TT2_Soln

TT2_Soln - W S 0 L U 770 M 5 Waterloo W University of...

This preview shows pages 1–7. Sign up to view the full content.

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

View Full Document

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

View Full Document

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

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: W S 0 L. U: 770 M 5 Waterloo W University of Waterloo Term Test #2 ACTSC 372 — Corporate Finance 2 Instructor: Peter Wood Date: March 14th, 2011 Time: 5:30 pm. Duration: 50 minutes Number of Pages: 7 (including the cover page and the blank page) Aids: Calculator. Name: ID#: FOR EXAMINERs’ USE ONLY Question Mark 1 :l /5 2 / 6 3 / 12 4 /4 TOTAL /27 ACT SC 3 72 Winter 2011 Term Test #2 M“ [5] 1. Suppose Ontario Inc and Manitoba Inc are two ﬁrms identical in every way, except their capital structures. Financial information on the two ﬁrms appears below. Assume there are no taxes and that both ﬁrms distribute all earnings as dividends immediately. Assume everyone can borrow or lend at the same rate of 10%. Assume that both ﬁrms always have the same EBIT. Ontario Inc. Manitoba Inc. Market value of debt \$1 million \$3 million Market value of equity \$4 million \$2.2 million Your friend plans to purchase 10% of the equity of Manitoba Inc. Show your friend how it is possible to construct a portfolio including Ontario Inc. shares instead at a lower total cost, such that the total dollar returns are identical to that of your friends planned investment in Manitoba Inc. no matter what the actual EBIT of the ﬁrms actually is (remember the EBIT of the ﬁrms is always assumed to be equal) , l ‘ ‘ﬂ [\jd‘l’L UOnf ’ (3m 10.} (out 9mg WI [sum it Page 2 of 7 AC TSC 3 72 Winter 2011 Term. Test #2 -——-——————_.__________ [6] 2. Waterloo Solar (WS) is planning to erect solar panels on the Math and Computer building. Details of the new project are as follows: 0 The initial cost of the panels will be \$1 million, and the panels are expected to generate EBIT of \$l00,000 per year for the 25 year life of the project. 0 WS has a stock beta of 1.5. The risk free rate is 4% and the market risk premium is 6%. The YTM on WS’s debt is 7%. Assume WS has a D/E ratio of l. 0 WS has secured a government low—interest loan of \$600,000 at 4% in order to ﬁnance the project. Assume the principal of the loan will be paid in full at the end of the project. 0 WS faces a 25% tax rate. Ignore CCA and the costs associated with ﬁnancial distress. Should Waterloo Solar undertake this project? [3(a) 3 )304, Page 3 of 7 ACTSC 372 Winter 2011 Term Test #2 *“M [12] 3. Proﬁtable Inc currently has no debt outstanding. Assume the following. o The current expected return on equity is 12%, and the equity has market value of \$500 million, with 10 million shares outstanding. o If Proﬁtable Inc. chooses to issue debt, the YTM on such debt would be 8%. o Proﬁtable Inc. faces a corporate tax rate of 25%. Assume no personal taxes. 0 Proﬁtable Inc. is planning to change its capital structure by issuing \$100 million in perpetual debt, and repurchasing \$100 million in equity. (a) Provide the market value balance sheet for Proﬁtable Inc. immediately before the announcement of the debt issue and equity repurchase. What is the price per share for Proﬁtable Inc.’s stock? s:§a:ewac (b) Provide the market value balance sheet for Proﬁtable Inc. immediately after the announcement, but before the debt issue. Asvne the EMH. What is the new stock price? : U41 F [g _ : 330m f .9695 6/4),“ 1/ / V /u* Page 4 of 7 AC TSC 3 72 Winter 2011 Term Test #2 (c) Provide the market value balance sheet after the debt has been issued and the shares repurchased. How many shares will Proﬁtable Inc. have outstanding after the share repurchase? “I'M ' 4/ (u?- '74 K675' : L012 ~: L70 [’7 A DH»: {rm (d) What is the new rate of return investors will expect from Proﬁtable Inc. stock? r 7 r "l 0/ (rt) AJ/OY P137) 0 ‘ “’ ’3 >961; Jr 1‘” "/72-5Zl(l’”7) \l L41? :irv/a r2—(am«~riﬁmlH/mi C/ll/m 7 9/7/06 Page 5 of 7 AC TSC 3 72 Winter 2011 Term Test #2 (e) (0 Suppose Proﬁtable Inc. was thinking of paying a \$100 million special dividend instead of repurchasing shares. What effect would this have on the stock price and the new rate of return expected by shareholders? Explain. 53 S; W: [ti-VD rd’w‘ié Page 6 of 7 AC T SC 3 72 Winter 2011 Term Test #2 [4] 4. (a) Give 2 examples of costs associated with ﬁnancial distress. M (432135 \$4ch fi/L Adm/(00707207 [LBJ (ml 822/63 v me My in Mel/Leif 6UJWS\$ “ Q35»? 603/5 (b) What is meant by “Dividend Signaling” and What effect does it have on stock prices? baggie»: mix/Veal a (1%,?) ,LL Jailed; as new mic ﬂawed/mg memes-Weak [Do/if is 06130 7! PL “£7211? . 59 am / sec/eeggs H 0 S/éjm/ 710 M max/X6717 7/4sz /WL4209’947L99¢/ AJ/Lugi [0%)qule w/ [MC/2.962%. We“ Sf/{L/L [LO/"CU WW Swab/Q16 page . / x4 Zj/u/iemi (9% 5610364 [4 pw<z z” le/b/J "XIV 5/7411/(2/ fQUJC/ﬂs > Page 7 of 7 ...
View Full Document

{[ snackBarMessage ]}

What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern