(a)
Eclipsys maintains a cash balance of €10.0 million. You forecast that over the next year cash outflows will exceed cash inflows by €15.0 million per month. Each time securities are bought or sold through a broker, the Company pays a fee of €1,000 and the annual interest rate on money-market securities is 4.0% per annum.
How much of Eclipsys’s cash should be retained and how much should be used to increase
the Company’s holdings of marketable securities?(6
(b)
You were recently appointed Chief Financial Officer of ZakGroup. The Company is expected
to report earnings before interest and taxes (EBIT) of €300.0 million next year and in
perpetuity. ZakGroup has net operating assets of €2.0 billion, 100.0 million shares
outstanding and a cash balance of €150.0 million. ZakGroup’s cost of equity is 8.0%, the deposit rate is 4.0% and it faces a 30.0% tax rate.
(i)Suppose you decide to use the entire cash balance of €150.0 million to repurchase
shares. Explain what happens to ZakGroup’s share price as a result of your decision.
Show all your workings.(10
(ii) Explain the cause of the share price reaction you predict in part (i) above.(4
(iii) How would you reconcile your answer to part (i) above with the typical reaction to share
repurchases that is observed in the stock market?(5
(a)
Aztek Inc. is all equity financed and has assets with a book value of $8.0 billion and 120.0 million shares outstanding. Aztek’s current cost of equity, rS, is 15.0%. Aztek is expected to report earnings before interest and taxes (EBIT) of €900.0 million in perpetuity. Aztek faces a tax rate of 40.0% and its payout ratio is 100%.
Aztek is thinking about a leverage recapitalization, selling $2.0 billion of debt and using the
proceeds to repurchase shares. Assume perpetual risk free debt, rB, is 8.0% and no costs of
distress.
(i)How would the proposed recapitalisation affect Aztek’s return on equity (ROE)?
(4
(ii) What would happen to Aztek’s share price as a result of the proposed recapitalisation?
(7
(iii) What would Aztek’s expected return on equity(rS) be after the proposed
recapitalisation?(4
(iv) What would Aztek’s weighted average cost of capital (WACC) be after the proposed
recapitalisation?(4
(v) How would the proposed recapitalisation affect Aztek’s earnings per share (EPS)?
Comment on your answer.(6
(a)
Gaucho Corporation has a cost of equity of 10.0%, a tax rate of 40%, and its cost of debt is a risk-free 4.0%. The market risk premium is 5.5%. Gaucho is considering the following 4-year investment project:
01234
Cash flow-2,000620620620620
Note: Amounts are in ‘000s
(i)Should Gaucho proceed with the project if it uses only equity capital to finance the
project?(4
(ii) Use the adjusted present value (APV) method to explain how your answer to part (i)
above would change if Gaucho decided to partially finance the project with €1.0 million
of debt capital instead? State your assumptions.(9
(iii) Suppose the proposed project is not a scale enhancing one but represents a new business
venture for Gaucho. If the average beta and debt/equity ratio for public companies with
which this new venture will compete are 1.40 and 10%, respectively, should Gaucho
proceed with the project? State your assumptions.(12
(a)
Sebastien Schroeder is a currency dealer in Frankfurt, Germany. He is offered terms for euro
by his local broker of ZAR: 11.0350 – 850. Simultaneously, he is offered terms of ZAR:
11.0222 – 729 by a dealer in Cape Town, South Africa. Transactions costs are 0.05 percent of the direct midpoint quote in each instance.
Do these quotes represent a profitable arbitrage opportunity for Sebastien?(6
(b)
EUROcal, a risk averse German firm, must pay a South African firm ZAR 900.0 million next year. The current EUR-ZAR spot rate is 11.494 and the interest rate in South Africa is 5.0% per annum. The current cost of a 1-year EUR call option with a strike price of 11.494 is €0.002 per ZAR.
(i)Explain how EUROcal can use the money market to hedge its exposure.(3
(ii) If EUROcal decides to use the options market to hedge its exposure, how much would it
gain or lose on its commitment if, at the time of payment, the EUR-ZAR spot rate spot
rate had decreased to 10.000? Note: Your answer should include a graph representing
the profit/loss scenario and must show all your workings.(13
(iii) Given a choice between the money market and the options market, which is EUROcal
more likely to use to hedge its exposure? Explain your answer.(3
(a)
RadFire Corporation, a software company, has a market value of €8.0 billion, is expected to
report €1.50 in earnings next year and is currently trading at €22.00 per share. NetCoyote Inc.,
a software company, has a market value of €1.5 billion, i
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