Name:

CORPORATE FINANCE
Grade:
FINAL EXAM
Instructions:
 The exam is closed book, essential formulas are given in the formula sheet attached at
the end.
 You are permitted to use a financial calculator. The use of computers or mobile
phones is not allowed.
 Answer all questions and show all work (your calculations, not only answers, and
justify your answers when it is needed) on the exam paper.
 The exam uses real data from Sanofi SA throughout.

Sanofi SA (SAN.PA) is a European healthcare company. The following graph (from Sanofi’s
website) supposedly shows the performance of Sanofi’s stock (lower line) together with the
French stock market index CAC 40 (upper line). Cumulative
Return

CAC 40

SAN.PA

Figure 1: ST and CAC 40

Stock prices (in EUR) for SAN for November 2018 to November 2019

Closing
Date Price
01 Nov. 2019 81.57

31 Oct. 2018 78.84

Table 1: Stock prices in EUR

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Question 1
Sanofi paid a dividend of 3.07 Euros on May 9, 2019. The ex-dividend price on this day was
73,38. Use the close price given in Table 1 to calculate the stock’s return between the 31st of
October 2018 and the 9th of May 2019 including the dividend payment? What was the stock’s
return between the 9th of May 2019 and the 1st of November 2019?

(73,38+3,06)/ 78,84-1 =-0,030

81,57/73,38- 1 = 0,11

Question 2
Based on the answers to the previous question, can you calculate the annual return from 31st
of October 2018 to the 1st of November 2019 assuming dividends are reinvested? Please also
calculate the capital gains rate, i.e. the return without dividend. The stock return on top of
Figure 1 given by Sanofi’ website is 3.49%. Comparing it with your calculated returns, do
you think 3.49% is a good measure of the holding period return for an investor? Why?

Total period return = (1+(-0.03))(1+0,11)-1=7,78%

Capital gains = 81,57/78,84-1= 3,46%, i.e. the number given by Sanofi -
This number is almost meaningless as it is not closely related to the investor’s return

Question 3
In 2018, the hedge fund Bridgewater Associates has taken massive short positions in many
major European companies such as Sanofi. To do this the fund has borrowed and sold 2
million shares in Sanofi. Assume that the fund started this short position on the 31st of Oct
2018, how much money did the fund raise from selling the borrowed shares?

They will raise 2 million*78,84= 157,68million,

Question 4
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If the fund decides to invest all of the proceeds from the short selling plus its own capital of
78.84 million in the CAC 40 index, what is the portfolio weight of the short position (e.g.
position in Sanofi) and what is the weight of the long position (e.g. position in CAC 40)?

-157,68/78,84=-200%
The fund can invest (157,68+78,84)/ 78,84=300% of its own capital in the CAC 40.

Question 5
What is the return the fund realized on his own capital with this combination of long and short
positions if the CAC40 generated a return of 13,12% and Sanofi 7,8%? (To understand this
number, note that dividends corresponding to the borrowed shares need to be paid to the
lender of the shares)

-200%*7,8%+300%*13,12%=23%
Despite the fact that he has lost on the short position he has made money overall

Question 6
What is the volatility of Bridgewater’s portfolio described in the previous questions, i.e. a
combination of a short position in Sanofi and a long position in the CAC 40? Assume that
both the CAC 40 and Sanofi have a volatility of 15% and that the correlation coefficient of
both returns is 0.5. (Note that the formula for the volatility of a portfolio given at the end of
the exam also applies with the negative weights used to describe short positions.)

[(-200%)^2*15%^2+300%^2*15%^2+2*0,5*(-200%)*(300%)*15%*15%]^0.5=39%

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Question 7
Sanofi’s beta with respect to the French market index is 0,6. Risk free rates are close to 0%.
Given the definition of the beta, if the CAC 40 had crashed over the last year by 30%, how
much would you expect Sanofi to fall?

0,6*-30%=-18%

Question 8
You expect the long run annual return on the French market to be 7%. According to the
CAPM, what annual return should you expect on Sanofi stock over the long run? Risk free
rates can again be assumed to be 0%.

0% + 0,6*7=4,2%

Question 9
Some investors prefer to calculate stock betas with respect to an index of global equities such
as the MSCI world rather than with respect to a national index such as the CAC 40. Do you
think that this makes sense according to the underlying theory? Would you expect the beta of
Sanofi with respect to the MSCI world to be higher or lower than the beta with respect to the
CAC 40, given that both indices have roughly the same volatility? Please explain without
making any calculations.

