2020/21 Academic Year
Corporate Financial Management
INSTRUCTIONS TO CANDIDATES
Please submit your assignment electronically through Canvas using the “Assignments” tab.
Please use your UB number as the submission title since the assignment requires an individual submission.
You can submit as many times as you like before the submission deadline. Your last submission prior to the deadline will be your final submission and this is the one that will be marked.
Your assignment will only be accepted if it is one of the approved file types. The permissible formats are limited to the following file extensions: .doc, .docx. Otherwise, your coursework will be marked as zero.
You need to answer all questions.
The individual coursework requires you to answer four questions. You should complete the coursework independently.
Guidance on how to write mathematical equations in Microsoft Word is provided below:
Math equation examples Descriptions How to write in Microsoft Word
2 + 2 = 4 Two plus two equals four 2 + 2 = 4
2 – 2 = 4 Two minus two equals zero 2 – 2 = 0
2 × 2 = 4 Two times two equals four 2*2 = 4
2÷2 = 1
2/2=1 Two divided by two equals one 2/2 = 1
2^2=4 Two to the power of two equals four 2^2 = 4
√4 = 2 Square root of four equals two Sqrt(4) = 2
4^(0.5) = 2
(i) Briefly explain the principal-agency problem and can you propose one potential solution to reduce costs associated with this problem? (10 marks)
(ii) Specify two typical types of behavioural biases when people make financial decisions. Do you think that the behaviour of buying lottery tickets is consistent with the theory of rational expectations? Explain your answer. (10 marks)
(i) Suppose Caterpillar Inc. has 665 million shares outstanding and each share is priced at $74.77. The company has now $25 billion in debt. Assume that Caterpillar maintains a constant debt-equity ratio in the next three years. At the end of the third year, if Caterpillar has 700 million shares outstanding and each share is priced at $83, how much debt will Caterpillar have? (5 marks)
(ii) Alpha plc plans to issue €100 million of bonds with a face value of €50,000, coupon rate of 4 per cent and 10 years to maturity. The current market interest rate on these bonds is 7 per cent. In one year, the interest rate on the bonds will be either 8 per cent with 60 percent probability or 5 per cent with 40 percent probability.
(a) If the bonds are non-callable, what is the price of the bonds today? (10 marks)
(b) If the bonds are callable one year from today, will their price be greater than or less than the price you computed in (a)? Discuss your answer from investor’s point of view. (5 marks)
(c) If a call price is £50,000, would the firm call the bonds? Please explain your answer (5 marks)
(i) ABC plc is an unlevered firm with expected annual earnings before taxes of £35 million in perpetuity. The current required return on the firm’s equity is 20%. The firm distributes all of its earnings as dividends at the end of each year. There is a corporate tax rate of 28%. The company has 1.5 million ordinary shares outstanding. Calculate the value of the firm and the price per share (10 marks)
(ii) Based on information given in (i), ABC plc. is planning a recapitalisation under which it will issue $40 million of perpetual 9% debt and use this proceeds to buy back its shares. Use the Adjusted Present Value (APV) method to calculate the company value after the recapitalisation. What is the value of equity after the announcement of the recapitalisation and the price per share? (10 marks)
(iii) Based on information in (i) and (ii), calculate the number shares to be repurchased, the value of equity after the repurchase has been completed, and the price per share after the completion of the recapitalisation. (10 marks)
Select a company listed on an internationally recognised and well established Stock Exchange (e.g. London, New York, Tokyo, Mumbai) for which you can access the share price data over the past 5 years.
(i) Describe the company’s business background (e.g. main shareholders/owners, features of products, CEO’s background) (5 marks)
(ii) Discuss how successful the company has been at delivering value to its shareholders over the past 5 years. (6 marks)
(iii) Determine the current value of the equity in this company. Use at least two evaluation methods of your choice (e.g. Price/Earnings Ratio, Discounted Cash Flow, Dividend Based Valuation). Do you believe that the stock of this company is currently overpriced, fairly priced, or underpriced? Support your opinion with evidence, analysis, and argument. (8 marks)
(iv) How can you reconcile any discrepancies in your valuations? (6 marks)
(Total: 25 marks)
Note: Your answers should demonstrate an understanding of the valuation methods you use, an appreciation of their implications, and an understanding of relevant financial theory e.g. Efficient Market Hypothesis (EMH). The answers should contain details of your calculations and assumptions. In order to answer the question, you will need to consider both accounting and market information, relevant to valuation. The data you need may be available from many resources (e.g. Thomson One Banker, yahoo finance), including information from the most recent report and accounts of the company. There is a limit of 1,000 words for answering this question.