrangement would be ironed out after the election, works councils -- which are elected by all workers in a factory, both blue and white collar, whether or not they belong to the union -- usually help decide things like staffing schedules and working conditions, while the union bargains on wages and benefits. They have the right to review certain types of information about how the company is doing financially, which often means that they're more sympathetic towards management's desire to make cutbacks when times are tough. During the recession, for example, German works councils helped the company reduce hours across the board rather than laying people off, containing unemployment until the economy recovered.

    In the early 1990s, Harvard labor law expert Paul C. Weiler interviewed managers about why they valued works councils. One representative executive told him:

    There are three major advantages of councils. You're forced to consider in your decision making process the effect on the employees in advance…this avoids costly mistakes. Second, works councils will in the final run support the company. They will take into account the pressing needs of the company more than a trade union can, on the outside. And third, works councils explain and defend certain decisions of the company towards the employees. Once decisions are made, they are easier to implement.

    In that way, works councils can be an ally of management in keeping the business strong for the sake of keeping workers employed over the long term. Weiler was given this example:

    [The parent company made] an agreement with the works council to introduce a flexible work-time system, around-the-clock operation through Saturday, starting again Sunday night. They were under tremendous pressure from the union not to do this, but let us go ahead. We couldn't have gotten that out of the union.… Our works council people are not hostile to rationalization of automation. On the contrary, they ask us to automate, to modernize our machinery so that our operations can be competitive. They say, 'We know that we lose jobs by this, but we agree that this is a good thing.'

    Works councils are also typically not allowed to call strikes, but they also don't usually need to, because their authority is baked into their agreements with the company (and, in Europe, usually enforced by law). If the UAW wants to strike over wages and benefits, it's still able to do so, but the likelihood of arriving at a mutually agreeable solution without one is much higher.

    That's why VW wants its plant to go union. According to VW's global works council leader, Bernard Osterloh, the company even sees its culture of worker codetermination as a "competitive advantage."

    That doesn't mean, however, that the vote is unopposed. National anti-union groups and the state's Republican leaders are campaigning against the UAW, saying unionization will spread like a contagion through Tennessee's other auto plants. “Then it’s BMW, then it’s Mercedes, then it’s Nissan, hurting the entire Southeast if they get the momentum," said Sen. Bob Corker (R.-Tenn.).

    BMW likes its works councils too, though. Apparently, some politicians think they know what's good for auto makers better than the companies do themselves.

  2. (24 points) Answer any four of the following questions:
    1. What is adverse selection? Give an example of adverse selection in the context of a corporation.
    2. How is the role of the stock market in stock value maximization?
    3. What is the difference between the sustainable growth rate and the internal growth rate?
    4. What happens to the control of the firm in bankruptcy?
    5. Explain how the financial system facilitates the sharing and transfer of risk. Provide two examples; at least one of them should use derivatives and you should provide some context as to how risk is transferred or shared (i.e. don't just give the name of the derivative).

  3. You borrowed money to buy your $2.5m. house five years ago. At that time, you had to put down a 20% down payment and the bank lent you the rest of the money at an APR of 12.68% p.a. on a 25 year mortgage with monthly payments. You have just made your sixtieth payment. You now wish to refinance your mortgage at the now available APR of 11% p.a. The new loan will be a 20-year loan.
    1. (10 points) If you wanted to pay off your existing loan right now, how much will you have to pay the bank?
    2. (5 points) If a friend offered to lend you the money to pay off your existing loan, would you borrow from him or would you refinance the loan? Your friend is currently getting a return of 11.5% on his investments and while he doesn't want to make any more money off you, he also doesn't want to lose money by lending to you.
    3. (8 points) If you decide to go with the new mortgage, what will your new monthly payments be?

  4. (18 points) Using the information below, answer the following questions:
    1. What is the quick ratio for HD, as of February 13, 2013? Use the definition "Total Current Assets less Inventory less Other Current Assets" ÷ Current Liabilities. What is the quick ratio as of Jan. 30, 2011? What would you conclude from these two numbers?
    2. Suppose you were told that the items under "Other Current Assets" were more liquid than Inventories. Would you modify the definition of the quick ratio from part (a), keeping in mind the purpose of the quick ratio? If yes, how would you modify it?
    3. Compute the average collection period for the year ending February 3, 2013. Compute the same number for the year ended January 29, 2012. What do you conclude from a comparison of these two numbers?
    4. (Bonus, 5 points) Suppose you were told that 50% of the sales for the year ending January 29, 2012 were cash sales, whereas only 25% of the sales for the year ending Febuary 3, 2013 were cash sales and the rest were credit sales. How would this information affect your conclusion in part (c)?
  5. Income Statement for The Home Depot, Inc. (HD)

