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    General Motors - Class Summary 3rd Aug-1401001 PDF

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    Sravya Doppani
    - The class discussion focused on the General Motors case involving valuation of Class E contingent notes offered during a merger. - Various compensation methods in mergers like stock exchange, cash, and debentures were discussed. Stock exchange allows target shareholders to become acquiring company shareholders but with dilution, while cash avoids dilution but has tax implications. - The GM case offered cash or cash and Class E shares with contingent promissory notes. Students calculated the value of the notes using CAPM and determined the values had to be equal for investors.

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    General Motors - Class Summary 3rd Aug-1401001 PDF

    Uploaded by

    Sravya Doppani
    179 views5 pages
    - The class discussion focused on the General Motors case involving valuation of Class E contingent notes offered during a merger. - Various compensation methods in mergers like stock exchange, cash, and debentures were discussed. Stock exchange allows target shareholders to become acquiring company shareholders but with dilution, while cash avoids dilution but has tax implications. - The GM case offered cash or cash and Class E shares with contingent promissory notes. Students calculated the value of the notes using CAPM and determined the values had to be equal for investors.

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    - The class discussion focused on the General Motors case involving valuation of Class E contingent notes offered during a merger. - Various compensation methods in mergers like stock exchange, cash, and debentures were discussed. Stock exchange allows target shareholders to become acquiring company shareholders but with dilution, while cash avoids dilution but has tax implications. - The GM case offered cash or cash and Class E shares with contingent promissory notes. Students calculated the value of the notes using CAPM and determined the values had to be equal for investors.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    179 views5 pages

    General Motors - Class Summary 3rd Aug-1401001 PDF

    Uploaded by

    Sravya Doppani
    - The class discussion focused on the General Motors case involving valuation of Class E contingent notes offered during a merger. - Various compensation methods in mergers like stock exchange, cash, and debentures were discussed. Stock exchange allows target shareholders to become acquiring company shareholders but with dilution, while cash avoids dilution but has tax implications. - The GM case offered cash or cash and Class E shares with contingent promissory notes. Students calculated the value of the notes using CAPM and determined the values had to be equal for investors.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 5

    Summary of class discussion

    Date: 3rd Aug, 2015 Session 15


    Case for discussion: General Motors: Valuation of Class E Contingent Notes
    Submitted By: Aditya Agrawal (1401001)

    Abbreviations used:
    CAPM: Capital Asset pricing Model
    Rm: Market Return

    Rf: Risk free rate

    Summary of main points discussed:

    Various modes of compensation that is offered to target companys shareholders


    during merger(advantages and disadvantages for acquiring company and target
    company perspective)
    Overview of contingent notes
    Valuation of call/put option
    Comparative analysis of combination of stock with put and combination of
    debenture with call (PUT CALL Parity)

    The discussion began with the general overview of the case where the importance of this
    case is understood for strategic financial management course perspective.
    Professor: What are your views about the case? Why should the case be included in this
    course?
    Aditya (1401001) : Variable compensation has become a trend with the availability of
    various financial instruments. For an instance, employee compensation is linked with
    stock options, warrants etc
    Professor: Not sufficient answer. Anything specific to this case?
    Aditya: In general motors case, a merger is taking place and combination of cash and
    class E share is offered along with contingent promissory note. This affects the cash flow,
    projections et cetera.
    Then the class discussion continued with: What are the simple ways of compensation in
    merger? Professor explained that stock exchange is one of the ways through which
    acquiring company provides its stock as a compensation to target companys
    shareholders. What are the benefits to target shareholders with stock exchange?
    Piyussh (1401090): Target companys shareholders become minority shareholder of the
    acquiring company so they gain the access to control the company.

