Solve all problems showing procedures and formulas
BFIN3211 Final Spring 2019 Final Exam Due Date: May 14th, Tuesday (11:59pm by email) Final Homework Assignment BFIN3211 Financial Strategy Name: ___________________ Student ID: _______________ This take-home exam is due at 11:59pm on May 14th, Tuesday. You should email your final answer to the professor’s email address (Hongfei.tang@shu.edu) before this due time. You are not allowed to discuss with any other person in any way on this exam. Any kind of academic dishonesty will lead to an “F” grade in this course and will be reported to the Dean’s office. The dishonesty includes, but not limited to, copying, sharing, or obtaining information from sources without proper citation, attempting to take credit for work that is not one’s own, falsification of information, and giving or receiving information about this exam to any other person than yourself. Good luck! Part A: Questions 1-5 are short essay questions. Each question is assigned 3 points. The answer to each question generally should not be more than one page with single-spaced Time New Roman Font 12. 1. Discuss Modigliani and Miller's Propositions I and II in a perfect world without taxes nor distress costs. List the basic assumptions, results, and intuition of the model. Based on this model, if the original unlevered firm value is $10 million and the CFO is planning to carry out a leveraged recapitalization to a debt equity ratio of 1:2. What’s the levered firm value? If the unlevered equity requires 12% annual return and the debt requires a 4% of annual return, what’s the required return for the levered equity? 2. Discuss Modigliani and Miller's Propositions I in a world with corporate tax but no other market frictions nor distress costs. List the basic assumptions, results, and intuition of the model. Based on this model, if the original unlevered firm value is $100 million, the corporate tax rate is 20%, and the CFO is planning to carry out a leveraged recapitalization to add a permanent debt of $60 million. The interest rate for the debt is 3% for the coming year. The unlevered equity requires 15% annual return. What’s the levered firm value? What’s the value of levered equity? 3. List the factors that might influence a firm’s choice of capital structure in the real life and explain how each factor affects the optimal leverage ratio in the context of tradeoff theory. 4. Explain how to estimate the cost of capital. In particular, explain how to estimate the equity cost of capital, list two different methods to estimate the debt cost of capital, and how to calculate the weighted average cost of capital for a given debt-equity ratio. 5. Out of the choices of cash dividend, stock dividend, stock repurchase, and interest payment, which are the payout policies to pay cash out to shareholders? Explain the implications of cash dividend, stock dividend, and open market stock repurchase to the stock price, existing shareholder portfolio value, in a perfect world without taxes. Part B. This question is assigned 15 points and requires your detailed calculation. Please write the equations and the additional assumption(s) if there is any. You should also email the professor your excel file for this question. Your answer should not be more than 6 pages. In this question, you are working for Peter & Emily Partners (PE) to decide whether it is worthwhile to purchase a private firm, Young LLC. Young LLC produces a type of communicating watch with its own apps. The following table shows the financial information for Young LLC. 2019 Income Statement and Balance Sheet Data for the Potential Target Year 2019 Year 2019 Income Statement ($000) Balance Sheet ($ 000) 1 Sales 10,000 Assets 2 Cost of Goods Sold 1 Cash and Equivalents 5,000 3 Raw Materials (1,600) 2 Accounts Receivable 4,000 4 Direct Labor Costs (1,800) 3 Inventories 2,500 5 Gross Profit 6,600 4 Total Current Assets 11,500 6 Sales and Marketing (1,500) 5 Property, Plant, and Equipment 3,000 7 Administrative (1,900) 6 Goodwill --- 8 EBITDA 3,200 7 Total Assets 14,500 9 Depreciation (600) Liabilities and Stockholder's Equity 10 EBIT 2,600 8 Accounts Payable 1,000 11 Interest Expense (net) (50) 9 Debt 1,000 12 Pretax Income 2,550 10 Total Liabilities 2,000 13 Income Tax (536) 11 Stockholder's Equity 12,500 14 Net Income 2,015 12 Total Liabilities and Equity 14,500 Young LLC has excess cash of $3.5 million. Based on its business, the comparable companies are Microsoft Corporation (MSFT), Alphabet Inc. (GOOGL), and Apple Inc. (AAPL), which have financial data on finance.yahoo.com and Bloomberg terminals in the Trading Room. The owner of Young is willing to accept a price based on the average of equity prices estimated using P/E, Enterprise Value/Sales, and Enterprise Value/EBITDA ratios for each of the comparable firm. Based on your analysis, what