333final10a - UNIVERSITY OF TORONTO Joseph L Rotman School of Management Apr 23 2010 Buti/Farooqi RSM333 FINAL EXAMINATION Ganguly SOLUTIONS 1(a

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: UNIVERSITY OF TORONTO Joseph L. Rotman School of Management Apr. 23, 2010 Buti/Farooqi RSM333 FINAL EXAMINATION Ganguly SOLUTIONS 1. (a) First we use the CAPM to obtain the cost of equity for firm ABC: k e = 0 . 08 + 1 . 1 × . 07 = 0 . 157 . Then we compute the WACC of firm ABC. As both firms pay no taxes, the WACC is invariant to the capital structure. Hence the WACC of firm ABC is also the cost of capital for XYZ’s project: k wacc = D D + E k d + E D + E k e = 1 2 × . 09 + 1 2 × . 157 = 12 . 35% . (b) Compute the NPV of the project: NPV =- $30 m + . 4($160 m ) + 0 . 6($70 m )- 75 m 1 + 0 . 1235 =- $2,407,655 < . Firm XYZ should not start the project. (c) If demand is high after one year, the firm can spend the $75 million and get $160- $75 = $85 million. If demand is low after one year, the firm can spend the $75 million but would only get $70- $75 =- $5 million. Therefore the firm will prefer to abandon the project if demand is low. The NPV of the project becomes: NPV(with option) =- $30 m + . 4($160 m- $75 m ) + 0 . 6($0) 1 + 0 . 1235 = $262,572 > . The firm should now accept the project. (d) To compute the option value, compare the NPVs with and without the option: Option value = $262,572- (- $2,407,655) = $2,670,227 . The maximum amount that XYZ is willing to pay for this option is $262,572 ( not $2,670,227). Any higher amount would make the NPV of the project negative. (e) The managers are wrong: the correct discount rate for the project is still k wacc = . 1235, so EDF should make the investment as the project has a positive NPV. The higher cost of equity capital could be due either to a higher leverage of the company or to the firm being highly diversified, so that the project does not necessarily belong to the firm’s core activity. 1 2. (a) Synergies will arise due to the tax shield on the $10 million loan and the interest rate subsidy. PV(tax shield) = (0 . 30)(0 . 04)($10,000,000) × A 4 . 13 = $356,937 , PV(interest subsidy) = (0 . 13- . 04)($10,000,000) × A 4 . 13 = $2,677,024 , Synergies = PV(tax shield) + PV(interest subsidy) = $356,937 + $2,677,024 = $3,033,961 . (b) Value of firm B before the acquisition = $2.3 × 1 million = $2.3 million. The total value of the cash offer is $2,300,000 + 0 . 8 × $3,033,961 = $4,727,169 ....
View Full Document

This note was uploaded on 04/26/2011 for the course RSM 333 taught by Professor Sabrinabutti during the Spring '11 term at University of Toronto- Toronto.

Page1 / 6

333final10a - UNIVERSITY OF TORONTO Joseph L Rotman School of Management Apr 23 2010 Buti/Farooqi RSM333 FINAL EXAMINATION Ganguly SOLUTIONS 1(a

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online