Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 (10,5 points) The equity capital of Melting company is composed by 40 million shares. The market value of the company assets is equal to € 200 million, while the outstanding financial debt is valued € 40 million (annual interest rate on debt equal to 6%). Expectations about the operating margin (revenues net of cash costs) in the short-run are as follows: year 1 = € 20 million; year 2 = € 25 million; year 3 = € 23 million. All the profits will be distributed as dividends. In the following years (after year 3), we expect that net profits will grow up by 5% each year, compared to the year before. The tax rate on corporate income is equal to 27%. Determine: 1) The market value of the shares 2) The expected net profits in the next 4 years (assuming that the value of debt will be constant) 3) The cost of capital for shareholders, implicit in the market valuation (also assuming that the value of debt will be constant) 4) The value of the company if the existing assets were financed only with equity capital (introduce detailed proper assumptions) 5) The ‘unlevered’ cost of capital for the company, if it was financed only with equity capital Suddenly, the management announces that the financial strategies of the company will change: indeed, the value of the debt will be ‘adjusted (starting from time 1) each year, with the objective to keep constant the ratio L between value of the debt and value of the assets. Should we expect a change in the assets value? A positive or negative variation? Why? Exercise 2 (10 points) Financial analysts are studying two companies, selling electric cars. Their debt is very low. The following table summarizes expectations about the two companies: Company Dividend per share just distributed Expected future profitability ROE (net profit / equity book value ) Payout ratio Current equity book value per share Trusla $ 0 .15 16% 70% for two years , then 80% $ 1 .8 BYOD $ 0 .12 20% for the next three years, then 13 % 60% $ 1 .1 Assuming that in the industry the annual cost of equity capital is equal to 12%, compute for each of the two shares: 1. The expected earnings per share, EPS, for the next 5 years; 2. The expected dividends for the next 5 years; 3. The theoretical equilibrium price of the shares, today; 4. The present value of growth opportunity (PVGO). If suddenly the cost of equity capital in the business grew up, due to rising interest rates, with no changes in the expectations reported in the table, which of the two stocks should be more penalized, relatively to the market value today? Why? Exercise 3 (10,5 points) The shortage of raw materials is hitting the construction and real estate business. Nevertheless, the company Italics invested in a new project, related to the construction of apartments for young families in a former industrial area. The value of the project today is equal to € 20 million. After two years, the value of the project could be € 35 million (in the case that the shortage crisis is over) or € 7 million (if the business will still suffer). The annual rate of return of risk-free bonds is equal to 1.5%, while the cost of Italics’ equity capital is equal to 13%. Compute: 1. The value of a forward contract, delivery 2 years, for the sale of the project at the predetermined price of € 30 million 2. The value of a European put option on the project, time to maturity 2 years, strike price € 10 million 3. The value of the corresponding European call option 4. The changes in the answer given to 1. assuming that the management of the project requires annual costs for insurance and operations equal to € 500,000 In order to finance the project, 3 months ago Italics issued bonds subscribed by institutional investors. Here is some information about the issuance: - Number of bonds issued: 100 - Par value of each bond: € 50,000 (paid back at maturity) - Issue price: 99 - Clean price of the bonds on the market today: 98,23 - Annual coupon: 4% paid annually - Maturity: 3 years after the issuance Compute: 5. The amounts of money raised at the issuance 6. The dirty price of the bonds today 7. The yield to maturity and the duration today 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 – July 11th 20 22