Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 The market value of the assets of a 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 5%). The operating margin of the company (i.e. revenues net of operating costs) is equal to € 6 million each year, on average. The e quity 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 capit al; 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 rais e new debt, for a further amount equal to € 19 million (at the same cost, 5%). The capital raised will be invested in new projects, this increasing the expected value of the annual operating margin, to € 8 million. Determin e: 5. the new value of the company a nnual 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 determine s 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 th e 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 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 t o 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 Paolo is a famous entrepreneur in Monza; he is considering to start producing masks and gloves. The initial investment required to build the manufacturing plant is equal to € 450,000. The following cash flows, gross of taxes, are expected in the future: first year € 80,000; second year € 120,000; third year € 480,000; fourth year € 280,000. The tax rate to be applied to cash flows is equal to 26%. The cost of capital (unlevered) is equal to 12%. Paolo is considering four different opportunities to finance the project: 1. Equity capital only 2. Equity and debt (loan € 200,000 to be paid back in 4 years, i.e. € 50,000 must be paid back each year; annual interest rate 5%) 3. Equity and debt (loan with leverage L=debt to value of the project equal to 60% each year; annual inte rest rate 5%) 4. Equity and grant from the European Union; € 100,000 are granted as a contribution (not to be paid back) and € 100,000 are granted as a subsidized loan (must be paid back at time 4 but no interests are paid) Compute the net present value of the project under the four alternatives. Compute the expected profitability for shareholders under the four alternatives. 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 – September 9th 20 20