Derive the present value of the bond as of december

Reference no: EM13929607

Project 1: BondValuation

This case study takes place on December 5, 2010. In Appendix 1 you find a Reuters screenshot showing the contractual features of a straight fixed-rate coupon bond issued by BASF. The rating of this bond, as of December 2010, is shown in the appendix, as well. You are interested in valuing this bond as of December 5, 2010. For the market interest rate for similar bonds on that day you take the (par) yield of benchmark bonds paying attention to both credit risk and time to maturity of the bond. You can find the yield of benchmark bonds for different rating classes and different maturities in Appendix1.

Tasks:

1.1) Derive the present value of this bond as of December 5, 2010. Give an exact economic explanation why the present value is above/below100%.

1.2) Assuming that the bond trades at the present value derived in question 1.1), compute the yield to maturity as of December 5, 2010. Explain precisely why the yield to maturity is above/below the coupon rate of thebond.

1.3) How would the present value and, assuming that the price equals the present value, the yield to maturity change if the market interest rate for similar bonds suddenly rose by 25 basis points (i.e. 0.25 %points)? For both numbers state both the size of the change and the direction of the change! In addition, give a plausible economic interpretation, why the present value increases/decreases due to this change in the interest rateenvironment.

1.4) Ignoring the scenario covered in question 1.3), what will be the present value in one year from now (i.e. on December 5, 2011) if in December 2011 the market interest rate for similar bonds is identical to the market interest rate used in question 1.1)? Give an economic interpretation, why the present value increases/decreases due to the mere passing oftime.

1.5) Describe as clearly as possible all bonds that can be valued using the yield to maturity of the BASF bond as a discountrate.

Project 2: CapitalBudgetingDecision

At the beginning of 2011, BASF considers investing in an investment project (with a useful life of 3 years) that is expected to provide the following cash flows (mil. EUR) in the nextyears:

Time (End ofYear)	1	2	3
Sales	100	115	130
Cost of GoodsSold	10	13	16
SGAExpenses	10	12	14

The initial outlay of this project is 120 mil. EUR. Even though BASF expects to obtain a salvage value ("true salvage value") of 20 mil. EUR, for tax purposes they use a salvage value of zero. Balance sheet forecasts show that the investment project will require the following levels of net working capital (mil. EUR) at the time of investment and in the next three years:

Time (End ofYear)	0	1	2	3
Level of NWCRequired	20	30	25	0

For the cost of debt of BASF you use the YTM of the BASF bond, computed in project 1 (question 1.2). For the cost of equity you use a rate of 8%.

You assume for BASF and for this investment project that the capital structure at market values (market value debt equity ratio) is identical to the industry average capital structure (debt equity ratio) that can be extracted from Appendix 2. The tax rate of BASF also corresponds to the industry average tax rate listed in Appendix2.

Following the GICS classification system you classify BASF as a chemical (diversified) company.

Tasks:

2.1) Compute the (after-tax) WACC ofBASF.

2.2) Compute the net present value of this investment project and recommend whether or not to invest in this project. State a reason for your recommendation, based on the net presentvalue.

2.3) Compute the internal rate of return of this investment project and recommend whether or not to invest in this project. State a reason for your recommendation, based on the internal rate ofreturn.

2.4) Assume that this investment project is implemented: By what amount does the shareholder value of BASF increase/decrease due to this investmentproject?

2.5) Having in mind the NPV of the investment project, describe if the goal of BASF should be rather to have a high or a low WACC. Argue precisely, why the financial manager would prefer to have a high/lowWACC.

2.6) Imagine that due to a liquidity crisis the yields on the bond market increase. Is there an impact on BASF's WACC? If yes, does the WACC increase or decrease due to the liquidity crisis? State a reason!

2.7) Describe the impact of the liquidity crisis, discussed in question 2.6), on the NPV. Does the NPV stay the same, increase or decrease due to the liquidity crisis? State areason!

Attachment:- selection.pdf

Reference no: EM13929607

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