Answer to the Corporate Finance

Chapter 14 Capital Anatomy in a Absolute Bazaar 14-1. Consider a activity with chargeless banknote flows in one year of $130,000 or $180,000, with anniversary aftereffect actuality appropriately likely. The antecedent advance appropriate for the activity is $100,000, and the project’s bulk of basic is 20%. The certain absorption bulk is 10%. a. What is the NPV of this project? b. Suppose that to accession the funds for the antecedent investment, the activity is awash to investors as an all-equity firm. The disinterestedness holders will accept the banknote flows of the activity in one year. How abundant money can be aloft in this way—that is, what is the antecedent bazaar bulk of the unlevered equity? c. Suppose the antecedent $100,000 is instead aloft by borrowing at the certain absorption rate. What are the banknote flows of the levered equity, and what is its antecedent bulk according to MM? E ? C (1)? = ? ? 1 (130, 000 + 180, 000) = 155, 000, 2 155, 000 NPV = ? 100, 000 = 129,167 ? 100, 000 = $29,167 1. 20 155, 000 = 129,167 1. 20 d. Disinterestedness bulk = PV ( C (1)) = Debt payments = 100, 000, disinterestedness receives 20,000 or 70,000. Antecedent value, by MM, is 129,167 ? 100, 000 = $29,167 . 14-2. You are an administrator starting a biotechnology firm. If your analysis is successful, the technology can be awash for $30 million. If your analysis is unsuccessful, it will be account nothing. To armamentarium your research, you charge to accession $2 million. Investors are accommodating to accommodate you with $2 actor in antecedent basic in barter for 50% of the unlevered disinterestedness in the firm. a. What is the absolute bazaar bulk of the close afterwards leverage? b. Suppose you borrow $1 million. According to MM, what atom of the firm’s disinterestedness will you charge to advertise to accession the added $1 actor you need? c. What is the bulk of your allotment of the firm’s disinterestedness in cases (a) and (b)? a. b. c. Absolute bulk of disinterestedness = 2 ? 2m = $4m MM says the absolute bulk of the close is still $4 million. $1 actor of debt implies the absolute bulk of disinterestedness is $3 million. Therefore, 33% of the disinterestedness charge be awash to accession $1 million. In (a), 50% ? $4m = $2m. In (b), 2/3? $3m = $2m. Thus, in a absolute market, the best of basic anatomy does not affect the bulk of the entrepreneur. There is a 20% adventitious that the assets will be account alone $20 million. The accepted certain bulk is 5%, and the Actor's assets accept a bulk of basic of 10%. a. If Acort is unlevered, what is the accepted bazaar bulk of its equity? b. Suppose instead that Acort has a debt with a face bulk of $20 actor due in one year. According to MM, what is the bulk of the Actor's disinterestedness in this case? c. What is the accepted acknowledgment of the Actor's disinterestedness afterwards leverage? What is the accepted acknowledgment of the Actor's disinterestedness with leverage? d. What is the everyman accessible accomplished acknowledgment of Acort’s disinterestedness with and afterwards leverage? a. b. c. d. 14-4. E[Value in one year] = 0. 8 ( 50 ) + 0. 2 ( 20 ) = 44 . E = D= 44 = $40m. 1. 10 20 = 19. 048 . Therefore, E = 40 ? 19. 048 = $20. 952m. 1. 05 44 44 ? 20 ? 1 = 10% , with leverage, r = ? 1 = 14. 55%. 40 20. 952 20 0 ? 1 = ? 50% , with leverage, r = ? 1 = ? 100%. 40 20. 952. Without leverage, r= Afterwards leverage, r= Wolfrum Technology (WT) has no debt. Its assets will be account $450 actor in one year if the abridgement is strong, but alone $200 actor in one year if the abridgement is weak. Both contest are appropriately likely. The bazaar bulk today of its assets is $250 million. a. What is the accepted acknowledgment of WT banal afterwards leverage? b. Suppose the certain absorption bulk is 5%. If WT borrows $100 actor today at this bulk and uses the gain to pay an actual banknote dividend, what will be the bazaar bulk of its disinterestedness aloof afterwards the allotment is paid, according to MM c. What is the accepted acknowledgment of MM banal afterwards the allotment is paid in allotment (b)? a. b. c. 14-5. (. 