EXP 482 Midterm Clifford W. Smith, Jr. Winter 2004 Name Friday

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EXP 482 Midterm Clifford W. Smith, Jr. Winter 2004 Name Friday
EXP 482 Midterm
Winter 2004
Clifford W. Smith, Jr.
Name __________________________________
Friday – February 13, 2004
•
This is a closed-book, closed-notes exam.
•
Please do not sit in adjacent seats.
•
The exam begins at 8:30 am and ends at 10:00 am.
•
Please do not open the exam until instructed to do so.
•
Read the questions carefully.
•
You are encouraged to use a couple of (blank) sheets of paper to organize your
answers before writing on the exam.
•
Try to provide answers that are focused, responsive, and constructive.
•
Please write only in the space provided for each question.
•
If you have questions during the exam, please ask me.
•
Good luck!
Clifford W. Smith, Jr.
Winter 2004
1. (5 pts) Define briefly
a. 401 K
b.
Debtor in possession
c.
Phantom stock
d.
Volatility
e.
Unfunded pension benefit
f.
Independent director
g.
Chapter 11
h.
Subordinated debt
i.
Sinking fund
j.
Investment tax credit
EXP 482
Midterm Exam
Clifford W. Smith, Jr.
Winter 2004
EXP 482
Midterm Exam
2. (6 pts) Your boss shows you a WSJ article that notes that restricted stock “costs a
recipient little or nothing and generally isn’t tied to future performance…best of
all, restricted shares aren’t stock options.” She suggests eliminating our use of
options and only awarding restricted stock. She asks what you think.
3. (9 pts) Home Properties is a Real Estate Investment Trust headquartered in
Rochester. Under the tax code, REITs are not taxed so long as they distribute their
earned income: Home Properties currently has a dividend yield of over 6%. How should
this affect its executive compensation and financing policies?
Clifford W. Smith, Jr.
Winter 2004
EXP 482
Midterm Exam
4. (15 pts)
a. Your boss notes that our firm has decided to call its outstanding convertible
bonds. This process requires that the bondholders be given 30 days to decide
whether to convert and take shares or to redeem the bonds for cash. Right now,
the conversion option is “In the money” so if the stock price stays the same for
the next 30 days, bondholders should convert. But if the stock price falls by
enough, we will have to give them cash. He says that an investment banker has
offered to underwrite the call, guaranteeing to convert any bonds redeemed for
cash. He asks what should be important in pricing this underwriting contract?
b. Your boss employs the analysis you suggested to value the underwriting contract,
compares this model price to the fee quoted by the investment banker and
concludes that the fee looks high. He asks if you can help him understand what
to do.
Clifford W. Smith, Jr.
Winter 2004
EXP 482
Midterm Exam
5. (15 pts) Discuss briefly
a. “The more debt a firm issues, the higher interest rate it must pay; thus well
managed firms operate with conservative debt levels.”
b. “(With their) currently high level of corporate debt…corporations have little
choice but to use their cash flow to pay back debt rather than increase capital
expenditure.”
c.
EXP 482 Midterm
Winter 2005
Clifford W. Smith
Name __________________________________
Friday – February 11, 2005
•
This is a closed-book, closed-notes exam.
•
Please do not sit in adjacent seats.
•
The exam begins at 8:30 am and ends at 10:00 am.
•
Please do not open the exam until instructed to do so.
•
Read the questions carefully.
•
You are encouraged to use a couple of (blank) sheets of paper to organize your
answers before writing on the exam.
•
Try to provide answers that are focused, responsive, and constructive.
•
Please write only in the space provided for each question.
•
If you have questions during the exam, please ask me.
•
Good luck!
Clifford W. Smith
Winter 2005
1. (5 pts) Define briefly
k. Dividend Unit
l.
ERISA
m.
Tax Loss Carryback
n.
Restricted Stock
o.
Subordination debt
p.
Liquidation
q.
Warrant
r.
Debenture
s.
