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**Unformatted text preview: **1 . (15 points) Christopher Wu is from Singapore His father has accumulated a substantial amount of
wealth which is invested in a well-diversiﬁed portfolio of Singapore stocks“ Christopher
has recently been given the responsibility for managing this portfolio and was recently
approached by an investment advisor ﬁ'om Zenith Banking PTE who encouraged him to
ﬁlrther diversify of'the portfolio by acquiring international stocks, As an illustration of
the beneﬁts of such ﬁnther diversiﬁcation, the advisor' gathered and summarized data
regarding the earned returns on two well-diversiﬁed portfolios (ﬁorn the perspective of'a
Singapore investor, including the effects of ﬂuctuating exchange rates between US
dollars and Singapore dollars) over the past 15 years: Singapore United States
Average Annual Return 123.0 1 1.0
Standard Deviation 30.10 - 20 0
Correlation 01.25 The adviser claims that a portfolio consisting of'40 percent Singapore stocks and 60
percent U St stocks would be far more attractive (assuming history repeats itself)
than the portfolio currently held by Wu. a) What are the expected return and standard deviation .of' the rate of return on the
40/60 portfolio? t ()C)(b)()(/W
E[Ip]=>5;9E r5‘1-1LXAE r; t: 0,4. /3 + 0. _ll \3\/)/ 1
615091032 + 291+ ZXa x30" :G/as)/ (3:0 13077 / b) Assuming Wu IS moderately risk-avergse is the 40/60 Singapore/US portfolio
more attractive than the 100/0 portfolio currently held by Wu? If so, why so; if
not, why not? Stone, the diversified port/“lib Nola-cc: Volaii'lilj A? _
outr K; out 14 “1‘3 about a i ’00th drop tin elven/gal ref-u,” Hut (#0le be at VIEW? attractive poPi—Riio/v /’ /‘ 2‘. (15 points) One of the hottest topics in managerial ﬁnance these days in performance measurement —
measuring the productivity of‘business'units, A measurement tool that has received
substantial attention (at places such as Coca-Cola) is called “Economic Value Added” or
EVA for short, While implementing EVA is somewhat complicated, the basic idea is simple:
EVA = (After-Tax Operating Income) —- (WACC x Assets Employed) That is, the EVA of‘a business unit (division or entire ﬁrm) is the after-tax income earned
by the unit less the cost of ﬁnancing the net assets used to generate that 1ncome. This
question is focused on determining the EVA for the Trane (Air Conditioning Systems)
Division of American Standard (ASD) for 2005. a) ASD has a beta of 1 25. If the current market equity risk premium is 4 percent and
the current risk-ﬂee rate is 5 percent, what is the estimated cost of equity capital under the CAPM for ASD? [Ignore size premium] //~—-—-,\ -
AE _—_ Kt“ FCeMKP) : 0.o§+(t.‘25‘)(0.o¢t)<: 0,: v /
. “~~CH,_,__,_/ b) ASD bonds are rated BBB (Ba) and the current YTM on BBB debt is about 8
percent. If the 1ncome tax rate is 40 percent, what rs the approximate after -tax cost of debt capital for ASD? ’41) f 0 0 8 ./ﬁ W..._m__.._,_ most) :: 0.08th01‘i)@ ' c) ASD has 60 million shares of stock outstanding ASD stock is currently priced at about $50 per share. What IS the current “market cap” of AOS’s equrty?
