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c09reviewproblems.solution.2009

c09reviewproblems.solution.2009 - UNIVERSITY OF TORONTO at...

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UNIVERSITY OF TORONTO at Scarborough MANAGEMENT MGTC09 (Intermediate Finance) Solutions for the Review Problems Professor: Syed W. Ahmed EXAM 1 Answer 1 (Cost of Capital) S = 12,000,000($50) = $600,000,000 B 1 = $200,000,000(0.9194) = $183,880,000 B 2 = $300,000,000(0.9329) = $279,870,000 V = S + B 1 + B 2 = $600,000,000+183,880,000+279,870,000 = $1,063,750,000 S/V = 600,000,000/1,063,750,000 = 0.564 B/V = (183,880,000+279,870,000)/1,063,750,000 = 0.436 a. r B = × + + × + = 0 09 183880 183 880 279 870 0 08 279 870 183 880 279 870 0 083965 . , , , . , , , . r D g P g S = + + = + = 0 0 1 2 108 50 008 01232 ( ) ( . ) . . WACC = 0.1232(0.564) + 0.083965(1-0.4)(0.436) = 0.09145 b. ( 29 ( 29 ( 29 NPV = - - + - + - ÷ 60 000 000 1 010 8 000 000 1 1 109145 0 09145 6 000 000 1 1 109145 0 09145 109145 10 15 10 , , . , , . . , , . . . = -$66,666,667+51,015,202+19,988,330 = $4,336,865 Answer 2 (Capital Structure) a. Her cash flow = (2,000,000-0.1(4,000,000))(300,000/6,000,000) = $80,000 r s = 80,000/300,000 = 0.2667 = 26.67% b. Sell all FRL’s shares; nets $300,000. Borrow $200,000 @ 10%. Interest cash flow = -$20,000. Use proceeds from selling shares and the borrowed funds to buy DFC’s shares: Her total cash flow now would be $2,000,000(500,000/10,000,000)-20,000 = $80,000 r s = 80,000/300,000 = 0.2667 = 26.67% c. r r r r B S s B DFC = + - = = 0 0 2 000 000 10 000 000 020 ( ) , , / , , . r r r r B S s B FRL = + - = + - = 0 0 0 20 020 010 4 6 0 2667 ( ) . ( . . ) . d. WACC DFC = 0.20 WACC r S V r B V FRL s B = + = + = 0 2667 6 10 010 4 10 0 20 . . . When there are no corporate taxes, the cost of capital for the firm is unaffected by the capital structure.
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-2- Answer 3 (Capital structure) a. V EBIT T WACC L c = - = - = ( ) , ( . ) . $1, , 1 331330 1 0 40 011694 700 000 V V T B U L c = - = - = 1 700 000 0 4 700 000 1 420 000 , , . ( , ) , , c) The firm has increased its value by $280,000 by issuing debt. As long as M&M Proposition I holds i.e. there are no bankruptcy costs and so forth then the firm should continue to increase its B/S ratio to maximize its value. Answer 4 (Capital Structure) a. The equilibrium interest rate paid by the corporations is 0.09/(1-0.4) = 0.15 = 15% Given the tax rates for the various groups, the investors will invest in bonds for interest rates that exceed: A: 0.09/(1-0.5)= 18% Invest in equities B: 0.09/(1-0.4)= 15% Indifferent C: 0.09/(1-0.3)= 12.88% Invest in bonds D: 0.09/(1-0.2)= 11.25% Invest in bonds E: 0.09/(1-0.1)= 10% Invest in bonds If A invests in equities, and B, C, D, and E in bonds, the value of equity will be S EBIT r B T r B c S = - - = - - = ( )( ) ( . ( ))( . ) . $53. 1 20 015 80 1 0 40 0 09 33 = = D E ratio B S 80 5333 . If A and B invest in equities, and C, D, and E in bonds the value of equity will be S = - - = ( . ( ))( . ) . $83. 20 015 50 1 0 40 0 09 33 = = D E ratio B S 50 8333 . Thus D/E ratio can range from 50/83.33 to 80/53.33 b. Taxes paid by corporations ($20-0.15(80))0.40 = $3.2 billion Taxes paid by investors B: $30(0.15)(0.40) = $1.8 billion C: $20(0.15)(0.30) = 0.9 billion D: $10(0.15)(0.20) = 0.3 billion E: $20(0.15)(0.10) = 0.3 billion Total Tax Bill $6.5 billion
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-3- EXAM 2 Question 1 (Valuation and Capital Budgeting for the Levered Firm) a. ( 29 ( 29 ( 29 NPV I I = = - + + - - + - - 0 1 000 000 400 000 1 0 40 1 1 112 012 1000 000 10 0 40 1 1 105 0 05 10 10 ( , , ) , ( . ) . . , , . . . = -I + 1,000,000 + 1,356,054 – 308,869 + 0.3088694I I = $2,962,081 b. ( 29 ( 29 ( 29 PVofTaxShield = + + + + 0 4 0 08 2 000 000 108 0 4 0 08 1 600 000 108 2 0 4 0 08 1 200 000 108 3 0 4 0 08 800 000 108 4 0 4 0 08 400 000 108 5 . ( . ) , , . . ( . ) , , ( . ) . ( . ) , , . . ( . ) , . . ( . ) , . = 59,259 + 43,896 + 30,483 + 18,817 + 8,711 = $161,166 ( 29 ( 29 ( 29 NPV = - + + - - + - - 2 500 000 1000 000 400 000 1 04 1 1 112 012 2 500 000 1 000 000 10 0 40 1 1 105 0 05 10 10 , , , , , ( . ) . . , , , , . . . NPV = -2,500,000 + 1,000,000 + 1,356,054 + 463,302 = $319,356 APV = $319,356 + 161,166 = $480,522 c. ( 29 ( 29 ( 29 APV = 0 = (-I + 1,000,000) + 1,356,054 + I - 1,000,000 10 ( . ) .
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