Delta
EXP 482
Midterm Exam
Clifford W. Smith
Winter 2005
EXP 482
Midterm Exam
2. (7 pts) Your boss shows you a WSJ article that says that “Imutex Pharmaceuticals is
reducing their R&D spending.” She asks what other changes you might expect in Imutex?
3. (7 pts) Your boss shows you a WSJ article which argues that the Federal Reserve
will raise rates over the next six months. She says we have two debt issues
outstanding – one convertible and one not. She asks which will be more affected by the
rate hike.
Clifford W. Smith
Winter 2005
EXP 482
Midterm Exam
4. (8 pts) You tell your brother that you just read a newly released book that you
enjoyed. He works at a movie studio and notes that his company just bought the movie
rights, but he thinks they overpaid. He argues that if we make the movie and the book
just has average sales, the movie would be unlikely to be profitable. Only if the
book turns out to be a best-seller, is the movie likely to make money. What do you
say?
5. (8 pts) Your boss shows you a draft of a memo addressed to the board. “Although
this new project fails to provide a rate of return as high as we have traditionally
demanded, we also have decided to increase our leverage. To implement this new
leverage policy, this project will be financed with 80% debt. Exploiting this
financing opportunity thus makes this project extremely accretive.” She asks your
advice.
Clifford W. Smith
Winter 2005
EXP 482
Midterm Exam
6. (15 pts) Discuss briefly
a. Some companies institute voluntary job-buyout plans to eliminate jobs — why not
just fire people?
b. “Golden parachutes, which pay millions to executives who lose their jobs after
a merger, rip off shareholders.
c.
EXP 482 Midterm
Winter 2006
Clifford W. Smith
Name __________________________________
Friday, February 10, 2006
•
This is a closed-book, closed-notes exam.
•
Please do not sit in adjacent seats.
•
The exam begins at 9:00 am and ends at 10:30 am.
•
Please do not open the exam until instructed to do so.
•
Read the questions carefully.
•
You are encouraged to use a couple of (blank) sheets of paper to organize your
answers before writing on the exam.
•
Try to provide answers that are focused, responsive, and constructive.
•
Please write only in the space provided for each question.
•
If you have questions during the exam, please ask me.
•
Good luck!
Clifford W. Smith
Winter 2006
1. (5 pts) Define briefly
t.
FASB
u.
Strike Price
v.
SAR
w.
Covenant
x.
Constructive Dividend
y.
Adverse Selection
z.
Defined Contribution Plan
aa. Fraudulent Transfer
bb.
Chapter 7
EXP 482
Midterm Exam
Clifford W. Smith
Winter 2006
EXP 482
Midterm Exam
2. (7 pts) Your boss shows you a NYT article on the revision to the bankruptcy code
which makes declaring personal bankruptcy more difficult. It says that “the new law
will be a huge giveaway to banks, credit card companies, and retailers at the expense
of middle- and lower-income families.” She asks what you think?
3. (7 pts) Your boss shows you a WSJ article that reports Ford and GM are making an
aggressive push of their “flex-fuel” vehicles—they can run either on gasoline or E85
(a fuel mix that is 85% ethanol and 15% gas). But the typical vehicle gets 18 mpg on
E85 compared to 25 mpg on gas, and there are only about 600 stations in the US that
sell E85. He says he doesn’t understand why anyone would buy a car with this new
engine. What do you say?
Clifford W. Smith
Winter 2006
EXP 482
Midterm Exam
4. (8 pts) Your boss shows you a 1/13/06 WSJ article that notes actress Cameron Diaz
and Director Nancy Meyers were offered contracts that gave each a share of their
film’s revenues after the studio had recouped its production and marketing costs. In
prior films, they received a share of total revenue. She notes that the studio had
lost money on several films lately and this was a better way to control costs. She
asks your thoughts.
5. (8pts) Your boss shows you a 10/27/05 WSJ article that notes Lear Corporation
reported a $750 million net loss. Most of the loss stemmed from a goodwill charge of
$9.98 per share as well as restructuring costs and fixed-asset impairment charges of
$1.09 per share. Excluding the charges, it would have lost $.10 per share. Your boss
says this seems silly—they took a poor quarter and turned it into a disaster. She
asks your opinion.
