Corporate Finance: Final Exam, Study notes of Corporate Finance

Download Corporate Finance: Final Exam and more Study notes Corporate Finance in PDF only on Docsity! Final Spring 2014 Name: 1 Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate that you are using (not just the PV). 1. Alliant Technology is a publicly traded company that sells both computer hardware and services. It has no debt outstanding or cash. In the most recent year, the company reported the following information about its two businesses:     Sector  Averages   Business   Revenues  (in  $   millions)   Enterprise   Value/Sales   Unlevered   Beta   Computer  hardware   $1,000   0.80   1.25   Computer  services   $600   2.00   0.9   The company also provides the breakdown of revenues geographically: Country   Risk  free  rate  In  local   currency   Equity  Risk   Premium   Marginal   tax  rate   Total  Revenues  (in  $   millions)   United   States   3.00%  (US  $)   5.00%   40%   $800.00   China   4.00%  (Yuan)   7.00%   25%   $800.00   Both countries have the same mix of hardware & service businesses. a. Estimate the cost of equity in US dollars for Alliant Technology (2 points) b. Now assume that Alliant wants to sell just its hardware business in the United States at fair value (based on the EV/Sales ratio for the sector) in the United States, borrow an additional $400 million in the US and invest the total amount in computer services in China. Estimate the cost of equity in US $ for Alliant after the transaction. (3 points) 2. Hillsdale Media is a specialty kitchen cabinet maker that produces cabinets to order. It is a mature business that earned EBITDA of $900,000 on revenues of $ 5 million in the most recent year and is expected to continue to generate these figures in perpetuity. The company is considering carrying some of its most popular models in inventory, with an eye on increasing sales and operating profits. It has collected the following information: • To carry inventory, the company will have to invest $2.25 million in a storage facility, which will be depreciated straight line over ten years down to a salvage value of $250,000. • With the inventory, the company expects its annual revenues to increase to $7.5 million and its overall EBITDA margin (EBITDA as % of sales) to increase to 20%. • For the next decade, the inventory will be maintained at 10% of total revenues, with the investment made at the start of each year. The inventory will be sold for book value at the end of ten years. • The cost of capital for the company is 10% and it faces a 40% tax rate. Final Spring 2014 Name: 2 a. Estimate the NPV of the project (carrying inventory) assuming at ten-year life for the investment. (4 points) b. Estimate the breakeven EBITDA margin for the company, for the investment to have a zero NPV, if you now assume that the project lasts forever. (2 points) 3. Voltaire Steel is a highly levered company with 20 million shares, trading at $10/share and $800 million in debt (in market and book value terms) outstanding. The pre-tax cost of debt for the company is 10%, the marginal tax rate is 40% and the levered beta for the company is 3.06. The risk free rate is 3% and the equity risk premium is 5%. a. Estimate the cost of capital for the company. (1 point) b. A bondholder in the firm is willing to accept 20 million newly issued shares in the company in exchange for $200 million in debt (which will be retired). This transaction will raise the company’s bond rating to BBB and lower their pre-tax cost of debt to 7.5%. Estimate the new cost of capital, if you go through with the swap. (2 points) c. Assuming that you go through with the swap of equity for debt (from part b), estimate the value per share after the transaction. (You can assume that the firm is in perpetual growth, growing 2% a year forever) ( 3 points) 4. You have been asked to assess the dividend policy of Gallows Inc., a funeral home company that was started as a business on January 1, 2011. You have been provided with the information from its operating history:     2011   2012   2013   Revenues   $1,000   $1,100   $1,200   Net  Income   $100   $110   $120   Depreciation   $40   $45   $50   Cap  Ex   $50   $60   $70   Non-­‐cash  Working  capital   (End  of  year)   $10   $30   $60   Total  Debt  (End  of  year)   $10   $15   $75   Dividend  payout  ratio   0%   40%   50%   a. Assuming that the company started operations on January 1, 2011, with no cash and no debt, how much cash did the company have at the end of each year from 2011 to 2013. (3 points) b. Now assume that the company plans to double its non-cash working capital as a percent of revenues and believes that doing so will allow it to grow revenues 20% a year for the next three years, while maintaining the net margin and payout ratio it had in the most recent year. If capital expenditures and depreciation are expected to grow 10% a year and the company intends to repay its existing debt in three equal annual installments, estimate the cash balance three years from now. (You can assume that you are at the start of 2014) (3 points)