DUKE UNIVERSITY Fuqua School of Business. FINANCE CORPORATE FINANCE Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2.


 Amy Osborne
 3 years ago
 Views:
Transcription
1 DUK UNIRSITY Fuqua School of Business FINANC CORPORAT FINANC Problem Set #4 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%. Consider a firm that earns $1,000 before interest and taxes each year (in perpetuity) with no risk. The firm s capital expenditures equal its depreciation expenses each year, and it will have no changes to its net working capital. The riskfree interest rate is 5%. (a) Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the firm s equity? (b) Suppose instead the firm makes interest payments of $500 per year. What is the value of equity? What is the value of debt? (c) What is the difference between the total value of the firm with leverage and without leverage? (d) The difference in part (c) is equal to what percentage of the value of the debt? 2. Western Lumber Company expects to have a free cash flow of $4.25 million in the coming year. Free cash flows are expected to grow at a rate of 4% per year thereafter. Western Lumber has an equity cost of capital of 10% and a debt cost of capital of 6%. The corporate tax rate is 35%. If Western Lumber maintains a (constantly rebalanced) debtequity ratio of 0.50, what is the present value of its interest tax shield? 3. Suppose that the Drazil Susej Corporation (DSC) has an equity cost of capital of 8.5%, a debt cost of capital of 7%, a marginal corporate tax rate of 35%, and a debtequity ratio of 2.6. Suppose that Goodyear does not plan to rebalance its debt, i.e., its current debt is perpetual. (a) What is DSC s WACC? (b) What is DSC s unlevered cost of capital? 4. Kurz Manufacturing is currently an allequity firm with 20 million shares outstanding and stock price of $7.50 per share. Although investors currently expect Kurz to remain an allequity firm, Kurz plans to announce that it will borrow $50 million and use the funds to repurchase shares (i.e., Kurz s announcement is not anticipated by investors and thus not reflected in the current stock price). Kurz will pay interest only on this debt, and it has no further plans to increase or decrease the amount of debt. Kurz is subject to a 40% corporate tax rate. (a) What is the market value of Kurz s existing assets before the announcement? 1
2 (b) What is the market value of Kurz s assets (including any tax shields) just after the debt is issued, but before the shares are repurchased? (c) What is Kurz s share price just before the share repurchase? How many shares will Kurz repurchase? (d) What are Kurz s market value balance sheet and share price after the share repurchase? 5. Merck s simplified balance sheets (using book and market values) are currently as follows: Balance Sheet (book values in millions) Net working capital 1,473 Longterm debt 5,269 Longterm assets 14,935 quity 11,139 Total assets 16,408 Total liabilities 16,408 Balance Sheet (market values in millions) Net working capital 1,473 Longterm debt 5,269 Market value of longterm assets 51,212 quity 47,416 Total assets 52,685 Total liabilities 52,685 Suppose that Merck decides to move to a 50% book debttovalue ratio by issuing debt and using the proceeds to repurchase shares. The corporate tax rate is 40%; consider only corporate taxes. Now construct Merck s balance sheet (with market values only) to reflect the new capital structure, making sure to add an item called P(additional tax shields) on the asset side of the balance sheet. Before it changes its capital structure, Merck has 1,248 million shares outstanding. What is the stock price before and after the change? 6. Hula nterprises is considering a new project to produce solar water heaters. The finance manager wishes to find an appropriate risk adjusted discount rate for the project. The(equity) beta of Hot Water, a firm currently producing solar water heaters, is 1.3. Hot Water has a debt to total value ratio of 0.4. The expected return on the market is 14% and the riskfree rate is 8%. Throughout this problem, assume that the debt is riskfree and that it is constant (i.e., the debt is never rebalanced). (a) Suppose the corporate tax rate is 30%. What is the asset (or unlevered) beta for the solar water heater project? (b) If Hula is an equity financed firm, what is the weighted average cost of capital for the project? (c) If Hula has a debt to equity ratio of 2, what is the weighted average cost of capital for the project? (d) Hula s chairman wishes to know why the cost of capital for Hot Water cannot be used directly. xplain why. (e) The finance manager believes that the solar water heater project can only support 30 cents of debt for every dollar of asset value, i.e., the debt capacity is 30 cents for every dollar of asset value. This is lower than the cents to every dollar of asset value (debt to equity ratio of 2) that current projects can support. Current projects have higher collateral value than the assets of the new solar heater project. Hence she 2