Clifford W. Smith
Winter 2006
EXP 482
Midterm Exam
6. (7 pts) Your boss shows you a BW article that notes “Thousands of suppliers have
been hit by lawsuits filed in the name of bankrupt companies to reclaim money debtors
paid out in the 90 days before they filed for bankruptcy.” Your boss asks “How can we
protect ourselves against such suits?”
7. (8pts) United Airlines, in their bankruptcy, decided to walk away from its defined
benefit pension plans. UAL said this “would add hundreds of millions in annual cash
flow that would enable it to boost spending on planes and facilities.” Your boss says
that she doesn’t understand why United isn’t already maintaining these assets. What
do you say?
Debtors in Rush to Bankruptcy as Change Nears
By TIMOTHY EGAN
Published: August 21, 2005
BOISE, Idaho - Rushing to beat an October deadline when the biggest overhaul of the bankruptcy law in a quarter century goes into
effect, rising numbers of Americans have filed for protection in the four months since the law was changed, seeking to have their debts
erased.
Since President Bush signed the new law in April, bankruptcy filings have jumped, particularly in
the heartland. Filings in the four months through July are up 17 percent this year over last in
Cleveland, 14 percent in Milwaukee and 22 percent in northern Iowa, according to court filings,
matching similar patterns in the Midwest and parts of the South and rural West.
Nationwide, bankruptcy filings for April, May and June were up by 12 percent over the same
period last year, according to LexisNexis, the data collection service, which tracks filings ahead
of the quarterly reporting done by the federal courts. The rise is coming after bankruptcy had
leveled off and even started a slight decline last year.
Under the revised law, debtors who earn more than the median income in their state and who can
repay at least $6,000 of their debt over five years will no longer be able to have their debts wiped
out for a fresh start under the more generous provisions of Chapter 7 of the bankruptcy code.
Instead, they will have to seek protection under Chapter 13, which requires a repayment schedule.
Joe Jaszewski for The New York Times
Delores Hawks, 56, of Ontario, Ore.,
went into debt to learn new skills.
In addition, under the new provisions, they will have to enroll in a court-supervised financial
counseling program.
The rise, which lawyers and bankruptcy experts say is driven in large part by people who say
they fear that it will become much more difficult to escape debt and seek a clean slate under the new law, appears to have caught some
bankers and lawyers by surprise.
When the new bankruptcy bill was passed by Congress last spring, bankers predicted it would turn many people away from the
protection of the courts by making it harder to extinguish debt. That may still turn out to be the case. But thus far, it has been a rush to
the courts in many places.
Here in Idaho, the soundless wave of Americans going broke washes up at the clerk's office in bankruptcy court, with nearly 20 fresh
declarations of desperation every working day.
There is the Moore family of Boise, Kevin and Linda, listing a $10 cat and a $5 toaster among their meager assets against a medical
bill of more than $18,000. There is Delores Hawks, going into debt to learn a skill, and never getting out because of endless credit card
interest on the self-loan that once looked so manageable.
"Someday, I think we'll eventually get ahead," said Linda Moore, a 41-year-old part-time school bus driver who said she did not know
of her husband's medical bills when she married him. "I don't know when that day will be."
Bankruptcy filings rose eightfold over the last 30 years, from 200,000 in 1978 to 1.6 million last year. Although filings vary from
month to month, the pace for this year, if it holds up, projects to about 1.8 million bankruptcies. The overwhelming majority of them
are personal, not business.
Economists say bankruptcy has become more likely as household debt has continued to rise while the savings rate has fallen
precipitously. The Federal Reserve reported that household debt hit a record high last year, relative to disposable income.
"Bankruptcies historically have risen with debt, and a lot more people are now living near the edge," said Henry J. Sommer, president
of the National Association of Consumer Bankruptcy Attorneys. "What we're seeing now is a rush to get in before October. After that,
a certain amount of people will be priced out of bankruptcy."
Courts in Indiana, Nebraska, Ohio, Tennessee, Texas and Wisconsin, among other places, report that people are hurrying into
bankruptcy in numbers rarely seen.
