CORPORATE FINANCE

I need this back in 3 hours, please do not shake hands if you cannot deliver. Please read the questions carefully and be sure you can solve them before you offer to help. Please let your calculations be clear and neat.

PART1

1.State the most appropriate objective of the firm and justify your answer.

2.Precisely define the intrinsic value of a security according to the lecture materials, and

   compare the intrinsic value analysis to the NPV rule in investment decision making. 

3.Discuss precisely the key difference between systematic risk and unsystematic risk.  RecentlyPfizer terminated its merger proposal with Allergan.  State the nature of the risk associated with Pfizer’s decision and explain precisely why risk averse investors would or would not be fully compensated for taking this type of risk given its nature. 

PART2

1.         Lee Inc. purchases a $300,000 digital color printer, which will be fully depreciated according tothe straight-line method over its 5-year economic life, for a 4-year publishing project.  The printer will be sold for $75,000 at the termination of the project.  The variable costs are $30 per copy of the book, and annual fixed production costs are $80,000.  An annual sales volume of 100,000 copies of the book is expected over the life of the project.  The marginal tax rate is 35%, the inflation rate is 2%, and the real discount rate is 12%.  This project requires an initial net working capital requirement of $50,000 of which 85% will be recovered at the termination of the project.  Compute, in nominal term, (a) the annual break-even operating cash flow, and (b) use your answer for (a) to compute the financial break-even price of the book.

<Hint:You are reminded to include all of non-OCF components in the break-even operating cash flow calculation!

2.         The dividends per share of Lee Corp., which has a stock beta of 1.15, is expected to be $0.90next year, and will grow by 15% in the following year.  Afterwards, its dividends will remain unchanged for one year before regaining momentum with a 40% growth in Year 4.  Afterwards, its dividends will grow indefinitely at an annual rate that reflects Lee Corp.’s 55% earnings retention ratio and a constant ROE of 20%.  The risk-free rate and the market risk premium are 2% and 10%, respectively.  Compute the intrinsic valueof Lee Corp's stock today.  If the stock price for Lee Corp. is $45.0 today, what is your investment recommendation on the stock according to the intrinsic value analysis?  Why?

3.         In financing its $200M project, Lee Corp. issues $30M par value of preferred stocks,  $60M par value of long-term debt, and finances the balance with common stocks that have a stock beta of 1.10.  Its 20-year 9% annual coupon paying bonds are priced at 105% of the par value.  Its preferred stocks have a 6% annual dividend rate on a par value of $50, and are priced at $54 per share.  Assume that the capital market is pricing all financial securities at their respective fair values, and the risk free return and the market risk premium are, respectively, 2% and 10%.

(a)                Compute thecurrent yieldand the capital gain yield of this bond issue. 

(b)               Compute the weighted average cost of capital (WACC), which is based on the market values of financial securities issued, for Lee Corp. assuming that the marginal corporate tax rate is 35%.

(c)                The flotation costs for raising new debt capital, preferred stock capital and equity capital are, respectively, 3%, 6% and 15%.  Besides, this $200M project is expected to generate a NPV of $19M without accounting for the flotation costs.  Compute the weighted average flotation cost, and the NPV of this project after taking into account of the flotation costs.

5) You are given the following information on the best guess of related outcomes for a 7-year project that is composed of a 2-year pilot study and a 5-year production period.  The initial cash outlay, which is the only cash flow associated with the pilot study, is $14M at t=0.  Afterwards, the company will spend an additional $85M to put the production facility in place at the end of the 2-year pilot study.  If the pilot study is successful, which is expected to have a probability of 0.75, the cash flow is estimated at $30M for the first year of production.  If the study fails, the cash flow is estimated at $18M for the first year of production.  Subsequently, the yearly cash flows are expected to grow at an annual rate of 5% during the 5-year production period.  The applicable discount rate is 14% during the 5-year production period, and 12% during the 2-year pilot study. 

(a)                Compute the NPV of this project (at t=0) assuming that the 7-year project will be implemented regardless of the outcome of the pilot study. 

(b)                 Now, you are given the option to build an upgraded production facility at t=2 for $115M if the pilot study fails, but you will stay with the original facility if the study is successful.  The upgraded facility is expected to generate $30M cash flow in the first year of production, which grows at an annual rate of 5% in subsequent years during the 5-year production period.  Compute (i) the NPV of this project that is embedded with the real option, and (ii) the value of the real option to upgrade.