University of Toronto. Faculty of Applied Science and Engineering. Final Examination, April Calculator Type 1. Exam Type D

Transcription

1 University of Toronto Faculty of Applied Science and Engineering Final Examination, April 2017 Third Year - Engineering Science CHE375 S - Engineering Finance and Economics Calculator Type 1 Exam Type D Examiner - Yuri Lawryshyn Aids allowed: one (1) 8.5" x 11" aid sheet, any type of calculator. Question Number Marks Total 56 Answer all questions. Name: Student Number:

2 Question #1 (8 marks) Bank of America Corp has raised $2,891, by issuing bonds on November 1, The bonds are denominated in multiples of $1,000, with maturity date set as November 1, The bonds have a coupon rate of 3% payable annually and were sold at a yield of 4%. Determine the amortization schedule for these bonds from inception to maturity. Prepare journal entries associated with these bonds for year end 2018 (December 31st, 2018) (you do not need to include closing entries, just the entry associated with accrued interest) and at bond maturity. Time 0 Interest Payment Interest Expense Premium Amortization Premium Account Balance Bond Carrying Amount Page 2 of 11

3 Question #2 (9 marks) As a consultant specializing in financial valuations, you have recently been asked by RSG Bank to value a loan for a new startup, CLL. CLL claims to have developed a novel method to detect a rare form of cancer with high accuracy through a simple blood test, but the technology has not yet been proven through independent validation. The company requires $600k to perform a validation study in the coming year. Clearly, if the technology works (i.e. the validation is successful), you expect the value of the company to be independent of how the market performs in the coming year and expect the value to be $10 million one year from now. After consulting with a number of medical scientists, you estimate that the probability of a successful validation is 30%. However, if the technology is proven not to work, CLL will have a salvage value that is dependent on the market. If the market does well in the next year then the salvage value would be $1.1 million and if the economy does poorly then the salvage value would only be $500k. Market expectations are as follow: Current market index price is $100 Expected market prices one year from now are $115 if the economy does well and $85 if the economy does poorly (with equal probability) Risk-free rate is 3% Determine the risk-neutral probability of the market doing well, q. What is the maximum amount that you would recommend RSG to lend to CLL at the risk-free rate? What is CLL's current market value, accounting for the $600k required for validation? What ra:e would you recommend for RSG to charge CLL if it were to provide full debt financing of $600k for the validation? (Hint: calculate the appropriate debt payoff value and then determine the quoted debt rate (recall that the quoted rate will be different from the expected rate)). Page 3 of 11

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5 Question #3 (13 marks) YJL, a publicly traded company, specializes in the development and sale of dissolved air flotation (DAF) systems for removing particulates in water. Through a heavy investment in R&D where YJL research engineers utilized computational fluid dynamics (CFD) modelling, YJL developed a technological breakthrough where they can increase the throughput of water through their DAF systems by a factor of 2.5 that has just recently been proven to work at full scale. Being a public company, YJL will need to disclose their working invention but has still not figured out the best way to finance the capital cost of $20 M associated with production of the new technology. YJL's current free-cash flows (FCF) are expected to be $10 M this year (2017) which would continue with no expected growth without the new technology. It is expected that the new technology will lead to a bump in FCF to a total of $15 M in 2018 and remain constant onward. Relevant data for YJL is as follows:. debt cost rate = 4% current market debt / equity ratio = 0.2 current book debt / equity ratio = 0.4 3=0.8 tax rate =25% shares outstanding = loom Market parameters are as follows: Expected market return = 8% Risk-free rate = 3% Calculate YJL's current enterprise value (not accounting for information related to the new technological development), YJL's market value balance sheet (i.e. Assets, Debt and Equity) and share price. What is YJL's unlevered enterprise value? What is YJL's tax shield value? What is the unlevered enterprise value accounting for the new technology assuming that the riskiness of the business will not be impacted by this new opportunity (hint: the capital cost associated with production of the new technology should be accounted for assume it is incurred at the beginning of 2017). What is the levered value of the enterprise accounting for the new technology (as above in d)) assuming that the debt to equity ratio remains at 0.2 after financing? Clearly, after the announcement is made regarding the value of the new technology and that financing for the new technology will be done in such a way that the debt to equity ratio will return to 0.2 (after financing), before financing the debt is the same as above so what must the market value of the equity be and what would be the new share price? Determine the market value balance sheet after financing. How would YJL finance the project, i.e. how much debt and equity (# of shares at what price) would be issued? Pages of 11

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8 Question #4 (8 marks) Below are the balance sheets for companies A and B. A purchases 100% of B for $1,000,000, by using $600,000 of its cash and borrowing the remaining $400,000. Next, A loans B $90,000. Show the balance sheets for A and B after the purchase, after the loan, and then the consolidated sheet, using fie following template. Calculate the Debt to Equity ratios for the different balance sheets and comment on the changes. a, 4J W nfla, o U to CO ca a, 0 U W Ln en : QJ Lh 00 0 Lt1 0, CO CO rj,-1 Lfl CO en en.-i 00. CO U Lr0 oor 0 u0oln C en.-i lzr Lfl O M o,-i CO 0. U (fl(fl : LU CA S CC 41 CL U, a,> (a(U OaJ.CuJ 0 Page 8ofll

9 Question #5 (9 marks) Consider BBB with revenues and balance sheet as shown below. The projected revenues for BBB are $121M for Estimate LPLL's 2017 balance sheet and income statement. Where there is an "x", justify the value used (for example, as shown, there is an "x" next to COGS - indicate how you estimated your COGS value for 2017). Then, provide the free cash flow and interest tax shield values for 2016 and O Revenue COGS 60.5 x GM 49.5 SG&A 5.5 EBITDA : 44 DEPN 8.75 EBIT INT 2.5 ix EBT Tax 6.55: :x NI 26.2 DIV :x Add tore Assets Cash (plug) x Current x Plant x Total Assets Liabilities Current 11 x Debt x Total Liabilities Equity Stock 50 x RE x Total Equity Liab. + Equity FCF ITS Page 9 of 11

10 Question #6 (5 marks) FireEye, Inc. (FEYE) is a cyber security company looking to develope a firewall system, "SeeMore", in response to the recent cyber-attacks on financial banks. This firewall system requires heavy investment on servers and hardware for monitoring communications. Due to high demand, the firewall is expected to roll out and bring sales starting next year. The free cash flows and interest tax shield associated with the project "SeeMore" are provided below. The company's portfolio of cyber security products has become increasingly popular in the industry leading to higher sales. In response, the management is to reduce debt levels based on how well their protection systems perform (therefore, it makes sense to discount the cash-flow associated with the interest tax shield at the asset rate of return). Also, FEYE has the following parameters: beta =1.3 cost of debt = 5% tax rate =20% and the following market parameters: risk-free rate = 2% expected market return = 8%. Determine the value of the opportunity. Clearly show your work FCF E 32' 40 59: Interest Tax Shield Page 10 of 11

11 Question #7 (4 marks) For students that presented Group A countries (Japan, S. Korea, China, Australia, India, Turkey and Russia): Which countries in the Americas I Europe are dealing with corruption and what events have happened in recent years? Explain how these events have impacted the economies of these countries. For students that presented Group B countries (France, UK, Norway, Canada, US, Mexico and Brazil) Which Asian countries are dealing with corruption and what events have happened in recent years? Explain how these events have impacted the economies of these countries. Page 11 of 11