C09-reviewproblems-solutions-2009

C09-reviewproblems-solutions-2009 - UNIVERSITY OF TORONTO...

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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.
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This note was uploaded on 04/19/2010 for the course MGT MGTC09 taught by Professor Syedahmed during the Spring '10 term at University of Toronto.

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C09-reviewproblems-solutions-2009 - UNIVERSITY OF TORONTO...

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