Question 1
Part (A): Assume that you work for a mutual fund that invests in emerging markets but no inside information or connections to Chinese authorities. Your bonus and promotion possibilities depend on the performance of your fund over the next five years or so. The required return p.a. on unlevered equity for comparable projects of your fund is 15%, and the risk-free rate is 7% p.a.
At the projected offer price of $16.44, would you buy shares in the IPO of PetroChina? What are the main risks of investing in PetroChina? State any additional assumptions clearly and discuss how much your answer is sensitive to them.
This is a valuation question: do you assign a value to PetroChina that is higher or lower than the offer price? I expect a standard DCF analysis based on the case projections, including a discussion of the validity of the assumptions and risks. A comparables analysis can add value if it reflects particularities of IPOs.
I gave you a setting in which you are interested in the long-term shareholder value (your career concerns depend on the performance over the next five years). Nevertheless, it may be interesting to discuss potential short-term gains from subscribing in potentially underpriced Chinese IPOs.
Good answers should discuss
• the Goldman assumptions (growth, cost cuts, investments). Are they reasonable and is there possibly
scope for more?
• general as well as country-specific risks for valuation. Here expropriation and tax risks are low, but
demand could depend on the state of the economy. Cost of products are in local currency, prices depend
on world prices for gas/oil and are less sensitive to local currency.
• governance issues of investing as a minority shareholder in a state-owned firm and other
interdependencies between PetroChina and CNPC. How does the current structure mitigate such problems?
Distinction answers may account for
• different scenarios (pessimistic, optimistic)
• sensitivity analysis
• long vs short investment horizon and your incentives

Part (B): How would you set the IPO price? What is “underpricing” and what are potential explanations for it? Discuss what the “winner’s curse” is and how it can explain underpricing.

You notice that each of the questions contains two parts, part A and part B. Usually one of the parts is more quantitative and the other one more qualitative. Some students combine their answer to the two parts. This is fine but do not forget to address both.
Also, the two parts are connected, and the qualitative part usually serves to interpret the quantitative answers. Keep this in mind as both of your answers will benefit from reflection upon the other. For example, a good answer should discuss that the offer price introduced in part A may be set with underpricing concerns.

For the answer of part B, I expect a discussion of underpricing and the winner’ s curse and a conclusion for PetroChina’ s price range. Which general considerations for underpricing apply to PetroChina, and to which extent? What are potential costs and benefits of not making an underpriced offer? Given these considerations, how important is underpricing in the PetroChina offer?
Distinction answers may discuss the institutional and political background and how it affects underpricing. One distinction answer discussed explicitly the process how PetroChina can arrive at more information (and perhaps more underpricing) during the roadshow.

Question 2
Part (A): Consider the following average spreads over the risk-free rate, interest coverage, debt betas, and probability of bankruptcy for Chinese corporate bank loans in 2000.
Calculate the value of PetroChina with leverage ratios of 20%, 40%, 60% and 80%. State your assumptions clearly and discuss how much your answer is sensitive to them.

Here I expect a standard APV valuation. Answers should briefly comment why APV is an appropriate choice. You can calculate taxshields and costs of distress from given data. Extra points are given for a discussion of other costs and benefits of leverage, especially in an emerging markets context. Some students calculated an unlevered cost of equity different from the one I gave you, which I did not expect here. (I wanted to keep things simple despite the international context! I do expect you to know in other contexts how to compute a WACC.)

Part (B): What accounts for the different effects of the leverage ratios? How can you reconcile these differences with the Modigliani-Miller theorem?

Answers should explain the theory and link it to the case: which costs or benefits of debt account for the greatest change in value? Which MM assumptions are the most important or the least likely to be true in the context of PetroChina? A common mistake here is a lack of interpretation of the part A results on the leverage ratios.
You may comment on how PetroChina would implement a different leverage ratio and the difficulties in doing so.

