February 10 2020

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Exercise 1 Buffalo Brothers is willing to raise money for new investments and is planning to issue a bond, with maturity 4 years, coupon paid each year. The total par value of the bonds will be equal to € 20 million (the company wants to raise money for the same amount). A credit rating agency issued the rating for the debt (BBB). The risk free interest rate on the market is equal to 0.2%. Compute: 1. The annual coupon that the company should pay (see the Table for spread values) 2. The duration of the bond at the issuance 3. The volatility of the bond price 4. The coupon that the company could have decided, if it was paid each quarter, instead of each year Assuming that the tax rate on corporate income is 23%, compute: 5. The tax saving that Buffalo Brothers will obtain each year 6. The present value of the financing (i.e. the present value of future tax savings) Now assume that Buffalo Brothers is introducing the option to reimburse the bond any time in the future, before maturity, at its own discretion. In order to raise the same amount of money at time 0, should the coupon be larger or lower? Exercise 2 Financial analysts just published their report about the future profitability of a company: Year 1 Year 2 Year 3 Thereafter ROE (*) 14% 12% 10% 10% Payout ratio 25% 40% 50% 60% (*) = ratio between annual earnings and book value of equity capital at the beginning of the year The book value of the equity capital of the company today is equal to € 60 million and is divided into 30 million shares. The earning per share of the last year was equal to € 0.3. The annual cost of capital is equal to 10%. The risk free rate is equal to 0.5%. Assuming that the company will not raise capital in the short run, compute: 1. The expected dividends in the short run (years 1 to 3) 2.…