MGFC10FS12_Assig2_Fall2015_Solution.pdf - MGFC10H3(Intermediate Finance L01 SOLUTION ANSWER 1 CovTOFM,M 0.06 1.5 = s = = a 0.22 M2 rs = rf s E rM rf =

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MGFC10H3 (Intermediate Finance) L01 SOLUTION ANSWER 1: a. , 2 2 0.06 1.5 0.2 TOFM M s M Cov β σ = = 5 ( ( ) ) s f s M f r r E r r β = + = 0.03 + 1.5 (0.08 – 0.03) = 0.105 = 10.5% b. ( ) ( ) 10 10 1 1 1 1 1.105 1 0.018 30,000 \$30,000 8,000(1 0.4) (0.4) 0.105 10 0.018 DM NPV + = + + = -\$30,000 + 28,871 + 10,893 = \$9,764 10 ( ) ( ) 5 5 1 1 1 1 1.105 1 0.018 18,000 \$18,000 7,500(1 0.4) (0.4) 0.105 5 0.018 SM NPV + = + + ( ) ( ) ( ) ( ) 5 5 5 1 1 1 1 1.105 1 0.018 18,000 1 \$18,000 7,500(1 0.4) 0.4 0.105 5 0.018 1.105 + + + + ÷ = -\$18,000 + 16,843 + 6,827 + (-\$18,000 + 16,843 + 6,827)/ (1.105) 5 = 5,670 + 3,442 = \$9,112 TOFM should purchase Deluxe Model c. 1. V L = V u + T c B = \$10,000,000 +0.4(2,500,000) = \$11,000,000 3 2. S = V L – B = \$11,000,000 – 2,500,000 = \$8,500,000 d. V with financial distress cost = \$11,000,000 -0.10(11,000,000) = \$9,900,000 2 Yes, TOFM should not lever.