Finance Homework Questions

Question 1: Agency Relationship and Takeover Defenses

1. We have discussed in the lecture that value maximisation of a business can be regarded the main goal of the firm. We also introduced the agency relationship. Now consider the following information: Many firms have devised defences that make it more difficult or costly for other firms to take them over (examples may include “poison pills”, “golden parachute”).

Do these defences create or affect firm’s agency problems? Are managers of firms with strong takeover defences more or less likely to act in the shareholders’ interests rather than their own? Discuss. (4-6 sentences)

2. a. What should be the compound annual interest rate in order to triple an investment in 10 year?

b. What is the effective interest on a loan that carries 1% weekly interest?

c. You plan to borrow from a bank and you have been offered the following terms: loan term is 6 year. The loan amount is 200 000 euros and the repayment schedule is based on an annuity with semi-annual payments. Find the principal payment for the second half of the first year, if the annual interest is 8%.

3. AS Holdings is going to issue new coupon bonds. The bonds will be redeemed exactly 5 years from now and carry 4% annual coupon interest. The par value is 100 euros. The expected yield from bonds with similar characteristics is 3%, given current market conditions. The company issues 45 000 bonds.

a) Find the value of bond given the information presented above

b) Assume that issue costs (including underwriting fees etc.) are 1.1% of the par value. Find how much capital is AS Holdings effectively raising by selling bonds to investors.

4. Your task is to find the cost of capital (WACC) for a company. The company has three sources of capital available. The marginal tax rate for the company is 25%.

Common stock: the company has 200 000 shares outstanding with current market value equal to 50 euros. Current risk free market rate is 2%, the company beta is estimated as 1.25 and current market risk premium is 8%.

Debt 1: The company has issued 1 200 coupon bonds with par value of 8 000 euros. These bonds carry 4% coupon rate but currently offer 5% yield to investors. The market value of bonds is 7 200 euros per bond.

Debt 2: The company has also recently obtained secured financing from the bank. The current loan balance is 4.5 million euros and the annual interest charged by bank is 2.65%.

a) Estimate the capital structure weights for each source and required rate of return for each source when necessary.

b) Find the cost of capital (WACC) for the company

c) Please describe shortly how an increase in the cost of capital could influence a company

A company is considering an investment into a new project. The company is going to sell a new purification system. They are planning the sales of 25 000 systems a year. The costs of market research were $100 000 and this money is already spent. The price of the product is 100$. The duration of the project is 5 years.

The variable costs are estimated 40% of the sales price. The fixed costs are 325 000 per year (excl. depreciation). The investment into fixed assets is 4.0 million, is fully amortised in 5 years but can be sold for 20% of the initial investment cost.

The need for investments into working capital to maintain projected level of sales is expected to be 20% of the monetary value of sales. The firm expects that all investments into working capital can be converted into cash at the end of the project. The corporate tax rate on profits is 25%.

a) Find the cash flows for the project

b) Should the company invest, if the required rate of return from the project is 12%. Find the cash flows for the project. Evaluate both NPV and IRR