Market C0»? : (fishnets; Oui'S'ianali (j )(pr’i :e {-ﬂqafﬂ) 2: Q00 M )(3/3'0) >53 lgi D
d) ASD currently has about $2.0 billion of debt outstanding What is the “debt ratio” for
ASD (based on market values):2 -D—-— D ' :r. /
y w D'th' {134,313 e) What is the approximate WACC for ASD (based on market values)? /’7\
Mice = RECO to) + Co MR9 — (0 éXOl) +— (0 No 0%): 0,07? «ICI If) f) Assuming the WACC for ASD is an appropriate measure for the cost of‘capital for its
Trane Division (which is the largest of'its divisions by far), what was the EVA of the
Trane Division in"2005 if its before-tax Operating Income was $5 00 million and its
Net Assets averaged $2, 400 million? ATOTz’E‘GOOMCF 04): A300!” _
A1; zizéeoorvt /" \ EUA- Aw: ﬂ WACC MC: 3lBODM- ~(‘0 manometer/1) Act/09 92 mil—(m) 3.. (25 points) Feenix F our (FF) is a real estate private equity fund that is raising capital to "invest in real
estate deals. One of the deals that have been put together over the past year is called
RiverAir, which involves the construction of‘a high-rise apartment complex above a
landmark Manhattan synagogue. Over the past year, FF has acquired the air rights from
the synagogue and has completed the architectural design and engineering. Feenix Four
has hired you as a consultant to value this project. ' RiverAir is expected to cost $300 million (160 units of 1250 square feet each at $1500/sqft, including commons Space and central facilities). Annual rental income,
adjusted for expected vacancy, is expectedtobe $45 million per year and cash operating
expenses (including the air'Space lease payment) are predicted to be $10 million per year;
thus net operating cash income is expected to be $35 million (assume received at end of
year). The initial cost would be depreciated over 30 years straight line and the
composite income tax rate (Federal, State and Local) is 45 %. Under the terms of’the air-
rights lease, at the end of 30 years the structure must be removed at a then estimated
after-tax cost of$100 million. Financial plans call for the project to be ﬁnanced 80% -
($240 million) debt at 7% interest rate and$60 million equity at a cost of 12%. Comparable quality/size/location high-rise apartment complexes in Manhattan are bought
and sold with some regularity and the prevailing market values are at about 9 times
annual Net Cash Operating Income (project revenues, adjusted for expected vacancy, less
cash operating expenses). (a) What is the WACC for the RiverAir project? .. '5 ‘P ,r .. ‘00 2.. :No .7)'—o,v§
WACC" ﬂéﬁ) + £b(?>d T) # (eonvgém ) + Nor—ea (O D U 3 If.»— 2. Q) z)(o (2) + (o'.e)(o.ov)(‘iro.~rr)iz 0,09%? D \/ (b) What are the annual after-tax cash ﬂows for the RiverAir project for 30 years? .___ fir/2&0}? t“ km)” :l\73( LIOSE? M /’ ~ ‘ I', A '
ATP C F {can lie-'1") + 032ch #» rigors? - pra;ﬁ..5j)lttﬁ4 5’- 5 + '0' v
. x." x Mu-mmw.,... A 2/ :$ _ ”K . .
g- . . 25’ ”
(c) Assuming the project can be constructed immediately (time 0), whamWi-esem
value of'the project using the WACC from (a) and the annual after-tax cas ows W31 a?»
from (b). [Hint Be sure to include the after-tax removal expense of$100 million at (as Eal' 0 ‘4
the end of'the 30th year] - 2- 01C #5) a: ’50
i 00 M / Pojﬁ‘mlatv
I I 5
NF v a: (awe at await"? r?" rm“ “G” 3" if“) ‘— 3° ‘3‘“
, _ C t 4— WA Cc)
T“ (5'29259‘4) I" I as 4533" time
- 7 (r + o. __ W?
. —-—-----~———.. , , o
00%? (ii-0.09%)
(on mm a0 A (d) What is the estimated value of the project using the comparable tr ansactrons a r ach? ,
afﬁne”? Wezéast‘ fray ={ falsM j (e) The promoters/manager's of‘FeenixFour receive have a contract which calls 'for
to be paid 20% of‘the value created by the enterprise. How much should the
promoter/managers of FF be paid for their work this year? Assumwtj tVe use 01C MW {Lo ﬁat/{jg {rm Valqe 91F“ 3%€_ Wigwam
Haj metal in lot 1001's; (0 2)<4e§ g7MM11§87 [71774 >
L3 / use. NPV +0 95?ij better/{$6 H' :5
Wilfﬁiﬁ‘nlrméh‘f of the mile OfEa+f at at: Hag
ergier‘fgv'kt While COMPGragole approich is am 4.. (10 points) lm‘JUtY-l'lrtm-E qvty'eja
Rambo’ 3 call options with a maturity oftwo years and an exercise price of$30 are selling for $3. Rambo” s current stock price is $20 and it not expected to pay a cash dividend
01/61 the next two years The annual risk-free rate is 1.5 percent. (a) Is the call option “in the money?” Circle One YES 69> / (b) What would be the value of a Rambo put option with the same maturity and exercise
price? PCP “.9 5+ P 2:", Pit/(E ) + C /,‘...._-w_h_v_hw r "H‘ p: 30 _.._.+3-— 1022;3‘1252 \
-. (Hams) , -\\_ (c) Is the put “in the money?” Circle One EB?) NO / 5 (35 points) Congratulations! You have just been promoted to full partner in a ﬁnancial consulting ﬁrm
and landed a big contract to help Tootsie Roll Industries (TR) evaluate a capital
restructuring. TR has been family controlled for decades and has large and stable 1ncome.
Its patriarch, Mr. Gordon (age 84), has just retired and his daughter rs willing to take more risk than her father. Here are the existing facts regarding TR as developed by your staff
(actual December 2005 data, rounded): Number of'shar'es outstanding 50 million
Current Market Price per Share $30 Book Value per Share _ $1 1 Total Debt Outstanding Virtually Zero
Beta- 0.80 Current Family Ownership Percent 35% Family Ownership ifAll Stock Options Were Exercised ' 39% (a) If the current risk-free rate is 5.5 percent and the corresponding market equity risk premium is 5.0 percent, what rs the CAPM—based cost of equity for IR (excluding any
size premium)? 55 5) $09“;\
{(0:11111651111’1: 0-0 +(0095C00 f'\ w /
(b) What is the unlever'ed cost of'equity for' TR? (Hint— this is easy.) 3/1”“ \
“Meyergi: when 19119114 harm debit 5‘5 unlevtrfoi Re if Re ' gzws } (c) The proposal is to issue $750 million debt and use proceeds to repurchase stock
Assume the inter est rate on existing and new debt is 7 0 percent and the 1ncome tax rate
is 40 percent. What would be the market value of‘TR aﬁer‘ the restructuring under M&M theory? RD M007 T: of} _
16551401195") )(nge E‘s—Lore): (90M )(f30)31¢l S Lillie/1 ” :V 14)?“ :10 58 + (o maker) =1 51.3131111m ) \\‘w—__~_ f/’ (d) How many shares could be repurchased with the debt proceeds if the repurchase price
was $36/share? 13‘7S'QM , {f 20 8’3 Millie/1 chart: “~>// 1131.. x ..h__ (e) What would be the value of a share of stock after the restructuring if shares could be
rcpurchased for $3 6/share? ' ' 3 : 2 .1
#311111: (111% (spurahqge, -= 50M 5 20.1? M =1 11/1 143%,”: : 11,—, 1.5 = $1.13 #3115011
7 _ _ ‘ $1.058 ..
Value pen Jinan: - .1... ’ 201.1'7M E 3 VI." D 225/10 8:8 (f) What would be the cost ofequity capital under M&M after the ﬁnancial restructuring? D .— :. 0 ‘75.:
RE ‘2' K01 “i” (KM 'RD)(‘§)C(’T\) Kb " 037/? [03' 07”; KM : “Mayer Bet COS; o~F Rial-3 2 0.0615
T30 { Re :2 was + (0.095? “a 07) am] C («M3 :— (g) What would be TR’s WACC after the restructuring if'M&M theory prevailed? tart-Cc: (%)R5 + (if; mjﬂbtzw'r )= (to )(0ws7)+(0‘7;)(o.o7)(r-—or~r) /: r: -.O 0 t? M\ '
r..\mmwﬂm, / (h) Why did you think the daughter favors using the proceeds of the debt issue to fund a
share repurchase rather than a cash dividend?
M“ (‘P SJ“. (5' WIHIj 7’9 {wake More “5% "ﬁﬁgan he» ﬁlf’lqe/ (”M flan/uh 1105? M19
+0 37/ QKPWUVE ‘L" 14’“: Ji—eek) and by 40:93 J'hr': JLJC inﬂame: ROE whrle
‘Crine—‘tuwj aerating SMthe (subjectiwithwek later: +0 more risk, but “WNW (i) If Tootsie Roll were to decide to restructure as proposed above, what additional effect
other than the income tax effects captured by the M&M theory and equations 15 likely to occur and will that effect tend to increase or decrease the total enterprise value as
expressed in the M&M model? TILL-CV = WE‘i‘ D896 “4'“ HV Ectugb :. ‘Tctmt Dtbf‘ we" Cash Edie-ace - 4"“ MV ECU/t?
f. 7/ d — i”! The JI/Iat/£h0id€l§ win 199a: 3%th risk which Witt {her/East: ﬁne. smegma r-jsJ: fay/award on Regatta) J Which he? "he eHEet' at: martian J THAL (MACE aldci heme icwertrj WE. {BM En+9"}9ﬁ$ﬁ Vaiwe M We Mgﬁ» MW: ...

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