5 ? 450+. 5 ? 200)/250 = 1. 30 => 30% E + D = 250, D = 100 => E = 150 (. 5 ? (450-105) + . 5 ? (200-105))/150 = 1. 4667 => 46. 67% Suppose there are no taxes. Firm ABC has no debt, and close XYZ has a debt of $5000 on which it pays absorption of 10% anniversary year. Both companies accept identical projects that accomplish chargeless banknote flows of $800 or $1000 anniversary year. Afterwards advantageous any absorption on the debt, both companies use all actual chargeless banknote flows to pay assets anniversary year. a. Fill in the table beneath assuming the payments debt and disinterestedness holders of anniversary close will accept accustomed anniversary of the two accessible levels of chargeless banknote flows. b. Suppose you authority 10% of the disinterestedness of ABC. What is addition portfolio you could authority that would accommodate the aforementioned banknote flows? 2011 Pearson Education, Inc. Publishing as Prentice Hall 186 Berk/DeMarzo. c. Suppose you authority 10% of the disinterestedness of XYZ. If you can borrow at 10%, what is an addition action that would accommodate the aforementioned banknote flows? ABC Debt Payments Disinterestedness Assets 0 800 0 1000 XYZ Debt Payments Disinterestedness Assets 500 300 500 500 a. FCF $800 $1,000 b. c. 14-6. Unlevered Disinterestedness = Debt + Levered Equity. Buy 10% of XYZ debt and 10% of XYZ Equity, get 50 + (30,50) = (80,100) Levered Disinterestedness = Unlevered Disinterestedness + Borrowing. Borrow $500, buy 10% of ABC, accept (80,100) – 50 = (30, 50) Suppose Alpha Industries and Omega Technology accept identical assets that accomplish identical banknote flows. Alpha Industries is an all-equity firm, with 10 actor shares outstanding that barter for a bulk of $22 per share. Omega Technology has 20 actor shares outstanding as able-bodied as a debt of $60 million. a. According to MM Proposition I, what is the banal bulk for Omega Technology? b. Suppose Omega Technology banal currently trades for $11 per share. What arbitrage befalling is available? What assumptions are all-important to accomplishment this opportunity? a. b. V(alpha) = 10 ? 22 = 220m = V(omega) = D + E ? E = 220 – 60 = 160m ? p = $8 per share. Omega is overpriced. Advertise 20 Omega, buy 10 alpha, and borrow 60. Antecedent = 220 – 220 + 60 = 60. Assumes we can barter shares at accepted prices and that we can borrow at the aforementioned agreement as Omega (or own Omega debt and can advertise at the aforementioned price). 14-7. Croft is a awful assisting technology close that currently has $5 billion in cash. The close has absitively to use this banknote to repurchase shares from investors, and it has already appear these affairs to investors. Currently, Cisoft is an all-equity close with 5 billion shares outstanding. These shares currently barter for $12 per share. Croft has issued no alternative antithesis except for banal options accustomed to its employees. The accepted bazaar bulk of these options is $8 billion. a. What is the bazaar bulk of Cisoft’s non-cash assets? b. With absolute basic markets, what is the bazaar bulk of Cisoft’s disinterestedness afterwards the allotment repurchase? What is the bulk per share? c. Assets = banknote + non-cash, Liabilities = disinterestedness + options, Non-cash assets = disinterestedness + options – banknote = 12 ? 5 + 8 – 5 = 63 billion. Disinterestedness = 60 – 5 =55. Repurchase Per allotment bulk = 55 = $12 . 4. 583 5b = 0. 417b shares ? 4. 583 b shares remain. 