"I'm probably about four times more busy than normal," said Merv Waage, a bankruptcy lawyer in Denton, Tex. "People are saying,
'Honey, we can't pay our bill. We have no choice. We can't live under the stringent new rules. Let's file now before it's too late.' "
Idaho, a state with an otherwise prosperous sheen to its economy, is among the per capita leaders in a category that no state will brag
about. Filings were up 11 percent for July over the same period last year - on a record pace for the year.
Gordon Barry, a bankruptcy lawyer in Toledo, Ohio, where filings are up 21 percent this year, said: "We've been busier than ever.
People are running in, trying to beat the deadline."
The new requirements are an incentive to seek protection now, perhaps the last chance for a relatively hassle-free bankruptcy, some of
the newly bankrupt say.
Certainly that was case of Ms. Hawks, who is 56, and lives in Ontario, Ore., just over the Idaho state line. After years of odd jobs, she
took out loans on credit cards to go to business school and learn office skills. Once out of school, she found she had a rare nerve
disease that she said kept her from holding a job. The debts piled up, even after she got rid of her credit cards.
She paid just enough to satisfy the credit card minimum payment, she said, but never advanced out of the loop of perennial debt on the
interest.
"I was paying interest on the interest," Ms. Hawks said, "it was $5,000, and I never got ahead of it. Month after month after month.
Finally, I just got tired of it. I said, 'I've had enough.' "
She had heard enough about the changes in the bankruptcy law to feel that it was important to file this summer rather than wait until
all provisions of the new law took effect in October, she said. "I had to do something," said Ms. Hawks, who now lives on $656 a
month in Social Security disability. "I decided to do it now rather than later."
Families with children are three times more likely to file as those without, according to studies done by Elizabeth Warren of Harvard
Law School and others, and more than 80 percent of them cite job loss, medical problems or family breakup as the reason.
Ms. Moore, an Air Force veteran of the Persian Gulf war who married a carpenter and inherited his outstanding medical bills, said
those old debts forced the couple into bankruptcy. Both Ms. Moore and her husband had been divorced before.
But she admits that they brought on some of the problem themselves.
"My husband, he's the kind of guy who when he gets a bill that he can't pay, he just puts it aside," Ms. Moore said.
The monthly math of the Moore family budget leaves little room for unplanned events. Mr. Moore makes about $1,200 a month as a
carpenter. Ms. Moore, a mother of three children, drives a school bus part time, and makes $11 an hour. She also receives $300 a
month in alimony. Their rent is $700 a month. Their food costs are $400 a month. Their cars, insurance and upkeep are $200 more.
Most months, they barely break even, she said. But what pushed them into bankruptcy were bills from the past, which kept growing
with interest - a mountain that finally turned into an avalanche. They detailed the bills in their court filings.
The biggest was an $18,000 medical bill, for Mr. Moore, from a severe knee injury. He also owed $2,469 to a hospital where he went
for care during a bout of depression. There was a $205 bill to DirecTV, and a $600 bill to Money Tree and a $615 debt to Capitol One
- both lending services. And he owed child support, for $542.
Ms. Moore said she did not know about most of her new husband's debts until she started getting her wages garnished from her busdriving job. She has health insurance from her Air Force days, but it has not been enough to keep them out of bankruptcy.
"My husband's old medical bills - that's what killed us," she said. Bankruptcy was a chance to start clean, she said. Bankers say the
surge in filings is driven in part by misinformation about how the new law will work. They say it will force only the small percentage
of people who abuse the system into regular payment schedules, while keeping an open door of debt forgiveness to the vast majority
of bankruptcy filers, who are individuals rather than businesses.
"I would hope that consumers are not getting the rush-rush because they're afraid they won't have the same protection in a few
months," said Wayne Abernathy, an executive at the American Bankers Association, which lobbied heavily for the new law.
Consumer groups say the law will only make matters worse for the large number of families who are not abusing the system. They say
families will be stuck in "debtor's prison without walls," as the Consumer Federation of America, which fought the new bill, calls it.
