Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 Buffalo Brothers 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 € 20 million (the company wants to raise mone y for the same amount). A credit rating agency issued the rating for the debt (B BB). The risk free interest ra te on the market is equal to 0.2 %. Compute: 1. The annual coupon that the company should pay (see the Table for spread values ) 2. The duration of the bond at the issuance 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 Assuming that the tax rate on corporate income is 23%, compute: 5. The tax saving that Buffalo Brothers wi ll obtain each year 6. The present value of the financing (i.e. the present value of future tax savings) Now assume that Buffalo Brothers is introducing the option to reimburse the bond any time in the future, before maturity, at its own discretion. In order to raise the same amount of money at time 0, should the coupon be larger or lower? Exercise 2 Financial analysts just published their report about the future profitability of a company: Year 1 Year 2 Year 3 Thereafter ROE (*) 14% 12% 10% 10% Payout ratio 25% 40% 50% 60% (*) = ratio between annual earnings and book value of equity capital at the beginning of the year The book value of the equity capital of the company today is equal to € 60 million and is divided into 30 million shares. The earning per share of the last year was equal to € 0.3. The annual cost of capital is equal to 10%. The risk free rate is equal to 0.5%. Assuming that the company will not raise capital in the short run, compute: 1. The expected dividends in the short run (years 1 to 3) 2. The long -run growth rate of the dividends 3. The theoretical value of the shares on the market 4. The present value of the growth opportunity (PVGO) The CFO of the company is considering to increase the long -run payout ratio from 60% to 75%. Other things being equal, should this have a positive or negative impact on the share price today? Why? Exercise 3 The price of platinum is soaring . The value of the metal on the market now is $ 30,000 per kilo (+30% in one year) . The value at time 2 years, according to market experts , can be equal either to $ 37,000 per kilo or $ 26,000 per kilo . The risk free interest rate on the dollar market is equal to 0.5%. Compute: 1. The value of a forward contract (time to delivery 2 years , delivery price $ 35,000 per kilo) 2. The forward price of platinum on the market (delivery 1 year and 2 years) 3. The value of a Eu ropean call option on platinum (time to maturity 2 years, strike price $ 33,000 per kilo ) 4. The value of a European put option (same parameters) 5. Ho w do the answers to the previous question 2. change if we consider costs of carry (storage and insurance) equal to $ 10 0 per kilo per year Demonstrate that the value of an American call option (time to maturity 2 years, strike price $ 33,000 per kilo ) will be always equal to the value of the European call option (question n. 3) , today and in the future. Breitlex manufactures luxury watches and wants to hedge against the risk of the price of platinum on the market . Describe alternatives, benefits and costs, of different hedging strategies. Academic year 20 19-20 20 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 – February 10th 20 20 Table: Rating and Bond spreads AAA - AA +0.8% A +1.2% BBB +1.75% BB +2.5% B +3.2% CCC +4.3%