    Period Ending Feb 3, 2013 Jan 29, 2012 Jan 30, 2011
    Total Revenue 74,754,000   70,395,000   67,997,000  
    Cost of Revenue 48,912,000   46,133,000   44,693,000  
    Gross Profit 25,842,000   24,262,000   23,304,000  
    Operating Expenses
    Research Development -   -   -  
    Selling General and Administrative 16,508,000   16,028,000   15,849,000  
    Non Recurring -   -   -  
    Others 1,568,000   1,573,000   1,616,000  
    Total Operating Expenses -   -   -  
    Operating Income or Loss 7,766,000   6,661,000   5,839,000  
    Income from Continuing Operations
    Total Other Income/Expenses Net 87,000   13,000   (36,000)
    Earnings Before Interest And Taxes 7,853,000   6,674,000   5,803,000  
    Interest Expense 632,000   606,000   530,000  
    Income Before Tax 7,221,000   6,068,000   5,273,000  
    Income Tax Expense 2,686,000   2,185,000   1,935,000  
    Minority Interest -   -   -  
    Net Income From Continuing Ops 4,535,000   3,883,000   3,338,000  
    Non-recurring Events
    Discontinued Operations -   -   -  
    Extraordinary Items -   -   -  
    Effect Of Accounting Changes -   -   -  
    Other Items -   -   -  
    Net Income 4,535,000   3,883,000   3,338,000  
    Preferred Stock And Other Adjustments -   -   -  
    Net Income Applicable To Common Shares 4,535,000   3,883,000   3,338,000  

    Balance Sheet for The Home Depot, Inc. (HD)

    Period Ending Feb 3, 2013 Jan 29, 2012 Jan 30, 2011
    Current Assets
    Cash And Cash Equivalents 2,494,000   1,987,000   545,000  
    Short Term Investments -   -   -  
    Net Receivables 1,395,000   1,245,000   1,085,000  
    Inventory 10,710,000   10,325,000   10,625,000  
    Other Current Assets 773,000   963,000   1,224,000  
    Total Current Assets 15,372,000   14,520,000   13,479,000  
    Long Term Investments 140,000   135,000   139,000  
    Property Plant and Equipment 24,069,000   24,448,000   25,060,000  
    Goodwill 1,170,000   1,120,000   1,187,000  
    Intangible Assets -   -   -  
    Accumulated Amortization -   -   -  
    Other Assets 333,000   295,000   260,000  
    Deferred Long Term Asset Charges -   -   -  
    Total Assets 41,084,000   40,518,000   40,125,000  
    Current Liabilities
    Accounts Payable 8,871,000   8,199,000   7,903,000  
    Short/Current Long Term Debt 1,321,000   30,000   1,042,000  
    Other Current Liabilities 1,270,000   1,147,000   1,177,000  
    Total Current Liabilities 11,462,000   9,376,000   10,122,000  
    Long Term Debt 9,475,000   10,758,000   8,707,000  
    Other Liabilities 2,051,000   2,146,000   2,135,000  
    Deferred Long Term Liability Charges 319,000   340,000   272,000  
    Minority Interest -   -   -  
    Negative Goodwill -   -   -  
    Total Liabilities 23,307,000   22,620,000   21,236,000  
    Stockholders' Equity
    Misc Stocks Options Warrants -   -   -  
    Redeemable Preferred Stock -   -   -  
    Preferred Stock -   -   -  
    Common Stock 88,000   87,000   86,000  
    Retained Earnings 20,038,000   17,246,000   14,995,000  
    Treasury Stock (10,694,000) (6,694,000) (3,193,000)
    Capital Surplus 7,948,000   6,966,000   6,556,000  
    Other Stockholder Equity 397,000   293,000   445,000  
    Total Stockholder Equity 17,777,000   17,898,000   18,889,000  
    Net Tangible Assets 16,607,000   16,778,000   17,702,000

  6. Suppose you have just turned 25 and have just started working on your new job. You plan to retire when you will have completed 30 years working. You expect to live for another 35 years after your retirement and you would want to have at least $70000 (in current dollars) at the beginning of every year for every year of your retirment. You expect to be able to invest your savings in a mutual fund earning an 8% p.a. real rate of return.
    1. (10 points) How much would you need to have saved up when you stop working? (Note that the required $70,000 each year has to be available to you at the beginning of the year.)
    2. (10 points) How much should you save each year, in real dollars, during your working life, assuming you save the same amount each year?
    3. (Bonus, 8 points) You realize that you would find it easier to save more in the later years of your life when you would have fewer obligations and a higher income. Based on this realization, you decide to want to save twice as much every year from year 41 to year 55, as from year year 26 to year 40. How much should you save every year for the first 15 years of your working life?