S+8 4 dd. St 20 4 14 4 = 64-5 GROUPE HEC CYCLE MASTER 1st Year CORPORATE FINANCE Final Exam May 2018 Professors: Matthias EFING / Guillaume VUILLEMEY FIRST NAME: ABN FAMILY NAME: IN PCCOBON 15 pages 6 questions, 69 points in total Duration of the exam: 3 hours Answer the questions directly on this document in blue or black ink Do notusea Pencil Open book, calculator allowed No computer, no mobile phone allowed Keep your answers short and clearly mark your final answersConsider a company with 100m outstanding shares, a current stock price of EUR 10, and safe debt Wah amarket value of EURFIOOny The bookualue of the equity is EUR 500m, the book value ofthe debt is EUR 100m. The corporate tax rate but, otherwise, financial markets are perfect. @) What is the market value of the firm? (1 point) | Vgiem = Veauity+ Voebt= 400-40 + 400 4.4b eur EUR G00m )ind use this amount to repurchase some of its outstanding shares. The CEO fathe, after theese maintain the new debt level in the Tong run. Assume that the old debt remains safe after the recapitalization (probability of default = 0). The & rede 3 leveraged recapitalization. Specifically, the firm will issue bonds to borrow 5) After the recapitalization is complete, what is the company’s book value of ‘equity? What is the book value of assets? (2 points) AD= 500m # shares Repuncnasee = 50m Lh BVeauity = 500m- 500m =O BV yiem = BVassots = ——— we Scom op ©) Compute the present value of the interest tax shield created by the new debt. (2 point) TS: D-4 = 500m-02- 40cm d) Compute the market value of the firm after the recapitalization. (1 point) MVgiem= 4.46 + 40om 4.36 wy Lw. ole TS ©) Compute the market value of total debt (old and new) after the recapitalization, (1 point) Dm= 400m-+ 500m = 600m ;1) Compute the market value of equity after the recapitalization. (1 point) €= 4.2b-60om:600m 8) What is the market value of the equity between the announcement of the recapitalization and the actual implementation of the recapitalization? What is the stock price reaction to the announcement? (2 point) a Vgiram OURROUDY Reacts Ox Onnouncemens = dtl D= 400 = ddb. E-44b Ps coon” 22€ Pt by de h) How many shares does the company have to repurchase to payout the entire proceeds of ‘the debt issuance? (2 point) L # snares: en. 45.5m shares i) What is the stock price after the recapitalization is completed? As a shareholder of the company, should you take part in the repurchase and sell your shares back to the company ‘or should you keep your shares? (2 point) oe snares: 4COm- 455-54, Sm shares Pos @OM we OS 2. Shorenoipoa, x 54.5m Om inpiqjenenc uestion 2(5 Firm X has two divsions A and B and debt of 450. Division A hasan EBITDA of 10 whereas division 8 has an EBITDA of 20. a) What is the debt-to-EBITDA ratio of Firm Xx? (1 point) D: 450 D = 460 eenoa* 57 4541 EBITDA,= 40+ 20 = 30 30 a‘The CFO of Firm X wishes to sell either division A or division B repay part of the debt. Division A would be sold for a price fora price of 250. to use the proceeds of the sale to whereas division B would be sold 'b) Which of the two divisions A and B should be sold to minimize the debt-to-EBITDA ratio of Firm X? (2 points) WA p= 450-200:280 ema = 20 Yésmon” 42.5 ofS YB 0 450-250=200 eBiTDA=10 %egirpq= 20 A friend of yours claims: “To reduce the debt-to-EBITDA ratio, companies can simply sell some assets and use the proceeds to repay (part of) their debt.” ©) Is yourfriend’s statement generally correct or false? Explain why (two sentences maximum). (2point) By souing assers +0 Repay Debt, DV but «ee SRITDA DECREAKLS AS WOU AS AhE ASSEES WORE USED tO = Generaxce RO&vCnURS, This sraLEMENt IS Jouse < (A00king ax poine b3, che sour of B decreases 6RITDA so mucn to 4 P/eeitpa) a Question 3 (9 poi Company BadRun has assets that, depending on scenarios, will be worth EUR 1,000 or EUR 500 a year later with equal probability. The company has debt of EUR 700 coming due in a year. For simplicity, assume that there is no discounting (discount rate = 0 for all claims). Prob. Assets Good 50% 1000 Bad 50% 500 Elvalue] Ea a) What is the market value of the firm, the debt, and the equity? (2 point) Vain 7.4000 +500. 