FINANCIAL MANAGEMENT

FIN310 – Financial Management

Responsable du module : Johan WIENBELT

Semestre 5 - Année 2020-2021

Consignes / Spécifications :

Final Exam Subject – December 2020

Exam Instructions:

1. Please put your name/surname on your exam sheet;

2. You have 120 minutes to complete the exam;
3. The formulas are listed below;
4. Points are indicated per question. There is no penalty;
5. Write your formulas and calculations clearly, each step. Correct formulas /
calculations with wrong answers still receive points.
Answers without calculations receive less points;
6. You can reply by writing in a Word document (show your formulas and
calculations!) or in Excel;
7. Total maximum points = 100 points;
8. Question 9.2 is a BONUS question for 10 points.
A compléter par l’étudiant (si les étudiants doivent répondre sur le sujet) :

Nom : ……………………………………………………………………………………..

Prénom : ...……………………………………………………………………………….

Numéro : …………………………………………
 Formulas

MAIN FORMULAS PROVIDED FOR THE FINAL EXAM

Annuity formula

F Future value of annuity

Variance of returns

Financial Management - session 1 153

MAIN FORMULAS PROVIDED FOR THE FINAL EXAM

Correlation
and
covariance
of returns

The standard deviation of a portfolio with two stocks

Var(

Financial Management - session 1 154

 MAIN FORMULAS PROVIDED FOR THE FINAL EXAM

Beta definitions.

Financial Management - session 1 155

 Final Exam

Brilliantly graduated from ESSCA, you find a job in a private equity boutique as a financial
analyst. You are asked to carry out financial analyses in order to advise investors on the
opportunity to invest in the following two rival firms: Longwood Inc. and Shortsticks Plc.
You have received the following data about the two companies:

Longwood Shortsticks
Number of shares outstanding (in
million) 30 5
Market value of Equity (in million €) 1,690 250
Market value of Net Debt (in million €) 75 90
Equity Beta 1.20 0.80
Risk free rate (rf) 1.00% 1.00%
Expected market return E(Rm) 7.00% 7.00%
Cost of debt (Rd) 3.00% 2.00%
Tax rate 30.00% 30.00%

In addition, you have the following Balance Sheet at the end of 2018 and Income Statement over the
year 2019:

2018 - Balance sheet (in million €) Longwood Shortsticks

Net Fixed Assets 1,500 300
Inventories 1,100 150
Receivables 800 40
Cash 435 60
= Total Assets 3,835 550
Longwood Shortsticks
Payables 872 100
Financial Debt 1,250 150
Total Shareholders' equity 1,713 300
= Total Liabilities & Shareholders' Equity 3,835 550

2019 - Income Statement Longwood Shortsticks

Sales 4,524 450
- Cost of sales 3,310 350
- Administrative & General costs 654 60
- Depreciation 122 15
= EBIT 438 25
- Interests 98 10
= Pre-tax income (EBT) 340 15
- Taxes 102 4.5
= Net Earnings / Net Income 238 10.5
- Dividends 70 4
 Questions
Part 1. Advising investors (46 points: 3 + 8 + 7 + 10 + 8 + 10)
• Question 1 (3 points)
Part of Net Earnings is paid as Dividends. What is happening with the remaining part?

• Question 2 (8 points)
Compute the Firm Value, Cost of Equity and the WACC for both Longwood Inc. and Shortsticks
Plc., in a % and two decimals. Explain/detail all your computations?

• Question 3 (7 points)
Compute Working Capital Requirement and Return of Capital Employed for Longwood Inc. and
Shortsticks Plc. (% and 2 decimals);

• Question 4 (10 points)

Compute the following 5 ratios for both Longwood Inc. and Shortsticks Plc. 2 decimals and
correct notation required (choose €, % or no units):

Pay-out Ratio, Dividend per Share (DPS), Price per Share, Dividend Yield and Price-Earnings Ratio
(PER);

• Question 5 (8 points)
Based on your answers for questions 2, 3 and 4, considering all ratios, would you advise your
clients to invest in Longwood Inc. or Shortsticks Plc.? (Explain & detail your answer);

• Question 6 (10 points)

You use the Dividend Discount Model (DDM). Give the correct formula for the theoretical share
price using the DDM.
What is the implied growth rate (g) of Longwood Inc. and Shortsticks Plc.?
What should be the Share price for each firm if their growth rate g = 2%?
Part 2 Advising Longwood Inc. (54 points: 24 + 19 + 11)
• Question 7 Capital budgeting (24 points: 7 + 5 + 7 + 5 points)
Longwood Inc. is considering investing in one of the 2 following projects:
Project 1 (in million €)
Years 0 1 2 3 4 5
Cash flows -420 100 110 120 130 140
Project 2 (in million €)
Years 0 1 2 3 4 5
Cash flows -200 105 35 55 80 30

We suppose that Longwood Inc.’s WACC is 7%.

• Question 7.1 (7 points) Compute the NPV for both projects?

• Question 7.2 (5 points)

The internal of return (IRR) of project 1 is equal to 12.40% and the IRR of project 2 is
equal to 18.50%. In which project do you advise to invest and why (detail your answer)?

• Question 7.3 (7 points)

Why would a company use the Payback Period criterion to select investment projects,
instead of the NPV?
What is the Payback Period of project 1 and of project 2? Express in years, months and
days; round off days to the nearest full number.
Suppose Longwood Inc. may have cash trouble and it prefers using the Payback Period to
select the best project. Which one would you recommend now?

• Question 7.4 (5 points)

In what type of circumstances do we use the Profitability Index?
If Longwood Inc. could execute both projects, rank these according to their PIs?
• Question 8 Bond Financing (19 points: 4 + 5 + 10 points)

• Question 8.1 (4 points)

Longwood Inc. thinks about financing both projects. Which sources of financing does a
firm have in general?

• Question 8.2 Bond Financing (5 points)

You advise Longwood Inc. to investigate the bond market to finance both projects for a total
amount of €420m + €200m = €620 million. Using the following zero-coupon bonds quotes,
calculate the yield-to-maturity (YTM) for each year.

Zero-coupon bonds quotation

Maturity (in years) 1 2 3 4 5

Quotes 99.5% 98.25% 96.00% 94.00% 92.00%

• Question 8.3 (10 points)

To finance the two projects, you imagine a bond issue with the following features:
▪ Total amount: 620 million €
▪ Face value of one bond: €1,000
▪ Coupon rate: 4%
▪ Annual Coupon payment
▪ Maturity: 5 years

How many bonds should Longwood Inc. issue?

Compute the price of one bond (using the yield curve). Round off, no decimals.
Compare with Par value and conclude if this is a premium or a discount bond?
How could you have concluded without calculating the price of one bond already?
• Question 9 Equity financing (11 points)
To finance both projects Longwood Inc. is considering a capital increase. A new investor,
Lumberjack is willing to invest the needed 620 million € and buy all new shares.

• Question 9.1 (11 points)

o Compute the number of new shares to be issued if the subscription price is €51.67?
N.B. Round off to the next higher, round number;
o Compute the % of voting rights of Lumberjack just after the capital increase.
o Use the existing share price before the issue from question 4 and compute the new
market price per share after the issue;
o What is the value of one PSR?
o What is the subscription parity (= number of rights to buy a new share)?
o What is the total cost of investment for Lumberjack? Give all components.
• BONUS Question 9.2 (10 points)
You alert Longwood Inc. that this capital increase may be subject to the Right Offering
mechanism. Explain briefly how it works (do not provide any computation).