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

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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 ...
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