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Unformatted text preview: UNIVERSITY OF SOUTHERN CALIFORNIA Marshall School of Business INTERNATIONAL FINANCIAL MANAGEMENT FBE 436 Aris Protopapadakis PROBLEM SET # 3: Problem #3.1: Below is the relevant cash flow report for a project. If the corporate tax rate is 34%, the Debt/Equity ratio is 1.00, the Cost of Debt is 11.0% and the unlevered Cost of Equity is 22.0% for this project, what is the Net Present Value? What is the current beta of the firm’s equity, assuming that Rf is 6.0%, and the market risk premium, ERPm, is 8.0%. Year Free Cash Flow Interest Tax Shield 1 2 3 2,772.00 3,102.00 3,036.00 340.00 400.00 410.00 PV of the Cash Flows Year 1 2 Free Cash Flow Interest Tax Shield Total Present Value: $ 3 FBE 436 Problem Set #3 Problem #3.2a: Given the information below, what is the Cost of Equity that should be applied to the free cash flows? CoE(levered) CoD(levered) Debt/Equity 28.00% 10.00% 1.25 Corporate Tax Rate 34.0% Risk Free Rate 4.50% Market Risk Premium 6.00% Problem #3.2b: Ralphson is an all-equity firm, and has a Japanese subsidiary. Given the information below, what is the Cost of Equity that should be applied to the Yen free cash flows of its subsidiary? The betas are refer to the firm betas Beta --World Beta -Japan 0.45 1.20 E(RP) –World In ¥ 6.0% 2 E(RP) –Japan In ¥ 5.0% RF In ¥ 1.05% FBE 436 Problem Set #3 Problem #3.3: The following cash flows are expected from the UK subsidiary, Beckham Ltd. The UK corporate tax rate is 45%. For year 3 and thereafter, quantity sold is expected to grow at 2.5%, prices at 4%, and CoGS at 6.6%. Capital Expenditures and Net Working Capital also grow at 6.6%. Furthermore, Rf = 7.0%, CoD = 11%, E(RPM) = 6.0%, the firm’s beta = 1.8, and the debt-to-equity ratio is 1.4. What is the value of BJC Ltd. in £s? Year: 1 3,000 £150 £105 2 3,200 £ 165 £ 115 £ 10,000 £ 10,660 Interest Taxable Income After Tax Income £ 27,500 £ 27,500 Year: Capital Expenditures Changes in NWC 1 £25,000.00 £2,000.00 2 £26,650.00 £2,132.00 Quantity Sold Price Unit Costs Sales Cost of Goods Sold Depreciation EBIT Year: Quantity Sold Price Unit Costs Sales Cost of Goods Sold Depreciation EBITDA 1 2 Interest Taxable Income After Tax Income 3 3 FBE 436 Problem Set #3 Year: 1 2 FCFs to be discounted at CoE(u) Interest tax shields Present Value of FCF Present Value of Tax Shields 4 3 FBE 436 Problem Set #3 Problem #3.4: Consider the FCFs and tax shields (in ¥1,000). Use the market information given below. What is the $-value of these cash flows (translating to $s before valuing)? Cash Flows in 1,000 Yen 1 2 ¥ 1,400,000 ¥ 1,400,000 ¥ 50,000 ¥ 62,000 Year FCF Int Tax Shields FX Forecasts: 125.00 118.00 ¥/$ 3 ¥ 1,750,000 ¥ 65,000 115.00 US Market Data: D/E Ratio Corp Tax Rate Risk_Free E(RPM) CoD Beta Year 1.20 46% 2.20% 5.50% 7.20% 2.30 Cash Flows in $ 1 2 3 1 3 FCF Int Tax Shields Year 2 PV(FCF) PV(Int Tx Shield) PY(Total) Discount by the appropriate discount factors to get: $ 5 FBE 436 Problem Set #3 Problem #3.5: Consider the FCFs and tax shields (in ¥1,000). Use the market information given below. What is the PV of these cash flows in ¥? What is the translated value in $s.? Cash Flows in 1,000 Yen 1 2 ¥ 1,400,000 ¥ 1,400,000 ¥ 50,000 ¥ 62,000 Year CFC Int Tax Shields 3 ¥ 1,750,000 ¥ 65,000 Japanese Market Data: D/E Ratio Corp Tax Rate Risk_Free E(RPM) FX Rate CoD Beta Year 1.20 46% 0.50% 5.41% 125 ¥/$ 5.42% 2.30 Cash Flows in 1,000 Yen 1 2 PV(CFC) PV(Int Tx Shield) PY(Total) Discount by the appropriate discount factors to get: ¥ , which translates into $. 