3 is not sure that the debt to equity ratio of 2 used in the weighted average cost of capital calculation is valid. What is the appropriate capital structure to use? What is the weighted average cost of capital that you will arrive at with this capital structure? 7. Company XYZ is currently financed with 40% debt (a 40% debttovalue ratio). The average current yield on government securities is 10%. The expected return on the S&P500 portfolio is 20%. The corporate tax rate is 20% and XYZ s stock has a beta of 1.6. XYZ can borrow at 200 basis points above the prevailing government rate. (a) What is XYZ s weighted average cost of capital under the current capital structure? (b) What is XYZ s cost of capital if it decides to pursueapolicy of always using 100% equity financing instead? (i) First, solve this under the assumption that XYZ s debt will never be rebalanced. (ii) Now, solve this under the assumption that XYZ s debt will be constantly rebalanced. 8. If it were unlevered, the overall firm beta for Wild Widgets Inc. (WWI) would be 0.9. WWI has a target debt/equity ratio of 1/2 and plans to constantly rebalance its debt in order to maintain it. The expected return on the market is 16%, and Treasury bills are currently selling to yield 8%. WWI oneyear bonds(with a face value of $1,000) carry an annual coupon of 7% and are selling for $ The corporate tax rate is 34%. (a) What is WWI s cost of debt? (b) What is WWI s weighted average cost of capital? (c) What is WWI s cost of equity? 3
4 Solutions 1. Because the firm s cash flows are riskless, we have r = r D = 5%. (a) If the firm has no debt and pays out its net income (of $600 = $1,000(1 0.40)) as a dividend each year, the firm s equity is worth U = $ = $12,000. (b) If the firm makes (riskless) interest payments of $500 per year, then the equityholders will receive an annual dividend of $300 = ($1,000 $500)(1 0.40). Their equity is then worth L = $ = $6,000. The bondholders receive $500 every year. Their debt is worth (c) The levered value of the firm is D L = $ = $10,000. L = L +D L = $6,000+$10,000 = $16,000. The difference between the levered value and the unlevered value is L U = $16,000 $12,000 = $4,000. (d) This difference is the present value of the interest tax shield, which is a fraction t c of the debt D L : P(interest tax shield) = t c D L = (0.40)($10,000) = $4, We can calculate the value of Western Lumber s interest tax shield by comparing its value with and without leverage. The expected return on Western Lumber s unlevered assets is given by r A = ( ) D r D + ( ) ( ) ( ) r = (0.06) + (0.10) = 8.67% If Western Lumber was allequity financed, then its value would be U = $4.25M = $91.07M. To calculate Western Lumber s levered value, we first need to calculate its weightedaverage cost of capital: WACC = D D + (1 t c)r D + D + r = (1 0.35)(0.06) + 1 (0.10) = 7.97%
5 The levered value of Western Lumber is therefore L = $4.25M = $107.14M. This levered value exceeds the unlevered value by the present value of the interest tax shield, that is, by P(interest tax shield) = L U = $107.14M $91.07M = $16.07M. 3. We have r = 8.5%, r D = 7%, t c = 0.35, and D/ = 2.6 (which corresponds to D/ = = 0.722). (a) DSC s weighted average cost of capital is WACC = D (1 t c)r D + r = (0.722)(1 0.35)(0.07) +(0.278)(0.085) = 5.65%. (b) We know that the weighted average cost of capital satisfies ( ) D WACC = 1 t c r A 5.65% = [ 1 (0.35)(0.722) ] r A. This implies that r A = 7.56%. 4. (a) Because Kurz Manufacturing is initially allequity financed, its value is the value of its equity: U = U = 20 million $7.50 = $150 million. (b) Right after the debt is issued, Kurz s value increases by the amount of debt it raised ($50 million), and by the tax shield that this debt creates(0.40 $50 million = $20 million). That is, its value increases by $70 million. (c) Before the debt is repurchased, the total value of the firm is $150 million+$70 million = $220 million. Since the debt is worth $50 million (i.e., the debtholders get what they pay for), the equity must be worth $220 million $50 million = $170 million. This implies that Kurz s share price is $170 million 20 million = $8.50. This in turn implies that the $50 million raised through the debt issue will allow Kurz to buy back $50 million $8.50 = million shares. (d) After the share repurchase, the total market value of Kurz Manufacturing is $220 million $50 million = $170 million. On the asset side of the balance sheet, Kurz s unlevered assets are worth $150 million, as before, and the debt tax shield is $20 million. On the liability side of the balance sheet, the debt is worth $50 million, and the equity is worth $120 million (20 million million = million shares trading at $8.50 each). 5. The longterm debt is increased from $5,269 to 50% of book = 50% $16,408 = $8,204, 5