Yes it makes sense given that the CAPM requires betas to be calculated to the largest possible market
portfolio, which does not only include French companies.
The beta with respect to the MSCI world should be lower because the correlation between Sanofi and
the MSCI should be lower than the correlation with the CAC 40.

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Question 10
Given that margins in the pharmaceutical industry are under threat, the market expects a long
run dividend growth rate of only 0.5%. Using the numbers calculated in Question 8 and the
last dividend of 3.07 Euros, what is the expected present value of future dividends for Sanofi?
You may simplify and assume that the next dividend is only paid in one year. Compare your
result to the current stock price and discuss.

3,07*(1+0,005)/(0,042-0,005)=83Euros –which is about the current stock price.

Question 11
Sanofi’s last bond issue on March 13, 2019 consisted in a sale of EUR 2 billion (i.e.
2,000,000,000) of notes rated at AA. The 10-year bond was priced at an annual interest rate
(yield to maturity) of 0.875%. Currently Sanofi's debt amounts to €24 billion, its market cap is
€ 104 billion. The company pays corporate taxes of 34,4 % in France. Please determine the
company’s tax adjusted WACC, using these numbers and the information from previous
questions.

24/(104+24)*0.875%*(1-0,34)+104/(104+24)*4,2%=3,5%

Question 12
An investment bank suggests that Sanofi should issue a convertible bond. According to the
bank, this would lower Sanofi’s cost of capital because the yield on a convertible bond is
lower than the yield on an otherwise identical bond without a conversion feature. Please
explain why the yield on a convertible bond is lower. Does this really reduce the company’s
cost of finance?

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Investors require a lower yield given that with some probability they will be able to realize a high
payoff in case the bond is concerted. However this conversion will be costly for shareholders as it will
dilute the value of the existing shares.

Question 13
At its 2018 shareholder meeting, shareholders voted a program allowing Sanofi to buy back
and cancel shares corresponding to up to 9,55% of its capital. Why do listed companies buy
back own shares, given that in a simple Modigliani Miller world, share buybacks should not
affect the share price? Please name at least two reasons for a share buyback!

Paying out excess liquidity

Optimizing capital structure
Tax advantages compared to dividend payments etc.
Freedom to spend the excess cash in in nearly total liberty, as opposite to the much more constraining
dividend commitments, which makes buybacks the preferred means of payout policy for them.
Because markets are not perfect decreasing the share count has frequently an artificial positive effect
on EPS and stock prices.

Question 14
Assume that Sanofi buys back and cancels 10% of its shares and finances these buybacks by
issuing additional debt. What will is Sanofi’s debt to equity (D/E) ratio before and after this
operation ?

Old leverage ratio: 24/104=0,23

New leverage ratio (24+10%*104)/(104-10%*104))=0,37

Question 15
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Please calculate Sanofi’s likely stock beta after the increase in leverage described in the
previous question by first un-levering and then re-levering the company’s current stock beta
of 0.6. You can assume that debt is risk free i.e. has a beta of 0 and that the company pays no
corporate taxes.

Old (1+(1-T)D/E)= (1+(1-0,34) (24/104))=1,15

New (1+(1-T)D/E) =(1+(1-0,34) (24+10%*104)/(104-10%*104))=1,24

Unlever 0,6/1,15=0,52
Relever 0,52*1,24=0,64

Question 16
Please calculate the company’s cost of equity and WACC with this new capital structure. The
cost of debt can be assumed to be unchanged.

%+ 0,64*7%=4,48%

34,4/128*0.875%*(1-0,34)+ 93,6*/128*4,48%=3,4%

Very small decrease in the already very low WACC

Question 17
Currently Sanofi has about $7 billion in cash on its balance sheet. Assuming perfect markets,
what should happen to the company’s stock price if this cash is paid out to shareholders as an
exceptional dividend? (Note: the company has 1.25 billion shares outstanding). What are the
advantages or disadvantages of dividends compared to share buybacks as a way of
distributing cash to shareholders?

