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ch9solns

ch9solns - Chapter 9 9-1 a There are a number of ways in...

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Chapter 9 9-1 a. There are a number of ways in which BMD can increase its debt ratio 1. It can borrow \$1.15 billion and buy back stock. 2. It can borrow \$1.15 billion and pay special dividends. 3. It can borrow more than \$1.15 billion and take projects over time, in which case its optimal dollar debt will be higher. For instance, if the money is borrowed now to take projects, the debt needed can be estimated approximately: X/(2,300+X) = 0.5, Solving for X, X = 2,300. b. From the viewpoint of the effect on equity, there is no difference between repurchasing stock and paying a special dividend. There may be a tax difference to the recipient, since dividends and capital gains are taxed differently. c. If BMD has a cash balance of \$250 million, it can use this cash to buy back stock. BMD, therefore, needs to borrow only \$1.025 billion to get to 50%. 9-2 a. Current 1 2 3 4 5 Debt \$100.00 \$100.00 \$100.00 \$100.00 \$100.00 \$100.00 Equity \$900.00 \$1,003.95 \$1,119.72 \$1,248.68 \$1,392.35 \$1,552.42 D/(D+E) 10.00% 9.06% 8.20% 7.41% 6.70% 6.05% D/E 11.11% 9.96% 8.93% 8.01% 7.18% 6.44% Net Income \$67.50 \$74.25 \$81.68 \$89.84 \$98.83 \$108.71 Dividends \$13.50 \$14.85 \$16.34 \$17.97 \$19.77 \$21.74 Beta 1.10 1.09 1.09 1.08 1.08 1.07 Expected Return 13.05% 13.01% 12.98% 12.94% 12.92% 12.89% Dividend Yield 1.50% 1.48% 1.46% 1.44% 1.42% 1.40% Exp. Price Appreciation 11.55% 11.53% 11.52% 11.51% 11.50% 11.49% b. Current 1 2 3 4 5 Debt \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 \$ 100.00 Equity \$ 900.00 \$ 940.93 \$ 978.71 \$ 1,012.06 \$ 1,039.43 \$ 1,059.00 D/(D+E) 10.00% 9.61% 9.27% 8.99% 8.78% 8.63% D/E 11.11% 10.63% 10.22% 9.88% 9.62% 9.44% Net Income \$ 67.50 \$ 74.25 \$ 81.68 \$ 89.84 \$ 98.83 \$ 108.71 Dividends \$ 27.00 \$ 29.70 \$ 32.67 \$ 35.94 \$ 39.53 \$ 43.48

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Stock Buybacks \$ 49.52 \$ 55.16 \$ 61.41 \$ 68.34 \$ 76.02 Beta 1.10 1.10 1.09 1.09 1.09 1.09 Expected Return 13.05% 13.03% 13.02% 13.01% 13.00% 12.99% Dividend Yield 3.00% 3.16% 3.34% 3.55% 3.80% 4.11% Exp. Price Appr. 10.05% 9.88% 9.68% 9.46% 9.20% 8.89% To estimate the stock bought back in year 1, estimate first the value of the equity at the end of year 1, which will be \$ 900 (1.1005). Then take 5% of that number, since the buyback occurs at the end of the year. 9-3 The solution to this problem is similar to that of problem 2, except that dividends are constant in this case. a) If the existing policy of paying \$ 50 million in dividends is continued. Current 1 2 3 4 5 Debt \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 Equity \$ 500.00 \$ 518.00 \$ 537.43 \$ 558.40 \$ 581.04 \$ 605.48 D/(D+E) 90.91% 90.61% 90.29% 89.95% 89.59% 89.20% D/E 1000.00% 965.25% 930.35% 895.41% 860.52% 825.79% Dividends \$ 50.00 \$ 50.00 \$ 50.00 \$ 50.00 \$ 50.00 \$ 50.00 Beta 1.20 1.16 1.13 1.09 1.06 1.02 Expected Return 13.60% 13.40% 13.21% 13.01% 12.81% 12.61% Dividend Yield 10.00% 9.65% 9.30% 8.95% 8.61% 8.26% Exp. Price Appr. 3.60% 3.75% 3.90% 4.05% 4.21% 4.36% b. When dividends drop to zero, the debt ratio drops faster. However, starting from a ratio of 90.91%, it is necessary to adopt more drastic strategies such as buying back equity to reach the desired debt-equity ratio of 30%. Current 1 2 3 4 5 Debt \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 \$ 5,000.00 Equity \$ 500.00 \$ 568.00 \$ 641.40 \$ 720.63 \$ 806.16 \$ 898.47 D/(D+E) 90.91% 89.80% 88.63% 87.40% 86.12% 84.77% D/E 1000.00% 880.28% 779.54% 693.83% 620.23% 556.50% Dividends \$ - \$ - \$ - \$ - \$ - \$ - Beta 1.20 1.08 0.97 0.89 0.81 0.74 Expected Return 13.60% 12.92% 12.35% 11.87% 11.45% 11.09% Div Yld 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Exp. Price Appr. 13.60% 12.92% 12.35% 11.87% 11.45% 11.09%
The information on growth rates in operating income and depreciation could be used, if desired, to obtain a different estimate of the market value of equity. 9-4 a. Current Return on Capital = EBIT(1-t)/(BV:D+E) = 300 (1-.4) / (1,000 + 2,000) = 6.00% Current Cost of Equity = 7% + 1.30 (5.5%) = 14.15% Cost of Capital = 14.15% (4,000/5,000) + 8% (1-.4) (1,000/5,000) = 12.28% Given that the return on capital is less than the cost of capital, DGF Corporation should try to increase its debt ratio by buying back stock or paying dividends, unless it expects future projects to earn more than its expected cost of capital (11.28%) - i.e, 1% less than the current cost of capital.

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ch9solns - Chapter 9 9-1 a There are a number of ways in...

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