6 that is it is increased by $8,204 $5,269 = $2,935. This implies that the debt tax shield is increasedby0.40 $2,935 = $1,174, andthemarketvalueofthefirmisnow$52,685+$1,174 = $53,859. The new balance sheet (with market values) will look as follows: Balance Sheet (market values in millions) Net working capital 1,473 Longterm debt 8,204 Mkt value of longterm assets 51,212 quity 45,655 P(additional tax shields) 1,174 Total assets 53,859 Total liabilities 53,859 Before the change, the equity is worth $47,416, and 1,248 shares are outstanding, so that the stock price is P = 47,416 1,248 = Upon the firm s announcement of its plans to repurchase shares, the firm s value should go up by the extra debt tax shield that this will generate. That is, the equity goes up to $47,416+$1,174 = $48,590, and each share is then worth P = 48,590 1,248 = The amount raised from the new debt, $2,935, is therefore used to repurchase 2, = shares. 6. (a) When the tax rate is 30%, the asset beta (unlevered beta) of the solar heater project is β 1.3 β A = 1+(1 t c ) D = 1+(1 0.30) 2 = Notice that the debttoequity ratio is = 2 3 when the debttovalue ratio is 0.4. (b) If Hula is an allequity financed firm, the weighted average cost of capital for the project is just the unlevered cost of equity. The unlevered cost of equity is given by the CAPM: r A = r unlevered = r f +β A (r m r f ) = 0.08+(0.8863)( ) = 13.32%. (c) The levered beta corresponding to a debttoequity ratio of 2 is [ β levered = 1+(1 t c ) D ] β A = [1+(1 0.30)(2)](0.8863) = Hence the return on equity corresponding to the leverage of 2 is given by the CAPM: r levered = 0.08+(2.13)( ) = 20.8%. Thus the weighted average cost of capital for the project is ( ) D p ( ) WACC = (1 t c )r p p D + r p = 0.667(1 0.30)(0.08) (0.208) = 10.7%. 6
7 (d) Hot Water may have a different capital structure and thus its weighted average cost of capital is not applicable. ven though the business risk is the same, the difference in capital structure implies a different weighted average cost of capital. (e) You are explicitly told that the new project has a lower debt capacity. Thus it can only support 30 cents of debt for every dollar of asset value. xisting assets can support cents. Thus the long run debt capacity of the new project is different. Hence we need to account for this while doing our capital budgeting. The appropriate leverage adjustment is the debt to value ratio of 0.3. First, the levered beta corresponding to the debt to total value ratio of 0.3 is calculated as follows: β levered = [ 1+(1 t c ) D ] β A = [ 1+(1 0.30) The corresponding return on equity, as given by the CAPM, is r = ( ) = 14.9%, and the weighted average cost of capital is then ( ) D p ( ) WACC = (1 t c )r p p D + r p ] (0.8863) = = 0.3(1 0.30)(0.08) + 0.7(0.149) = 12.1%. Hence 12.1% rather than 10.7% is the right answer. 7. (a) With a debttovalue ratio of 40%, we have D = 40% 60% compute the cost of equity: = 2/3. We use the CAPM to r = r f +β (r m r f ) = ( ) = 26%. Noticing that r D = 10%+2% = 12%, we have ( ) ( ) D WACC = (1 t c )r D + r = 0.40(1 0.20)(0.12) +0.60(0.26) = 19.44%. (b) The risk premium on XYZ s debt is 0.02 = β D ( ), for a β D of 0.2. (i) When the debt is permanent, we can unlever the equity beta to get an (unlevered) asset beta as follows: Using CAPM, we find β A = β + ( D ) (1 tc )β D 1+ ( D ) (1 tc ) = (1 0.20)(0.2) (1 0.20) = r A = r f +β A (r m r f ) = ( ) = 21.13%. 7
8 (ii) When the debt is constantly rebalanced, we can unlever the equity beta to get an (unlevered) asset beta as follows: ( ) ( ) D β A = β D + β = (0.40)(0.2) +(0.60)(1.6) = Using CAPM, we find r A = r f +β A (r m r f ) = ( ) = 20.40%. 8. From the data we have r m = 0.16, r f = 0.08, D/ = 1/3, and / = 2/3. Also the beta of an otherwise identical but unlevered firm is 0.9. This means that r A = r f +(r m r f )β A = 0.08+( )(0.9) = 15.2%. (a) WWI oneyear coupon bonds have a face value of $1,000. One year from now, they will pay the face value and the 7% coupon, i.e. 1,000(1+0.07) = 1,070. Since WWI s bonds are now selling for $972.72, we can deduct the value for WWI s (pretax) cost of debt: r D = 1,070 1 = 10% (b) The weighted average cost of capital for a levered firm can be calculated as follows: WACC L = r A D t cr D = (0.34)(0.10) = %. 3 (c) Since WACC L = r D (1 t c ) D +r, we have = 0.10(1 0.34) 1 3 +r 2 3, which implies r = 17.80%. 8
DUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2.
