Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 MagPie (MP) is a company financed with equity capital only. There are 30 million shares outstanding and the price of each share on the market is equal to € 2. The annual operating margin of the company on average is equal to € 10 million and the corporate tax rate is equal to 25%. Compute: 1) The market value of the company assets 2) The annual EPS (earning per share) and the return k E offered to shareholders Skata (SK) is another company very similar to MP: same revenues, same operating costs, same physical assets. The only differences are: (a) the company is financed also with debt (€ 10 million, annual interest rate 3%, the amount is kept constant in the future) and (b) the number of shares outstanding is equal to 50 million. Compute: 3) The market value of SK assets (properly specify the assumptions) and the market value of the equity capital 4) The equilibrium market price of the shares, the annual EPS and the return k E offered to shareholders 5) The weighted average cost of capital (WACC) for SK company 6) The optimal financial structure of company SK and the equity value if we consider that there are costs of financial distress and agency costs related to debt, in € million, equal in present value to 0.004*D 3 where D is the value of the debt in € million (e.g. if the debt is € 2 million the costs are € 0.032 million) Exercise 2 Elster Inc. wants to raise money on the market. The company is rated BBB by the top rating agencies. The interest rate structure and the average credit spreads are reported below. Two different types of bonds will be issued on the market: A) Annual coupon 2%, paid annually, maturity 4 years B) Annual coupon 1.5%, paid annually, maturity 3 years Term structure of interest rates (risk-free) Requested spread for rating notches AAA - AA 0.2% A 0.7% BBB 1.1% BB 1.5% B 2.5% CCC 4.1% 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 Months Compute: 1) The equilibrium issue price, the duration, the expected volatility of the two bonds Four months later, the clean price of the bonds on the market is equal to 99.847 (bond A) and 98.843 (bond B). Compute: 2) The accrual and the dirty price of the two bonds in that moment 3) The yield to maturity (YTM) of the two bonds in that moment 4) The value of forward contracts (in that moment) to buy (or sell) bond A, delivery price 100, time to delivery 6 months after that moment (assume risk free rate r f in that moment is equal to 0% on short maturities) 5) The value of the same forward contracts but with time to delivery 12 months after that moment (assume r f = 0%) 6) If we can create an arbitrage in the situation that someone is offering to you the opportunity to access to one of the forward contracts described in points #4 and #5 at different conditions (e.g. for free) Exercise 3 Urraca SA is considered an interesting company by analysts. Expectations are as follows: Year 1 Year 2 Year 3 Year 4 and thereafter Return on equity (ROE) ROE=26% ROE=24% ROE=22% ROE LT=20% Payout ratio (PR) PR= 30% PR=40% PR=50% PR LT=70% The return on equity is the ratio between the net profit during the year and the book value of the equity capital at the beginning of the year. The company is not levered and for sake of simplicity there are no taxes on corporate income. The equity capital is made up by 80 million shares and the book value per share is today 0.2 €. Yesterday a dividend equal to € 0.01 has been paid. The annual cost of equity capital k E is equal to 14%. Find: 1. The expected dividends from time 1 to time 4 (and the growth rate in the long run) 2. The theoretical market value of the shares and the present value of growth opportunity (PVGO) 3. The theoretical M/B (market/book) and P/E (price/earnings) ratios today 4. The best prediction that we can obtain from the information above, about the total market value of the equity capital of the company expected at time 4 Evelyne agrees with the analysts’ estimations, with one exception. She thinks that ROE LT will be different and in fact she evaluates the shares € 0.348. What is the long run return on equity expected by her? Academic year 20 21-20 22 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 – January 24 th 20 22 0,6% 0,5% 0,4% 0,3% 0,2% 0,1% 0 -0,1%