Solution to Problem Set 7  FINA 4200 Spring 2010
I.
Multiple Choices
1. a
2. a
3. b
4. a
5. a
6. b
7. b
8. b
9. b
10. a
11. d
12. c
13. d
14. e
15. c
16. c
17. b
Explanations to multiple choice questions
12. r
sL
= 8% + 2.0(4%) = 16%; r
sU
= 0.20(8%) + 0.80(16%) =
14.4%
.
13. Price per share =
.
=
million
4
million
$72.52
$18.13
14.
The unlevered cost of equity is 17.5%. All cash flows are discounted at this rate
:
Time line:
(In millions)
0
r
sU
= 17.5%
1
2
g = 4%
3 Years




45
+9
+25
(15+5)(1.04)=20.8
10
HV =
20(1.04)
15 = FCF
(0.175 – 0.04)
+
2
= 154
17
1
5
4
171
V
ops
= $9/(1.175) + $171/(1.175)
2
= $131.5 = V equity since there is no debt.
The NPV is $131.5 – $45 =
$86.5 million
.
15.
The premerger weight of debt is $5/($5 + $10) = 0.333
The premerger required rate of return on equity is 6% + 1.36(4%) = 11.44%.
WACC = w
d
r
d
(1 – T) + w
S
r
S
= 0.333(11%)(1 – 0.40) + 0.667(11.44%) =
9.83%
.
16.
The correct discount rate is the unlevered cost of equity.
The levered cost of equity is
6% + 1.36(4%) = 11.44%, the percent of debt is $5/($5 + $10) = 0.333.
The rate on the debt is
11%.
The unlevered cost of equity is w
d
r
d
+ w
s
r
sL
= 0.333(11%) + 0.667(11.44%) =
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View Full Document17.
Because the cash flows are all discounted at the same rate, we don’t need to separately
calculate the unlevered value of operations and the value of the tax shield.
We can simply enter
the sum of the tax shields and free cash flows and their horizon values for each year into the
financial calculator:
Time line:
(In millions)
0
r=11.29%
1
2
3
4 Years





PV = ?
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 Spring '08
 WU
 Corporate Finance, Net Present Value, NJ, Basic financial concepts

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