FINA 2311: Case studies in corporate finance Assignment 2 1. In a two-date (date 0 and 1) binomial model with perfect market assumption, Company AA has existing projects that generate a cash flow worth $ 100 million at date I if the up state occurs and S50 million if the down state occurs. Assume no taxes, a risk-free rate of 0, and risk-neutral probabilities of 50% attached to each of the two states. AA currently has debt maturing at date 1 with a face value of $ 60 million. It has 1 million shares outstanding Suppose Company AA unexpectedly announces that it will issue additional debt, with the same seniority as existing debt and a face value $ 10 million. The company will use the entire proceeds to repurchase back some of the outstanding shares. Just after the announcement, what will be the share price of AA? How many outstanding shares will be repurchased back? 2. Ms White owns 50,000 shares of the common stock of IBM Corporation with a market value of $2 per share, or $100, 000 overall. The company is currently financed as follows: Book Value Common Stock $2,000,000 (8 million shares) Short-term loans $2,000,000 IBM now announces that it is replacing Si million of short-term debt with an issue of common stock. What can Ms White do to make her position same as before in terms of return-risk trade-off)? (Ignore taxes) 3. Company AAA is a new company. In its balance sheet, it has only a project which lasts for one year. The project's cost is $ 50 million occurring now (T). The cash flow of the project in one year (T.) has the following joint distribution with the market portfolio Market Scenario Probability Cash flow Next Year Market Net Return AAA's Project 0.75 $ 80 million 30 $ 40 million -20 Also, the risk-free interest rate is 5% Based on the above information, do the following questions 1)-7). 1) Find the risk neutral probability for the "Good" state and "Bad" state. Based on the risk neutral probability calculate the present value (PV) of the project. 2) Use direct tracking method to work out the tracking portfolio, the PV of the project, the NPV, the expected (required) return of the project, the actual return of the project (IRR), the beta of the project's expected return. Plot the expected return and actual return in Mean return-Beta diagram and comment 3) Based on the expected return's beta you have worked out in 2. use CAPM to calculate the expected (required) return of the project and use DCF method to find the PV of the project. 4) Find the certainty equivalent (CE) value of the project's cash flow. FINA 2311: Case studies in corporate finance Assignment 2 1. In a two-date (date 0 and 1) binomial model with perfect market assumption, Company AA has existing projects that generate a cash flow worth $ 100 million at date I if the up state occurs and S50 million if the down state occurs. Assume no taxes, a risk-free rate of 0, and risk-neutral probabilities of 50% attached to each of the two states. AA currently has debt maturing at date 1 with a face value of $ 60 million. It has 1 million shares outstanding Suppose Company AA unexpectedly announces that it will issue additional debt, with the same seniority as existing debt and a face value $ 10 million. The company will use the entire proceeds to repurchase back some of the outstanding shares. Just after the announcement, what will be the share price of AA? How many outstanding shares will be repurchased back? 2. Ms White owns 50,000 shares of the common stock of IBM Corporation with a market value of $2 per share, or $100, 000 overall. The company is currently financed as follows: Book Value Common Stock $2,000,000 (8 million shares) Short-term loans $2,000,000 IBM now announces that it is replacing Si million of short-term debt with an issue of common stock. What can Ms White do to make her position same as before in terms of return-risk trade-off)? (Ignore taxes) 3. Company AAA is a new company. In its balance sheet, it has only a project which lasts for one year. The project's cost is $ 50 million occurring now (T). The cash flow of the project in one year (T.) has the following joint distribution with the market portfolio Market Scenario Probability Cash flow Next Year Market Net Return AAA's Project 0.75 $ 80 million 30 $ 40 million -20 Also, the risk-free interest rate is 5% Based on the above information, do the following questions 1)-7). 1) Find the risk neutral probability for the "Good" state and "Bad" state. Based on the risk neutral probability calculate the present value (PV) of the project. 2) Use direct tracking method to work out the tracking portfolio, the PV of the project, the NPV, the expected (required) return of the project, the actual return of the project (IRR), the beta of the project's expected return. Plot the expected return and actual return in Mean return-Beta diagram and comment 3) Based on the expected return's beta you have worked out in 2. use CAPM to calculate the expected (required) return of the project and use DCF method to find the PV of the project. 4) Find the certainty equivalent (CE) value of the project's cash flow