Loose Ends 1 Closed End Funds You are

Loose Ends 1

Closed End Funds You are investing in a closed end mutual fund that invests in stocks. Given the risk of the stocks it invests in and assuming a reasonable equity risk premium, your required return is 10%. Omaha Oracle, the manager of the mutual fund, though, has historically earned 2% more than required. If you assume no growth in the fund’s size and Barren will continue to outperform the market, estimate the premium or discount on the fund. (Hint: Think of investing $ 100 in this fund and estimate the value of the excess returns to you…) Would your answer change if you were told that Omaha is 81 years old? 2

Cross holdings q q q Company A owns 60% of company B and the financial statements are consolidated. If these financial statements are used to estimate cash flows & value, how much of company B is incorporated in this value? None of company B 60% of company B 100% of company B 40% of company B Company A owns 10% of company B. If your use company A’s financial statements to estimate cash flows & value, how much of company B is incorporated in this value? None of company B 10% of company B 100% of company B 3

Management Options Assume that you have valued equity in a firm to be worth $ 1 billion, by discounting free cash flows to equity at the cost of equity. The firm has 100 million shares outstanding. What is the value per share? Now assume that the firm grants 10 million options to its CEO, with a strike price set equal to $ 10. What is the value per share? q q $ 9. 09 (1000/110) $ 10 (The options have no exercise value) Between $9. 09 and $ 10 Something else 4