final fall 21

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University of Pennsylvania The Wharton School Fall 2021 Howard Kaufold FNCE 611 Final Exam December 15, 2021 Quiz Instructions This is an open book and open notes exam. You may use a calculator, laptop (EXCEL), summary sheets, textbook, internet content, but not use any notes from students that have taken this class previously. You may use past exams for preparation, but not during the exam. You are to take this exam on your own with no help from any other person. The exam time is 120 minutes. The clock will begin to run the moment you click "Take the Quiz", and you are not able to pause it. If possible, please select a quiet, private location with a steady internet connection. Good luck!

FNCE 611 Final, Fall ‘21 : 2 Part I Please use this information as the basis for answering Questions 1 through 7. In answering Questions 1-3, please assume that there are no personal taxes or costs of financial distress. Also, assume that markets are semi-strong efficient. Tucker Inc.’s projected income statement for the year ahead – and for all years thereafter - is: (All items in $s million) Sales 2,500.00 Cash operating expenses (1,150.00) Depreciation (300.00) Interest (150.00) Taxable income 900.00 Taxes (20%) (180.00) Net income 720.00 The company plans to invest $300 million annually in new capital equipment to match depreciation expense, and pays taxes at a 20% rate. Tucker is targeting a debt-to-value ratio of 1/3, borrows at a rate of 5%, and estimates its unlevered required return on equity at 10%. Question 1 12 pts Assuming Tucker maintains its target capital structure, calculate its enterprise value using the Weighted Average Cost of Capital (WACC) method. Please show the relevant cash flows and steps in the valuation process. Question 2 2 pts Based on the value you calculated in Question 1, how much debt should Tucker have outstanding? (Assume the debt is perpetual.) [Format: Suppose you want to answer $1.5 billion, please enter 1,500.00.] Question 3 6 pts Using your answer to Question 2, use the Adjusted Present Value (APV) method to calculate the enterprise value of Tucker. Please show the relevant cash flows and steps in the valuation process. For Questions 4-6, assume that Tucker decides its debt level is excessive, and will issue $1 billion of new equity and use the proceeds to retire this amount of debt. Also assume that, before this recapitalization, the company had 100 million shares outstanding. Question 4 4 pts Calculate Tucker’s post-recapitalization enterprise value. [Format: Suppose you want to answer $1.5 billion, please enter 1,500.00.] Question 5 4 pts What will Tucker’s price per share be after the recapitalization? [Give your answer in dollars. Format: Suppose you want to answer $15, please enter 15.00.] Question 6 2 pts How many shares will Tucker have outstanding after the recapitalization? [Give your answer in millions of shares. Format: Suppose you want to answer 1.5 million, please enter 1.50.] Question 7 0 pts Briefly explain your approach/thinking while solving the Questions 1-6 above, allowing us to give partial credit. If you are confident in your numerical answers, feel free to skip this.

FNCE 611 Final, Fall ‘21 : 3 Part II Please use this information as the basis for answering Questions 8 and 9. Biogen shares are currently (December 2021) selling for 232.62 per share. The company does not pay dividends. Biogen June 2022 (European) call options with an exercise price of 230 are selling for 31.50. The annual yield on six-month Treasury securities is 0.2%, and you estimate the annual volatility on Biogen’s stock to be 30%. Question 8 8 pts If your estimate of Biogen’s volatility is accurate, what should the Biogen calls sell for? Please outline the steps and calculations involved in the valuation process. Question 9 2 pts Based on your answer to Question 8, the 30% estimate of Biogen’s volatility appears to be: Multiple choice: Higher than the market’s estimate The same as the market’s estimate Lower than the market’s estimate Could be higher or lower than the market’s estimate Please use this information as the basis for answering Questions 10 through 13. You own shares of Biogen. You want to continue to hold the shares given their potential future appreciation. There is a risk, however, that they will decline in price. The premiums for several Biogen calls and puts expiring in April 2022 are given in the following table. Expiration Strike Calls Puts Apr 210 34.50 10.90 Apr 220 30.60 22.80 Apr 230 24.80 28.20 Apr 240 23.00 29.41 Apr 250 18.50 35.90 Biogen 232.62 Question 10 3 pts What option purchase or sale could you add to your portfolio that would set a minimum value on your Biogen shares of 230/share through April? Be specific about the option exercise price and expiration date. Question 11 2 pts What is the current cost per share of pursuing the option strategy you chose in Question 10? [Format: Suppose you want to answer $15, please enter 15.00.] Question 12 2 pts Excluding the option premium, if the Biogen share price is 200 at the option expiration, what would the value/share be at expiration of the combination of 1) the Biogen share and 2) the option strategy you chose in Question 10? [Format: Suppose you want to answer $15, please enter 15.00.]