Many economists and legal experts say that once all provisions of the law take effect in October, bankruptcies should fall again. And
some experts say people will be caught in an endless cycle of debt repayment.
Ms. Hawks, who said that she declared Chapter 7 bankruptcy last month to get out of the endless interest payments on credit cards she
had long given up, is puzzled by the financial industry's continued interest in her.
"Couple of times a week, I get a phone call or something in the mail trying to get me to accept a new credit card," she said. "I don't get
it - because I'm broke."
Ford, GM Make Big Push
To Promote 'Flex-Fuel' Vehicles
By KAREN LUNDEGAARD
Staff Reporter of THE WALL STREET JOURNAL
January 10, 2006
Although they've been working on vehicles that run on ethanol for more than a decade, Ford Motor Co. and
General Motors Corp. are now making an aggressive push into the alternative fuel.
Last week GM ran its first national advertising campaign promoting one of its so-called flex-fuel vehicles, the
Chevy Tahoe. Ford last month began selling flex-fuel versions of its popular F-150 pickup. Vehicles that are
designated flex-fuel are capable of running on gasoline but can use the alternative E85, a fuel mix that is 85%
ethanol and 15% gas.
Both auto makers are also helping to increase the number of ethanol fueling pumps at gas stations around the
country. At least five million vehicles that can run on E85 fuel already are on U.S. roads -- but most operate on
gasoline alone because of the unavailability of ethanol. Only about 600 gasoline stations out of some 170,000 in
the U.S. carry E85. Most are concentrated in the Midwest -- with roughly 200 in Minnesota alone. Still, the total
number more than doubled in 2005 and could increase fourfold this year, says Phillip Lampert, executive
director of the National Ethanol Vehicle Coalition, a group that promotes ethanol use. "This has been an uphill
battle," he says, but in the past several months, "people have begun to take notice."
In November Ford said it will work with Brookings, S.D.-based ethanol producer VeraSun Energy Corp. to
convert more existing fuel pumps to E85. GM last week said it would lead a project in California to get the state
Department of Transportation to use between 50 and 100 of its flex-fuel Impalas. Chevron Corp. plans to add
ethanol pumps at some gas stations near the agency's offices.
Ford and GM combined plan to produce 650,000 vehicles this year that can use E85, which currently costs
about $2 a gallon. Vehicles that run on ethanol -- which is distilled from corn and grain -- are less fuel efficient
than gasoline, in the order of 25%, according to the U.S. Department of Energy. The average cost to operate a
Chevrolet Monte Carlo, for example, using E85 is $1,578 compared with $1,344 on gasoline alone, according to
the Energy Department's fueleconomy.gov. The gasoline version emits an estimated 7.6 tons of greenhouse gas
per year compared with 5.6 tons for E85.
Indeed, there is good reason for GM and Ford to make the ethanol push. Both auto makers had been falling
behind in the green war among auto makers to appear environmentally conscious to their customers.
Ethanol is an area where domestic auto makers have a competitive advantage over their Japanese counterparts
that don't sell flex-fuel vehicles in this country -- except Nissan Motor Co., which offers a version of its pickup,
the Titan, as E85 compatible. And they can present themselves as patriotic by advocating domestic oil powering
vehicles built in the U.S., which is exactly what the companies plan to do.
Bill Ford Jr., chairman and chief executive officer of
Ford, used the podium Sunday in front of some 6,800
journalists at the North American International Auto
Show in Detroit, to boast about the auto maker's
commitment to ethanol, noting it helps American
farmers while reducing the country's dependence on
foreign oil.
Then the auto maker unveiled a massive concept
pickup truck, the Super Chief. Although its size
makes it look like a gas guzzler, the engine is
designed to run on a combination of gas, ethanol and hydrogen. The Super Chief currently isn't slated to go into
production because mass hydrogen fueling stations aren't expected for decades to come.
Historically, auto makers have been criticized for only building flex-fuel vehicles to receive credit on federal
fuel-economy requirements. Now they are trying to raise consumer awareness of the capabilities of flex-fuel
vehicles. "I'm the biggest zealot for ethanol," said Mark LaNeve, GM's head of North American sales and
marketing.