Question 3
Part (A): In January 2002, CNPC announces that PetroChina should invest in a 4,000 km pipeline between Xinjiang and Shanghai. According to Energy Compass, “developing Xinjiang, one of China’s most remote western regions, is a priority for Beijing, which is eager to quell dissent in the largely
Rating
AAA
AA
A
BBB
BB
B
Spread
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
Interest coverage
>8.5
6.5-8.5
4.25-6.5
2.5-4.25
1.75-2.5
1.5-1.75
Beta
0.15
0.25
0.25
0.25
0.25
0.25
Prob. (bankruptcy)
0.1%
1.0%
1.5%
5.0%
15.0%
30.0%

Muslim Xinjiang province, and is said to be a pet project of the president [at that time, ed.], Jiang Zemin.”1
The capacity of the pipeline is 12 billion cubic meters or 420 billion cubic feet of natural gas annually, and the cost for it is estimated to be around RMB 140 billion. Calculate the value of the pipeline to PetroChina, its dispersed and controlling shareholders, and PetroChina’s chairman, Mr. Ma. Assume that Ma’s compensation in 2001 was comparable to his compensation in 2000 and that he will only be able to exercise his options by the end of 2002 (both tranches). Use a WACC of 12%.

This question asks for the valuation of an investment project (a quite major one considering the 4000 kms!). Most numbers you need are given in the question itself – one other major input is the gas price. There are some estimates in the case, but you will notice that gas prices are volatile and drive the valuation quite a lot. This sensitivity to gas prices and gas price estimates is something a good answer should discuss. Another driver of the results is how much of the capacity will be used, and a good answer should discuss this as well. Nevertheless, you will quickly see that even with prices well above today’ s level, the NPV is negative. A quick news search will reveal similar conclusions by the media (for example the “pipe dreams” article that I cite).
Once you arrive at the NPV, it is easy to calculate the value of the project for PetroChina’s dispersed shareholders. You can do that on a per-share basis or for all the 10% of equity that is traded. Obviously this is a giant value-destroying project for the dispersed shareholders. This question illustrates potential conflicts of interest in state-controlled firms – or firms with majority shareholders in general.
The value of the project to Mr. Ma is less straight forward to calculate, and it is here where a distinction student can go all the way to calculate the value of Mr. Ma’s options. The upward potential here is almost unlimited: you can discuss the value of his options using various assumptions, especially about the gas prices. Despite this being a finance course, however, you should see that Mr. Ma is perhaps not only incentivized by the value of his options. Just like the hypothetical analyst in question 1, he has career concerns: he probably wants to stay in his position and not get fired, perhaps he wants to get promoted to another, bigger company afterwards.

Part (B): Discuss any potential conflicts of interests between majority and minority shareholders. What are potential solutions to such conflicts? Does Ma’s compensation structure align him with the interest of all shareholders?

The case devotes a long section on shareholder rights protection. At the time of the IPO, it is clear to PetroChina that minority shareholders will be concerned about potential conflicts of interest. It proposes a number of solutions to this problem. One prominent one is Mr. Ma’s compensation.
A good answer to this question should discuss conflicts of interests in public companies in general and then refer to the discussion in the case. With your knowledge about the pipeline project, do you think that PetroChina’ s “solutions” are enough to make minority shareholders willing to invest into the IPO? Your answer should also discuss the relationship between PetroChina, CNPC and the government. If the government’ s interest differs from the one of minority shareholders the government is likely to be prevail – perhaps even without majority stakes.
A distinction answer may comment on China and compare it to other countries in terms of quality of enforcement. Also, there is a lot of scope for a discussion on compensation structure and incentives: you may want to offer alternatives (stock, deferred compensation) and discuss their benefits.

