March12017

Pagina 1

Exercise 1 The market value of the assets of Pre&Tun company is equal to € 60 million. The company is financed with debt (the market value is equal to € 24 million, the annual c ost of debt is equal to 6%). The operating margin o f the company (i.e. revenues net of operating costs) is equal to € 6 mi llion each year, on average. The equity capital is divided in 10 million shares. The tax rate on corporate gross profit is equal to 28%. Determine: 1. the annual net profit (earnings) and the earning per share (EPS); 2. the share market price and the expected profitab ility k E of the equity capital; 3. the value of the ‘tax shield’, i.e. the present value of the tax savings related to debt financing (list the relevant assumptions to be made); 4. the value of the company, in the case it is fina nced only with equity (unlevered). The CEO is willing to raise new debt, for a further amount equal to € 19 million (at the same cost, 6%). The capital raised will be invested in new projects, this increasing t he expected value of the annual operating margin, t o € 8 million. Determine: 5. the new value of the company annual earnings (ne t profit); 6. the market value of the assets and of the equity capital after the increase in the debt amount; 7. the new value of the equity return; 8. the new market value of the share. Now, assume that the amount of debt X exceeding the total amount of € 30 million determines costs rela ted to financial distress C, that may be estimated (in present value ) equal to C(D) = 0,03 * D 2 (C is in € million, number D is equal to the value of X in € million). Find out if the CEO propos al is the best solution to maximize the value of th e assets, or if it is better to raise a part of the € 19 million issuing new equity capital (rather than debt).…