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #7 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Suppose the corporate tax rate is 40%, and investors pay a tax
More informationGESTÃO FINANCEIRA II PROBLEM SET 4  SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE
GESTÃO FINANCEIRA II PROBLEM SET 4  SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 20102011 Chapter 12 Estimating the Cost of Capital 121. Suppose
More informationFinancial Markets and Valuation  Tutorial 6: SOLUTIONS. Capital Structure and Cost of Funds
Financial Markets and Valuation  Tutorial 6: SOLUTIONS Capital Structure and Cost of Funds (*) denotes those problems to be covered in detail during the tutorial session (*) Problem 1. (Ross, Westerfield
More informationChapter 14 Capital Structure in a Perfect Market
Chapter 14 Capital Structure in a Perfect Market 141. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required
More informationFN2 Ron Muller 200708 MODULE 4: CAPITAL STRUCTURE QUESTION 1
MODULE 4: CAPITAL STRUCTURE QUESTION 1 Gadget Corp. manufactures gadgets. The average selling price of this finished product is $200 per unit. The variable cost for these units is $125. Gadget Corp. incurs
More informationCHAPTER 18. Capital Budgeting and Valuation with Leverage. Chapter Synopsis
CHAPTER 18 Capital Budgeting and Valuation with everage Chapter Synopsis 18.1 Overview of Key Concepts There are three discounted cash flow valuation methods: the weighted average cost of capital (WACC)
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationIf you ignore taxes in this problem and there is no debt outstanding: EPS = EBIT/shares outstanding = $14,000/2,500 = $5.60
Problems Relating to Capital Structure and Leverage 1. EBIT and Leverage Money Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes [EBIT] are projected
More informationSOLUTIONS. Practice questions. Multiple Choice
Practice questions Multiple Choice 1. XYZ has $25,000 of debt outstanding and a book value of equity of $25,000. The company has 10,000 shares outstanding and a stock price of $10. If the unlevered beta
More informationCost of Capital and Project Valuation
Cost of Capital and Project Valuation 1 Background Firm organization There are four types: sole proprietorships partnerships limited liability companies corporations Each organizational form has different
More informationTest3. Pessimistic Most Likely Optimistic Total Revenues 30 50 65 Total Costs 2520 15
Test3 1. The market value of Charcoal Corporation's common stock is $20 million, and the market value of its riskfree debt is $5 million. The beta of the company's common stock is 1.25, and the market
More informationChapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.)
Chapter 17 Corporate Capital Structure Foundations (Sections 17.1 and 17.2. Skim section 17.3.) The primary focus of the next two chapters will be to examine the debt/equity choice by firms. In particular,
More informationUse the table for the questions 18 and 19 below.
Use the table for the questions 18 and 19 below. The following table summarizes prices of various defaultfree zerocoupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price
More informationMore Tutorial at Corporate Finance
Corporate Finance Question 1. The cost of capital (8 points) St. Claire Enterprises is a levered firm. The equity cost of capital for St. Claire is 7%. The debt cost of capital for St. Claire is 2%. Assume
More information] (3.3) ] (1 + r)t (3.4)
Present value = future value after t periods (3.1) (1 + r) t PV of perpetuity = C = cash payment (3.2) r interest rate Present value of tyear annuity = C [ 1 1 ] (3.3) r r(1 + r) t Future value of annuity
More informationPrinciples of Corporate Finance
Principles of Corporate Finance Chapter 18. Does debt policy matter? Ciclo Profissional 2 o Semestre / 2009 Graduaccão em Ciências Econômicas V. Filipe MartinsdaRocha (FGV) Principles of Corporate Finance
More informationLeverage. FINANCE 350 Global Financial Management. Professor Alon Brav Fuqua School of Business Duke University. Overview
Leverage FINANCE 35 Global Financial Management Professor Alon Brav Fuqua School of Business Duke University Overview Capital Structure does not matter! Modigliani & Miller propositions Implications for
More informationGESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE
GESTÃO FINANCEIRA II PROBLEM SET 5 SOLUTIONS (FROM BERK AND DEMARZO S CORPORATE FINANCE ) LICENCIATURA UNDERGRADUATE COURSE 1 ST SEMESTER 20102011 Chapter 18 Capital Budgeting and Valuation with Leverage
More informationCHAPTER 15 Capital Structure: Basic Concepts
Multiple Choice Questions: CHAPTER 15 Capital Structure: Basic Concepts I. DEFINITIONS HOMEMADE LEVERAGE a 1. The use of personal borrowing to change the overall amount of financial leverage to which an
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1
Chapter 17 Valuation and Capital Budgeting for the Levered Firm 17A1 Appendix 17A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationThe Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction
Chapter 18 Valuation and Capital Budgeting for the Levered Firm 18A1 Appendix 18A The Adjusted Present Value Approach to Valuing Leveraged Buyouts 1 Introduction A leveraged buyout (LBO) is the acquisition
More informationCapital Structure in a Perfect World (ModiglianiMiller, 1958) Gestão Financeira II Undergraduate Courses
Capital Structure in a Perfect World (ModiglianiMiller, 1958) Gestão Financeira II ndergraduate Courses 20102011 Clara Raposo 20102011 1 Capital Structure in a Perfect World The Capital Structure of
More informationU + PV(Interest Tax Shield)
CHAPTER 15 Debt and Taxes Chapter Synopsis 15.1 The Interest Tax Deduction A CCorporation pays taxes on proits ater interest payments are deducted, but it pays dividends rom atertax net income. Thus,
More informationThe AdjustedPresentValue Approach to Valuing Leveraged Buyouts 1)
IE Aufgabe 4 The AdjustedPresentValue Approach to Valuing Leveraged Buyouts 1) Introduction A leveraged buyout (LBO) is the acquisition by a small group of equity investors of a public or private company
More informationBA 351 CORPORATE FINANCE. John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD
BA 351 CORPORATE FINANCE John R. Graham Adapted from S. Viswanathan LECTURE 10 THE ADJUSTED NET PRESENT VALUE METHOD FUQUA SCHOOL OF BUSINESS DUKE UNIVERSITY 1 THE ADJUSTED NET PRESENT VALUE METHOD COPING
More informationFinance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011. Part One: MultipleChoice Questions (45 points)
Question 1 Finance 2 for IBA (30J201) F.Feriozzi Resit exam June 14 th, 2011 Part One: MultipleChoice Questions (45 points) Assume that financial markets are perfect and that the market value of a levered
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. 1. DayTop Inns is a publicly traded company, with 10 million shares
More informationChapter 17 Does Debt Policy Matter?