acquisition price will you propose to pay for the owner (the equity holder)? Valuation Ratios of Comparable Firms Multiple MSFT GOOGL AAPL P/E 27.87 29.57 17.07 EV/Sales 7.66 5.10 3.84 EV/EBITDA 18.07 17.19 12.82 Your manager wants to know how much money can PE make after buying the firm. You are given the following assumptions (if you need any other assumptions, please list them explicitly in your answer): 1. Market size for this type of watch is 1 million units in current year and is expected to grow at the rate of 8% per year in the coming five years; 2. Market share of Young is 10%. With some sales and marketing strategies, the market share can be increased by 300 basis points per year for the coming 5 years. That is, the market share next year will be 13%. 3. The average sales price is $100/unit in current year and is expected to grow at the rate of 2% per year. 4. The raw materials cost $16/unit in current year and is expected to grow at the rate of 4% in the coming 5 years. 5. The direct labor costs are $18/unit in current year and is expected to grow by 5% per year in the coming 5 years. 6. The sales and marketing costs account for 15% of the sales in current year. To increase the sales, PE plans to increase these costs to 16% in the next year and 17% in the year after next. After that, the costs will be 18% of the sales every year. 7. The administrative costs are 19% of sales in current year. PE plans to decrease them to 17% of sales in the next year, and 15% of sales from the year after next on. 8. The tax rate is 21% for current year. It is expected to be at this level for the coming years. 9. The depreciation expense equals 20% of Property, Plant and Equipment of the previous year. 10. The Capital expenditure equals the depreciation cost. 11. Your manager wants you to use the discounted cash flow approach to estimate the continuation value. 12. The unlevered cost of equity is 9%. To improve the operational efficiency, PE hopes to reach the following goals from the next year on: the accounts receivable will be 45 days of sales revenue, the raw materials will have 20 days of inventory, the finished goods will have 30 days of inventory; the minimum cash balance will be 30 days of sales. The wage payable will be 15 days of labor costs (including both the direct labor cost and administrative costs) and other account payable will be 60 days of raw materials and sales & marketing costs. To increase the firm value, PE wants to increase the debt level so that the interest expense for every year equals 50% of the EBIT of year 2019 for the coming 5 years. The interest rate for the safe debt is 5% per year. After five years, the acquired firm is expected to be sold as an unlevered firm at a price valued based on the perpetual free cash flows growing at 3% per year rate forever. Based on these assumptions, what is the NPV of acquiring Young LLC.? What’s the IRR for the investment? What’s the Cash multiple to the PE firm’s investment? Final Exam: due at 11:59pm on May 14th, Tuesday Page 2 of 2 -End- Page 2 of 2 Final Exam: due at 11:59pm on May 14th, Tuesday Page 1 of 2 Final Ho mework Assignment BFIN3211 Financial Strategy Name: ___________________ Student ID: _______________ This take - home exam is due at 11:59pm on May 14 th , Tuesday. You should email your final answer to the professor’s email address (Hongfei.tang@shu.edu) before this due time. You are not allowed to discuss with any other person in any way on this exam. Any kind of academic dishonesty will lead to an “F” grade in this course and will be reported to the Dean’s office. The dishonesty in cludes, but not limited to, copying, sharing, or obtaining information from sources without proper citation, attempting to take credit for work that is not one’s own, falsification of information, and giving or receiving information about this exam to any other person than yourself. Good luck! Part A: Questions 1 - 5 are short essay questions. Each question is assigned 3 points. The answer to each question generally should not be more than one page with single - spaced Time New Roman Font 12. 1. Discuss Modigli ani and Miller's Propositions I and II in a perfect world without taxes nor distress costs. List the basic assumptions, results, and intuition of the model. Based on this model, if the original unlevered firm value is $10 million and the CFO is planning to carry out a leveraged recapitalization to a debt equity ratio of 1:2. What’s the levered firm value? If the unlevered equity requires 12% annual return and the debt requires a 4% of annual return, what’s the required return for the levered equity? Final Exam: due at 11:59pm on May 14th, Tuesday Page 1 of 2 Final Homework Assignment BFIN3211 Financial Strategy Name: ___________________ Student ID: _______________ This take-home exam is due at 11:59pm on May 14 th , Tuesday. You should email