High gas prices following Hurricane Katrina "finally brought into the equation consumer awareness for an
alternative fuel," said Curtis Magleby, director of governmental affairs for Ford. "In the past, with gas prices so
low, consumers weren't really looking for an option."
Ethanol has been around for decades. The original Ford Model T was designed to run on pure ethanol. In the
1970s, there was a big push toward gasohol, a blend of 90% gasoline and 10% ethanol. All vehicles now are
capable of running on that blend -- four billion gallons of ethanol were sold in 2005, with the bulk going into
this blend.
Auto executives note that ethanol is never going to be a complete replacement for gasoline because ethanol
production isn't sustainable on a mass level. But if some fraction of gasoline could be replaced by ethanol, even
10%, that could have a significant impact on foreign-oil dependence.
Critics are concerned about the economic equation. Ethanol is heavily subsidized, from federal dollars given to
farmers to the 51 cents a gallon given to companies blending the fuel. But corn is just one way to create ethanol,
and research continues that will allow it in the future to be made from anything that was once green, including
sawgrass, rice straw, tree bark or sugarcane waste, to name a few examples.
Last week's ad promoting the Chevy Tahoe's
ethanol capabilities is the first of a wave of
new advertising. GM's Mr. LaNeve said he
would kick off an advertising campaign at the
Chicago Auto Show next month. He won't
advertise much nationally, he said, because
few gas stations offer E85 in much of the
country. "We don't want to frustrate the
customers." Still, he said, promoting ethanol
capabilities is "going to be a major emphasis
for us."
While Ford and GM have a jump on the
competition, the technology to make vehicles'
ethanol compatibility is relatively simple and
inexpensive -- no auto maker currently
charges more to buy a flex-fuel vehicle than
its regular counterpart. Yet auto makers
charge thousands of dollars for hybrid
vehicles that run on both gasoline and electric motors and significantly boost fuel economy.
Toyota Motor Corp. and Honda Motor Co. have taken different environmental paths in the U.S. than their
American competitors. Ben Knight, vice president of research and development at Honda, said the auto maker
is building flex-fuel vehicles in Brazil, where ethanol is more prevalent. Honda is concerned that consumers in
the U.S. will be turned off by less fuel-efficient ethanol even if it becomes more readily available, he said.
Honda has chosen to concentrate more on hydrogen, where the environmental benefits are even greater. Mr.
Knight declined to discuss, if ethanol interest rises dramatically, how long it would take the auto maker to
introduce flex-fuel vehicles in the U.S.
Toyota officials said they haven't produced ethanol-capable vehicles here because they haven't needed the
credits for government fuel-economy requirements. Toyota doesn't believe that corn-based ethanol is an
environmentally friendly or sustainable solution, said Bill Reinert, national manager of advanced technology for
Toyota's U.S. operation, but the company's opinion could change if ethanol is successfully made from other
materials.
Write to Karen Lundegaard at [email protected]
Sweetheart Star Deals Go Sour; After a Down Year at the Box Office, Studios
Are Taking a Hard Look At Big Money Deals With Top Talent
Kate Kelly and Merissa Marr. Wall Street Journal. (Eastern edition). New York, N.Y.: Jan 13, 2006. pg. A.9
Abstract (Document Summary)
LAST FALL, after releasing such bombs as "Stealth" and "Bewitched," executives from Sony Pictures Entertainment decided to
rethink their spending on the romantic comedy "Holiday." In order to sign actress Cameron Diaz and director Nancy Meyers, the
studio had planned to offer both women a share of the movie's gross box-office revenue from its first day of release on. It is a
practice known as "first-dollar gross" and it's standard fare for top-tier talent.
In making "King Kong," for instance, General Electric Co.'s Universal Pictures granted director Peter Jackson, who was fresh off
the tremendous success of the "Lord of the Rings" trilogy, $20 million up front and 20% of Universal's share of the movie's first
dollar gross, minus his original fee. The recently released movie has taken in $473 million in world-wide ticket sales. But
because Universal must split the box-office revenue with exhibitors, recoup its production costs and give Mr. Jackson his take of
the ticket sales at the same time, it is unclear when or if "Kong" will turn a profit -- even though Mr. Jackson has already banked
tens of millions of dollars.