Chapter 17 Does Debt Policy Matter? Multiple Choice Questions 1. When a firm has no debt, then such a firm is known as: (I) an unlevered firm (II) a levered firm (III) an allequity firm D) I and III only
More informationFINC 3630: Advanced Business Finance Additional Practice Problems
FINC 3630: Advanced Business Finance Additional Practice Problems Accounting For Financial Management 1. Calculate free cash flow for Home Depot for the fiscal yearended February 1, 2015 (the 2014 fiscal
More informationFinance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012. Part One: MultipleChoice Questions (45 points)
Finance 2 for IBA (30J201) F. Feriozzi Resit exam June 18 th, 2012 Part One: MultipleChoice Questions (45 points) Question 1 Assume that capital markets are perfect. Which of the following statements
More informationEconomics 173B  Corporate Finance Fall 2016 Prof. Garey Ramey. Study Problems II
Economics 173B  Corporate Finance Fall 2016 Prof. Garey Ramey Study Problems II Problem 4.1. Consider an outstanding bond issue having a coupon rate of 5% and a time to maturity of two years, with interest
More informationFinance 2 for IBA (30J201) F.Feriozzi Regular exam December 15 th, 2010. Part One: MultipleChoice Questions (45 points)
Finance 2 for IBA (30J201) F.Feriozzi Regular exam December 15 th, 2010 Question 1 Part One: Multiplehoice Questions (45 points) Which of the following statements regarding the capital structure decision
More information1 Pricing options using the Black Scholes formula
Lecture 9 Pricing options using the Black Scholes formula Exercise. Consider month options with exercise prices of K = 45. The variance of the underlying security is σ 2 = 0.20. The risk free interest
More informationPractice Exam (Solutions)
Practice Exam (Solutions) June 6, 2008 Course: Finance for AEO Length: 2 hours Lecturer: Paul Sengmüller Students are expected to conduct themselves properly during examinations and to obey any instructions
More informationCHAPTER 8. Problems and Questions
CHAPTER 8 Problems and Questions 1. Plastico, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Liabilities
More informationCorporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document)
Corporate Finance, Fall 03 Exam #2 review questions (full solutions at end of document) 1. Portfolio risk & return. Idaho Slopes (IS) and Dakota Steppes (DS) are both seasonal businesses. IS is a downhill
More informationLECTURE 07. Cost of Capital Berk, De Marzo Chapter 14 and 15
1 LECTURE 07 Cost of Capital Berk, De Marzo Chapter 14 and 15 2 Equity Versus Debt Financing Capital Structure: The relative proportions of debt, equity, and other securities that a firm has outstanding.
More informationChapter 7. component of the convertible can be estimated as =
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationThe Assumptions and Math Behind WACC and APV Calculations
The Assumptions and Math Behind WACC and APV Calculations Richard Stanton U.C. Berkeley Mark S. Seasholes U.C. Berkeley This Version October 27, 2005 Abstract We outline the math and assumptions behind
More informationBUS303. Study guide 2. Chapter 14
BUS303 Study guide 2 Chapter 14 1. An efficient capital market is one in which: A. all securities that investors want are offered. B. all transactions are closed within 2 days. C. current prices reflect
More informationValuating the levered firm
Valuating the levered firm Valuation and Capital Budgeting for the Levered Firm 180 Introduction In a strict MM world, firms can analyze real investments as if they are allequityfinanced. Under MM assumptions,
More informationChapter 7. . 1. component of the convertible can be estimated as 1100796.15 = 303.85.
