Fall 2008 Final Exam Solution

# Fall 2008 Final Exam Solution - ANSWER 1 Tc = 0 Desired B/S...

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ANSWER 1: Tc = 0 Desired B/S = 0.5 V u = \$30(1,500,000) = \$45,000,000 V L = B + S = 15,000,000 + \$30(1,000,000) = \$45,000,000 5 Net Income of V u = E Net Income of V L = E – 8%(15,000,000) = E – 1,200,000 RiskTaker T s = T B = 0.40 Before Rebalancing 5 She owns \$1,350,000/45,000,000 = 0.03 = 3% of the firm \$ Investment \$ Return Stock -1,350,000 0.03E Borrowing 600,000 -0.08(600,000) -\$750,000 0.03E-48,000 After tax \$ return (0.03E-48,000)(1-0.4) = 0.018E-28,800 After Rebalancing 5 \$ Investment \$ Return 3% of levered equity -900,000 0.03(E-1,200,000) Borrowing 150,000 -0.08(150,000) -750,000 0.03E-48,000 After tax \$ return (0.03E-48,000)(1-0.4) = 0.018E-28,800 RiskAverse T s = T B = 0.30 Before Rebalancing 5 He owns \$2,250,000/45,000,000 = 0.05 = 5% of the firm \$ Investment \$ Return Stock -2,250,000 0.05E Lending -400,000 0.08(400,000) -2,650,000 0.05E+32,000 After tax \$ return (0.05E+32,000)(1-0.3) = 0.035E+22,400 After Rebalancing 5 \$ Investment \$ Return 5% of levered equity -1,500,000 0.05(E-1,200,000) Lending -1,150,000 0.08(1,150,000) -2,650,000 0.05E+32,000 After tax \$ return (0.05E+32,000)(1-0.3) = 0.035E+22,400

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ANSWER 2: a. 1. B/S = 2/3 Therefore B/V = 2/5 & S/V = 3/5 2 \$7,500,000 of internally generated funds can support \$7.5 + 5 = \$12.5 million in new Projects Take all the projects which have IRR > 21% Project Investment IRR 4 A 6,000,000 30% B 4,000,000 27 D 2,000,000 24 12,000,000 Out of \$7,500,000 of internally generated CFs only 12,000,000 x 3/5 = \$7,200,000 will be used on capital investment projects and the remaining \$300,000 will be paid out as cash dividend at \$300,000/1,000,000 = \$0.30 per share.
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