12 b. 14-8. Schwartz Industry is an automated aggregation with 100 actor shares outstanding and a bazaar assets (equity value) of $4 billion. It has $2 billion of debt outstanding. Management has absitively to bear the close by arising new disinterestedness to accord all outstanding debt. a. How abounding new shares charge the close issue? b. Suppose you are a actor captivation 100 shares, and you disagree with this decision. Assuming a absolute basic market, call what you can do to disengage the aftereffect of this decision. c. Allotment bulk = 4b/100m = $40, Affair 2b/40 = 50 actor shares ©2011 Pearson Education, Inc. Publishing as Prentice Hall d. You can disengage the aftereffect of the accommodation by borrowing to buy added shares, in the aforementioned admeasurement as the firm’s actions, appropriately carrying your own portfolio. In this case, you should buy 50 new shares and borrow $2000. 14-9. Zetatron is an all-equity close with 100 actor shares outstanding, which are currently trading for $7. 50 per share. A ages ago, Zetatron appear it will change its basic anatomy by borrowing $100 actor in concise debt, borrowing $100 actor in abiding debt, and arising $100 actor of adopted stock. The $300 actor aloft by these issues, additional addition $50 actor in banknote that Zetatron already has, will be acclimated to repurchase absolute shares of stock. The transaction is appointed to action today. Assume absolute basic markets. a. What is the bazaar bulk antithesis area for Zetatron b. Afore this transaction? c. Afterwards the new antithesis are issued but afore the allotment repurchase? d. Afterwards the allotment repurchase? e. At the cessation of this transaction, how abounding shares outstanding will Zetatron have, and what will the bulk of those shares be? g. A = 50 banknote + 700 non-cash L = 750 disinterestedness A = 350 banknote + 700 non-cash L = 750 disinterestedness + 100 concise debt + 100 abiding debt + 100 adopted banal iii. A = 700 non-cash L = 400 disinterestedness + 100 concise debt + 100 abiding debt + 100 adopted banal b. 14-10. Repurchase 350 400 = 46. 67 shares? 53. 33 remain. Bulk is = 7. 50. 7. 50 53. 33 Explain what is amiss with the afterward argument: “If a close issues debt that is risk-free, because there is no achievability of default, the accident of the firm’s disinterestedness does not change. Therefore, certain debt allows the close to get the account of a low bulk of basic of debt afterwards adopting its bulk of basic of equity. ” Any advantage raises the disinterestedness bulk of capital. In fact, certain advantage raises it the best (because it does not allotment any of the risks). 14-11. Consider the administrator declared in Section 14. 1 (and referenced in Tables 14. 1–14. 3). Suppose she funds the activity by borrowing $750 rather than $500. a. According to MM Proposition I, what is the bulk of the equity? What are its banknote flows if the abridgement is strong? What are its banknote flows if the abridgement is weak? Hardmon Enterprises is currently an all-equity close with an accepted acknowledgment of 12%. It is because a leveraged recapitalization in which it would borrow and repurchase absolute shares. a. Suppose Hardmon borrows to the point that its debt-equity arrangement is 0. 50. With this bulk of debt, the debt bulk of basic is 6%. What will the accepted acknowledgment of disinterestedness be afterwards this transaction? b. Suppose instead Hardmon borrows to the point that its debt-equity arrangement is 1. 50. With this bulk of debt, Hardmon’s debt will be abundant riskier. As a result, the debt bulk of basic will be 8%. What will the accepted acknowledgment of disinterestedness be in this case? c. A chief administrator argues that it is in the best absorption of the shareholders to accept the basic anatomy that leads to the accomplished accepted acknowledgment for the stock. How would you acknowledge to this argument? a. b. c. 14-13. re = ru + d/e(ru – rd) = 12% + 0. 50(12% – 6%) = 15% re = 12% + 1. 0(12% – 8%) = 18%. Returns are college because accident is higher—the acknowledgment adequately compensates for the risk. There is no chargeless lunch. Suppose Microsoft has no debt and an disinterestedness bulk of basic of 9. 2%. The boilerplate debt-to-value arrangement for the software industry is 13%. What would its bulk of disinterestedness be if it took on the boilerplate bulk of debt for its industry at a bulk of debt of 6%? At a bulk of debt of 6%: D (rU ? rD ) E 0. 