The plan called for KPE’s current shareholders to exchange their shares for 21% of the new firm’s common equity, or 204,898,750 shares. KKR’s current principals would retain the remaining (770,809,583) shares. To demonstrate their commitment to the long-term performance of KKR, the principals also proposed to grant Contingent Value Interests (“CVIs”) to KPE shareholders that would transfer up to an additional 6% of the new firm’s shares to KPE shareholders depending on the firm’s share price three years from closing. The relevant terms of the CVI (per KPE share turned in) are as follows:

If on the 3rd anniversary of the closing the new firm’s shares trade at or above $22.25 per share, the CVIs granted to the KPE shareholders would expire worthless.[2]

If the shares trade at or below $17.31 per share, KKR’s principals would transfer an additional 6% of the firm’s market value to the CVI shareholders.

At any price between $17.31 and $22.25 per share, the principals would transfer an additional percentage share of the firm’s market value such that each KPE shareholder would receive the difference between $22.25 and the firm’s share price.

1. (2pt) Assuming that KPE shareholders retain their initial KKR share grant and the CVIs attached to that grant, what is the maximum number of shares held after three years by KPE shareholders?

2. (2pt) What is the total payoff for a KPE shareholder who is granted one share of KKR stock and one unit of the CVI at closing if the KKR share price is $17.31 after three years?

3. (2pt) What is the total payoff for this KPE shareholder if the share price is $22.25 after three years?

4. (2pt) What is the total payoff for this KPE shareholder if the share price is $24.75 after three years?

5. (4pts) Draw and label the payoff diagram for a KPE shareholder who is granted one share of KKR stock and one unit of the CVI at closing. (see last page for graph template)

6. (3pts) On a separate graph, draw and label the payoff diagram for one unit of the CVI. (see last page for graph template)

7. (5pts) What combination of options, stock, and/or risk-free bonds would replicate the payoff from one unit of the CVI?

4. (10pts)Compare and contrast bookbuilding with Hambrecht’s Dutch auction for IPOs. Your response should include discussion of the fundamental incentive distortion they aim to resolve, how they go about doing so, and their relative strengths and weaknesses.

5. (5pts) Suppose “dirty” auctions became the norm for IPOs. What is a dirty auction and why might it be inferior to bookbuilding? You may wish to tie your response to your response to the preceding question.

6. (15pts)In what sense did Rural Metro’s board breach its fiduciary duty to shareholders? How did RBC “aid and abet” the Board’s breach of fiduciary duty? A strong response to these questions will evidence a good understanding of the economic tradeoffs and incentive conflicts facing sell-side boards and bankers as well as the legal standards for behavior.

7. (5pts)According to Holmstrom (2015), what is the primary purpose of the money markets and how is that purpose served by “over-collateralized” debt?

8. (10pts)Explain why repurchase agreements fit Holmstrom’s notion of over-collateralized debt and why repos were at the core of the 2008 financial crisis. Your response should evidence understanding of how repo financing contributed to a liquidity crisis that effectively led to a run on the shadow banking system.

9. (15pts) Several boutique investment banks already have gone public and Parella Weinberg Partners (PWP) has considered this option. Given that the founders of most of these firms have spoken of the benefits of being narrowly focused private partnerships, why would they want to go public? Your response should include a critical review of the costs and benefits from operating as a partnership, the tradeoffs facing a boutique that is considering going public, and should connect these ideas with PWP’s thoughts on organizational structure and culture.

[1] KPE was essentially a publicly-traded mutual fund that enabled unitholders (shareholders) to participatein some of KKR’s private equity investments.

[2]The payoff actually depended on the 30-day average price at the end of year three but we will ignore that for the purposes of this problem.

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13.00

52.0044.00+   8.0013.0013.00F513.0065.0061.00+   4.0013.00

17.00

Graph information to show price or cost per basket and quantityof baskets of fish per hour.How many fish should be harvested at amarket price of $ 17, $13, and $9. How much total revenue iscollected at each price? How much profit does the farmer make ateach of these prices?

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Use Excel to answer the following questions in 2-5 sentences each. You have to provide your answers here even if you are attaching a separate Excel file.

1) What is the NPV for Project Alpha? In your answer explain what NPV is, why it’s useful as well as its shortcomings.

2) Does Project Alpha pass the economic efficiency test based on your answer in part 1)? Why? Explain?

3) What is the BCR for Pro Project Alpha? In your answer explain what BCR is, why it’s useful as well as its shortcomings.

4) Does Project Alpha pass the economic efficiency test based on your answer in part 3)? Why? Explain?