Chapter 7 71 Income bonds do share some characteristics with preferred stock. The primary difference is that interest paid on income bonds is tax deductible while preferred dividends are not. Income bondholders
More informationNIKE Case Study Solutions
NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the
More informationProblem 1 Problem 2 Problem 3
Problem 1 (1) Book Value Debt/Equity Ratio = 2500/2500 = 100% Market Value of Equity = 50 million * $ 80 = $4,000 Market Value of Debt =.80 * 2500 = $2,000 Debt/Equity Ratio in market value terms = 2000/4000
More informationInvestments, Chapter 4
Investments, Chapter 4 Answers to Selected Problems 2. An openend fund has a net asset value of $10.70 per share. It is sold with a frontend load of 6 percent. What is the offering price? Answer: When
More informationThings to Absorb, Read, and Do
Things to Absorb, Read, and Do Things to absorb  Everything, plus remember some material from previous chapters. This chapter applies Chapter s 6, 7, and 12, Risk and Return concepts to the market value
More informationChapter 13, ROIC and WACC
Chapter 13, ROIC and WACC Lakehead University Winter 2005 Role of the CFO The Chief Financial Officer (CFO) is involved in the following decisions: Management Decisions Financing Decisions Investment Decisions
More informationCorporate Finance & Options: MGT 891 Homework #6 Answers
Corporate Finance & Options: MGT 891 Homework #6 Answers Question 1 A. The APV rule states that the present value of the firm equals it all equity value plus the present value of the tax shield. In this
More informationUniversity of Pennsylvania The Wharton School
University of Pennsylvania The Wharton School FNCE 100 PROBLEM SET #6 Fall Term 2005 A. Craig MacKinlay Capital Structure 1. The XYZ Co. is assessing its current capital structure and its implications
More informationTHE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE
IX. THE FINANCING DECISIONS BY FIRMS: IMPACT OF CAPITAL STRUCTURE CHOICE ON VALUE The capital structure of a firm is defined to be the menu of the firm's liabilities (i.e, the "righthand side" of the
More informationLeverage and Capital Structure
Leverage and Capital Structure Ross Chapter 16 Spring 2005 10.1 Leverage Financial Leverage Financial leverage is the use of fixed financial costs to magnify the effect of changes in EBIT on EPS. Fixed
More informationAccording to ModiglianiMiller Proposition II with corporate taxes, the value of levered equity is:
Homework 2 1. A project has a NPV, assuming all equity financing, of $1.5 million. To finance the project, debt is issued with associated flotation costs of $60,000. The flotation costs can be amortized
More informationCorporate Finance: Final Exam
Corporate Finance: Final Exam Answer all questions and show necessary work. Please be brief. This is an open books, open notes exam. For partial credit, when discounting, please show the discount rate
More informationBonds, Preferred Stock, and Common Stock
Bonds, Preferred Stock, and Common Stock I. Bonds 1. An investor has a required rate of return of 4% on a 1year discount bond with a $100 face value. What is the most the investor would pay for 2. An
More informationCHAPTER 14 COST OF CAPITAL
CHAPTER 14 COST OF CAPITAL Answers to Concepts Review and Critical Thinking Questions 1. It is the minimum rate of return the firm must earn overall on its existing assets. If it earns more than this,
More informationENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company
More informationRisk (beta), Return & Capital Budgeting Chpt. 12: problems 2,6,9,13,15. I. Applications of CAPM. 1) risk premium
Risk (beta), Return & Capital Budgeting Chpt. 12: problems 2,6,9,13,15 I. Applications of CAPM 1) risk premium estimate from historical data (Ibbotson) 2) risk free rate Tbill vs. Tbond, consistent with
More informationCOST OF CAPITAL. Please note that in finance, we are concerned with MARKET VALUES (unlike accounting, which is concerned with book values).
COST OF CAPITAL Cost of capital calculations are a very important part of finance. To value a project, it is important to discount the cash flows using a discount rate that incorporates the debtequity
More informationCORPORATE FINANCE REVIEW FOR THIRD QUIZ. Aswath Damodaran
CORPORATE FINANCE REVIEW FOR THIRD QUIZ Aswath Damodaran Basic Skills Needed What is the trade off involved in the capital structure choice? Can you estimate the optimal debt ratio for a firm using the
More informationDUKE UNIVERSITY Fuqua School of Business. FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2
DUKE UNIVERSITY Fuqua School of Business FINANCE 351  CORPORATE FINANCE Problem Set #8 Prof. Simon Gervais Fall 2011 Term 2 Questions 1. Hors d Age Cheeseworks has been paying a regular cash dividend
More information17.10 SUMMARY AND CONCLUSIONS. Chapter Review and SelfTest Problems
598 PART SIX Cost of Capital and LongTerm Financial Policy CONCEPT QUESTIONS 17.9a What is the APR? 17.9b What is the difference between liquidation and reorganization? 17.10 SUMMARY AND CONCLUSIONS The
More informationSAMPLE FACT EXAM (You must score 70% to successfully clear FACT)
SAMPLE FACT EXAM (You must score 70% to successfully clear FACT) 1. What is the present value (PV) of $100,000 received five years from now, assuming the interest rate is 8% per year? a. $600,000.00 b.
More informationEMBA in Management & Finance. Corporate Finance. Eric Jondeau
EMBA in Management & Finance Corporate Finance EMBA in Management & Finance Lecture 5: Capital Budgeting For the Levered Firm Prospectus Recall that there are three questions in corporate finance. The
More informationMM1  The value of the firm is independent of its capital structure (the proportion of debt and equity used to finance the firm s operations).