13 rE = 0. 092 + (0. 092 ? 0. 06) 0. 87 = 0. 0968 rE = rU + = 9. 68%. 14-14. Global Pistons (GP) has accepted banal with a bazaar bulk of $200 actor and debt with a bulk of $100 million. Investors apprehend a 15% acknowledgment on the banal and a 6% acknowledgment on the debt. Assume absolute basic markets. a. Suppose GP issues $100 actor of new banal to buy aback the debt. What is the accepted acknowledgment of the banal afterwards this transaction? i. If the accident of the debt does not change, what is the accepted acknowledgment of the banal afterwards this transaction? b. Suppose instead GP issues $50 actor of new debt to repurchase stock. ii. If the accident of the debt increases, would the accepted acknowledgment of the banal be college or lower than in allotment (i)? ©2011 Pearson Education, Inc. Publishing as Prentice Hall Berk/DeMarzo Corporate Finance, Second Edition 2 (15% ) 6% + = 12% = ru . 3 3 189 a. b. wacc = i. re = ru + d / e ( ru ? rd ) = 12 + 150 (12 ? 6) = 18% 150. If rd is higher, re is lower. The debt will allotment some of the risks. 14-15. Hubbard Industries is an all-equity close whose shares accept an accepted acknowledgment of 10%. Hubbard does a leveraged recapitalization, arising debt and repurchasing banal until its debt-equity arrangement is 0. 60. Due to the added risk, shareholders now apprehend a acknowledgment of 13%. Assuming there are no taxes and Hubbard’s debt is risk-free, what is the absorption bulk on the debt? acc = ru = 10% = 1 0. 6 x ? 1. 6 (10) ? 13 = 3 = 0. 6 x ? x = 5% 13% + 1. 6 1. 6 14-16. Hartford Mining has 50 actor shares that are currently trading for $4 per allotment and $200 actor account of debt. The debt is certain and has an absorption bulk of 5%, and the accepted acknowledgment of Hartford banal is 11%. Suppose a mining bang causes the bulk of Hartford banal to abatement 25% to $3 per share. The bulk of the certain debt is unchanged. Assuming there are no taxes and the accident (unlevered beta) of Hartford’s assets is unchanged, what happens to Hartford’s disinterestedness bulk of capital? u = WACC = 1 1 200 (11) + (5) = 8% . re = 8% + (8% ? 5%) = 12% 2 2 150 14-17. Mercer Corp. is an all-equity close with 10 actor shares outstanding and $100 actor account of debt outstanding. Its accepted allotment bulk is $75. Mercer’s disinterestedness bulk of basic is 8. 5%. Mercer has aloof appear that it will affair $350 actor account of debt. It will use the gain from this debt to pay off its absolute debt and use the actual $250 actor to pay an actual dividend. Assume absolute basic markets. a. Estimate Mercer’s allotment bulk aloof afterwards the recapitalization is announced, but afore the transaction occurs. b. Estimate Mercer’s allotment bulk at the cessation of the transaction. (Hint: use the bazaar bulk antithesis sheet. ). c. Suppose Mercer’s absolute debt was certain with a 4. 25% accepted return, and its new debt is chancy with a 5% accepted return. Estimate Mercer’s disinterestedness bulk of basic afterwards the transaction. a. b. MM => no change, $75 Antecedent action bulk = 75 ? 10 + 100 = 850 actor New debt = 350 actor E = 850 – 350 = 500 Allotment bulk = 500/10 = $50 c. Ru = (750/850) ? 8. 5% + (100/850) ? 4. 25% = 8% Re = 8% + 350/500(8% – 5%) = 10. 1%. Corporate Finance, Second Edition In June 2009, Apple Computer had no debt, absolute disinterestedness assets of $128 billion, and an (equity) beta of 1. 7 (as appear on Google Finance). Included in Apple’s assets was $25 billion in banknote and certain securities. Assume that the certain bulk of absorption is 5% and the bazaar accident exceptional is 4%. a. b. 128-25=103 actor Because the debt is risk-free? U = E ? E E+D 128 = (1. 7) 103 = 2. 11 c. rWACC = rf + ? ( E[ RMkt ] ? rf ) = 5 + 2. 11? 4 = 13. 4% alternatively rE = rf + ? E ( E[ RMkt ] ? rf ) = 5 + 1. 7 ? 4 = 11. 8% E D $128 $25 rE + rD = (11. 8%) ? (5%) = 13. 4% E+D E+D $103 $103 rwacc = 14-19.

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