5) What is the IRR for Project Alpha? In your answer explain what IRR is, why it’s useful as well as its shortcomings.

6) Does Project Alpha pass the economic efficiency test based on your answer in part 5)? Why? Explain?

7) Are your conclusions about economic efficiency consistent in parts 2), 4), and 6)? Why or why not? Did you expect this?

8) What is the NPV for Project Beta?

9) Does Project Beta pass the economic efficiency test based on your answer in part 8)? Why? Explain?

10)What is the BCR for Project Beta?

11) Does Project Beta pass the economic efficiency test based on your answer in part 10)? Why? Explain?

12)What is the IRR for Project Beta?

13)Does Project Beta pass the economic efficiency test based on your answer in part 12)? Why? Explain?

14)Are your conclusions about economic efficiency consistent in parts 9), 11), and 13)? Why or why not?

15)Which project would you recommend? Why?

16)What if I told you that Project Alpha is a football stadium and Project Beta is a hospital and your jurisdiction currently does not have either? Would your answer change? Why or why not?

17)Instead of implementing either project, if you invested your $1,000,000 today at a 5% interest rate which compounds quarterly, how much money would you have in 10 years?

2. (28 points) It’s that time of the year and you have to calculate your federal taxes. (Lucky for you, there are no state or local income taxes where you live.) You have gathered these data about your finances:

i. Wage income = $45,000

ii. Corporate bond interest income = $800

iii. US Treasury bond interest income = $1000

iv. Tax-exempt Interest income from the bond issued by the State of Georgia = $600

v. Total itemized deductions = $12,000

Use the personal exemptions, standard deductions and rate schedule in this link:https://taxfoundation.org/2017-tax-brackets/

First, suppose you are single:

1) What is your marginal tax rate?

2) What is your tax liability?

3) What is your effective tax rate?

4) How would a $1,000 tax credit change your tax liability and effective tax rate?

Now, suppose you are married and your spouse has no wage or interest income and your joint itemized deductions are still $12,000:

5) What is your joint marginal tax rate?

6) What is your joint tax liability?

7) What is your joint effective tax rate?

8) How would a $1,000 tax credit change your tax liability and effective tax rate?

Now, suppose you are married and your spouse has the exact same income profile as you and your joint itemized deductions are still $12,000:

9) What is your joint marginal tax rate?

10)What is your joint tax liability?

11) What is your joint effective tax rate?

12)How would a $1,000 tax credit change your tax liability and effective tax rate?

13)Do you think this is fair? Does this make you want to get married or stay single?

14)Is this tax system progressive, regressive, or proportional? Why?

3. (14 points) A small town has a property tax base with an appraised value of $400,000 of taxable real property, $80,000 of taxable personal property, and $50,000 of non-taxable property. The assessment ratio is 40% for this local government. The homestead exemption is relatively small but reduces the assessed value by $50,000. The town estimates that the budgetary needs at $120,000.

1) What statutory tax rate would allow the town to meet its budgetary obligations?

2) Given the statutory tax rate you found in part 1), what is the effective property tax rate for this town?

3) You are contemplating about moving to this town. The property you are interested in buying has a market value of $150,000. How much would you pay in property taxes to this school district?

4) How would your answer in part 3) change if you discovered that you could get a $5,000 exemption against the assessed value of your new home?

5) Would your property tax bill affect your decision to move to this town? Why or why not? What other information might be helpful in making your decision?

6) Suppose that the property tax rate you found in part 1) increases by 3%. What is the new rate and your new tax bill?

7) Suppose that the property tax rate you found in part 1) increases by $1 per $100 of assessed value. What is the new rate and your new tax bill?

4. (12 points) Suppose you are in the 25% federal income tax bracket and want to invest $100,000 in an interest-earning asset.

1) Which asset would you invest in and why:

i. AAA rated (highest rating) municipal bond with a 4% yield or

ii. AAA rated (highest rating) corporate bond with a 5.4% yield

iii. U.S. treasuries with a 5.5% yield? Explain.

2) Suppose you get a large pay raise and your marginal income tax rate is now 39.6%. How would your answer change in part 1)?

3) What do you conclude about the value of tax-exemption for different income groups?

4) Do you think this type of tax preference is fair?

5) Would you answer change if the corporate bond rating declined to below investment grade? Why?

6) Would your answer change if the municipal bond rating declined to below investment grade? Why?

5. (6 points) Explain the role of financial statement analysis, Balance Sheet and Income Statement, and financial ratios in evaluating financial health of a jurisdiction or an organization in 1-2 paragraphs.

Attachments:

Problem-Set-4….docx

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