Universidade Nova de Lisboa José Neves Adelino

Faculdade de Economia Bernardo Teles Fazendeiro

Isaac Hacamo

Finance

Mid-term

April 19, 2008

Before you begin answering your mid-term please write your name and number on the answer pages.

Please, answer each question in the corresponding answer sheet.

Proctors will not answer questions during the test.

When you complete your exam, please keep seated and wait until your answer book is collected.

Duration: 2 hours.

Good luck!

Question 1(xx points)

Ellington, Fitzgerald& Armstrong inc. (EFA) is a successful brokerage firm, dealing with government bonds. The company observed the following bond data from its Bluebergdata screen:

Bond type / Price / Coupon Rate / Maturity (in years)
Zero coupon / 99% / - / 0,25
Zero coupon / 98% / - / 0,5
Quarterly payments / 98% / 1,5 % / 0,75
Annual payments / 99% / 3,5 % / 1
Annual payments / 102% / 5,75 % / 2

a)Please compute the spot interest rate for the first year;

b)Please compute the spot interest rate for the second year;

c)The bankJaycee Morgan has commissioned EFA to determine the appropriate interest rate to place on a single payment loan: the bank wants to know, now, the appropriate interest to place on a client’s one year loan that will be issued next year. Hence, what should be EFA’s suggestion?

Please notice: the next two questions can be answered without answering the previous three questions.

d)Please compute the yield to maturity of both zero coupon bonds;

e)Please compute the spot interest rate for the third quarter.

Question 2(xx points)

The sport’s equipment firm,Tonel&Gladstone Inc. (T&G),will generate dividends of 56 million euros by the end of the first year. That amount is then expected to grow at a rate of 5% per year for the next nine years. At the end of the eleventh year, T&G’s dividends will go up to 90 million euros and stop growing, remaining constant thereafter. T&G has 8 million shares outstanding and its cost of capital is 12%.

a)Please compute the price of T&G’s stock.

b)If the company has a yearly payout of 65% during the first ten years, calculate the annual return on invested capital for that period. Also, what is the payout of the firm after the eleventh year?

c)T&G has to re-evaluate now its performance due to unexpected losses, which caused its price to decrease to 55 euros per share. Please indicate the total amount of the loss of T&G.

Question 3(xx points)

Mr. Beenie wants to save up for his retirement. He needs exactly 100.000 euros twenty five years from now. His local bank offers him the following saving plan: deposit fifty equal semiannual installments, the first of which is placed one semester from now, each compensated at an annual equivalent interest rate of 5%.

a)If Mr. Beenie goes along with the proposal, what is the value of each installment?

b)Mr. Beenie realized however that he will cash in an insurance policy, eight years from now, which will allow him to deposit 7000 euros, in one lump sum, into his saving plan, at the end of eight years. Also, in years twelve though fourteen, he will have to assist his twin sons Rupert and Lloyd through college, meaning that he will not be able to save from after the end of the eleventh year till the beginning of the fifteenth year. The bank has allowed Mr. Beenie to stop saving in the years mentioned and to deposit the 7000 euro amount. Therefore, considering the situation above, please write neatly the total expression needed to calculate the new installment so that Mr. Beenie may have exactly 100.000 euros in 25 years. (Hint: plotting a time graph helps in solving this exercise).

c)Now ignore the situation described in b). Please calculate the total amount of interest obtained from the saving plan after the 25 years.

Question 4(xx points)

SLB Inc., a highly successful global company, is considering a new project. The project is expected to last for three years, and the investment proposal was prepared by an outside consulting firm to which SLB must pay, immediately, €150,000.

According to the project, the new business unit will generate €600,000 of revenues in the first year. Revenues are expected to grow 5% and 10% in the second and third years, respectively. Incremental costs for the project are expected to be constant throughout the three years, at €350,000.

SLB must invest €500,000 in new equipment. The new equipment is to be fully depreciated over 10 years. However, at the end of the project (in three years), the equipment will be sold for €400,000.

The project requires an immediate investment of €100,000 in net working capital . NWC is expected to represent 30% of revenues at the end of periods 1 and 2.

Resources allocated to this project will decrease pre-tax revenues in former activities by about €30,000 per year. At the end of the project, SLB’s former business returns to normal.

The new business requires the use of a piece of land belonging to SLB. That land is worth €200,000 if sold in the market. In three years, SLB expects the value of the land to be the same.

The company uses straight-line depreciation. The corporate tax rate is 30% and the appropriate discount rate for projects of similar risk is 15%. Assume that the sale of the land is exempt from taxation.

a)Estimate free cash flow for this project;

b)Estimate NPV. Should the company invest in this project?

c)Would your answer be different if you new that the company has a policy of paying out, as dividend, 50% of Net Income?

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