Exercises Part 1

Page 1

Politecnico di Milano Corporate Finance Es. 1 Monti is an unlevered company and its market value of equity is € 50 million. The equity capital is divided into 25 million shares. The average annual operating profit (revenues less operating costs) is € 7.5 million. Compute: 1) The share price, the earning per share (EPS) and the expected profitability for shareholders kE. Assume no taxes on corporate income exist. Monti then decides to raise debt capital for an amount equal to € 10 mi llion. The annual interest rate on debt is 6%. The capital raised will be used to repurchase part of the shares outstanding, in order to leave the book value of assets and liabilities unchanged. 2) How will this operation affect the share price, the earning p er share and the expected profitability for shareholders? 3) Show how to replicate the expected profitability for the shareholders after the debt issue by investing in 4 shares of the levered company (and investing personally in debt securities). Es. 2 The market value of the assets of Livestock Inc. is equal to € 45 million. The market value of the outstanding debt is equal to € 7 million (the annual interest rate is equal to 5% and the debt is always constant). The equity capital is made up by 9 million s hares. The average annual operating income (difference between revenues and operating cash costs) is equal to € 4.8 million. The tax rate on corporate income is equal to 27%. All the company profits are paid to shareholders. 1) Compute the market value of the equity capital and the equilibrium price of each share 2) Compute the annual net profit and the earning per share 3) Compute the expected return for shareholders 4) Compute the annual saving on taxes that Livestock Inc. obtains through debt financing Now, assume t hat Livestock…