this is corporate finance

1 2. Case study 1 Johnsons Acoustics (JA) is the market leader in acoustic equipment. As there is no major technological breakthrough in the acoustic industry, there is little growth in this industry. JA decides to diversify to a new business area: optical instruments. JA believes that, as the demand of optical lens for mobile phones is huge, the diversification will bring an excellent growth opportunity to the company. In the diversification plan, the optical instruments project will last for 5 years and a new factory will be built. The construction of the new factory requires $280 millions and it will be financed by issuing both common stocks and bonds. The information about the company's current capital structure is as follows: The common stock is now trading at $15.65. We have used analysts' estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 20 million. The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 100,000 bonds outstanding. The annual revenue, cost and profit forecast for the coming 5 years is as follows: $(Million) Revenue 230 Variable cost 39 Fixed cost 35 Tax (35%) 54.6 Net Profit 101.4 Assume that Johnsons Acoustics has a 35% tax rate. At the end of year 5, an additional cost of $50 millions (net of tax) will be incurred. a Compute the cost of equity of JA by dividend growth model. (5 marks) b What is the after-tax cost of debt of JA? (5 marks) If JG wants to maintain its current capital structure after issuing new equity and debt, compute is the WACC of JA. (5 marks) d The project manager of JA feels that the appropriate discount rate of the new project should be 3% above the WACC. Compute the NPV, payback period and IRR of the new project. (15 marks) As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. Two additional scenarios, namely, best scenario and worst scenario, will be considered. In the best scenario, the revenue and variable cost will be increased by 20%. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the additional two scenarios. Should JA accept the new project? Discuss in detail. (10 marks) Case Study 2 (40%) e The Tiger Securities LLC is an active player in global financial markets. Its proprietary trading division holds a large local bond and stock portfolio, and is now seeking for new investment Thunder Inc (RT) is the Tiger's new target. The RT is a new developer of mobile games. Its a b opportunities for short-term speculation and assessing their risks correspondingly. Rolling earnings this year. The company made a profit for the first time in the company's history and paid a dividend of $0.5. You are an analyst in Tiger Securities and you are quite optimistic about the prospect of RT. It is expected that RT will experience an extraordinary growth of 30% next year and 20% in year 2. And then, the growth rate will be stabled at 10% in the foreseeable future. If the current market price of RT is $5.5 and the required rate of return of this share is 18%, what is your investment advice to Tiger Securities? (8 marks) As the market of technical stocks is high volatile, various kinds of hedging strategies have been considered. The derivatives trading department suggests that either futures or options may be used to hedge the risk of holding RT's shares. Discuss appropriate futures and option strategy in detail. (10 marks) Tiger Securities invested heavily in long-term zero-coupon bonds. As the world is now in pandemic situation, the major central banks adopt various form of quantitative easing to keep interest rates at historical low. What is your bond investment advice to Tiger Securities? Discuss in detail. (7 marks) Tiger also holds substantial shares of Lion Bank Corp. The Lion Bank adopts a stable growth dividend policy. Recently, the regulatory authority announced that dividend payment is prohibited for the coming 12 months in order to reserve more cash flow in the bank and hence improve the bank's vitality. The share price of Lion Bank dropped significantly after the announcement. You believe that the market overreacted to this announcement. Discuss the impact of a change in dividend policy according to the theories you have learnt in this course. (15 marks) d Case Study 3 Unique Corp Ltd is a manufacturer of smart phone. John, the CEO of Unique Corp, has been aware of an acquisition opportunity in the market. The target firm, Stardust Tech, designs and manufactures mobile devices. Its new product, Uranus phone, is well received by the market. Financial analysts forecast that, as a result of the success of the new product, Stardust Tech stock's dividend is expected to grow at 16% p.a. for the next two years. Thereafter, the dividend is expected to grow at 10% p.a. because new competitors are expected to enter the market and the growth of sales of Uranus phone will slow down. The current dividend is $4. John is now considering purchasing the shares of target firm. John seeks for your advice on this issue. e Discuss the nature of this acquisition. What is (are) the possible benefit(s) of this acquisition to Unique Corp Ltd? f What is the maximum price that John would be willing to pay for the Stardust Tech stock if he requires a 20% p.a. rate of return? 8 Instead of purchasing the target firm's shares in the market, John also consider purchasing selected assets of the target firm only. Discuss the advantages and disadvantages of acquisition of stock and acquisition of assets. h After reviewing the target firm's balance sheet, John found that the target firm had a relatively high amount of debt in its capital structure. He worries that the target firm will become a financial burden to Unique Corp after it is acquired. As John's financial advisor, do you recommend the potential acquisition? Please explain your answer in detail. i Recently, the CEO of the target firm announced that the company will not accept any invitation for merger and acquisition. Therefore, the possible acquisition by Unique Corp will be considered as unfriendly. Discuss the possible action(s) taken by the target firm if Unique Corp initiates the acquisition. j The current market price of Stardust Tech is $45. John worries that if the news of potential acquisition is leaked out into the market, the stock price of Stardust Tech as well as the cost of acquisition will surge significantly. He wishes to hedge against that risk by using call option or futures contract. The information of the derivatives market is as follow: Call option: Strike price: $45 Expiration date: 1 month later Type: European Option price: $3 Futures: Futures price: $46 Expiration date: 1 month later k. Please advise appropriate derivatives strategies for John. Illustrate your answer with tables or diagrams. 1. Discuss the advantages and disadvantages of using call options and futures for hedging in detail