Question

1. Suppose a firm, that has a WACC of 11.8%, has expected free cash flows to the firm from U.S. operation of $4.1 million next year, $4.8 million in year 2, and $5.2 million in year 3. Also suppose the firm expects cash flows from European countries of 1.7 million Euro in year 1, 1.4 million Euro in year2, and 1.2 million Euro in year 3. The firm also expects cash flows from the U.K. of 1.3 million pounds in year1, 1.4 million pounds in year 2, and 1.3 million pounds in year 3. Further suppose that after year 3, the firm’s cash flows in the U.S. will grow at a constant rate of 4% indefinitely, the firm’s cash flows in the European countries will decrease at a rate of 2% indefinitely, and the firm’s cash flows in the U.K. will remain constant indefinitely. Further assume that the Euro/Dollar exchange rate is $1.28 and the Pound/Dollar exchange rate is $1.58. What is the value of this multinational firm?

2. Given the following information, determine the value of a currency call option and currency put option that expires in the next 6 months. (use the Table attached to the back of this exam)

- Spot price the Australian Dollar is $0.45

- The strike price of the option is $0.50

- The volatility of the Australian Dollar is 40%

- The expiration is 6 months

- The simple interest rate in the U.S. is 3%

- The simple interest rate in the U.K. is 4%

Answer 1

1). Value of US operations:

Formula	Year (n)	1	2	3	1st Cash flow in perpetuity
After 3 yrs, CFs grow at 4% pa)	US FCFF (in mn)	4.1	4.8	5.2	5.4
CF1/(k-g) where k = 11.8% & g = 4%	Perpetuity CF				69.3
	Total CFs	4.1	4.8	5.2	69.3
1/(1+k)^n	Discount factor @ 11.8%	0.894	0.800	0.716	0.716
(CFs*Discount factor)	Discounted CFs	3.67	3.84	3.72	49.62
	US Value (in $mn)	60.84

Value of European operations:

Formula	Year (n)	1	2	3	1st Cash flow in perpetuity
After 3 yrs, CFs decrease at 2% pa)	Euro FCFF (in €mn)	1.70	1.40	1.20	1.18
FCFF*rate ($1.28/Euro)	FCFF (in $mn)	2.18	1.79	1.54	1.51
CF1/(k-g) where k = 11.8% & g = -2%	Perpetuity CF				10.9
	Total CFs	2.18	1.79	1.54	10.9
1/(1+k)^n	Discount factor @ 11.8%	0.894	0.800	0.716	0.716
(CFs*Discount factor)	Discounted CFs	1.95	1.43	1.10	7.81
	European Value (in $mn)	12.28

Value of UK operations:

Formula	Year (n)	1	2	3	1st Cash flow in perpetuity
After 3 yrs, CFs remain constant)	UK FCFF (in £mn)	1.30	1.40	1.30	1.30
	FCFF (in $mn)	2.05	2.21	2.05	2.05
CF1/(k-g) where k = 11.8% & g = 0%	Perpetuity CF				17.4
FCFF*rate ($1.58/GBP)	Total CFs	2.05	2.21	2.05	17.4
1/(1+k)^n	Discount factor @ 11.8%	0.894	0.800	0.716	0.716
(CFs*Discount factor)	Discounted CFs	1.84	1.77	1.47	12.46
	UK Value (in $mn)	17.53

Total value of the firm = sum of all three values = 60.84 + 12.28 + 17.53 = $90.66 million.