333final09a

333final09a - UNIVERSITY OF TORONTO Joseph L Rotman School...

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Unformatted text preview: UNIVERSITY OF TORONTO Joseph L. Rotman School of Management Apr. 29, 2009 Buti/Farooqi RSM333 FINAL EXAMINATION Florence/Konukoglu SOLUTIONS 1. (a) M&M Proposition I states that firm value is independent of the capital structure if the tax rate is zero and under the absence of financial distress and bankruptcy costs. Therefore the value of the levered firm will be V L = V U = 32,000 × \$32 = \$640,000 . (b) Using the CAPM, the cost of equity of XYZ before the debt issue is k e = 0 . 04 + 0 . 8 × . 10 = 12% . After the debt issue, we can use MM Proposition II to obtain the cost of equity as k e = 0 . 12 + 300 340 (0 . 12- . 08) = 0 . 12 + 0 . 0353 = 15 . 53% . (c) The levered firm value under a tax rate of 34% can be found by adding the present value of the tax-shields of the debt issue to the levered firm value under a zero tax rate: V L = V U + 0 . 34 D = \$640,000 + 0 . 34 × \$300,000 = \$742,000 . (d) The minimum tax-rate XYZ is willing to issue the debt can be obtained by solving the equation \$25,000 = T C × \$300,000 ⇒ T C = \$25,000 / \$300,000 = 8 . 33% . 2. (a) The NPV of an acquisition is the difference between the synergies and the costs. Clearly both Y and Z should get synergies from the merger ( S y ) that are high enough to cover the costs. So for firm Y the minimum amount of synergies can be obtained from the following equation: NPV = V ABC + S y /r- C = \$400,000 + S y / . 1- \$600,000 = 0 ⇒ S y = \$20,000 . 1 Similarly for firm Z we have: NPV = V ABC + S y /r- C = \$400,000 + S y . 1- 40,000 540,000 (\$7,500,000 + \$400,000 + S y . 1 ) = 0 ⇒ S y = \$20,000 ....
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333final09a - UNIVERSITY OF TORONTO Joseph L Rotman School...

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