I NEED STEP BY STEP SOLUTIONS FOR QUESTION 3 AND WITHIN 6 HRS

FIN 320 - Managerial Finance Problem Set 2 Due: Sept. 22, 2017 Question 1 You are a financial manager that wants to know projected cash flows next year for decision-making purposes. Below is some financial statement information that is loosely based on Pfizer (symbol: PFE) for the year ended December 31, 2016: Income Statement (in millions $) Year Ended December 31, 2016 Sales Cost of Sales Gross Income Selling, General, Administrative Expenses Research and Development Depreciation Expenses Operating Income (EBIT) Interest Expense Pre-tax Income Tax Net Income 52,900 12,300 40,600 14,900 7,800 5,800 12,100 3,700 8,400 1,100 7,300 Balance Sheet (in millions $) Year Ended December 31, 2016 Cash Net Receivables Inventory 20,900 Accounts Payable 11,300 Short Term Debt 6,800 9,400 21,700 Current Assets 39,000 Current Liabilities 31,100 Net Property, Plant, Equipment 132,600 Long Term Debt Total Assets Total Liabilities Total Stockholders' Equity 171,600 Total Liabilities and Equity 80,900 112,000 59,600 171,600 Assume the following: (1) net property, plant, and equipment for the year ended December 31, 2015 was $123,600M; (2) long-term debt for the year ended December 31, 2015 was $73,300M; and (3) proforma short-term debt is calculated based on its percentage of COGS from 2016 (similar to how you calculate pro-forma accounts payable). a) Construct a pro-forma income statement for December 31, 2017 based on the optimistic assumption that sales will grow by 6.0 percent next year. Be clear about your work and assumptions. b) Construct a pro-forma balance sheet for December 31, 2017. Assume that the firm will buy another $6,000M in property, plant, and equipment. Also assume that a dividend of $10,000M will be paid out next year. If total assets is greater than total liabilities plus equity, correct this imbalance (i.e. the net funding need) by adding to long-term debt. If total assets is less than total liabilities plus equity, correct this imbalance by retiring long-term debt. Be clear about your work and assumptions and report how much you add to or subtract from long-term debt. c) What is the projected free cash flow (FCF) for December 31, 2017? Use the following equation to solve for FCF: = , where = + + . Make sure to show the individual numbers used in this equation. The free cash flows are the cash flows available for distribution to the firm's investors (stockholders and bondholders). d) The free cash flow is the cash available to pay out to your investors (i.e. your bondholders and stockholders). According to your pro-formas, how much do you plan to pay your investors in 2016? (This will be the sum of interest and dividend payments.) By how much does this exceed the free cash flow you calculated in part (c)? e) The present value of all future free cash flows for PFE represents the market value of assets for PFE. Assume that the pro-forma free cash flow in 2017 will grow at 3.0 percent per year in perpetuity. Assume that the beta of assets for PFE is 0.66. Also assume a risk-free rate of 3.0 percent and a market risk premium of 5.0 percent. What is the market value of PFE assets? How does it compare to market value of assets for PFE from Yahoo! Finance? (You would calculate this latter number by adding the market capitalization and the total liabilities on the balance sheet for PFE.) Question 2 Suppose you want to create a \"Condor Spread\" option strategy based on PFE call options. The condor spread will involve the following: Buying a call option with strike price $34 Selling a call option with strike price $35 Selling a call option with strike price $36 Buying a call option with strike price $37 You want all of these options to have the same maturity of January 19, 2018. a) Go to Yahoo! Finance and search for Pfizer (symbol: PFE), then click on the \"Options\" tab, then select \"January 19, 2018\" from the dropdown box below the stock price to obtain a list of PFE options with approximately four months to expiration. The \"Ask\" price is the price at which you can buy an option while the \"Bid\" price is the price at which you can sell an option. Report the bid and ask prices for each of the four call options described above. Also report the date, time, and stock price when you retrieved these options prices. You should collect these data during regular trading hours (10:30am to 5:00pm CST on weekdays), as bid and ask prices are sometimes not available during off-market hours. b) Like in class, provide the payoff function for each range of strike prices in which the stock price in could land at expiration. There are five ranges in which the stock price could land at expiration: 37 c) Graph the payoff of the option strategy as a function of . d) What is the net cost of this condor spread? Remember to use the bid price when you sell a call option, and the ask price when you buy a call option. You receive money when you sell an option and pay money when you buy an option. e) What kind of price movement are we betting on with this strategy? (no calculations needed for this question) f) Suppose you buy a PFE call option that has a strike price equal to $33 and expiration on January 19, 2018. Because the strike price is less than the current stock price, this option is considered \"in-the-money.\" Report the ask price of this call option and the current stock price of PFE. Suppose you immediately exercise this call option. What is your payoff? Why do you think the payoff is less than the (ask) price at which you bought this option? Question 3 You are the sole bondholder in a firm that will be liquidated at its market value next year. For example, if the market value of the firm ends up being $70M next year, then the firm will be sold (liquidated) for $70M. Your main concern is that you will not be paid back the $50M you are owed next year, as the market value of the firm next year could end up being less than the $50M that you are owed. a) Provide the payoff diagram for the bondholder next year with the final market value of the firm on the x-axis. The financial manager of the firm is deciding whether he should take on one last risky project before the firm is liquidated next year. If this project is taken on, then the potential liquidation value could be much higher next year, but it could also be much lower. If the manager does not take on the risky project, we will assume that the manager does nothing instead. b) Suppose that the financial manager decides to do nothing. In this case, the market value of the firm will equal either $60M (state A) or $40M (state B) next year, with equal probability. It follows that upon liquidation next year, the bondholder with either receive the $50M they are owed (state A) or only $40M (state B). In each state, the stockholders receive whatever is left over after the bondholder is paid off. What is the expected liquidation value of the firm? What is the expected payoff to the bondholder? What is the expected payoff to the stockholders? c) Suppose that the financial manager decides to take on the risky project. In this case, the market value of the firm will equal either $90M (state A) or zero (state B) next year, with equal probability. It follows that upon liquidation next year, the bondholder with either receive the $50M they are owed (state A) or nothing (state B). In each state, the stockholders receive whatever is left over after the bondholder is paid off. What is the expected liquidation value of the firm? What is the expected payoff to the bondholder? What is the expected payoff to the stockholders? d) Assume that the manager wants to maximize the expected payoff to the stockholders. Would he choose to do nothing (as in part (b)) or take on the risky project (as in part (c))? Explain. e) The financial manager decides to take on the risky project from part (c). This is detrimental to the bondholder because there is now a chance that the bondholder will not be repaid any of $50M he is owed. If you were the bondholder and wanted to completely protect yourself against the state of the world where the firm does not pay you back (so that the option payoff is $50M in state B), would you buy a (call or put) option on the final market value of the assets of the firm, and at what strike price? f) This option you purchase has a price of $20M. You decide to borrow $20M from the bank to pay for the option. The bank charges you a 10% interest rate per year, and you must pay back the loan with interest in one year. What is your payoff in state A? (This is calculated as the payoff from the bond plus the payoff from the option minus the loan repayment.) What is your payoff in state B? What is your expected payoff? Would you be better off purchasing the option? Firms that go bankrupt are typically unable to fully repay all of their bondholders. Bondholders can protect themselves from these bankruptcy events by purchasing a \"Credit Default Swap,\" an agreement in which the bondholder pays a third counterparty a fee or a sequence of fees over time; in exchange, the third counterparty repays the bondholder what he is owed in the event that the firm goes bankrupt and cannot repay the bondholder