RUC
Corporate Finance
Exam Spring 2022
4 hours written exam
Open Book
Remarks:
1)
2)
3)
4)
It is not allowed to connect the internet during the exam.
The exam consists of 4 questions. A percentage is given to each question, which is a guidance
concerning their weights on the total points.
If you need to supply further assumptions, please make clear what you assume.
Please answer the exam in a word file and submit this file converted into a pdf, without
attachments. Attachments (such as excel sheets or any other) will not be considered in the
corrections of the exam.
Good Luck!!!!
Problem 1 [max 20%]: Two government bonds with face value of 100 pay coupons of 2% once a year. Both
bonds are priced at par value. The short-term bond has a maturity of 5 years and the long-term bond a
maturity of 10 years. Hint: You can answer questions c and d without answering any of the previous
questions.
a)
b)
c)
d)
What is the current price of each bond? Explain.
If the market yields of these bonds increase to 5% per year, what will be their new prices?
Explain the relation between the price of a bond and its market rate (yield).
When observing your answers in the prior questions, which of the bonds is more sensitivity to yield
changes? Please comment why prices of bonds of different maturities present different sensitivities
to changes in their yields.
Problem 2 [max 30%]: You are offered 2 different mutually exclusive projects, which cash flows are
summarized in the table below. You decide to use the WACC of your company as discount rate for the cash
flows of these projects. Suppose that cash flows occur in the end of each year. Hint: You can answer
question f without answering any of the previous questions.
Year
0
1
2
3
Project A
-2000
240
900
2000
Project B
-2000
1600
900
100
Suppose further that the
beta for your company equals 3;
corporate tax rate equals 30%;
expected return for the market portfolio equals 8%;
risk-free rate of the economy is 1%;
yield to maturity on the Bonds of the company equals 4%;
debt-equity ratio is 1/3.
Answer the following questions:
a) Calculate the cost of equity capital for your company using the CAPM.
b) Calculate WACC.
c) Using WACC as discount rate, what is the net present value of each of the projects? What project
would you choose according to this criterion? Explain with your own words.
d) Calculate the IRR (internal rate of return) of each of the projects? Which project would you choose
according to this criterion?
e) D
c
d If yes, which criterion would you finally
chose (NPV or IRR) to take your final decision? Explain with your own words.
f) Do you see any problems of using WACC as discount rate for the cash flows of these projects?
Explain with your own words.
Problem 3 [max 25%] You are planning to invest in stocks. At the moment, you are analyzing 2 stocks.
Details for the stocks are given in the table below.
State
Bad
Normal
Good
Assume that the market
Returns
Probability
0.25
0.50
0.25
M
Equity A
1%
20%
28%
6% and the risk-
Equity B
-15%
15%
40%
F
1%.
a)
b)
c)
d)
Calculate the expected return of each equity?
Calculate the total risk of each equity (standard deviation)?
Calculate the beta of each equity. Which equity has the highest systematic risk?
Which equity is riskier? Which type of risk should the rational investor finally consider for his
investments? Explain with your own words.
e) Suppose now that the investor is willing to make a portfolio with 40% of a risk-free asset and the
other 60% devided equally by equities A and B. Calculate the Beta and the expected return of this
portfolio.
Problem 4 [max 25%] - Given the information below related to companies X and Y, answer the following
questions:
Company X: Company X plans to purchase a new factory. The management of Company X would like to be
more exposed to movements of interest rates. Thus, they would like to finance the new factory with
floating interest loans. For company X, a new fixed loan would cost 12% per year, while the floating interest
loan would cost Euribor + 3%.
Company Y: The management of Company Y wants to convert part of its floating loans into fixed. For
Company Y, floating loans cost Eurlibor + 1.5% and fixed loans 12% per year.
a) Do you see any opportunities for these companies to benefit from an interest rate SWAP? Explain
with your own words.
b) How should they proceed to make the SWAP? How should they exchange the flows? Explain.
c) Make an example for this SWAP. You do not have necessarily to draw the example, but just
describe the operations.
d) Compute
DKK in debt as basis for your SWAP. Suppose an Eurlibor of 1%.