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FNCE 611 Final, Fall ‘21 : 4 Question 13 2 pts Excluding the option premium, if the Biogen share price is 260 at the option expiration, what would the value/share be at expiration of the combination of 1) the Biogen share and 2) the option strategy you chose in Question 10? [Format: Suppose you want to answer $15, please enter 15.00.] Please use this information as the basis for answering Questions 14 through 18. Suppose that the option strategy you chose in Question 10 achieves your insurance objective, but the cost of protection is higher than you would like. You decide that you would be willing to give up potential gains on the Biogen shares above 250/share, if that will reduce the cost of setting the 230/share minimum. Question 14 3 pts What option purchase or sale could you add to your portfolio (owning the shares and pursuing the Question 10 option strategy) to reduce the cost of the portfolio insurance by sacrificing Biogen gains above 250/share? Question 15 2 pts What is the net cost of the combination of strategies you outline in Questions 10 and 14? [Format: Suppose you want to answer $15, please enter 15.00.] Question 16 2 pts Excluding the option premium, if the Biogen share price is 200 when the options expire, what would the value/share be at expiration of the combination of 1) the Biogen share, 2) the option strategy you chose in Question 10, and 3) the option strategy from Question 14? [Format: Suppose you want to answer $15, please enter 15.00.] Question 17 2 pts Excluding the option premium, if the Biogen share price is 240 when the options expire, what would the value/share be at expiration of the combination of 1) the Biogen share, 2) the option strategy you chose in Question 10, and 3) the option strategy from Question 14? [Format: Suppose you want to answer $15, please enter 15.00.] Question 18 2 pts Excluding the option premium, if the Biogen share price is 280 when the options expire, what would the value/share be at expiration of the combination of 1) the Biogen share, 2) the option strategy you chose in Question 10, and 3) the option strategy from Question 14? [Format: Suppose you want to answer $15, please enter 15.00.] Question 19 0 pts Briefly explain your approach/thinking while solving the Questions 8-18 above, allowing us to give partial credit. If you are confident in your numerical answers, feel free to skip this.

FNCE 611 Final, Fall ‘21 : 5 Part III Please use this information as the basis for answering Questions 20 through 22. In answering this question, please assume that there are no personal taxes or costs of financial distress, and that markets are semi-strong efficient. Stela, Inc., a profitable electric vehicle manufacturer, is evaluating an investment in a new battery manufacturing plant. The facility would cost $250 million, last seven years, and would be depreciated on a straight-line basis over its 7-year life to a zero salvage value. Stela expects to generate net revenue (pre- tax revenue less cash costs) of $50 million in the first year operating the facility, and expects this amount to grow 10% per year. The company pays tax of 40%, and estimates the required asset return appropriate for this project to be 15%. Question 20 12 pts If Stela finances the project entirely with internally available equity, should it build the new plant? Please show the relevant cash flows and steps in the decision process. Question 21 6 pts If Stela goes forward with the project, it has the opportunity to borrow 80% of the plant construction cost. The interest rate on the loan would be 6%, and the loan would be unamortized (there would be no required principal payments until the end of Year 7, when the full loan amount would have to be repaid.) How would this financing opportunity affect the company’s evaluation and decision with respect to proceeding with the plant construction? Please show the relevant cash flows and steps in the decision process. Question 22 7 pts A second lender makes Stela this alternative loan offer. If the project is undertaken, the company could borrow $200 million immediately (Time 0), and then increase borrowing by 10% each year until the end of Year 7. No principal payments would be due until that time, at which point the entire loan balance would be due. The interest rate on the loan would remain 6%. How would this financing opportunity change the company’s evaluation and decision with respect to moving forward with the plant project? Please show the relevant cash flows and steps in the decision process.

FNCE 611 Final, Fall ‘21 : 6 Part IV Please answer Questions 23, 24, and 25, and explain your answers in one or two sentences. Full credit will be given only if a correct response is adequately explained. Question 23 5 pts If markets are only weak-form efficient, which of the following statements is true (choose one): (i) Prices reflect all available information. (ii) It is not possible to consistently produce excess returns (i.e. returns above an appropriate benchmark after accounting for trading costs and risk) using a trading rule based on past prices. (iii) Prices adjust instantaneously following all public announcements. (iv) None of the above Please use this information as the basis for answering Questions 24 and 25. Fossil Fuels (FF) is an all-equity firm with 10 million shares outstanding currently traded at $50 per share. Suppose that yesterday FF discovered that its oil reserves are much larger than previously estimated. The greater reserve estimate will generate an additional, previously unanticipated, cash flow of $60 million over the year ahead. This discovery will not affect cash flows in subsequent years. The company will announce this discovery tomorrow morning. Assume that RD’s required return on equity is 20%. Question 24 5 pts Suppose the market for the company’s shares is semi-strong efficient, but strong form inefficient. FF’s post-announcement stock price should be: (i) $50 (ii) $55 (iii) $60 (iv) None of the above Question 25 5 pts Suppose the market for the company’s shares is strong form efficient. FF’s post-announcement stock price should be: (i) $50 (ii) $55 (iii) $60 (iv) None of the above

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