Teaching Note Miller Modigliani Consider an economy for which the Efficient Market Hypothesis holds and in which all financial assets are possibly traded (abusing words we call this The Complete Markets
More informationThe cost of capital. A reading prepared by Pamela Peterson Drake. 1. Introduction
The cost of capital A reading prepared by Pamela Peterson Drake O U T L I N E 1. Introduction... 1 2. Determining the proportions of each source of capital that will be raised... 3 3. Estimating the marginal
More informationChapter 14: Capital Structure in a Perfect Market
Chapter 14: Capital Structure in a Perfect Market1 Chapter 14: Capital Structure in a Perfect Market I. Overview 1. Capital structure: mix of debt and equity issued by the firm to fund its assets Leverage:
More informationPRACTICE EXAM QUESTIONS ON WACC
Dr. Sudhakar Raju Financial Statements Analysis (FN 6450) PRACTICE EXAM QUESTIONS ON WACC 1. The return shareholders require on their investment in a firm is called the: a. dividend yield. B. cost of equity.
More informationCHAPTER 22: FUTURES MARKETS
CHAPTER 22: FUTURES MARKETS PROBLEM SETS 1. There is little hedging or speculative demand for cement futures, since cement prices are fairly stable and predictable. The trading activity necessary to support
More informationCopyright 2009 Pearson Education Canada
d) If Dorval calls in the outstanding bonds, a bondholder who currently owns bonds with $100,000 of face value will have to sell them back to the firm at face value. The bonds would be more valuable than
More informationLecture 15: Final Topics on CAPM
Lecture 15: Final Topics on CAPM Final topics on estimating and using beta: the market risk premium putting it all together Final topics on CAPM: Examples of firm and market risk Shorting Stocks and other
More informationCOST OF CAPITAL Compute the cost of debt. Compute the cost of preferred stock.
OBJECTIVE 1 Compute the cost of debt. The method of computing the yield to maturity for bonds will be used how to compute the cost of debt. Because interest payments are tax deductible, only aftertax
More informationThe Tangent or Efficient Portfolio
The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of rewardtovolatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r
More informationCh. 18: Taxes + Bankruptcy cost
Ch. 18: Taxes + Bankruptcy cost If MM1 holds, then Financial Management has little (if any) impact on value of the firm: If markets are perfect, transaction cost (TAC) and bankruptcy cost are zero, no
More informationCurrent Ratio: Current Assets / Current Liabilities. Measure of whether company has enough cash to cover immediate expenses
1 Beta: a measure of a stock s volatility relative to the overall market (typically the S&P500 index is used as a proxy for the overall market ). The higher the beta, the more volatile the stock price.
More informationMBA 8230 Corporation Finance (Part II) Practice Final Exam #2
MBA 8230 Corporation Finance (Part II) Practice Final Exam #2 1. Which of the following input factors, if increased, would result in a decrease in the value of a call option? a. the volatility of the company's
More informationNIKE Case Study. Professor Corwin. An overview of the individual questions and their relation to the lecture topics is provided below.
NIKE Case Study Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the most important
More informationHomework Solutions  Lecture 2
Homework Solutions  Lecture 2 1. The value of the S&P 500 index is 1286.12 and the treasury rate is 3.43%. In a typical year, stock repurchases increase the average payout ratio on S&P 500 stocks to over
More informationAFM 372 Fall 2007 Midterm Examination Friday, October 26. This exam has 11 pages including this page. A separate formula sheet will be provided.
Student name: Student number: Instructor: Alan Huang Duration: 2 hours AFM 372 Fall 2007 Midterm Examination Friday, October 26 This exam has 11 pages including this page. A separate formula sheet will
More informationCHAPTER 20. Hybrid Financing: Preferred Stock, Warrants, and Convertibles
CHAPTER 20 Hybrid Financing: Preferred Stock, Warrants, and Convertibles 1 Topics in Chapter Types of hybrid securities Preferred stock Warrants Convertibles Features and risk Cost of capital to issuers
More informationExpected default frequency
KM Model Expected default frequency Expected default frequency (EDF) is a forwardlooking measure of actual probability of default. EDF is firm specific. KM model is based on the structural approach to
More informationAnswers to Chapter Review and SelfTest Problems
CHAPTER 15 Cost of Capital 517 Chapter Review and SelfTest Problems 15.1 Calculating the Cost of Equity Suppose stock in Watta Corporation has a beta of.80. The market risk premium is 6 percent, and the
More informationYieldCo Cost of Capital
by Josh Lutton and Shirley You Large renewable energy project developers often use a type of financing vehicle colloquially known as a YieldCo to finance portfolios of assets that are expected to have
More informationValuation Free Cash Flows. Katharina Lewellen Finance Theory II April 2, 2003
Valuation Free Cash Flows Katharina Lewellen Finance Theory II April 2, 2003 Valuation Tools A key task of managers is to undertake valuation exercises in order to allocate capital between mutually exclusive
More informationUSING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE
Graduate School of Business Administration  University of Virginia USING THE EQUITY RESIDUAL APPROACH TO VALUATION: AN EXAMPLE Planned changes in capital structure over time increase the complexity of
More informationCHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING
CHAPTER 12 RISK, COST OF CAPITAL, AND CAPITAL BUDGETING Answers to Concepts Review and Critical Thinking Questions 1. No. The cost of capital depends on the risk of the project, not the source of the money.