350 2 Voeet= G00 Veauivy = aso 7‘The company has the opportunity to invest into an asset that costs EUR 200 today and will return EUR 300 a year later but only in the “Good Scenario” in which the existing assets have a value of EUR b) Ifthe existing shareholders had to finance the initial investment cost out of their own pocket, would they invest? (1 point) \ & o 6 With ane picayect, ECVeanity becomes 2S 1300 300 G00 ‘ 0S S00 50 O oe << 200 300 c) The management is considering external financing. Specifically, they want to issue new junior debt to raise the required EUR 200 for the investment. Is this operation in the interest of the existing creditors? What is the new market value of. ‘equity? (2 point) a Gq. & 5 go ¢& * Existing crecitors 0S 1200 400 8400 200 are inpijjorens since S00. 500 , Wert hOS NOtChANGeD os 2 O_O Cintne goon scenario Ahoy 600 30 400 WERE REpoiD OnyUoWy) * Vea@uity 40 400 d) How does your answer to question c) change if the new debt is senior to the existing debt? Again, compute the new market value of equity. (2 points) ZL a sp ob 6 + Existing ceenitoes 0. WO MUee CVDObE $ 1300 200 300 400 i piceo eee °S 500 200 300 0. snononowens won —— Oppicae as 200 — Veguuity 4 1 200) €) Which bankruptcy code is better at preventing shareholders and managers from taking ‘excessive risk (from overinvesting) at the expense of existing creditors: US Chapter 11 or UK Receivership? Explain why (maximum 2 sentences). (2 points) 2 UK Receivership is boxer as it ceesn't auLOWw Companies 40 issue SevioR Feb CSitUOION D, WNERE O& NeGotive NPV prcojectis JUnD2o, WOLLLDI' & happen). senior crepitoRs Nc nor managomens Cas in US Cn 44) In Crawnge, ONO AERIS QUDIDS OxcesSie RISK voucing. 5fog Ou 100 shares of Firm A which has 1000 outstanding shares in totl an The company has operating assets which will be econ EUR 2200 or EUR 1100 next’ year with equal 400 Question 4 (8 points} Probability. Furthermore, Firm A holds EUI ¥ cash in a bank account. For simplicity, assume that you and Firm A can lend and borrow cathat-gn interest rate of 10% and that the discount rate for valuing the operating assets of Firm A also equals 10%, 2) What isthe fair market value of the equity of Firm A? (1 points) Voporaring assers = (2200+ 4400 -4. = 4800 2 4a Vjiem= eed 4600 p:0 [&: 4€00) 4) ‘her borrow EUR 80 from a bank or you would sell some of Your shares to finance the purchase, ©) You call the CFO of Firm A, who is a good friend of yours, and ask her whether Firm A would lke to buy back some of your shares in retum for EUR ap, How many shares should the CFO ask for? How will the stock price change after the share buyback? (2 points) E= 4600 A =[50 ] ve shou ase re SO FShaRes= 4000 ra6 = (50) +e change” Pwon's be a1jeceen ; Vaiem= eee ae #SNORLS = 950 ©) What is your total wealth (value of your remat ) if you accept your ffiend’s offer? Should you accept the offer? (2 pe Wwiem= 4600-400 = 4500 . rae 4000 406-965 Ps= 4.56 AgtRR PePURCNasS in the end, the CEO of Firm A intervenes and forbids the share repurchase that you and the CFO had Prepared. Hence, Firm A will keep its cash of EUR 100 on the balance sheet and you borrow EUR 80 from a bank to buy the car.The next day, whi listening to the radio in your new car, you hear of Firm B which owns the same ith the same future values of EUR 2200 or EUR 1100) as Firm A. However, Firm B Chal Falco recast and, unlike the shares of Firm A, its 1000 outstanding shares donot wade at their fair stock-price But at EUR 1.4. 