Unformatted text preview: 1) The expected return on equity is 10%. The expected return on debt is 5%. The marginal tax rate is 25%. The debt‐equity ratio is 1. What is the WACC? 2) There are two investors and two firms in the market. Firm A has 100 shares outstanding, Firm B has 200 shares outstanding. Mr. Smart knows the industry of both firms very well and has private information as he is good friends with the CEOs of both firms. Mr. clueless does not know anything about the firms. Can Mr. clueless ensure that he is not outsmarted by Mr. Smart? If so, how? If not, why? 3) According to the portfolio theory, why should all investor solely consider investing in the Tangency portfolio and the riskfree asset? 4) You buy an apartment for $400,000. You pay $100,000 in cash and finance the remainder with a loan for thirty years (an annuity with yearly payments and an APR of 6%)? The interest component of the annuity is tax deductible. Suppose your marginal tax rate is 40%. What is the tax shield associated with the interest paid between year 9 and 10? Without doing any calculations is this higher or lower than the tax shield in year 20? 5) Explain the concept of alpha and why it makes sense to evaluate fund managers based on alpha. Suppose the CAPM holds, what is the (true) alpha of every stock? 6) List 3 Pitfalls of the IRR Rule relative to the NPV Rule 7) What is the crucial difference between cash flows and accounting earnings? 8) Suppose the yield curve is upward sloping. What can you say about the yield to maturity of two default‐ free bonds with the same maturity, but different coupon rates? Explain! 9) Suppose outstanding payroll of firm Y is 100,000 per pay period (month) in perpetuity. How much would it generate in present value if they shifted the pay date from the beginning of the month to the end of the month? The monthly interest rate is r. 10) Explain what many refer to as “dilution” of shareholders. What is the underlying mistake? QUESTION 5) Valeo Industries has 10 million shares outstanding with a current market price of $8.50, and no debt. Valeo has the opportunity to acquire a smaller privately‐held competitor for $20 million. Valeo’s management expects the acquisition to contribute $1.75 million to its EBIT at the end of this year, and expects this contribution to grow at a rate of 4.5% per year thereafter. The acquisition will have no consequences for Valeo’s net working capital requirements or net investment. Valeo’s corporate tax rate is 20%, and its equity beta is 0.70 (which is consistent with its industry). The risk‐free interest rate is 5%, and the expected return of the market portfolio is 10%. Assume that investors did not anticipate this acquisition prior to its announcement, and that there are no market imperfections other than corporate taxes. a) Suppose Valeo plans to raise the $20 million needed for the acquisition by issuing new shares. Assuming investors agree with management’s assessment of the acquistion’s contribution to Valeo’s future earnings and cash flows, what share price will Valeo receive when it announces the transaction and issues the new shares? New share price is $_______________ b) Suppose Valeo anticipates a standalone EBIT (that is, EBIT without the contribution from the acquisition) at the end of this year of $4.25 million. What will be Valeo’s earnings per share (EPS) without the acquisition? What will be Valeo’s earnings per share (EPS) if it pays for the acquisition using equity? Repeat the analysis if Valeo expects a standalone EBIT this year of $5.75 million or $7.25 million, and fill in the table below: 4.25 EPS without Acquistion = EPS with Equity‐financed Acq. = Standalone EBIT ($ million) 5.75 7.25 c) Valeo is also considering using debt to pay for the acquisition. Valeo could borrow the $20 million at an interest rate of 6.25%. If it instead uses debt to pay for the acquisition, what will be its EPS at the end of this year given standalone EBIT as projected in part (b)? Standalone EBIT ($ million) 5.75 4.25 EPS with Debt‐financed Acq. = 7.25 d) For each projection of Valeo’s standalone EBIT, indicate the best alternative for Valeo’s shareholders. (Check one for each column, or more than one in case of a tie.) Explain your answer. 4.25 No Acquistion Equity‐financed Acq. Debt‐financed Acq. Standalone EBIT ($ million) 5.75 7.25 ...
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This note was uploaded on 12/16/2009 for the course UGBA 08547 taught by Professor Odean during the Fall '09 term at Berkeley.
 Fall '09
 ODEAN

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