That was Sony's thinking with "Holiday," the story of an American woman and her man troubles. Ms. Diaz is a well-loved star,
and Ms. Meyers, who directed "The Parent Trap" and "What Women Want," has a solid box-office track record. But Ms. Meyers
is known for long shoots, and her last Sony picture, "Something's Gotta Give" with Diane Keaton and Jack Nicholson, ballooned
to a $100 million budget largely because of payments to talent. (It took in $267 million world-wide.)
Full Text (1195 words)
Copyright (c) 2006, Dow Jones & Company Inc. Reproduced with permission of copyright owner. Further reproduction or
distribution is prohibited without permission.
LAST FALL, after releasing such bombs as "Stealth" and "Bewitched," executives from Sony Pictures Entertainment decided to
rethink their spending on the romantic comedy "Holiday." In order to sign actress Cameron Diaz and director Nancy Meyers, the
studio had planned to offer both women a share of the movie's gross box-office revenue from its first day of release on. It is a
practice known as "first-dollar gross" and it's standard fare for top-tier talent.
But for "Holiday," the studio asked the star and director to take a vacation from their usual terms and receive a share of the
movie's haul only after the studio had recouped its production and marketing costs.
This particular kind of deal downsizing -- which Ms. Diaz and Ms. Meyers eventually agreed to, according to people familiar with
the matter -- may become more commonplace. Hollywood executives suffered through a 7% downturn in movie attendance in
2005 and grappled with increased competition from Xboxes, iPods, TiVo and other home- entertainment options. As a result,
Hollywood is struggling to find fresh ways to keep profit margins intact, and practices such as first- dollar gross are falling under
new scrutiny.
For Sony Pictures, a Sony Corp. division with a reputation for being relatively free-spending, the "Holiday" negotiation was a
stark turnabout, reflecting the studio's concern over bloated budgets that cost it dearly last year. Other studios are making similar
moves. At News Corp.'s Twentieth Century Fox, executives try to either avoid first-dollar gross players altogether or to limit them
to one per picture. At studios like Walt Disney Co. and Time Warner Inc.'s Warner Bros. Pictures, executives are also reshaping
some of their traditional talent deals.
It will be a hard fight to win. First-dollar gross is perhaps the most coveted perk in Hollywood, because it allows movie stars,
directors and producers to immediately begin collecting money when a film opens -- from the moment the "first-dollar" comes in - regardless of whether the picture is profitable. But with movie costs skyrocketing, allowing directors and actors to pocket a
percentage of the first-dollar gross can delay the studio's path to profitability.
In making "King Kong," for instance, General Electric Co.'s Universal Pictures granted director Peter Jackson, who was fresh off
the tremendous success of the "Lord of the Rings" trilogy, $20 million up front and 20% of Universal's share of the movie's first
dollar gross, minus his original fee. The recently released movie has taken in $473 million in world-wide ticket sales. But
because Universal must split the box-office revenue with exhibitors, recoup its production costs and give Mr. Jackson his take of
the ticket sales at the same time, it is unclear when or if "Kong" will turn a profit -- even though Mr. Jackson has already banked
tens of millions of dollars.
Executives at Disney hoped to avoid such a scenario when they set out to make the second and third installments of "Pirates of
the Caribbean." Based on a hugely successful first movie, "Pirates of the Caribbean: The Curse of the Black Pearl," which took
in $654 million world-wide, the studio sketched out an ambitious plan for the sequel and third part. The plan was to shoot both
films on location in the Caribbean, back to back, with returning star Johnny Depp and Jerry Bruckheimer, one of Hollywood's
best-compensated producers.
But because the undertaking promised to be costly -- an estimated $175 million per picture at the outset -- Disney took a tougher
line with the talent, according to people familiar with the matter. Disney told Messrs. Depp and Bruckheimer that they would
have to forgo some of their usual privileges, including their first-dollar gross. Mr. Bruckheimer's publicist had no comment and
Mr. Depp's representative could not be reached for comment.
