Task: Final Assignment (40% of the total grade)

You are asked to answer all the questions in the proposed two cases.

This task assesses the following learning outcomes:

• Understand the bonds and stocks valuation inside business enterprises.
• Develop understanding of corresponding finance theories.
• Improve analytical and quantitative skills.

LAUNCH: WEEK 10 / DELIVERY: WEEK 13 Latest MAY 10th, 2020, 23:59hrs ON MOODLE

Submission file format: Word document with all the answers, clearly identifying both cases separately.

Rubrics

Points are stated at the end of each question.

CASE 1 (65 points)

Ramirez S.L. was founded nine years ago by brother and sister Joan and Maribel Ramirez. The company manufactures and installs commercial heating, ventilation, and cooling units. Ramirez S.L. has experienced rapid growth because of a proprietary technology that increases the energy efficiency of its units. The company is equally owned by Joan and Maribel. The original partnership agreement between the siblings gave each 50,000 shares of stock. In the event either wished to sell stock, the shares first had to be offered to the other at a discounted price.

Although neither sibling wants to sell, they have decided they should value their holdings in the company. To get started, they have gathered the information about their main competitors in the table below.

Last year, Ramirez S.L. had an EPS of €3.15 and paid a dividend to Joan and Maribel of €45,000 each. The company also had a return on equity of 17 percent. The siblings believe that 14 percent is an appropriate required return for the company.

QUESTIONS:

1. What are the total earnings for the company? Hint: multiply EPS by number of shares outstanding. (5 points)
2. What are the payout and retention ratios? (5 points)
3. What is the growth rate? (5 points)
4. What is the value per share of the company’s stock? Assume the company continues its current growth rate. (10 points)

To verify their calculations, Joan and Maribel have hired Marc Puig as a consultant. Marc was previously an equity analyst and covered this industry. Marc has examined the company’s financial statements, as well as examining its competitors’ financials. Although Ramirez S.L. currently has a technological advantage, his research indicates that other companies are investigating methods to improve efficiency. Given this, Marc believes that the company’s technological advantage will last only for the next five years. After that period, the company’s growth will likely slow to the industry growth average. Additionally, Marc believes that the required return used by the company is too high. He believes the industry average required return is more appropriate.

5. What are the industry payout and retention ratios? (5 points)
6. What is the industry growth rate? (5 points)
7. What is your estimate of the stock price, based on Marc’s assumption regarding the growth rate? Hint: use non-constant growth model, implying that after the next five years the company’s growth rate will slow down to the industry growth rate. (15 points)
8. Assume the company’s growth rate slows to the industry average in five years. What future return on equity does this imply, assuming a constant payout ratio? (5 points)

After discussing the stock value with Marc, Joan and Maribel agree that they would like to increase the value of the company stock. Like many small business owners, they want to retain control of the company, so they do not want to sell stock to outside investors. They also feel that the company’s debt is at a manageable level and do not want to borrow more money.

9. How can they increase the price of the stock? (10 points)

CASE 2 (35 points)

Quick Air S.L. was founded 10 years ago by friends Peter Smith and Javier Benet. The company has manufactured and sold light airplanes over this period, and the company’s products have received high reviews for safety and reliability. The company has a niche market in that it sells primarily to individuals who own and fly their own airplanes. Peter and Javier have decided to expand their operations. They instructed their newly hired financial analyst, Laura Sanchez, to enlist an underwriter to help sell $35 million in new 10-year bonds to finance construction. Laura has entered into discussions with Sandra Harper, an underwriter from the firm of Castle & Partners, about which bond features Quick Air should consider and what coupon rate the issue will likely have.

Although Laura is aware of the bond features, she is uncertain about the costs and benefits of some features, so she isn’t sure how each feature would affect the coupon rate of the bond issue. You are Sandra’s assistant, and she has asked you to prepare a memo to Laura describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature.

QUESTIONS:

1. The security of the bond (that is, whether the bond has collateral). (5 points)

2. The seniority of the bond. (5 points)

3. The presence of a sinking fund. (5 points)

4. A call provision with specified call dates and call prices. (5 points)

5. Any positive covenants. Also, discuss several possible positive covenants Quick Air might consider. (5 points)

6. Any negative covenants. Also, discuss several possible negative covenants Quick Air might consider. (5 points)

7. A conversion feature (note that Quick Air is not a publicly traded company). (5 points)