Q 1. Which of the following divisions would you expect to benefit from a spinoff

Question

Q 1.

Which of the following divisions would you expect to benefit from a spinoff?

I. A division with largely independent operations doing business in a market substantially different from the parent corporation
II. A division being managed by a parent corporation's managers, who are regarded as highly competent by current and potential investors (the parent corporation's managers will not be in charge of the division after it is spun off)
III. A non-regulated division of a parent corporation that reports consolidated income and is itself under significant regulatory restrictions

Select one:

A. I and II only

B. I and III only

C. II and III only

D. I, II, and III

Q2.

You have been asked to do an analysis of the shareholder cash distribution policies of the following firm:

Firm A: SCD/FCFE = 90%; ROE = 13.50%; Ke = 12.50%

Firm B: SCD/FCFE = 50%; ROE = 8.50%; Ke = 12.00%

Firm C: SCD/FCFE = 110%; ROE = 15.00%; Ke = 11.00%

The industry in which these firms operate has a ROE of 14.00% and a Ke of 12.00%. Which of these firms should clearly increase its SCD/FCFE ratio?

Select one:

A. Firm A only

B. Firm B only

C. Firms A and B

D. Neither firm should increase its SCD/FCFE ratio

Explanation / Answer

Answer: Option B. I & III Only

A spinoff is the creation of an independent company through the sale or distribution of new shares of an existing business or division of a parent company.

A spinoff is a type of divestiture.

Businesses wishing to streamline their main operations often sell less productive or unrelated subsidiary businesses as spinoffs.

Therefore, division 1 and division 3 will benefit from spin off.

Benefit to I: Since the business are independent of each other. Parent company will be able to better focus on its main operations.

Benefit to II: There are no benefits in situation II as managers of parent to competent to manage division.

Benefit to III: By spin off of Division, Division will be free of regulatory compliances which are only applicable to Parent.

Answer to Question 2:

Option B: Only Firm B

Share holders cash distribution is cash distributed to shareholders (similar to Dividend). SCD/FCFE refers to amount of cash flow distributed out of total amount of cash available for equity shareholders.

If Returns on Equity (ROE) is more than Ke (cost of equity), then firm can earn more on available CFs. Therefore, firm should retain more cashflows and distribute lesser cash to shareholders. Since firm B have ROE less than Ke, it should distribute more amount. Therefore, it should increase its SCD/FSFE

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