ME1311 210301 Final Exam-1 PDF

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EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

KTH Industrial Engineering and Management

FINAL EXAM COURSE ME1311 MONDAY, MARCH 1, 2021, 8.00 - 12.00 A reminder!  Start the answer of a question on top of a new piece of paper!  Write your name and person number on top of all pages!  Try to answer all questions and explain your reasoning!  When you answer problems you need to: 1. show the equations that you use with correct symbol for variables (define variables only as needed) 2. show calculations 3. clearly show your answer.  All calculations should be handed in. No points for just an answer if calculations are needed. Deductions will be made if you don't state the equation.  Unreadable text will not be graded. Grading There are 10 questions with a total of 100 points For grade A 90 % out of 100 % is needed For grade B 80 % out of 100 % is needed For grade C 70 % out of 100 % is needed For grade D 60 % out of 100 % is needed For grade E 51 % out of 100 % is needed For grade Fx 48 % out of 100 % is needed, Fx can be upgraded to E by doing a supplementary exam. 47 % and below is F (fail).

CALCULATOR AND THE FORMULA SHEET HANDED OUT AT EXAM ALLOWED NO BOOKS, NO DICTIONARIES, NO NOTES

Most of all – stay focused, be systematic.

Best of Luck!

EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

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Problem 1a (Max 5 points) •

Banacob Inc. has a beta of 0,92. Assume the economy has a 75% chance of the market return will be 22% next year and a 25% chance the market return will be -13% next year. Assume the risk-free rate is 7%. – What is Banacob’s expected return next year?

Problem 1b (Max 5 points)

•

Answer the following questions related to the diagram for bonds below : – a. What are these types of curves called? – b. What is the profile of the 2006 curve called (downward slope)? – c. What is the profile of the 2008 curve called (upward slope)?

– d. What are Nominal interest rates? – e. What are Real interest rates?

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EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

Problem 2 (Max 10 points) •

Tasle and Gstop stocks have the historical annual returns shown in the table. – a) What are the expected returns and volatility for each of the two stocks? (6p) – b) What is the correlation between the two stocks? (4p) Year

Tasle Return

Gstop Return

2009

-7%

-4%

2010

12%

-2%

2011

23%

17%

Problem 3a (Max 7 points) •

You are considering getting a race boat. The boat is expected to last for 10 years. There are two alternative. 1) You can buy the boat for $4000 up front and $6000 in 5 years; or 2) You are offered to pay $110 per month for 10 years. The interest rate for both alternatives is 10% APR with semi-annual (2 times/year) compounding. – Show which alternative is better.

Problem 3b (Max 3 points) •

Name the financial models that use the following equations

Div1 Div2 DivN PN   L   2 N 1  rE (1  rE ) (1  rE ) (1  rE ) N

–

a)

P0 

–

b)

PV0 

–

c)

P0 

PV (Future Total Dividends and Repurchases) Shares Outstanding 0 V0  Cash0  Debt 0 Shares Outstanding0

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EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

Problem 4a (Max 5 points) The chart below shows Cost of Capital relative to the Debt-to-value ratio typical for a company. Identify the 5 lines A to E.

A B D

C

E

Problem 4b (Max 5 points) a. List the three conditions for Perfect Capital Markets? (3p) b. What is the "Conservation of Value Principle for Financial Markets" (if perfect capital markets)? c. What is Modigliani and Miller's Proposition II?

EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

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Problem 5a (Max 6 points) •

You have the following bonds: a) A no default risk, 2-year, zero coupon bond with a risk free rate of 6% and face value of $2000. - What are the price and the yield to maturity of the bond? (show calculations) b) A risk of default, 2-year, zero coupon bond with face value of $2000. Risk free rate is 6%. Probability of default is 40%; if default it pays $1200, otherwise full face value. - What are the price and the yield to maturity of the bond? c) A certain default, 2-year, zero coupon bond with face value of $2000. Risk free rate is 6%. The bond issuer will pay 90% of the obligation. - What are the price and the yield to maturity of the bond?

Problem 5b (Max 4 points) •

Breman SA has an enterprise value to EBITDA multiple of 7,8. The company has $190 million in debt, $3120 million in cash, EBITDA of $2460 million, and 300 million shares outstanding. – Estimate the value for a share of Breman stock.

