330.

236 Advanced Financial Planning and Control

ao.Univ.Prof. Mag. DDr. Thomas Dangl

Vorname: ......................

Nachname: ......................

Matrikelnummer: ......................

Studienkennzahl: ......................

Problem 1 (50 %):

Consider a firm with uncertainty gross profit. The timing in our firm model is as
follows: At the begin of year t − 1, new information about the firm’s profitability
is revealed which allows us to determine end-year gross profit (i.e., gross profitt )
exactly. However, at time-t we receive again new information that puts us in the
position to determine gross profitt+1 , etc.
Assume the firm’s gross profit follows a Geometric Brownian Motion with
growth rate g = 1% and volatility 40%. Selling and administrative expenses are
assumed constant amounting to EUR 7 000 000, the firm’s net investment is a
constant EUR 1 000 000. The discount rate is constant at 5%, corporate tax is
25%.
We are now at time t = 0. Invested capital is EUR 20 000 000 and the firm’s
net investment is constant EUR 1 000 000. At t = 0 we know that the gross profit
at t = 1 will be EUR 10 000 000. At t = 0, t = 1, and t = 2, the firm has the
opportunity to abandon operations if optimal. After t = 2 there is no opportunity
to abandon operations.
All Investors are risk neutral!

a) Build a Binomial Tree (∆t = 1)for the firm’s gross profit and indicate the
gross profit, operating profit and NOPLAT in nodes at t = 1 and t = 2.
Determine the probability of an upward move in the tree.

b) Calculate the present value of all future gross profit in every node of the
tree, if abandoning production is NOT possible. As a continuing value, use
the present value of the perpetual Geometric Brownian Motion.

c) Calculate the present value of all future operating profit in every node of the
tree, if abandoning production is NOT possible. Again, use as a continuing
value the present value of operating profit calculated from the continuing
value of the gross profit under the given assumption that the firm’s fixed
costs are constant.

1
 d) Calculate the present value of all future NOPLAT in every node of the tree,
if abandoning production is NOT possible. (Attention: NOPLAT is not
growing at the same rate as gross profit does!!)

e) Calculate the present value of all future free cash flow in every node of the
tree, if abandoning production is NOT possible. (Attention: Free cash flow
is not growing at the same rate as gross profit does!!)

f) Determine the value of the firms operations under the optimal stopping
rule at every node of the firm (consider reinvestment properly) and indicate
nodes where the firms should optimally abandon operations.

g) Calculate ROIC and operating leverage at every node.

Problem 2 (50 %):

Consider firm A which has debt with time to maturity of T = 1/2 year and a
face value of debt of D = 90 outstanding. The current value of the productive
assets of the firm is V0 = 100. It follows a Geometric Brownian motion with
an annualized standard deviation of the value process is σ = 0.30. The riskless
rate of interest over one year is supposed to be 10%, the growth rate under the
objective probability measure is 15%.
Build a one time step Merton Model of the firm with

V1/2 u = V0 ∗ u state u with probability π,

(
VT =
V1/2 d = V0 ∗ d state d with probability (1 − π).

a) Determine the objective as well as the risk-neutral probabilities for state u

and state d that are implied by the stated assumptions?

b) What is the value of equity and debt in this simple one-step binomial model
(if we neglect bankruptcy costs)?

c) What is the objective as well as the risk-neutral rate of return of the asset
value, of the value of equity and of the value of debt. Hint: if R is the rate
of return, then it satisfies exp(R T ) = E(VT )/V0 , with E either the objective
or the risk neutral expectation.

d) What is the risk-neutral probability of default?

e) Now assume that in the case of bankruptcy, costs of 20 occur. What is now
the value of the firm’s equity and debt.