Questions will be posted live at the time of the assessment. Scheduled for 15 February @ 9am PST
Question 1 (8 marks) Question 1 (8 marks) You have just been hired by HTC. The company R&D has found a new, revolutionary concept of ‘super-smartphone’. The study leading to this new approach has cost 6 million euros. To implement this new phone HTC needs to spend 50 million euros on a new plant. The plant is linearly depreciated over 6 years. At the end of this 5 years project, the remaining assets will be “sold” at a market value expected to be 10 million euros. The capital gains tax rate is of 35%. The company expects to be able to sell 90000 phones for 500€ each during the first year. The sales are forecasted to grow by 5% every year. Fixed costs will be 12 million euros a year; variable costs are 45% of the price (depreciation excluded). The working capital requirements will be 1 month of turnover. Knowing that the tax rate is 30% and the cost of HTC’s capital was evaluated to be 7%, should the project be undertaken? Justify your recommendation to the board in non technical terms, using a) The net present value b) The payback period c) The internal rate of return. Question 2 (4 marks) Considering the following net dividends expected by the analysts of company M: Y1 Y2 Y3 Y4 33 24 29 31 You expect the dividend to grow after that, forever, at 2.5% a year. Knowing that the cost of equity of M is estimated at 10%, what should be the price of its stock? You believe that the price should be 400€ and that only the first dividend forecasted (33€ in year one) has meaning. What growth rate do you expect for the dividends? Question 3 (3 marks) An analyst explains to you that since your company has a beta of 1.5 and the market price of risk is estimated to be 6%, your stock should have an average yearly return of 13%. What model is he using, and what are the values of the parameters he/she does not speak about? Question 4 (2 marks) List the main methods for appraising an investment project and explain how they relate to each other and why some are preferred. Question 5 (2 marks) Explain why firms frequently try to obtain their financing from markets and list the main forms of such financings. Question 6 (1 mark) If a given bond has a coupon rate of 5% and is emitted at a price of $1012 when its face value is $1000, is the actuarial rate of bonds of similar risks higher or lower than 5%? 1 Corporate Finance MIB 2016-2017 I. Investment decisions 1) The historical average return on US T-bills is 3.8% per year, while the average return for small company shares is 16.9% per year. Assuming these rates occur annually in the future, how much more cash would you have in 20 years by investing $50,000 in small company shares rather than T-bills? 2) Your daughter is currently 8 years old. You anticipate that she will be going to university in 10 years. You would like to have £100,000 in a saving account at that time. If the account promises to pay a fixed interest rate of 3% per year, how much money do you need to put into the account today to ensure that you will have £100,000 in 10 years? 3) You own a gold mining company and are considering opening a new mine. The mine is expected to generate $10 million for the next 21 years. After 21 years, the gold is expected to be depleted but the site can be sold for an expected $20 million. If the cost of capital is 8%, what is the most you should invest to open the mining operation at time 0? 4) You are considering opening a new hotel. The hotel will cost £150 million upfront and will be built immediately. It is expected to produce profits of £20 million every year forever. Calculate the NPV of this investment opportunity if your cost of capital is 10%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. 5) The Professional Golfers’ Association (PGA) is considering developing a new PGA-branded golf ball. Development will take 3 years at a cost of $250,000 per year. Once in production, the ball is expected to make $250,000 per year for 5 years at which time new technology will make it obsolete. The cost of capital is 10%. Calculate the NPV of this investment opportunity. Should the PGA make the investment? 6) Your firm owns a Volkswagen dealership, and you are considering entering into a 5-year agreement to also sell Audi A4s. The car would cost $26,000 and you believe that you can sell 50 Audis per year at an average price of $30,000. You would have to hire 2 new sales people that you would pay $30,000 per year each year plus 5% of the revenue they generate. Audi would require that you invest $200,000 (depreciable straight line over 5 years) in Audi- related signage, equipment and furniture to place in your dealership. You would also be required to invest in 20 cars to keep in inventory over the life of the project. After 5 years, you can recover your investment in working capital, and the unneeded equipment would have a market value of $50,000 (assuming no tax is applied on this sale). Your firm requires a 12% return on all new investments and the tax rate is 40%. Should you accept the project? 7) You have been offered a unique investment opportunity. If you invest $10,000 today, you will receive $500 one year from now, $1,500 two years from now, and $10,000 ten years from now. a. What is the NPV of the opportunity if the interest rate is 6% per year? Should you take the opportunity? b. What is the NPV of the opportunity if the interest rate is 2% per year? Should you take the opportunity? 2 8) The TinTin Company is considering opening a tin mine. The initial investment will cost £10 million. The profits from the mine will be £3 million per year for eight years. The company will have to provide environmental measures to the nearby communities and they will cost £12,000 per year forever. What is the NPV of this investment if the cost of capital is 5%? Should the firm undertake the project? 9) You are deciding between two mutually exclusive projects. The first project, codenamed Alphaville, will generate $2 million a year (starting at the end of the first year) in perpetuity. The second project, Betapod, will generate $1.5 million at the end of the first year and the profit will grow at 2 percent per year for every year after that. The first project costs $10 million while the second $9 million. Which investment would you pick if the cost of capital is 8% and why? 10) Your friend has invented a money machine. The main drawback of the machine is that it is slow. In fact, it is so slow that it takes one year to manufacture €100. However, once built, the machine will last forever and will require no maintenance. The machine can be built immediately, but it will cost €1,000 to build. Your friend wants to know if he should invest the money to construct it. a. If the discount rate is 9.5 per cent per year, what should your friend do? b. How would your answer change if the machine takes one year to build? 1 II. Financing Decisions 1) What rate of return should be required on the Aventis share, which has a β of 0.7, if Pinault Printemps Redoute share, which has a β of 1.1, returns 10% and is correctly valued, and the rate of risk-free asset is 5%? 2) The government bond rate is 5% and the market portfolio return is expected to be 13%. a. What is the market risk premium? b. What is the required rate of return on an investment which has a beta of 1.6? c. If the expected return on BMW AG is 17%, what is its beta? d. If an investment with a beta of 1.8 was expected to give a return of 19%, what can you conclude about this investment? 3) Suppose the risk-free return is 4% and the market portfolio has an expected return of 10% and a volatility of 16%. Vivant SA share has a 20% volatility and a correlation with the market of 0.06. a. What is Vivant’s beta with respect to the market? b. Under the CAPM assumption, what is its expected return? 4) Suppose Intel share has a beta of 2.16, whereas Boeing share has a beta of 0.69. If the risk-free interest rate is 4% and the expected return of the market portfolio is 10%, what is the expected return of a portfolio that consist of 60% Intel share and 40% Boeing share, according to the CAPM? 5) Xian Electronics has issued a 7-year bond with a 9 percent coupon. The bond offered a yield to maturity of 8 percent. The face value of the bond is $1,230. a. What interest payments do bondholders receive each year? b. At what price should the bond be sold, assuming annual interest payment? c. What will happen to the bond price if the yield to maturity falls to 7%? Will it go up, go down or remain the same? 6) Keema Corporation will pay a dividend of €0.65 one year from now. Analysis suggests that this dividend will grow at 12% per year thereafter until the fifth year. Then, the growth will level off at 2% per year. What is the value of a share of Keema Corporation if the cost of capital is 8%? 7) The shares of a company quote $150, and its next dividend should be $12. What is the cost of its equity, if a) the forecasted dividends are constant and b) the forecasted dividends increase by 5% per year? 8) Given the risk level of Rohmer SA, the shareholders expect a return of 8%