6 3 FBE 436 Problem Set #3 Problem #3.6: Arena Enterprises is considering a Greenfield investment in an unnamed emerging market in the same line of business. The operation will supply local markets. The US-calculated beta for Arena’s business is 2.80. Below are some data for the US and the Erehwon (an emerging market) index returns. What would be a reasonable estimate for the beta of this new direct foreign investment, from the point of view of US investors? Would your answer be affected if the investment were a manufacturing facility built to supply the US market exclusively? US Market Returns 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Erewhon Market Returns -0.05404 0.04397 0.21570 -0.39305 0.19710 -0.12424 -0.33244 -0.13923 -0.10223 0.02427 -0.05886 0.24168 -0.03351 0.35500 0.42762 -0.48405 0.48861 0.58540 0.10285 -0.53323 -0.61405 -0.22483 -0.77756 -0.11051 -0.15833 -0.11867 -0.15495 -0.18853 0.16877 -0.47577 7 FBE 436 Problem Set #3 Problem #3.7: Below are available market data on bond yields and inflation forecasts for 5 years. You are asked to provide market-based FX rate forecasts suitable for translating future cash flows into $s, to be used for valuation purposes. Assume that you are at the end of year 0. Current spot rate is 7.80 SK/$. 1 7.9466 Government Debt Yields (SK --by maturity year) Expected $ Inflation: Expected SK Inflation: 3 n.a. 4 n.a. 5 n.a. 1.90% Forward (SK/$) Treasury Bond Yields ($ --by maturity year) 2 n.a. 3.50% 4.20% 4.80% 5.00% 3.75% 5.10% 5.65% n.a. n.a. 2.10% 3.00% 2.50% 4.00% 3.00% 4.25% 3.30% 4.00% 3.20% 3.75% Best Available Forecast: Forecast Spot Rate (SK/$) ALL PPP Forecast: Forecast Spot Rate (SK/$) Problem #3.8: There aren’t sufficient data in Baht to value Baht cash flows. Accordingly, the US parent, Harkes Inc., plans to translate US CoC’s and apply those to the Baht cash flows. The following data are relevant. The “betas” refer to the business risk of the project to be valued. Beta -World E(RP) –World Rf 1.25 7.30% 1.40% T-Bond 1 Yr 2.50% Gov Sec 1 Yr (Baht) 12.45% Harkes’ current cost of debt is estimated at 5.65% What are the appropriate Baht CoE (u) and CoD (L) that Harkes Inc. should use? 8 FBE 436 Problem Set #3 We have not discussed international taxation issues and you are not responsible for any of that material. However, you might want to try to work out this small taxation problem. Problem #3.9: The foreign and domestic corporate tax rates are shown below. “Withholding Taxes” are taxes paid on dividends or interest remitted, over and above income taxes. What taxes does the corporate entity pay, if dividends are remitted immediately? Dividends equal earnings in this case. Assume that a tax treaty exists in this case. A tax treaty allows taxes paid abroad to be fully deductible from taxes paid in the US. Taxable Income = $200,000 (translated to $s). Tax Rates U.S. Foreign Withholding 34% 28% 5% Problem #3.10: Consider the valuation of a start-up, Robinho Enterprises, without an established track record of positive cash flows and profits. Its current revenue is $2.45/share. In its IPO prospectus, the investment bank proposes a share price of $16.50, for 10,000,000 shares. (Hint: Use the Perkins approach. Additional details are in Tom.com) (1) (2) (3) (4) What average growth rate does Robinho’s stock price need to achieve in order to make this a good investment? What should the price of Robinho’s share have to be in 5 years? What revenues must Robinho generate in 5 years’ time? What is the implied CAGR? 9 FBE 436 Problem Set #3 Problem #3.11: Crouch Inc. is contemplating a foreign acquisition. The Finance VP assigned the task of valuing the foreign company to a team of young experts, and they produced an apparently very thorough estimate of the PV of the company cash flows. Their estimate is $140 Million. The VP noticed however, that 70% of the value of the company came from the “Terminal Value”. Here is what she found, upon closer examination. Market Data: 3- Month TBill 5.25% L.T. Foreign 10.00% 3-Year T-Note 6.60% Like Risk U.S. Market Beta 1 1.60 20-Year TBond 7.20% 8.60% 3-Month Foreign 8.40% Foreign Inflation 4.00% 3-Month Foreign 8.40% AAA Yield U.S Inflation 2.50% Calculated or Assumed Values: Rf 7.20% 1 Exp U.S. Market Return 6.50% CoD(L) CoE(u) 8.60% 17.6% Approximate S.T. Growth 17.0% L. T. Growth 9.50% The business beta of the “like-risk” firms was calculated from quarterly data. How good do you think the team’s analysis was? What would you change? Problem #3.12: Given the following information on a simple no-options bond, what would be its market value per $? Calculated or Assumed Values: Coupon 6.00% Maturity 22 Coupon Frequency Every 6 months 10 Current Yield 8.40% ...
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