Download Seminar 8 - Wednesday 19-10-2016 questions

School of Business, Bachelor’s program in International Business
Aalto University
Question 1.
You are a CFO in a small French MNE firm exporting to regional countries within the EU. Your firm
sources all of its debt from a stock exchange listing on the Paris Bourse. However assuming your firm’s
credit default premium over the French government bond yield remains constant at 56 basis points and given
the information in credit rating table below, evaluate the impact on the firm cost of debt arising from of a
French government slip in credit rating from AAA to A between 2008 (pre-credit downgrade) and 2011
(post-downgrade).
Rating
2008 (basis points)
2011 (basis points)
Aaa
830
820
Aa
900
890
A
1,200
1,250
Baa
1,860
1,980
Ba
3,470
3,560
B
5,850
5,900
Caa
13,210
15,000
Question 2.
You are the CFO of Mittal cafes in Dubai – which is a small chain of restaurants (cafes) which is a wholly
owned subsidiary of Mittal group – a large family-owned business group from India. In order to finance
expansion across the United Arab Emirates – beyond Dubai you are considering three options:
a) “External” Bank Loan. Face value of AED 1,000,000; Annual Interest Rate of 8%; Monthly repayments
and a 2 year duration (lifespan) of loan until full amortization
b) Bond issue. Face value (principal) of AED 1,000,000, Coupon rate of 5% with payment annual and
duration to maturity being 2 years. As an individual UAE registered firm your credit worthiness has been
rated by Standard & Poors as “Baa”.
c) “Internal” credit line (or loan). Face value of AED 1,000,000; with interest paid monthly – as a bank loan
– and with a 2 year duration to maturity (amortization). However in terms of the internal capital market
(within-group) and you have a good relationship with the controlling family who have assured you of their
highest possible credit rating (assume the equivalent of an Aaa rating)
The yield on UAE treasury bonds is 2% per annum.
1
Rating
Credit Default Risk
(basis points)
Aaa
71
Aa
780
A
1,210
Baa
2,960
Ba
3,570
B
5,850
Caa
13,210
a) Compare the annual effective rates of interest and yield of each of the three debt options. Which offers
investors the best annual rate of expected return?
b) what is the Bond price? [Hint draw out schedule of payments and calculate NPV]
c) What is “total cost” of “external” bank loan and “internal” credit line? Comment on the difference in
terms of internal versus external capital markets
d) using the annualized yields from part (a) and assuming amount of debt raised is AED 1,000,000 is
constant while the amount of equity raised is 500,000 with a cost of equity of 15% and a corporate tax rate of
30%. What is the WACC for firms using each of the three contrasting debt options?
e) using the three WACC rates – contrast how these impact the profitability (NPV) of the project A below
with expected cash flows as detailed in table below:
Year
Cash Flow
0
- 500,000 (Sunk/ start-up costs)
1
3,000,000
2
10,000,000
2