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 allequity 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
debttoequity 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 UScalculated 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 marketbased 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% TBond 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 startup, 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% 3Year TNote
6.60%
Like Risk U.S.
Market Beta 1
1.60 20Year TBond
7.20% 8.60% 3Month
Foreign
8.40% Foreign
Inflation
4.00% 3Month
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 “likerisk” 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 nooptions 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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 PROTOPAPADAKIS
 Net Present Value

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