Question 1.

You are a currency arbitrager for a Japanese bank. The spot rate this morning is /USD111.22, and early indications are that short-term interest rates in the United States (90 day rates) are about to rise from their current level of 3.125 percent. The Federal Reserve is worried about rising inflation and has publicly announced that it is considering increasing short term interest rates by 25 basis points (1/4 percent). The 90-day forward rate quoted this morning to you by local banks are all about the same, /USD111.14. The current 90-day Yen deposit rate of interest is 2.156 percent. You have 250 million to invest. a. How can you make a profit through an interest arbitrage transaction? How much Yen profit can you hope to make in 90 days given the above data.( Ans: 424,388) b. If future spot exchange rates are determined by interest rate differentials (that is, if the forward rate provided a good forecast of future spot rates), what would you expect the spot rate to be in 90 days if the Federal Reserve were to increase interest rates by 25 basis points?

Question 2.

Chateau Cheval Noir is one of the leading premium wine producers of France with its 50 acres vineyard located at St. Julien in the Bordeaux region. The owners have wanted to expand their production, but the scarcity and astronomical prices asked for vineyards adjacent to the existing property, have led them to explore the possibility of buying a top winery outside of France. They identified both Australia and California as regions that could produce wines of a quality approaching those from their own vineyards. In March 2001, during a trip to the Barossa Valley of South Australia, the owners found a 80 acre vineyard that promised to meet all of their requirements: soil, exposure, micro-climate, age and condition of the vines, condition of the wine-making facilities, and brand image. After a preliminary study, the French owners estimated that Australian vineyard would have the following attributes: (1) Annual sales of A$16 million, in real (March 2001) terms. (1) Earnings before interest and tax of A$14 million, in real (March 2001) terms. (2) Annual capital expenditures equal to annual depreciation expenses. (3) Working capital requirement equals to one month of sales. (4) The economic life of the vineyard, for purposes of the analysis, would be five years. (5) The value in A$ of the vineyard at the end of five years would be estimated as a growing annuity based on the level of cash flow after tax attained in the following year. No growth in real terms is expected after the end of the economic life of the project. Other available information relevant to the investment: (1) Annual inflation rates expected: Australia 5 percent p.a. France 2 percent p.a. (2) Spot rate: A$1.75 per Euro (3) Required rate of return on investment: 10 percent in Euros and A$. (4) Corporate tax rate in Australia: 30 percent; no additional taxes would be paid in France on repatriated income. (5) Risk free rate [in Euros]: 5.50 percent (6) Political risk [penalty taxes imposed by Australia]: very low to nil. What would be the maximum price in A$ and in Euros the owners of Chateau Cheval Noir could pay for the Australian vineyard?

Question 3

Your firm is considering building a $600 million plant to manufacture HDTV circuitry. You expect operating profits (EBITDA) of $145 million per year for the next 10 years. The plant will be depreciated on a straight-line basis over 10 years (assuming no salvage value for tax purposes). After 10 years, the plant will have a salvage value of $300 million (which, since it will be fully depreciated, is then taxable). The project requires $50 million in working capital at the start, which will be recovered in year 10 when the project shuts down. The corporate tax rate is 35%. All cash flows occur at the end of the year. a. If the risk-free rate is 5%, the expected return of the market is 11%, and the asset beta for the consumer electronics industry is 1.67, what is the NPV of the project? (Ans: -11 mn) b. Suppose that you can finance $400 million of the cost of the plant using 10-year, 9% coupon bonds sold at par. This amount is incremental new debt associated specifically with this project and will not alter other aspects of the firms capital structure. What is the value of the project, including the tax shield of the debt?3. Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. Dunbar's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Eastern is 16%. Eastern has 4 million shares outstanding and no debt. Eastern's current price is $16.25. What is the maximum price per share that Dunbar should offer?

Question 4.

Your firm is considering building a $600 million plant to manufacture HDTV circuitry. You expect operating profits (EBITDA) of $145 million per year for the next 10 years. The plant will be depreciated on a straight-line basis over 10 years (assuming no salvage value for tax purposes). After 10 years, the plant will have a salvage value of $300 million (which, since it will be fully depreciated, is then taxable). The project requires $50 million in working capital at the start, which will be recovered in year 10 when the project shuts down. The corporate tax rate is 35%. All cash flows occur at the end of the year. a. If the risk-free rate is 5%, the expected return of the market is 11%, and the asset beta for the consumer electronics industry is 1.67, what is the NPV of the project? (Ans: -11 mn) b. Suppose that you can finance $400 million of the cost of the plant using 10-year, 9% coupon bonds sold at par. This amount is incremental new debt associated specifically with this project and will not alter other aspects of the firms capital structure. What is the value of the project, including the tax shield of the debt?

Question 5

Dunbar Hardware, a national hardware chain, is considering purchasing a smaller chain, Eastern Hardware. Dunbar's analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Eastern is 16%. Eastern has 4 million shares outstanding and no debt. Eastern's current price is $16.25. What is the maximum price per share that Dunbar should offer?