The company would pay a 7/1,25=5,6 Euro dividend and stock prices would decrease by the same
amount. In perfect markets neither dividends nor buybacks affect shareholders wealth , but a share
buyback is typically perceived as a more positive signal and has a tax advantage compared to
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dividends. For some shareholders this is indeed true, particularly in countries where tax tares of
capital gains and dividends are different. For other shareholders, attracted to long-term income, a
constant rise in dividends is preferable.

Question 18
Large pharmaceutical companies such as Sanofi typically have low leverage ratios. Please
give at least one reason for why this is the case.

A lot of cash and therefore no need to take on leverage (pecking order theory) igh risk and high capex
because of very expensive patents (tradeoff theory)
The above is certainly true for established big pharma. Some of these would indeed be able to
leverage more. Smaller cos. And biotech firms might have a different setup.

Question 19
Assume that an investor holds 10.000 Sanofi shares that currently quote at €83 a share. He
wants to hedge potential losses of more than €7 per share until June 2020 using the derivatives
and prices from the following table:
Strike
Put Call
price
100.00 17.23 0.16
96.00 13.42 0.37
92.00 9.83 0.78
88.00 6.65 1.59
84.00 4.15 3.10
80.00 2.41 5.37
76.00 1.33 8.30
72.00 0.70 11.70
68.00 0.37 15.38
64.00 0.22 19.23
60.00 0.13 23.16
56.00 0.09 27.13

Table 2: Prices of Derivatives on Sanofi stock with maturity in June 2020. Each put or call allows its owner to
sell or buy one share. Source: Eurex

How many of which type of derivative with what strike price does he need to buy? Please
illustrate with a simple qualitative graph, the profit and loss profile for the investor as a function
of the price of Sanofi stock in June 2020. Do not forget to include the option premium and also
label the graph accordingly.

€83-

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 €7=76€, hence the investor needs to buy 10 000 put options at a price of 1.33€/ option. The long put
together with the stock produces the following payoff profile ( in red) -Long Put + Stock

Question 20
Assume that Sanofi shares quote at €90 at maturity of the option. Will the investor exercise the
option? What is the absolute value of the profit or loss that the investor realizes with the
combination of shares and derivatives and what is the return in percentage of his initial portfolio
value?

The option will not be exercised.

(€90-€83) * 10,000 - €1,33 * 10,000 = 56 700
The option price can be interpreted as insurance premium.

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Formula Sheet
1. Returns
 Return on dividend paying stock between t 1 and t 2 if dividend is paid at time t2 :
Pt  Divt 2
rt1 , t 2  2 1
Pt 1
 Return from time t 1 to time tn if dividends are paid at time t 2 , t3 , … t n1 assuming re-
investment of dividends: 1,
rt tn  r
1 , 2t t  r

1 2 , t3 t   r
1 ... 1 t, n
1 1
tn 
n
1
 Arithmetic average of returns: r arithmetic 
n
r i
i 1
1
 Geometric average (compound annual returnr geometric 

r1 1 
 r 2 1 ... r
n
1
  n 1
2. Risk




Volatility:  r 1 r arithmetic
 r
2
2 rarithmetic  2
 
... rn rarithmetic 
2

n1
 A Cov 
r A, rM 
 A, M A,M 
Var rM 
Beta:
M
3. Portfolio Theory
 Return  𝑟 of portfolio consisting of a percentage 𝑤of asset 1 and 1−𝑤 of asset 2 with returns

𝑟 and 𝑟 : rP  w1r1  1 w1 r2  

 Volatility 𝜎 of portfolio consisting of two assets with volatility 𝜎 and 𝜎, given a correlation
2 2 2 2
of 𝜌,: P  w1  w2 
1 2  2w 1 1w 2
21, 2
r A r f
 Sharpe ratio of an asset A: SA 
A
4. Corporate Finance
 Cost of debt if debt is risky rD expected return = contractual yield – expected loss rate
E D
rWACC re  rd  (1 
T) 
 Tax adjusted weighted average cost of capital: E D E D
 Relationship between levered and unlevered beta assuming T=0:
E D

unlevered
 levered debt
E D E D
 Relationship between levered and unlevered beta assuming T  0 but debt  0 :

levered unlevered 
 1 T D 
1  
 E
5. Risk Management
 Payoff function of a Call and Put at maturity: Call max 
0, Stockprice Strike 
Put  max0, Strike - Stockprice 

Put Call Parity:
Value Put  Underlying Asset  Preset Value Strike  Value Call

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