Problem 6a (Max 8 points) – Helix Industries is considering expanding into a new product line. Earnings-pershare is currently $6 and it is expected to grow annually at 6% without the new product line, but growth would immediately increase to 8% if the new product line is introduced. To finance the new product line, Helix would need to cut its dividend payout ratio from 80% to 50%. – If Helix’s equity cost of capital is 12%, what would be the impact on Helix’s stock price if they introduce the new product line? Assume the equity cost of capital will remain unchanged.

EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

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Problem 6b (Max 4 points) •

You have sold short a call (for $1.00) and you have also sold short a put (for $2.00) on the same share of stock for Karp Company with the same exercise date. The exercise price of the call is $20 and the exercise price of the put is $25. – Plot, in a diagram, the overall net value to you of this combination of options as a function of the stock price on the exercise date. – When, in terms of pricing and volatility, may this overall position be a good combination?

Problem 7 (Max 8 points) 

Fletch-B PLC expects to have free cash flow in the coming year of $X million, and its free cash flow is expected to grow at a rate of 4 % per year thereafter. The value of its interest tax shield is $18 Million. Fletch-B has an equity cost of capital of 16 % and a debt cost of capital of 6%. It maintains a debt-equity ratio of 0.5, and the corporate tax rate is 40%. o What is the free cash flow in the coming year ($X million) for Fletch-B?

Problem 8a (Max 7 points) Provide the terminology that matches the definitions below: a) A contract that gives its owner the right (but not the obligation) to purchase an asset at a fixed price as some future date b) A contract that gives its owner the right (but not the obligation) to sell an asset at a fixed price as some future date c) Options that allow their holders to exercise the option on any date up to, and including, the expiration date d) Options that allow their holders to exercise the option only on the expiration date e) Price at which an option holder buys or sells a share of stock at expiration f) State of firm that has difficulty meeting its debt obligations (but has not failed) g) State of firm that fails to make the required interest or principal payments on its debt, or violates a debt covenant (condition). Debt holders are given rights to assets of firm.

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EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

Problem 8b (Max 3 points) Regarding Bond prices and Bond trading. Fill in the blanks (****) in a) and b), and answer c):  

a) When the bond price is greater than face value: We say the bond trades ****. b) When the bond price is equal to face value: We say the bond trades ****.



c) When the bond price is less than face value: Indicate how the Coupon rate relates to Yield to maturity?

Problem 9 (Max 10 points)



Fixerb is considering launching a new product which they expect to sell during a 3 year period. Sales will be $50 million each year. Cost of Goods Sold will be 68% of sales. Additional selling costs will be $5 million per year (years 1 to 3).



Fixerb has to spend $6 million to buy equipment immediately (before they can start sales). The equipment has a three year life and straight line depreciation is used. After one year the company has to buy additional equipment for $2 million depreciated in straight line over two years. Tax rate is 30 %.



Receivables will be 20 % of current year’s sales and payables 15 % of current year’s cost of goods sold. Inventory of 5% of the following year’s sales are needed. - Calculate change in Net Working Capital for years 0-4. - Calculate incremental Free Cash Flows for years 0-4. - Calculate NPV of the new product (Fixerb’s cost of capital is 15%). - (Note: Show how calculations are done in table.)

Year Sales

0

1 50

2 50

3 50

4 0

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EXAM COURSE ME1311 MONDAY, MARCH 1, 2021

Problem 10a (Max 5 points) •

Divoc91 had the following stock prices and dividends paid in 2019. What was the total annual return for the company? Date 12/31/2018 1/31/2019 7/30/2019 10/31/2019 12/31/2019

Price ($) 15.60 17.55 16.18 16.95 17.41

Dividend ($) 0 0.27 0.24 0.30 0

Problem 10b (Max 5 points) – EASTCO and WESTCO are both expected to pay a dividend of $4.6 million per year in perpetuity. EASTCO’s cost of capital is 11% per year and WESTCO’s cost of capital is 15%. The risk free rate is 6%. EASTCO has a beta of 2.0, and CAPM would assign it an expected return of 14%. WESTCO’s beta is 1.8. – For EASTCO: What is the market value and alpha? (2 points) – For WESTCO: What is the market value, CAPM expected return, and alpha? (3 points)...