University of California Walter A Haas School of Business UGBA 103 Introduction to Finance Prof Dmitry Livdan 15 May 2013 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 2 questions 5 Use the white spaces and backs of pages in this question booklet as scratch paper for the multiple choice questions Your nal answers should be indicated with a pen 6 Write your answers on the empty pages or on the back 7 Important Print your name on the rst page of your answer sheet booklet Also indicate your section 8 This is a closed book exam 9 Laptops PCs PDAs IPhones IPads and any other communication enabling devices are prohibited UGBA 103 FINAL 2 1 20 points total You are faced with the task of valuing the stock of the Leknufrag Nomis Corporation a rm entirely nanced with equity You estimate that the rm as a whole has a beta of 1 and that the expected return on the market is 14 The corporation expects its new investments made at the end of last year and at the end of the upcoming two years to generate an annual return of 20 in perpetuity Its new investments after that are expected to generate an annual return of 16 in perpetuity Also L N s earnings per share were 4 last year which just ended and the rm expects the following growth rates in earnings per share in the future Year 1 2 3 4 and after Growth 20 15 10 8 The growth in year 1 represents the growth in earnings from last year to the end of the rst year In other words earnings at the end of the rst year are expected to be 4 00 1 20 4 80 a 3 points What are LNC s expected earnings per share E1 reinvestments I1 and dividends D1 at the end of the rst year b 3 points What are LNC s s expected earnings per share E2 reinvestments I2 and dividends D2 at the end of the second year c 3 points What are LNC s s expected earnings per share E3 reinvestments I3 and dividends D3 at the end of the third year d 3 points What are LNC s s expected earnings per share E4 reinvestments I4 and dividends D4 at the end of the fth year e 5 points What is the value P0 of LNC s s stock today f 3 points What fraction of the stock price comes from Assets in Place and what fraction comes from PVGO UGBA 103 FINAL FEEL FREE TO WRITE YOUR SOLUTION HERE 3 UGBA 103 FINAL 4 2 55 points total Easy Beer Ltd EBL is a producer of light lager located on the west coast The rm is currently all equity nanced The rm is not publicly traded Tu Stout Inc TSI a producer of Irish type stout with operations on the east coast only is considering acquiring EBL In particular Tu Stout is interested in knowing the maximum price that it should consider bidding for EBL s assets and operations Tu Stout is publicly traded It is currently nanced with 5 200 000 shares each worth 10 i e 52 million of equity and 25 million worth of debt A regression of Tu Stout s last 120 monthly stock returns on the market returns yields an estimated equity beta of 2 0 The beta of its debt is 0 25 The expected risk premium of the market is currently 9 and the yield on a 10 year treasury bond is 3 The corporate tax rate is 34 Tu Stout s chief nancial o cer estimates that EBL s expected after tax cash ows its unlevered free cash flows will be as follows you need to ll empty cells 1 Operating income 2 Tax on operating income 3 4 5 6 7 After tax operating income Depreciation Capital expenditures Change in working capital Proceeds from asset sales 1 2 620 End of Year 2 3 4 3 406 3 712 4 045 425 524 200 3 500 450 518 250 1 800 450 525 205 450 535 225 5 4 330 450 554 254 8 After tax cash ows UFCF The CFO also estimates that these after tax cash ows will grow at an annual rate of 2 3 after year 5 a 10 points Let us assume for now that after the acquisition Tu Stout will try to maintain its debt equity ratio around its current value Suppose also that EBL s operations are similar to those of Tu Stout Under this set of assumptions what is the maximum bid that Tu Stout should consider UGBA 103 FINAL FEEL FREE TO WRITE YOUR SOLUTION HERE 5 UGBA 103 FINAL 6 In order to get a clearer picture of EBL s value Tu Stout s CFO decides to calculate the adjusted present value in two parts the value of EBL s unlevered assets plus the value of the expected tax shields that the new debt will bring to Tu Stout She also decides to be more precise about the exact nature of the extra debt capacity resulting from the acquisition To nance the acquisition Tu Stout will be able to borrow 9 million at 8 competitive market rate for such loans and the proper discount rate for the interest tax shields for the acquisition of EBL The rest will be nanced in cash using last year s earnings The debt contract is a ve year contract during which Tu Stout is expected to repay the bank in ve equal end of year installments The U S Government is looking to promote light beer consumption and is willing to subsidize the loan by lowering its interest by 0 5 to 7 5 Under this scenario the CFO conservatively assumes that Tu Stout will not be able to take on more debt as a result of acquiring EBL Since EBL is not publicly traded the risk has to be assessed using a comparable rm Luckily Tu Stout is such a comparable rm and so the CFO decides to use Tu Stout s asset beta to estimate the risk of EBL s assets b 25 points Under this set of assumptions what is the maximum bid use APV that Tu Stout should consider UGBA 103 FINAL FEEL FREE TO WRITE YOUR SOLUTION HERE 7 UGBA 103 FINAL 8 Upon further consideration the CFO decides that EBL s operations are actually somewhat di erent from those of Tu Stout First the west coast beer market tends to be more a ected by swings in the business cycle Furthermore EBL s operations being smaller than Tu Stout s they do not bene t from the same economies of scale in bottle manufacturing and won t even after the acquisition Instead EBL s operations are deemed more comparable to another west coast rm Russian River Beer RRB which is publicly traded RRB is currently nanced with 15 million …