Management Engineering - Finance Lab + Corporate FInance

First partial exam

Exercise 1 Clinton&Trump Industries (C&T) is a company selling caterpillars. Analysts estimate that the market value of the assets in place is equal to $ 800 million. The company raised debt and the outstanding value of the debt is equal to $ 200 million. The equity capital is made up by 80 million shares. The annual cost of debt is equal to 3%. The average annual operating income (i.e. the difference between revenues and operating costs) expected for the future is equal to $ 100 million. The tax rate on corporate gross profits is equal to 25%. 1) Compute the theoretical price of the shares on the market. 2) Compute the expected earning per shares (EPS). 3) Compute the expected profitability for shareholders k E. 4) Compute the likely value of the assets of the company if it was financed only with equity capital. A new government is elected and a number of public investments in civil works (walls) are expected. This raises investors’ optimism and new expectations are as follows: (i) increase of the asset value up to the total value of $ 1 billion, and (ii) increase of the expected annual operating income up to the total value of $ 125 million. 5) Compute the new theoretical price of the shares on the market. 6) Compute the new expected earning per shares (EPS). 7) Compute the new expected profitability for shareholders k E. After the election results, the company takes the opportunity to raise more money borrowing new debt and buying back shares on the market (not to modify the composition of the assets). 8) Compute the amount of debt to be raised in order to deliver an expected profitability to shareholders k E in the future equal to 12% A bank proposes to C&T to borrow debt at cheaper conditions (i.e. annual rate 2.95% with interests paid in advance each month). 9) Is this a convenient option compared to the existing cost of debt? Exercise 2 On the market there are three different corporate bonds: · DE387: the issuer is rated AAA, zero-coupon, maturity 10 months, market price today 99,917 · DE231: the issuer is rated AAA, annual coupon 0.75% (paid annually), maturity 22 months, clean market price 101,061 · IT999: the issuer is rated BBB, annual coupon 1.25% (paid annually), maturity 22 months, clean market price 100,688 Find out: 1) The accrual (accrued interest) and the dirty price for DE231 and IT999 2) The yield to maturity (YTM) for DE231 and IT999 3) Some points of the interest rate term structure 4) The average spread requested by the market on the yield of IT999 5) The duration of the three bonds 6) The expected volatility for the three bonds 7) How we can build a synthetic zero coupon bond with maturity 22 months combining DE387 and DE231 Political turmoil causes the spread found in question (4) to increase suddenly by 50 bps (+0.5%): 8) Find the new theoretical equilibrium clean price of bond IT999 and compare the change in the price with the results of question (6) 9) Explain the economic/financial reason why this new equilibrium on the market leads to a lower duration of the IT999 bond (it’s not enough to show the result in numbers! Explain why…) Academic year 2016-2017 The test must be completed in 90 minutes. Write immediately surname and name on papers provided by the staff. During the test you cannot read personal notes or books. If the text is not clear, or is ambiguous, you can introduce proper assumptions. Corporate Finance (Prof. G. Giudici) First written test – November 23th 2016