Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 (10 points) Leboni’s Inc. is financed by equity capital only. The current market value of the assets is equal to € 120 million while the accounting value of the assets is equal to € 40 million. The number of shares outstanding is equal to 80 million. The annual operating margin on average is equal to € 10 million. Assuming that there is no taxation on corporate income, compute: 1. The equilibrium market price of the shares 2. The earning per share and the expected market return for shareholders k E Now Leboni’s managers are willing to restructure the liabilities. They buy back a part of the equity capital (amount € 20 million) and borrow debt from a bank for the same amount (annual interest rate 5%). Compute: 3. The new equilibrium market price of the shares 4. The new earning per share and the new expected market return for shareholders k E 5. Show that Proposition II by Modigliani and Miller predicts the previous answer After the buyback, Mr. Alby buys on the market 100 shares of the levered company. Explain to him how he could replicate the same risk/return profile by investing into shares of Leboni’s company before the buyback and borrowing/investing in the company debt. Another investor, Mr. Cachi, after the buyback buys on the market 100 shares of the levered company and invests into the company debt for an amount equal to € 20. Compute the expected market return of the investment, and try to use Proposition II by Modigliani and Miller to predict the answer. Exercise 2 (10 points) Atlantis is an investment company involved in many business areas, including the management of some toll freeways. The equity capital is made up by 600 million shares and its accounting book value today is equal to € 2 billion. Analysts estimate the following figures for the future: Year 1 Year 2 Year 3 Following years ROE (*) 12% 10% 10% 8% Payout ratio 75% 80% 80% 90% (*) = ratio between earnings and book value of equity capital at the beginning of the year Assuming that the cost of capital for shareholders is equal to 8%, compute: 1. The expected dividends in the next 3 years and the long run growth rate of the dividends 2. The theoretical price of the shares on the market 3. The PVGO (present value of growth opportunity) Suddenly, a bridge on the freeway collapses and the Government announces that the license to manage the freeways will be revoked. This immediately changes the market expectations: Year 1 Year 2 Year 3 Following years ROE 12% 8% 8% 7% Payout ratio 75% 90% 90% 95% 4. Compute the expected change in the share price and in the PVGO The day after the Government changes opinion: the license will not be revoked but the company will be obliged to pay immediately € 200 million (not deductible from taxable income) in order to refund damages and restore the bridge. 5. How should the market react to this new announcement? Exercise 3 (10 points) The Turkish lira is falling and many engineering companies involved in infrastructure works in Turkey are worried. Astella won a contract to build an oil pipeline and in the past days operations started. The value of this project today is US$ 400 million. If the lira crisis will end, the value of this project at time 1 will be US$ 700 million, while if the crisis will be persistent the value of the project at time 1 will be U$ 200 million. The annual interest rate in Turkey is equal to 30%, while in the US is equal to 3%. Astella is considering some offerings to sell the project. To this extent, find: 1. The value of a call option on the project, maturity at time 1, strike price US$ 500 million 2. The value of a put option on the project, maturity at time 1, strike price US$ 300 million 3. The value of a forward contract on the project, time to delivery time 6 months, delivery price US$ 350 million The project is financed with equity capital only. Assuming that the cost of capital for shareholders k* is equal to 15% and the corporate tax rate is equal to 20%, find: 4. The weighted average cost of capital (WACC) if the company decided to finance 40% of the project value with debt (annual interest rate 6%) 5. The increase in the project value today, under the financing option described in 4. (according to the company expectations, the project will exhibit constant cash flows for the next 7 years) 6. The debt to be raised at the beginning, under the financing option described in 4. 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 – September 6 th 2018