4) Remembering your training at HEC, you immediately spot the arbitrage opportunity. Explain Your arbitrage strategy and calculate its payoffs in year Oand in year 1. (3 point) The Jota P Jor B Snow Ee (E25 4 4.5-¥ Firm Bis unceeprig 2 a The StRoxeay is to buy AOSRORS 0) B, Short soUing 4O shares WRC nga Aonning, 4€. By tencing ano buying Yor Repo core dOShORESOY A bu you SPEND ds€. x JO4 Os Y=O 46-45-46 ano OW zhe CASHINZLOWS WILL CONCR OU A4tOR Below, you are given historical and forecast financial information {in EUR million) for Company X, a. Private company whose fiscal year ends on 31 December. In addition, you are provided with information on three publicly traded peers of Company X. Estimate the market value of Company X's Guitjas of 1 January 2017 4) using the average EV/EBITDA multiple derived from Company X's Peers (and Company X's EBITDA realized during the fiscal year 2016), ) using a DCF analysis based on the WACC method (with a terminal value based on a growing perpetuity). All assumptions of the CAPM hold. Corporate income taxes are the only relevant violation of the ‘Modigliani-Miller assumptions. Forecast values are expected values, Company X's cost of debt is Sava to the risk-free rate of 3%. The market risk premium is 5%. The corporate income tax rate is 20%. Company X maintains a target leverage ratio, D/(D+E), of 20% (now and in oll future years). arly, Company X's peers maintain constant debt-to-equity ratios, and the debt-betae ofall peers are zero. The market value of debt is equal to the book value for all firms. Company X's free cash flows (FCF) will grow at a rate of 2% per year in all years after the explicit forecast horizon (i.e., the free cash flows in 2019 will be 2% higher than the free cash flows in 2018 and so on...). Any cash Teported on the firms’ balance sheets is excess cash (i Comparable, publicly traded peers of Company X (Data as of FY 2016) ] eee a EBITDA ‘Shareprice Number of shares (in milion) Debt Cash EquityBeta/MC gy 4.82 [Companya a0 16 220 585 551.898 13520 4050 4.99 [companys 575 27 85 660 85 1943 |229S 2890 519 [Companyc 250 2 175 77 40 1325 [3649S 4440COMPANY X= INCOME STATEMENT eee 2357 rs as a) aaa coon 27029783. a9 ted eenses 5k sy ‘sig. gene ainsoe emer nie sion (a) as a Dereon naman Fo a ie ines nome leges) 2 ar a bem te 0 440 [Re eee COMPANY X- BALANCE SHEET Historical st Forecast 2016 2017 +2018 Cash and other liquid assets 661951 Accounts receivable 624 642+ 6554 Total current assets 1843 2,160 2,480 Property, plant, and equipment (net) 1247-1284 1,310) Goodwill and other intangible assets 125 128 131 Total non-currentassets 1372 1413 1441] Total assets 3215 3,572 3921] Historical Forecast 2016 2017 2018 Shor-Tem debt and current portion of long-term debt @) a a7 Accounts payable 946 9740 994 Total current liabilities 1,029 1060 1,084, 975.975 yeast Tong-term debt (75)Total non-current liabilities 975 ~—«978 975 ‘Shareholders’ equity 1,211 1,538 1,868] Total liabilities and equity 32158 3,572 3921 COMPANY X- CASH FLOW STATEMENT Historical Forecast 2016 2017 2018 Net income 303 ~—~—«327«327 Depreciation and amortization 201-274 283 Increase in inventories 34257 Increase in trade and other receivables m4 193 Increase in trade and other payables 26 0B 19 Net cash flows from operating activities 381586 600 Net purchase of intangible assets ua Net purchase of property, plant, and equipment 195 312308 "Net cash flows from investing activities 209 (6 au] Dividends paid ar) Share repurchases ° 0 0 Proceeds from issuing shares ° 0 0 Repayment of current financial debt 6 886 Proceeds from raising current financial debt 8 8687 Proceeds from raising long-term debt °o 0 0 Net cash flows from financing activities B22 [Net increase in cash and cash equivalents 188273290 Cash and cash equivalents at beginning oF period 200 388661 Cash and cash equivalents at end of period 388 661951 ee |a) (See sole pat) + GV= MC+D-C & @ 4050 & 2840 c 4440 4.82 se pverage “epitpg= 3 EBITPA X 2016 = 304 (9) €Vy = 30%. 5= 3535 Mc: 6V-D+C= 3635- (83+995)+398 = (2865 ioe NO) see page bejore _— Dog Bus Mare | ; 463 B as4 Cc 02 4.09 o see eiGar a 02 0.95 4 Ker 3+ 496-5 = 448/ WAL: /44,8%.+98 + 0,2+ (4-03 wo vw e % [ i aFCF 2014 2018 CBITCA4) 313.¢ 322 +Dep +244 +282 - Awc 45 do - CAPEK 316 = FCOF 260.8 284 WC = AR+t-ap 2016 509 2014524 2018 534 TVz01g = 284402 = BUY 32633,4¥ 2.0986 -0.02 “ 363332 EVroq > 2808 , 284+ pees” BARBRA, 3416.58 Boy 40036 4,0086° Sune = BARON. 