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FIN 6301: Financial Management problem set 4




Question;PROBLEM SET 4;1. Consider;Macbeth Spot Removers, a publically traded company with an infinite life span;which faces a range of annual operating incomes as depicted in the table below. The rate of return on Treasury bonds is 10%.;Data;Number of;shares;700;Price per;share;$12;Market value;of equity;$8400;Outcomes;Operating;income;$500;$1,000;$1,500;$2,000;Earnings per;share;Return on equity;a. Calculate;the earnings per share and return on equity in the table above.;i.;Shown In Table Above;Macbeth Spot;Removers issues $2,400 of risk-free debt and uses the proceeds to repurchase;200 shares.;b. Rework;the table above to show how earning per share and equity returns now vary with;operating income.Shown In Table Below;Data;Number of;shares;500;Price per;share;$12;Market value;of equity;$6000;Outcomes;Operating;income;$500;$1,000;$1,500;$2,000;Interest;Net Income;Earnings per;share;$240;$260;$0.52;$240;$760;$1.52;$240;$1260;$2.52;$240;$1760;$3.52;Return on;equity;4.33%;12.66%;21%;29.33%;c.;If the beta of Macbeth?s unlevered assets is 0.8 and its debt is;risk-free, what would be the beta of the equity after the debt issue?Ms. Macbeth?s;investment bankers have just informed her that the new issue of debt is risky.;Debtholders will demand a return of 12.5%, which is 2.5% above the risk-free;interest rate.;d. How;does this affect return on assets and return on equity? Calculate these values.Shown;In Table Below;Data;Number of;shares;500;Price per;share;$12;Market value;of equity;$6000;Outcomes;Operating;income;$500;$1,000;$1,500;$2,000;Return on;Assets;5.95%;11.9%;17.86%;23.81%;Return on;equity;3.33%;11.67%;20%;28.33%;e.;Suppose that the? of unlevered equity was 0.6. What will?A,?E, and?D;be after the change to the capital structure?;2. Happy;Valet, Inc. has a 14.5% cost of unlevered equity and can issue debt at a rate;of 8%. It faces marginal corporate;income tax rate of 40% and has debt and equity assets of 30% and 70%;respectively (calculated using market values).;a.;What rate of return do stockholders require on Happy Valet?s levered;equity assets?;b.;What is the firm?s WACC?;3. Consider;the case of Henrietta Ketchup, a budding entrepreneur with two possible;investment projects that offer the following payoffs;Investment;Payoff;Probability;of Payoff;Project 1;20.4;25.5;1.0;Project 2;20.4;40.8;0.6;0;0.4;Ms. Ketchup;approaches her bank and asks to borrow the present value of $10 (she will fund;the rest out of internal funds).;a. Calculate;the expected payoffs to the bank and to Ms. Ketchup if the bank lends the;present value of $10. Which project;would Ms. Ketchup undertake?;b. Is;this the same project that the bank would want Ms. Ketchup to undertake? Explain why or why not.;c.;What is the maximum amount the bank could lend that would induce Ms.;Ketchup to take the bank?s preferred project?;d.;If the bank was to lend the $10, but was acting strategically in its;own interest, what interest rate would the bank require on its loan?;4. You have the following information about;Ledd?a publicly traded (and therefore infinitely lived) company;Operating income: $20 million;Cost of unlevered equity: 10%;Risk-free interest rate: 5%;Corporate marginal tax rate: 0;a.;If Ledd is financed entirely by;equity;i.;What is the value of the firm?;ii.;What is the return required by;stockholders?;iii.;What is the company?s WACC?;b.;Ledd decides to issue bonds with;the market value of 40% of total assets, using the proceeds to repurchase;equity. The bonds are considered to be;risk-free.;i.;What is the value of Ledd with;the new capital structure?;ii.;What is the return required by;stockholders of the leveraged firm?;iii.;What is the WACC?;iv.;What is the tax shield of debt?;c. The government implements a marginal;corporate tax rate of 36%.;i.;Recalculate;your answers to a) and b) in a world with taxes.


Paper#51272 | Written in 18-Jul-2015

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