More informationCorporate Finance. Slide 1 咨询热线 : 学习平台 : lms.finance365.com
Corporate Finance Capital Budgeting Cost of Capital Measures of Leverage Dividends and Share Repurchases Working capital management Corporate Governance of Listed Companies Slide 1 Capital Budgeting Slide
More informationEMERSON AND SUBSIDIARIES CONSOLIDATED OPERATING RESULTS (AMOUNTS IN MILLIONS EXCEPT PER SHARE, UNAUDITED)
CONSOLIDATED OPERATING RESULTS (AMOUNTS IN MILLIONS EXCEPT PER SHARE, UNAUDITED) TABLE 1 Quarter Ended March 31, Percent Change Net Sales $ 5,854 $ 5,919 1% Costs and expenses: Cost of sales 3,548 3,583
More informationINTERVIEWS  FINANCIAL MODELING
420 W. 118th Street, Room 420 New York, NY 10027 P: 2128544613 F: 2128546190 www.sipa.columbia.edu/ocs INTERVIEWS  FINANCIAL MODELING Basic valuation concepts are among the most popular technical
More informationCopyright 2009 Pearson Education Canada
The consequence of failing to adjust the discount rate for the risk implicit in projects is that the firm will accept highrisk projects, which usually have higher IRR due to their highrisk nature, and
More informationCHAPTER 17 Does Debt Policy Matter?
CHPTR 17 Does Debt Policy Matter? nswers to Practice Questions 1. a. The two firms have equal value; let represent the total value of the firm. Rosencrantz could buy one percent of Company B s equity and
More informationSample Problems Chapter 10
Sample Problems Chapter 10 Title: Cost of Debt 1. Costly Corporation plans a new issue of bonds with a par value of $1,000, a maturity of 28 years, and an annual coupon rate of 16.0%. Flotation costs associated
More informationForecasting and Valuation of Enterprise Cash Flows 1. Dan Gode and James Ohlson
Forecasting and Valuation of Enterprise Cash Flows 1 1. Overview FORECASTING AND VALUATION OF ENTERPRISE CASH FLOWS Dan Gode and James Ohlson A decision to invest in a stock proceeds in two major steps
More informationSTATUTORY BOARD SBFRS 32 FINANCIAL REPORTING STANDARD. Financial Instruments: Presentation Illustrative Examples
STATUTORY BOARD SBFRS 32 FINANCIAL REPORTING STANDARD Financial Instruments: Presentation Illustrative Examples CONTENTS Paragraphs ACCOUNTING FOR CONTRACTS ON EQUITY INSTRUMENTS OF AN ENTITY Example
More informationSTATUTORY BOARD FINANCIAL REPORTING STANDARD SBFRS 32. Financial Instruments: Presentation Illustrative Examples
STATUTORY BOARD FINANCIAL REPORTING STANDARD SBFRS 32 Financial Instruments: Presentation Illustrative Examples CONTENTS Paragraphs ACCOUNTING FOR CONTRACTS ON EQUITY INSTRUMENTS OF AN ENTITY Example
More informationFIN 413 Corporate Finance. Capital Structure, Taxes, and Bankruptcy
FIN 413 Corporate Finance Capital Structure, Taxes, and Bankruptcy Evgeny Lyandres Fall 2003 1 Relaxing the MM Assumptions E D T Interest payments to bondholders are deductible for tax purposes while
More informationFutures Price d,f $ 0.65 = (1.05) (1.04)
24 e. Currency Futures In a currency futures contract, you enter into a contract to buy a foreign currency at a price fixed today. To see how spot and futures currency prices are related, note that holding
More informationa) The Dividend Growth Model Approach: Recall the constant dividend growth model for the price of a rm s stock:
Cost of Capital Chapter 14 A) The Cost of Capital: Some Preliminaries: The Security market line (SML) and capital asset pricing model (CAPM) describe the relationship between systematic risk and expected
More informationEstimating Cost of Capital. 2. The cost of capital is an opportunity cost it depends on where the money goes, not where it comes from
Estimating Cost of Capal 1. Vocabulary the following all mean the same thing: a. Required return b. Appropriate discount rate c. Cost of capal (or cost of money) 2. The cost of capal is an opportuny cost
More informationCost of Capital. Katharina Lewellen Finance Theory II April 9, 2003
Cost of Capital Katharina Lewellen Finance Theory II April 9, 2003 What Next? We want to value a project that is financed by both debt and equity Our approach: Calculate expected Free Cash Flows (FCFs)
More information