Question 4
Part (A): The Chairman of PetroChina, Ma, suggests to CNPC that he would like to postpone the new pipeline project introduced in question 3 by three years. (The only data from question 3 that you need here is that the cost of the pipeline is RMB 140 million and the pipeline has a capacity of 420 billion cubic feet of natural gas annually.) Mr. Ma believes that due to increasing demand in the Chinese market, gas prices will possibly more than double—in fact, increase by 172% according to his calculations—over that period and stabilize afterwards. (He predicts that the current annual volatility of gas prices is around 1.) He also believes that demand will continually increase such that in three years, he can sell the full capacity of the pipeline, 420 billion cubic feet of natural gas. According to energy experts, however, gas prices are more likely to fall to 1/3 of their current level. They predict that in such a scenario, without the pipeline, the stock price will fall to $8.22. They also predict that the stock price could rise to as high as 24.66 in the scenario that Mr. Ma describes.
Calculate the value of the option to build the pipeline in three years. The annual risk-free rate is 7%. You can use binomial trees or the Black-Scholes formula.

This is a real options question. To do the calculation, you need to identify which numbers map into a standard option pricing framework.
First, the question states that Mr. Ma would like to postpone the project by 3 years. So 3 years may be a good proxy for an expiration date. Judging from the tone of his suggestion, he proposes to postpone it by exactly 3 years, which makes this option comparable to a European call option.
The driver of risk is the gas price. The text states that the annual volatility of the gas price is 1 (which conveniently stays 1 if you take it to the power of anything). If you choose to use binomial trees for the calculation you can use his two scenarios. You can use the stock prices for the two scenarios given in the text to calculate the risk-neutral probabilities.
For the value of the underlying, you need to calculate the potential value of the project. See the answer to question 3 for more detail on that.
Finally, the cost for the pipeline maps into the exercise price of a European call option.
Plug in the Black Scholes formula or build a binomial tree to get option value of today. Bear in mind that we would always give you the choice between binomial trees and the Black Scholes formula.

Part (B): What are potential advantages and disadvantages of the different possible ways to estimate the value of the option to build the pipeline? Describe the assumptions that your valuation method uses and comment on their compatibility with this situation.

Here it seems unrealistic that gas prices stay stable after 3 years. Nevertheless it may a good idea to wait: perhaps demand cools down and there won’t bean apparent need for the pipeline. So “waiting” would be a politically more correct way to convince CNPC to abandon the project.

Question 5
Part (A): Describe different ways to underwrite an IPO. What are the costs and benefits of each method? How do they differ for a secondary offering?

You answer should discuss the methods, their costs and benefits, and incentives for underwriters. Distinction students may discuss possible hedging by underwriters.
In secondary offerings, the market has more information on the issuer. Therefore, the certifying function of the underwriter is less important. There is also no need for an extensive roadshow. Secondary offerings also differ technically: issuers may undertake a rights offering, in which the underwriter acts standby and does not necessarily make the market. In the United States, issuers can undertake shelf offerings that disseminate shares over time.

Part (B): Assume that the standard deviation of the potential demand for PetroChina shares is around 5% and that underwriters typically demand a spread of 7%. The monthly risk-free rate for March 2000 is 1%. How much more should PetroChina pay for firm commitment underwriting compared to best efforts underwriting? What if the standard deviation is 15% instead?

With firm commitment, the issuer can sell the 1,600m shares to the underwriter, no matter how big the market demand, for a pre-agreed price. That price is the issuance price minus the spread. In this case, that price is at a discount of 7% of 16.44, or 15.29. In other words, the issuer has the option to sell these shares to the underwriter. This is equivalent to a put option.
S = 16.44, X = 15.29, rf = 1%, s = 5%
Value of one call with Black Scholes = 1.318
Value of one put via Put-Call-Parity = C – S + PV(X) = 1.318 – 16.44 + 15.29/1.01 = 0.166 Total value = 0.166 x 1600 = 26.58
For 15% volatility: 690.58
A good answer should comment on the sensitivity of the value on volatility.

1楼给出案例原文，2-3楼给出配套问题和解决思路。

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