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University of CaliforniaWalter A. Haas School of BusinessUGBA 103Introduction to FinanceProf. Dmitry Livdan 15 May 2013FINALQuestion BookletINSTRUCTIONS1. 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 con-duct.3. You have 3 hours4. The exam consists of 2 questions5. Use the white spaces (and backs of pages) in this question booklet as scratch paper for themultiple 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 on the ﬁrst page of your answer sheet booklet. Also indicateyour section.8. This is a closed-book exam!9. Laptops, PCs, PDAs, IPhones, IPads, and any other communication enabling devices areprohibitedUGBA 103 FINAL 21. (20 points total) You are faced with the task of valuing the stock of the Leknufrag & NomisCorporation, a ﬁrm entirely ﬁnanced with equity. You estimate that the ﬁrm as a whole hasa 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 theupcoming two years to generate an annual return of 20% in perpetuity. Its new investmentsafter that are expected to generate an annual return of 16% in perpetuity. Also, L&N’searnings per share were $4 last year (which just ended), and the ﬁrm expects the followinggrowth rates in earnings per share in the future:Year Growth1∗20%2 15%3 10%4 and after 8%∗The growth in year 1 represents the growth in earnings from last year to the end of the ﬁrstyear. In other words, earnings at the end of the ﬁrst 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) anddividends (D1) at the end of the ﬁrst year?(b) (3 points) What are LNC’s’s expected earnings per share (E2), reinvestments (I2) anddividends (D2) at the end of the second year?(c) (3 points) What are LNC’s’s expected earnings per share (E3), reinvestments (I3) anddividends (D3) at the end of the third year?(d) (3 points) What are LNC’s’s expected earnings per share (E4), reinvestments (I4) anddividends (D4) at the end of the ﬁfth 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 fractioncomes from PVGO?UGBA 103 FINAL 3FEEL FREE TO WRITE YOUR SOLUTION HEREUGBA 103 FINAL 42. (55 points total)Easy Beer Ltd. (EBL) is a producer of light lager located on the west coast. The ﬁrmis currently all-equity ﬁnanced. The ﬁrm is not publicly traded. Tuﬀ Stout Inc. (TSI), aproducer of Irish type stout with operations on the east coast only, is considering acquiringEBL. In particular, Tuﬀ Stout is interested in knowing the maximum price that it shouldconsider bidding for EBL’s assets and operations.Tuﬀ Stout is publicly traded. It is currently ﬁnanced with 5,200,000 shares, each worth $10(i.e., $52 million of equity), and $25 million worth of debt. A regression of Tuﬀ Stout’s last120 monthly stock returns on the market returns yields an estimated equity beta of 2.0. Thebeta of its debt is 0.25. The expected risk premium of the market is currently 9%, and theyield on a 10-year treasury bond is 3%. The corporate tax rate is 34%.Tuﬀ Stout’s chief ﬁnancial oﬃcer estimates that EBL’s expected after-tax cash ﬂows (itsunlevered free cash flows) will be as follows (you need to ﬁll empty cells).End of Year1 2 3 4 5(1) Operating income 2,620 3,406 3,712 4,045 4,330(2) Tax on operating income(3) After-tax operating income(4) Depreciation 425 450 450 450 450(5) Capital expenditures 524 518 525 535 554(6) Change in working capital -200 -250 205 225 254(7) Proceeds from asset sales 3,500 1,800(8) After-tax cash ﬂows (UFCF)The CFO also estimates that these after-tax cash ﬂows will grow at an annual rate of 2.3%after year 5.(a) (10 points) Let us assume for now that, after the acquisition, Tuﬀ Stout will try to main-tain its debt/equity ratio around its current value. Suppose also that EBL’s operationsare similar to those of Tuﬀ Stout. Under this set of assumptions, what is the maximumbid that Tuﬀ Stout should consider?UGBA 103 FINAL 5FEEL FREE TO WRITE YOUR SOLUTION HEREUGBA 103 FINAL 6In order to get a clearer picture of EBL’s value, Tuﬀ Stout’s CFO decides to calculatethe adjusted present value in two parts: the value of EBL’s unlevered assets plus thevalue of the expected tax shields that the new debt will bring to Tuﬀ Stout. She alsodecides to be more precise about the exact nature of the extra debt capacity resultingfrom the acquisition.To ﬁnance the acquisition, Tuﬀ Stout will be able to borrow $9 million at 8% (competitivemarket rate for such loans and the proper discount rate for the interest tax shields) forthe acquisition of EBL. The rest will be ﬁnanced in cash using last year’s earnings. Thedebt contract is a ﬁve-year contract, during which Tuﬀ Stout is expected to repay thebank in ﬁve equal end-of-year installments. The U.S. Government is looking to promotelight beer consumption and is willing to subsidize the loan by lowering its interest by0.5% to 7.5%. Under this scenario, the CFO conservatively assumes that Tuﬀ Stout willnot 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 ﬁrm.Luckily, Tuﬀ Stout is such a comparable ﬁrm, and so the CFO decides to use Tuﬀ Stout’sasset beta to estimate the risk of EBL’s assets.(b) (25 points) Under this set of assumptions, what is the maximum bid (use APV) thatTuﬀ Stout should consider?UGBA 103 FINAL 7FEEL FREE TO WRITE YOUR SOLUTION HEREUGBA 103 FINAL 8Upon further consideration, the CFO decides that EBL’s operations are actually some-what diﬀerent from those of Tuﬀ Stout. First, the west coast beer market tends to bemore aﬀected by swings in the business cycle. Furthermore, EBL’s operations beingsmaller than Tuﬀ Stout’s, they do not beneﬁt from the same economies of scale in bottlemanufacturing (and won’t, even after the acquisition).Instead, EBL’s operations are deemed more comparable to another west coast ﬁrm,Russian River Beer (RRB), which is publicly traded. RRB is currently ﬁnanced with$15 million of equity and $5 million of debt. The beta of RRB’s

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