NAME SID GSI University of California Walter A Haas School of Business UGBA 103 Introduction to Finance Prof Dmitry Livdan 12 December 2017 FINAL Question Booklet INSTRUCTIONS 1 Please don t open the exam until you are told to do so 2 This exam is being administered under the University s rules for academic conduct 3 You have 3 hours 4 The exam consists of 1 long question 5 Use the white spaces and backs of pages in this question booklet as scratch paper for the multiple choice questions Your final answers should be indicated with a pen 6 Write your answers on the empty pages or on the back 7 Important PRINT YOUR NAME AND SIS ID on the first page of your answer sheet booklet Also indicate your LECTURE section 8 This is an open book exam 9 Laptops PCs PDAs IPhones IPads and any other WiFi enabled communication enabling devices are prohibited UGBA 103 FINAL 2 35 points total Pegoretti Inc pays 40 in corporate taxes and is financed entirely by common stock with a 1 000 shares outstanding trading at 60 per share Pegoretti has only assets in place and thus does not grow 1 5 points total Pegoretti s CFO wants to use CAPM to calculate Pegoretti s equity beta E However she does not know several key variables like the market risk premium market s standard deviation and the risk free rate She does know that the stock market s Sharpe s ratio is equal to 0 4 She also knows that since CAPM applies to every security she can find some of these values using data from Pegoretti s two competitors Merxx and Pinarello both of which have no debt i 2 points If Merxx s and Pinarello s assets have a cost of capital equal to 13 and 21 respectively and their asset betas are equal to 0 8 and 1 6 respectively what are the risk free rate and the stock market risk premium rM rf ii 2 points What is Pegoretti s cost of equity capital if its market risk is equal to 0 375 iii 1 point What is Pegoretti s EBIT per share UGBA 103 FINAL 3 2 10 points total Pegoretti considers embarking on a 5 year growth plan presented in the table below Year PBR ROE POR 1 2 3 4 5 0 4 0 4 0 4 0 4 0 6 50 50 50 50 55 0 6 0 6 0 6 0 6 0 4 First investment is made in the year 1 year 1 ROE is the return on the year 1 investment and so on Investment is paid out of the earnings Each investment pays forever The ROE is the same after year 5 and is equal to 55 After finishing this investment plan Pegoretti once again becomes a no growth company i 1 point What is the Pegoretti s EPS investment and dividend in year 1 ii 1 point What is the Pegoretti s EPS investment and dividend in year 2 iii 1 point What is the Pegoretti s EPS investment and dividend in year 3 iv 1 point What is the Pegoretti s EPS investment and dividend in year 4 UGBA 103 Continues on the next page FINAL 4 UGBA 103 FINAL v 1 point What is the Pegoretti s EPS investment and dividend in year 5 vi 4 points What is Pegoretti s price P 0 with this reinvestment policy vii 1 point What is PVGO from such investment policy Continues on the next page 5 UGBA 103 FINAL 6 4 3 20 points total Pegoretti is considering an alternative 5 year project Since this project is very different from Pegoretti s current assets the adjusted present value will be used to value the project The project requires an initial investment of 75 000 in new assets which will be depreciated straight line to 0 over the project s 5 year life These assets will be worthless in five years i e they will not be resold Each year for five years the project is expected to generate pre tax revenues of 60 000 and to require pre tax costs of 24 000 The entire project will be financed through a 5 year bank loan with an annual rate of 10 it is also the discount rate The principal on the loan will be repaid in equal installments of 15 000 each i e each year the company pays 15 000 in principal and pays the interest on the outstanding loan It is estimated that the pre tax costs payable at time zero of negotiating the loan will be 4 of the amount borrowed and these costs cannot be amortized The project s risk is very similar to the risk of Roaming Divide RD Inc s assets This firm is currently financed by 100 000 shares worth 12 50 each and 750 000 worth of debt and has the same tax rate as the Pegoretti s The beta of RD s stock is 1 5 and the company borrows at a rate of 11 The values for the risk free rate and the market risk premium are the same as in the first part of this exam i i 4 points What is the appropriate discount rate for the project Round to two digits e g 0 33 instead of 0 3266 ii 2 points What is the NPV of project s assets Please use the discount rate found in the previous part to discount the depreciation tax shields NOTE Part iii is on the next page UGBA 103 FINAL 7 iii 7 points What is the NPV of the loan and APV of the project NOTE Part iv is on the next page UGBA 103 FINAL 8 iv 7 points Now consider an alternative financing The entire project still will be financed through a 5 year bank loan but with government subsidized annual rate of 8 5 market rate for such loans is still 10 and with principal repaid in a lump sum at the end of the fifth year However such loan requires floatation costs payable at time zero of 10 of the amount borrowed In this case the floatation costs can be amortized over the project s 5 year life amortization means that the value is straight line depreciated to zero over 5 years and Pegoretti is getting the depreciation tax shield back every year for instance costs of 5 000 depreciate by 1 000 every year and the tax shield is 0 4 1 000 400 Would you prefer this loan to the previous one Please give a quantitative answer