Università della Svizzera italiana (USI)

Academic year – 2021/2022

Corporate Finance

Professor Laurent Frésard

Final Exam

(September 6th 2022)

NAME:________________________ Student ID:___________________________

Instructions

 The exam consists of five questions

 Each question has 20 points for a total of 100 points

 You have 2 hours

 You have to answer all questions

 The exam is closed book and closed notes (you are allowed one auxiliary sheet for help)

 Circle you numerical answers

 Provide you answers in the space provided ONLY

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 Question 1

The following information is available about GM: Equity Beta is 1.14; Expected market return
(E(Rm)) is 10%; Risk free rate (Rf) is 3%; Today’s dividend is $0.20 per share; Dividends are
expected to grow at 1% per year.

A. How much is a share of GM worth?

B. After many years in business GM announces that it does not expect its earnings to keep
growing at the steady rate they used to. That is earnings are expected to remain constant at
$0.20 per share. The new policy will consist of distributing all earnings in the form of
dividends. How does the price of GM change?

C. In order to re-vitalize the business, GM announces that it has started to invest in a growth
project that is expected to yield 15% per year. Therefore, only 40% of GM’s earnings will
be distributed as dividends. The remaining share will be reinvested in the growth project.
How does the price of GM change? What should be GM’s PE ratio?

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D. If GM is trading at a price of $3 per share, what is the market expectation about the
performance of the growth project?

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 Question 2

The US Social Security system provides workers with the option of retiring at age 62 and having
a lower monthly social security benefit or waiting until age 66 and receiving their full benefits.
This year, somebody retiring at age 62 would receive $1,900 per month whereas somebody who
turns 66 this year would receive $2,550 per month. Each year, the benefit levels increase with
inflation. In other words, if somebody is currently age 62 and starts taking benefits, next year’s
monthly income will be $1,900 increased by one year of inflation. If the 62 year old waits until
age 66 to retire, their first year benefits would be higher than $2,550 by three years of inflation
A. You are advising a friend who is about to turn 62 on whether she should start receiving
benefits now or wait until age 66. Assume that the appropriate discount rate is 6%, inflation
is expected to be 2.5% per year for the future, and that your friend expects to live until age
80. Assuming no changes to the program, would it be more valuable to wait until age 66
or start receiving benefits now?

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B. Policymakers are concerned about the long-term viability of Social Security and are
considering dramatic changes to the program. The Social Security system currently raises
$840 billion per year in income and pays $786 billion per year in benefits. However, with
the pending retirement of the Baby Boom generation, benefits levels are expected to
increase at the rate of 3.5% per year (2% inflation plus 1.5% annual increase in the number
of beneficiaries) whereas income is expected to grow only 2% per year (inflation) as the
workforce is not forecast to grow. Continue to assume that the appropriate discount rate is
6%. Using a 75 year forecast time period, what is the value of its expected payments
relative to its expected tax revenues (i.e., income)?

C. To bring the system to solvency, by how much would they have to modify benefits this
year, i.e. the new baseline level of benefits (that will still grow with inflation plus the
growth rate in the number of beneficiaries assumed above)?

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 Question 3
JuraSki operates ski resorts in different locations in Switzerland and France. They mostly target
families with young children. They have identified a potential new location to develop a brand
new resort in the Italian alps. They estimate that acquisition of the land and construction of the
facilities (e.g., cable cars and ski lifts) to cost CHF 80 million. The following information was
provided regarding the operations of the resorts. The facilities are expected to operate for 50 years.
Revenues are expected to remain constant at CHF 36.5 million per year. Operating expenses are
expected to be 70% of revenues and stay there for the entire 50 year operating life. The facilities
will be fully depreciated straight-line over the entire 50 year life of the facility. It is not expected
to need additional capital expenditures. Maintenance costs are included in the operating expenses.
They will need to maintain working capital of 10% of sales each year with the initial investment
made the year prior to opening. The working capital will be recovered in the 50th year. JuraSki
faces a tax rate of 30%, and they expect to be able to sell the land at the end of the 50 years for
CHF 10 million.
A. What is your forecast of free cash flow in the first year?

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B. JuraSki’s facilities have positive systematic risk. Their equity beta is 1.2 and their debt beta
is 0.2. The risk free rate is 4% and the expected market risk premium is 7.2%. If the firm
is 50% debt and 50% equity, what cost of capital would you use to evaluate this investment
opportunity?

C. Should the project be taken? Explain and show all calculations. (6 points)

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 Question 4
Phillips Company is a young technology firm that has historically avoided debt but is now
considering raising capital from a bank. They generate sufficient operating cash flow to internally
fund their investment opportunities so the funds would instead be used to repurchase some of their
outstanding shares. In fact, they are so profitable that their earnings per share (EPS) have risen
each of the last five years. This past year (2008), its earnings were $37.8 million, translating to
$4.52 per share. It currently has 8.365 million shares outstanding valued in the market at $41.76
per share. The firm is considering borrowing $60 million for ten years at an interest rate of 3.14%
per year and would only make interest payments quarterly until the loan matures.
A. If the firm took out the bank loan and used the proceeds to repurchase outstanding shares,
what would be its new leverage ratio?

B. Phillips Company took out the bank loan at the beginning of this fiscal year (2009). At the
end of 2009, the company issued an earnings announcement bragging about their sixth
straight year of EPS growth, announcing earnings of $4.60 per share, despite the downturn
in the economy. What would its EPS have been had the firm not altered its leverage ratio?
Ignore taxes.

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C. Does the fact that the EPS at Phillips Company rose mean that the adoption of leverage
created value for Phillips Company shareholders? Explain completely.

D. If the correct cost of capital for the firm before the debt issuance was 12%, what rate of
return would equity holders require after the debt issuance? Assume the debt was correctly
priced and that it is risk-free.

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 Question 5

A. Explain what is the yield curve, and carefully explain what an upward-sloping curve tells
us about future economic prospects?

yield curve is a line that plots yields (interest rates) of bonds having equal credit quality
but differing maturity dates.

The slope of the yield curve gives an idea of future interest rate changes and economic
activity.

There are three main shapes:

UPWARD SLOPING: one in which longer maturity bonds have a higher yield compared to
shorter-term bonds.
Most common type of yield curve (as longer-maturity bonds usually have a higher yield to
maturity than shorter-term bonds.)
responding to periods of economic expansion, conditions that are often accompanied by
higher inflation, which can result in higher interest rates.

DOWNWARD SLOPING:
periods of economic recession

FLAT: Market partecipnats think rates wonìt change a lot.

B. Explain what is a venture capital (VC) fund.

Suppongo che nel nostro case choìieda PE FUNDS:

PE funds are funds that invest in private companies, companes which are not listed in the stock
market.

Can also invest in public companies and buying them take them out of stock markets.

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C. Explain how the lowering of interest rates by central banks stimulate the economy.

Interest rates can be considered the cost of money (It is the cost of, for example, a loan or
a mortage) .
If the cost is low people will more likely buy cars or homes or other goods in general.
If a lot of pleople buy goods their production will increase too and prices and salary will
follow the same trend.

D. Explain why it is more attractive for Ocean Carrier to incorporate its ships in Hong Kong
as opposed to New York.

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