    Abhinav (1401012): Gave the example of Tata Steel and Corus merger.
    Professor: Usually, in merger, the success rate is pretty low (approx. 1/3 successful and
    2/3 unsuccessful). In general, Strategy is not a problem for this low success rate but the
    major problem is proper implementation.
    Other than stock exchange, cash is also one of the options (one of the safest but the
    problem is tax implications). In stock exchange, there is no tax implication for current
    scenario as there is only exchange and value will only be realised in future.
    In stock exchange, there is dilution in equity and at the same time, target company
    shareholders gain access to control. Although, dilution may not necessarily happen all
    the time.
    One of the other options is exchanging equity with debentures. The point to consider here
    is that equity and debt holders possess different risks. Equity is more risky than debt.
    Suresh (1401049): Would the investor be institutional or retail?
    Professor: Can be both.

    Few considerations while compensation.


    1: Value of all the options offered should be same.
    2: The type of offering depends upon the circumstances of the company. The acquiring
    company issues/offers debenture if it wants to increase its D/E ratio. It may issue equity
    if want to decrease the financial leverage.
    Sumit Singh: Debenture are risky as they are susceptible to interest rate change. Why
    would they be issued for an exchange?
    Professor: They are risky but certainly less as compared to equity as volatility of equity
    shares is more than that of a debenture.
    In the process of merger, Investment banker and brokers play a major role and help the
    companies in valuation and with other market data. They do the financial engineering for
    designing the suitable package or combination of various financial instruments.
    After basic introduction, Professor started the case facts discussion. Two options are
    available: $22 in cash or $17.60 in cash plus 2/10 of a unit (one share of class E common
    stock (GME) and one contingent promissory note). As the value should be equal,
    therefore,$4.4 is worth 0.2 units.
    Aditya (1401001): Should the values be same?
    Professor: Yes, they have to same because if they are different, then investors will get
    biased towards one of them.

    S
    GME

    Payoff for Stock


    plus put option

    62.5

    62.5

    GME

    If at maturity, the shares were selling less than $62.5, the GM would have to pay the
    difference. Otherwise, GM would have no liability.
    Value of the put option is dependent upon:
    Stock price (S)
    Strike price (X)
    Time to option exercise date (T)
    Risk free rate(R)
    Volatility
    If we have all these 5 values then we can calculate the premium or option value.
    The problem here is how to value GME price. As it is not publicly traded therefore
    valuation becomes difficult.
    Exhibit 2: We can see a various types of shares the company has issues (Class E, Class
    H, preferred, preference shares et cetera)
    Point to note:
    L

    GME

    GMA

    GMEE

    EDS

    EPS of GME is linked to assets that are coming from


    EDS. The performance of GMEE will be driven by
    performance of EDS.

    As given in page 3, if the option is exercised at maturity the return is 16.1% per annum.
    Now using CAPM,
    R=Rf + beta (Rm - Rf)
    R=8.2 +1.1(5.6)
    R=14.3% (approx)
    As this is less than 16% therefore it can be considered that all the options get exercised
    only at maturity.
    Now in case, S, X, T and R is given.
    Volatility needs to be calculated now. It can be done by calculating historical volatility or
    through implied volatility. As the data for last 5 years is given, we can calculate historical
    volatility of returns. Implied volatility is preferred over historical as it considers the
    underlying trading securities in the market.
    From Exhibit 5, using the data of September call in below panel, we can calculate the
    implied volatility. Then we can calculate the premium of put option.
    The payoff of debenture with call option (Mogen case) is same as the payoff with stock
    with put option. This is also known as PUT CALL Parity.

    Convertible Equity

    Convertible Debenture

    (S + P)

    (D + C)

    Tax implication

    During later stage

    Immediate impact

    Balance
    representation

    Sheet Equity with contingent put

    Debenture with Contingent


    call

    Payment(cash flows)

    Pay dividend

    Pay interest

    Impact on leverage

    Reduces leverage

    Increases leverage

    As Debt is rated and research companies issue debt rating. For equity, Equity grading
    term is often used for gauging equity.

    Pay off for Debenture minus Put

    TA

    P
    Value of put =0

    The decisions involved are:

    Investment Decision
    Corporate financial restructuring decision
    Dividend decision

    Transaction costs are different in debt and equity market and there is difference in
    perspective in equity and debt market.

    With this, the discussion ended.

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