11. (17 points) Steve Smith, a trusted insurance company analyst at a large investment bank,
makes a public comment that Zoolander Life Insurance Company is an attractive
takeover candidate. Tomas Lyon asks you, the CFO, for your thoughts on these
comments.
(a) (4 points) Outline why Zoolander might be attractive as a takeover candidate.
Include details on the following:
i. Capital Structure
ii. Product mix
iii. ROE / Financial Results
iv. Corporate Orgainzation and Management
(b) (2 points) Describe protections that currently exist as well as further steps that
could be taken to prevent a hostile takeover of Zoolander.
(c) (2 points) Zoolander’s desired capital structure, as described in the Kelly Ratings
memo, is 30% debt. Explain the advantages and disadvantages of altering the
mixture of debt and equity in the capital structure.
(d) (4 points) Using the financial data in the case study, evaluate the appropriateness
of the 30% leverage ratio. Assume the standard deviation of return on assets is
10%. Show your work.
(e) (2 points) Assume Zoolander moves to its desired capital structure, with a
projected total value of outstanding securities of $1.2 billion. Evaluate whether
Zoolander’s target pre-tax ROE of 15% is reasonable. Show your work.
(f) (3 points) Recommend an appropriate capital structure for Zoolander. Describe
three ways that the firm can deploy its excess capital.
COURSE 8: Fall 2005 - 12 - GO ON TO NEXT PAGE
Finance Segment
Afternoon Session
Questions 11-12 pertain to the Case Study.
Each question should be answered independently.
12. (8 points) Zoolander is considering an acquisition of ABC Annuity, a small annuity
company. ABC Annuity focuses entirely on selling fixed annuities through independent
brokers. The company was founded only five years ago and has grown rapidly.
At December 31, 2004, ABC Annuity reported the following numbers in their financial
statements:
• GAAP reserves = $3,450 million
• Statutory reserves = $3,500 million
• Required Capital = $157 million
Projected financial statement values (in millions) for ABC Annuity are below:
Income Statement Data 2005 2006 2007
Premium 267 268 270
Investment Income 226 243 261
Death Benefits 2 7 5
Surrender Benefits 100 101 101
Operating Expenses 30 32 35
Commissions 9 9 9
Taxes 8 9 9
Balance Sheet Data as of December 31 2005 2006 2007
Statutory Reserves 3,763 4,045 4,348
GAAP Reserves 3,462 3,721 4,000
Tax Reserves 3,650 3,923 4,218
Required Capital 169 182 196
In preparation for a potential bid, CEO Tomas Lyon asks you to evaluate the acquisition.
(a) (1 point) Identify additional data needed to perform an actuarial appraisal on
ABC Annuity.
(b) (2 points) Calculate the present value of distributable cash flows for the years
provided using Zoolander’s desired WACC as the discount rate. Assume cash
flows occur at the end of each year. Show your work.
(c) (3 points) Outline the key considerations that should be taken into account in
deciding to proceed with the acquisition.
COURSE 8: Fall 2005 - 13 - GO ON TO NEXT PAGE
Finance Segment
Afternoon Session
12. Continued
(d) (2 points) Suggest at least three distinct ways that capital could be raised by
Zoolander to acquire ABC Annuity. For each, indicate:
i. how appropriate an option this would be for Zoolander in raising capital
for this acquisition
ii. costs associated with implementing that option
iii. the impact on existing Zoolander equity holders.
13. (4 points) Leede is a medium-sized Property and Casualty Insurance Company that is
publicly owned. Leede’s marginal tax rate is 30%.
An investment in one of the following two par bonds is being considered:
• Bond #1 – Fully taxable bond yielding 8% per year maturing in 2 years
• Bond #2 – Tax-exempt bond yielding 6% per year maturing in 2 years
Weather models suggest a 60% chance of extreme hurricane activity over the next two
years that would completely eliminate all of Leede’s taxable income.
(a) Assuming both bonds have the same risk profile, demonstrate which investment
Leede should choose today. Show your work.
(b) Assume after one year the bonds are still trading at par. There has been no
hurricane damage and there is only a 10% chance of hurricane loss over the next
year. Calculate the level of transaction costs that would make Leede indifferent to
switching investments at that time.
(c) Explain how your answer in (b) would be impacted if the risk profiles of the two
bonds were no longer the same.
COURSE 8: Fall 2005 - 14 - GO ON TO NEXT PAGE
Finance Segment
Afternoon Session

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