Management Engineering - Finance Lab + Corporate FInance

Full exam

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 cost of debt is equal to 6%). The operating margin of the company (i.e. revenues net of operating costs) is equal to € 6 million 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 profitability 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 financed 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 the expected value of the annual operating margin, to € 8 million. Determine: 5. the new value of the company annual earnings (net 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 related 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 proposal is the best solution to maximize the value of the assets, or if it is better to raise a part of the € 19 million issuing new equity capital (rather than debt). Exercise 2 Soul Mechanics wants to invest in Industry 4.0 technologies in order to be more competitive in manufacturing. The initial investment is equal to € 800,000. Expected operating differential cash flows, gross of taxes, are as follows (assume a conventional tax rate on cash flows equal to 25%): Year 1: € 20,000 Year 2: € 45,000 Year 3: € 350,000 Year 4: € 950,000 Year 5: € 1,250,000 The required cost of capital k* is equal to 18% (if the project is financed only by the company’s own resources). 1. Compute the net present value (NPV) of the project in the ‘base case’ 2. Compute the NPV in the case that Soul Mechanics borrows € 300,000 from a bank, that charges an annual interest rate equal to 5% (interests are deductible from the taxable income); the debt is paid back at time 5 3. Compute the NPV in the case that Soul Mechanics borrows € 300,000 from the bank, that charges an annual interest rate equal to 5% (interests are deductible from the taxable income); the debt is paid back half at time 3, half at time 5 4. Compute the NPV in the case that Soul Mechanics borrows money from the bank, that charges an annual interest rate equal to 5% (interests are deductible from the taxable income), and wants to keep the ratio L between debt and value of the project equal to 50%, each year 5. Compute the amount of debt that should be borrowed from the bank in case 4, now. 6. Compute the expected profitability for shareholders (namely the cost of equity capital) k E in cases 2. and 4. Exercise 3 Tronc&Strap shares are traded on the exchange. The price today is equal to € 6,075. The annual cost of capital estimated by shareholders is 14% while the risk free rate is equal to 1%. The equity capital is divided into 50 million shares. The consensus on the market is as follows: Year 1 Year 2 Year 3 Following Years Earnings € 23 million € 25 million € 28 million Average growth rate from year 3 = g Payout ratio 85% 85% 80% 75% 1. Estimate the dividend per share for the next 3 years 2. Estimate the long term growth rate g expected by the market 3. Compute the present value of growth opportunity (PVGO) for the share: is it a value stock or a growth stock? 4. Assuming that in the long run (from time 4) the return on equity ROE is constant, compute its value 5. Compute the value of the forward contract, according to which we sell the share at time 6 months at the delivery price equal to € 7 6. Compute the value of the same forward contract, but with time to delivery 15 months Academic year 2016-2017 The test must be completed in 120 minutes. Write immediately surname and name on papers provided by the staff. During the test you cannot read personal notes or books. If – to your opinion - the text is not clear, or is ambiguous, you can introduce proper assumptions. Corporate Finance (Prof. G. Giudici) Written test – March 1st 2017