It looks like Disney's move was a shrewd decision. Disney had to halt shooting of the movies in the Bahamas last year because
of Hurricane Wilma and production costs have since escalated, say people familiar with the matter.
The notion of cracking down on sweetheart deals with actors and directors isn't new to Hollywood -- the industry has tried to
wrestle such costs down in the past. The 35% of the first-dollar gross that was once reserved for top-tier talent has ratcheted
down in recent years to a combined 25% cap at most studios.
Indeed, when Tom Cruise tried to push his pay packet beyond his usual 20% for "Mission: Impossible III" last year, Viacom Inc.'s
Paramount Pictures put the entire movie on ice, complaining that such a deal would mean it would have to bring in $500 million
just to break even, according to people familiar with the situation. Paramount and Mr. Cruise ultimately came to an agreement
on a less demanding financial structure for the movie.
On the coming "Da Vinci Code," Sony asked the stars and filmmakers to reduce their usual first-dollar gross demands to get the
movie made. The main players -- including Tom Hanks, who is starring in the film based on the best-selling novel, director Ron
Howard and producer Brian Grazer -- were poised to take a combined bite of about 40% out of the back end. They agreed,
however, to reduce their gross on a pro- rata basis so that the studio could hold it at 25%. Representatives for Messrs. Hanks,
Howard and Grazer did not return calls for comment.
As movie-production costs have soared, awarding first-dollar gross has become an increasingly risky proposition for studios.
The average Hollywood picture costs around $64 million today, not including marketing costs, according to the Motion Picture
Association of America. But the big-event movies that major studios rely on to bring in the big bucks -- like the $207 million
"Kong" or the recently released "Harry Potter and the Goblet of Fire," which cost Warner Bros. about $200 million -- can cost
three times that much or more.
"Mathematically, it starts getting difficult with budgets beyond $100 million to recoup money on a movie with major first-dollar
gross participants," says Bill Mechanic, the former head of Twentieth Century Fox and a former top Disney executive. "Firstdollar gross is fine if a movie is successful, but if it's not, participants will continue earning fees which only pushes the studio into
further losses."
That was Sony's thinking with "Holiday," the story of an American woman and her man troubles. Ms. Diaz is a well-loved star,
and Ms. Meyers, who directed "The Parent Trap" and "What Women Want," has a solid box-office track record. But Ms. Meyers
is known for long shoots, and her last Sony picture, "Something's Gotta Give" with Diane Keaton and Jack Nicholson, ballooned
to a $100 million budget largely because of payments to talent. (It took in $267 million world-wide.)
It was the combination of high-priced talent and a 2006 slate of pictures that includes megabudget projects like "The Da Vinci
Code" that prompted Sony studio heads Michael Lynton and Amy Pascal to curb the first-dollar gross arrangements on
"Holiday," say the people familiar with the matter. The director and the star actress eventually agreed, in part because they were
keen to work together. (Representatives for Ms. Diaz and Ms. Meyers declined to comment.)
LOSS CARRYFORWARDS are restricted by some revenue-hungry states.
Federal and most state laws let corpora-tions carry forward their net operating losses
and deduct them from taxable income in future years. But a countertrend may be beginning
at the state level, says James P. Sweeney of Arthur Andersen & Co., CPAs. Pennsylvania
not only raised corporate tax rates this year but also eliminated the use of loss
carryforwards. California suspended for tax years started in 1991 and 1992 its partial
deduction for carryforwards.
Texas enacted a corporate levy that
critics call a disguised income tax. A deduc-tion for carryforwards isn'’ allowed in the
first year, 1992, but is supposed to be after then. In New York, Sweeney notes, many
companies are required to pay the state’s al-ternative minimum tax, which doesn’t allow
deductions for carryforwards. For that mat-ter, the calculation of the 20% federal minimum tax permits the deduction of only 90% of a carryforward.
Multistate companies coming out of the recession will have to plan carefully for state
taxes, Sweeney declares.