Why might you expect capital expenditures and additions to working capital to exceed depreciation in the stable growth period?

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How would you create the equivalent payoff function using other securities?

 

1) Four Seasons hotel reported revenue and EBIT of $6,321 m and $912m, respectively for the fiscal year that ended on December 31, 2012. The company also reported depreciation and amortization charges of $251m. CAPEX was $362m during the year and working capital on December 31, 2012, totaled- 1.74% of the revenue in 2012. This working capital ratio reflected Starwood’s average working capital needs for the foreseeable future.

At the end of 2012, the company had an outstanding debt with both a book value and a market value of $1,656m. The debt had an average annual yield to maturity of 5%

The FS hotel had 191.51 million shares of stock outstanding, which closed price of $57.36 per share on December 31, 2012. The beta for FS stock was 2.02 and the average tax rate paid by the firm was expected to average 10% for the foreseeable future. The 30 year Treasury bond rate at the end of 2012 was a 2.95% and the market risk premium, estimated using the Ibbotson data for the 1926 to 2012 period, was 5.17% this problem might be answered with APV

Analysts expected the firm’s revenue, operating profits, CapEx and depreciation and amortization to grow at an annual rate of 7.25% for the following 5 years, after which the growth rate was expected to drop to 3%. They also expected that capex and additions to working capital would equal 120% of depreciation after five years. FS planned to increase its debt/total capital ratio to 25% at the end of year five, thereby increasing its pretax cost of debt to 5.5%

a) What was the intrinsic value of the enterprise value of FS on December 31,2012?

b) What were the intrinsic value of the firm’s equity and its intrinsic value per share?

c) Why might you expect capital expenditures and additions to working capital to exceed depreciation in the stable growth period?

 

2)The common stock of X company is selling for USD90. A 26-week call option written on X stock is selling for USD8. The call option’s exercise price is USD100. The annual risk –free rate is 3.97%

a) Suppose that put options on X stock are not traded, but that you want to buy one. How would you create the equivalent payoff function using other securities?

b) Suppose that, two months later, it is possible to buy three-month call options and three put options on the stock. If the risk-free rate is still 3.97% and both options have an exercise price of USD95 and are worth USD5, what is the stock price?

 

3) A writer (seller) of a call option may or may not actually own the underlying asset, if he or she owns the asset, and therefore will have the asset available to deliver should the option be exercised, he or she is said to be writing a covered call. Otherwise, he or she is writing a naked call and will have to buy the underlying asset on the open market should the option be exercised. Draw the payoff diagram of a covered call (including the value of the owned underlying asset) and compared it with the payoff of other options

 

4)W is considering launching a hostile takeover of Y. Y is currently unlevered with a cost of equity of 15%. In the event of a takeover, Y’s pre-tax cash flows from operations (EBIT) will be USD10 million in the first year and will grow at an expected annual rate of 7% forever. CAPEX and additions to working capital are expected to exceed depreciation and amortization by an amount that equals 10% of EBIT each year. X would lever up Y so that it would have an interest expense of USD2m in the first year, and this amount would also be expected to grow at a rate of 7% forever. Assuming a before-tax cost of debt of 9% and a tax rate of 40$, what is the maximum X should pay for all the equity on Y?

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