Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 Marmitte&Scodelle SpA (M&S) 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 € 50 million (the company wants to raise money for the same amount). A credit rating agency issued the rating for the debt (BB). The risk free interest rate on the market is equal to 0.7%. Compute: 1. The annual coupon that the company should pay (see the Table for spread values) 2. The duration of the bond 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 Assume that after the issuance, 4 months later, the risk free rate on the market goes up to 1.2% while the.bond rating is the same as before. Compute: 5. The theoretical clean and dirty prices of the bond on the market 6. The yield to maturity (YTM) Exercise 2 Francesco is planning to start an entrepreneurial activity in the healthcare business, in Dallas. The initial investment in R&D activity and equipment is equal to $ 1 million. Operating cash flows, gross of takes, are as follows: $ - 0.5 million (time 1), $ 1 million (time 2), $ 3 million (time 3), $ 2 million (time 4). The corporate tax rate on operating cash flows in Texas is equal to 18%. The unlevered cost of equity capital for this risky project is equal to 20%. Compute: 1. The net present value of the project in the base case (financed only with equity capital) 2. The net present value if the project is financed a time 0 also with a bank loan ($ 0.6 million, to be paid back at time 4; annual interest rate on debt 8%) 3. The net present value if the project is financed a time 0 also with a bank loan ($ 0.75 million, to be paid back at time 1 (25% of the principal), time 2 (another 25%), time 3 (25%), time 4(25%); annual interest rate on debt 8%) 4. The net present value if the project is financed a time 0 also with a bank loan, annual interest rate 8% (Francesco wants to keep each year the ratio L between the debt outstanding and the value of the project equal to 60%); compute the debt to borrow at time 0 and the cost of capital for shareholders 5. The net present value in the case that at time 0 the initial investment is financed by shareholders and by a loan from the Texas State under the Lonely Star Programme (loan equal to $ 0.5 million, no interest rate, to be paid back at time 2); compute the expected profitability for shareholders in this case 6. The net present value if the project is financed a time 0 also with a mezzanine loan ($ 0.45 million, annual interest rate 10%); in mezzanine debt contracts the principal is paid back at time 4, and interests due each year are compounded and paid at time 4, as well) Exercise 3 A real estate investment fund is considering to buy a property in Arcore. The value of the property today on the market is equal to € 50 million. The value at time 2 years, according to the fund managers, can be equal to: (i) € 60 million, if the real estate market will recover from the recent crisis, (ii) € 48 million, on the contrary. The risk free interest rate on the market is equal to 0.5%. The target return for the fund’s investments is equal to 10%. Compute: 1. The value of a European call option on the property (time to maturity 2 years, strike price € 55 million) 2. The value of a European put option (same parameters) 3. The value of a forward contract (time to delivery 2 years, delivery price € 55 million); is it possible to compute the value of this contract, if the time to delivery was 1 year? 4. In the case that the property generates revenues for the owner (rents net of costs and taxes) each year equal to € 1 million, describe if the values of the contracts determined before will be larger or lower (and why) 5. Demonstrate that the value of the European put option (Question 2.) cannot be lower than € 4 million The investment fund is willing to hedge against the risk of the property value going down on the market. Describe alternatives, benefits and costs, of different hedging strategies. Academic year 2017-2018 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 – July 23 rd 2018 Table: Rating and Bond spreads AAA - AA +0.9% A +1.2% BBB +1.7% BB +2.4% B +3.3% CCC +5.0%