June 14 2021

Page 1

Exercise 1 Surprise Inc. is a company financed with both equity capital and debt. The number of shares outstanding is equal to 80 million and the market price of the shares is currently equal to € 1.25 each. The value of the debt is € 20 million and the annual interest rate charged by the bank is equal to 4%. On average the annual gross operating margin (revenues net of operating cash costs) is equal to € 8 million; the tax rate on company gross profit is equal to 30%. Compute: 1) The total market value of the assets today 2) The expected profitability of the company assets kA today, gross of taxes (i.e. consider the gross operating margin) 3) The earning-per-share (EPS) 4) The expected profitability kE for shareholders today 5) The total market value of the assets if the company is financed with equity capital only (introducing proper assumptions) 6) The expected profitability kE for shareholders if the company is financed with equity capital only Now assume that the controlling shareholders want to raise new debt, but according to the market this will increase the probability of financial distress. The company will access to a new loan, amount € 25 million, that will cumulate with the previous debt. The annual interest rate on the new debt will be 6% while the interest debt on the ‘old’ debt will not change. The cash raised will be used to finance new investments with the same return kA computed in question 2). Assuming that the new debt generates costs of financial distress equal (in present value) to 3% of the same new debt, compute: 7) The new total market value of the assets 8) The new EPS 9) The new expected profitability kE for shareholders Exercise 2 Scotch&Rock (S&R) is going to be listed on the Euronext Stock Exchange in a few months. Financial analysts…