0c. aa TET] @ 1Question 6 (13 points XB Corporation (XBC), a furniture manufacturer, is re-evaluating its capital structure. Currently, the balance sheet of the company looks as follows (book values, in EUR millions): ‘Assets (Book value) Liabilities (Book value) ‘Cash: 200 Debt: 500 * MV Operating assets: 1,500 Equity: 1,200 The cash is excess cash, and the market value of the debt is approximately equal to its book value. The debt consists of bonds that were issued two years ago with a coupon rate of 10%. These bonds are currently rated AA. The credit spread (above the risk-free rate) for similar firms with an AA rating currently 3%. Furthermore, the yield on 2-year US government bonds is currently 5% while the vield onX9E2r Us government bonds 8%. The corporate tax rate is 35%, XBC haf/60)nilion shares, an equity beta off2.145] and a stock price of USD (0 per share. The (expected) excess return of the stock market (over the risk-free rate) is 5%, The assumptions of the Modigliani-Miller theorem hold, except for taxes. a) What is the asset beta of XBC? (Assume a debt-beta of zero and that XBC has historically maintained a constant debt-to-equity ratio.) What does the value of XBC’s asset beta imply for the sensitivity of XBC’s operations to the business cycle? (2 points) : 45 Pe 2.145 Ruz oa = ta G42 = 60Dm= 40-60 00 2 ND = 500-200-300 Bur4, so xBC operaxions are. very Cyc cod b) What is XBC’s current cost of debt (before tax)? (1 point) Roz 8/43Y. = 447 ¢) XBC’s equity has historically earned a return on equity (ROE) of 15% over the past four years. Furthermore, XBC has paid a constant dividend of 1 dollar per share over the past three years, and expects to maintain its dividend policy in the current year. What is XBC’s cost of ame ea Jee (using ane Milt) 2 Bf + 2145-54 = 48.42S/ cape Dy 4 Bd) What is XBC’s WAC? (1.5 points) . + 30, 44%-0,.66+ SO. 42.4257 = wace Z $2. 447 = f = 4d4.84/. AS ©) What would XBC’s WACC be (going forward) if it were to pay out all of its cash as a special dividend? Assume that this decision does not affect XBC’s credit rating or any of the market prices of the different securities. (1 points) C=0 «LD ayy. 400 : ND= 500 WAC = SAE W7-965 4 a 18.9287. &= 600-200- 400 = 42.297, 4 f}XBC contemplates a major capital structure change and assesses three option: ~ Option 4: Raise USD 200 million in new stock at a price of 10 dollars per share, and use the proceeds to repurchase part of the outstanding debt. This will improve XBC’s ‘credit rating to AAA rated firm. AAA rated debt currently yields 9% in the market place. * Option 2: Raise USD 200 million in new debt and use the proceeds to buy back shares in an open-market repurchase. This will lead to a drop in the debt rating to A-. A- rated debt currently yields 11% in the market place. ~ Option 3: Raise USD 400 million in new debt and use the proceeds to buy back shares. in an open-market repurchase. This will lower the credit rating to CCC. CCC rated debt currently yields 18% in the market place. ‘What is th inder each option, knowing that XBC’s stock price is currently 10 dollars oe nara of these computations, assume that the debt-beta is zero and that XBC will maintain a stable debt-to-equity ratio after implementing any of the three options.) (1.5 points). 14ayn 63) Ruz 443 64 - 7 NO 4OQ. 74.64 = 800 D=30D C=200 NO- 20% — Re ne = 8/. +4,64°57 = 4a04y 2) e-400 wo-S00 NO-5 Ber24s = 20.26) aa cd pes een ee @3) s-200 ND=400 3 Re= 6435 4 2 Kez 40,195 8) What is the after-tax cost of debt under each option? (1.5 points) rep =(8/+ Speean)(4- 0.25) ® 97-96 = Say. @ 447-965 = 4157 AS @ 487-965: ay. h) What is the WACC under each option? (1.5 points) 0) 5 9ased. 46,04 = 44.94% @ B. 418+ £. 20.26 = 42. 98/. AS ® $444 3 4014S = 48.037. i) Why does the higher credit rating in option 1 not translate into a lower cost of capital? (1 point) Because we are SWItCUNG CObE Witty Couey AN AhEREYORE LOSING Ane benetic 4 4 5n2 Lox shiow