Q1
Bumtug Ltd. (BTG) focuses solely on beverage contract packing for a variety of firms in Australia. You aim to value this firm using the Free Cash Flows to Firm model. The following information is needed to model the free cash flows to the firm (FCFF) for the next three years:
The firm’s equipment book value is worth of $12mil which can be fully depreciated straight-line over the three years for tax purposes. After that, depreciations will be minimal and not relevant for valuation purposes.
The net working capital is 10% of the annual sales.
Sales revenue was $50mil this year and expect to grow at 10% every year for the next three years. Total manufacturing costs and operating expenses (excluding depreciation) are 80% of sales.
After year 3, since estimating the future FCFF explicitly becomes too imprecise, you assume that the FCFF will grow at long-term GDP growth rate of 2% forever.
You further collect the information about debt and equity to assist the valuation:
Debt: BTG’s long-term debt consists of 12% bonds issued with a face value of $15 million, paying semi-annual coupons. These bonds have exactly 8 years to maturity with 16 coupons to be paid. The bonds are currently trading at par. You also estimate that the bond’s default risk is 0.
Equity: Its equity consists entirely of ordinary shares. The firm’s stock price is current at $2/share. There are 10 million shares outstanding. The equity beta is 2.
Market Data: The market risk premium is 9% and the risk-free rate is 3%. The tax rate is 30%.
a.What are the free cash flows to the firm for the first three years?
b.What is the firm’s Weighted Average Cost of Capital?
c.What is the firm’s enterprise value? What is the firm’s equity value? What is the firm’s share intrinsic value?
d.Based on your valuation, will you invest/ not invest in the company?
Q2
Part A: Peter Smiths is a portfolio manager of Silver global technology fund in Sydney. He is concerned about currency fluctuations related to the equity portfolio. The portfolio is valued in AUD, but has foreign currency exposure, primarily the USD.
Based on his analysis, Peter generates the following forecast:
Expected return (in USD) of the Portfolio 12.4%
Standard deviation (in USD) of the portfolio 18%
Expected FX spot rate in one year 1USD = 1.2047AUD
Standard deviation of the FX 5%
Correlation between FX and the portfolio (in USD) – 0.06
A FX dealer provides the following market quote
USD / AUD spot rate 1.1870
1 year USD / AUD forward rate 1.2058 – 1.2079
Peter considers to sell USD and buy AUD using a one-year forward contract to fully hedge USD currency risk. He would like to execute the trade only if he can increase the portfolio return by at least 30 basis points.
Based on Peter’s forecast, should he execute the forward contract? Please justify your responses with calculations
Part B One of the non-USD FX exposures in Peter’s portfolio is JPY. Peter regularly adjusts his portfolio’s JPY position based on his short-term forecast. Peter predicts JPY will appreciates by 4% against AUD over the next 90 days. The FX spot rate is 84.03 (1 AUD = 84.03 JPY). Peter is considering the following 90-day European options to increase JPY exposure in the following 90 days and simultaneously minimize his cash flow to create option portfolio
Choice 1: Buy call option on JPY with 87.72 strike price and Sell call with 89.84 strike price
Choice 2: Buy call option on JPY with 84.03 strike price and Sell call with 87.72 strike price
Choice 3: Buy call option on JPY with 84.03 strike price and Sell call with 89.84 strike price
Determine which Choice most likely satisfy Peter’s objective at expiration and justify why the OTHER TWO CHOICES are NOT suitable (No more than 50 words).
Q4
Tommy Brown is an equity analyst focusing on healthcare and biotech industries. Recently, he believes that the share price of TTH, a biotech firm, will be significantly influences by the outcome of US food and drug administration approval on its new drugs. If the application is successful, Tommy believes that TTH’s share price will would increase sharply. If the application is unsuccessful, he believes that TTH’s share price would fall significantly. Tommy wants to profit from his beliefs by implementing a straddle. He collects the following information
Current share price of TTH $10.60
Risk free rate 1.3%
Price of 30-day call option with strike price 11.50 is $1.2
Price of 30-day put option with strike price 11.50 is $1.5
A Calculate the profit per share on the straddle if TTH’s application is successful and TTH’s share price doubles.
B Calculate two share prices of TTH at which breakeven for straddle occurs