Unit IVC-D Supplemental Practice Problems
1.
Consider a company with assets of $50,000, no debt, and 1,000 shares.
Answer the
following questions.
a.
How much is shareholder wealth, broken down into shares and price per share?
b.
Suppose the firm uses $20,000 to repurchase shares.
What will be the total
shareholder wealth broken down into cash, shares, and price per share?
c.
Suppose that instead the firm decides to pay a $10,000 dividend.
Now what will
be the total shareholder wealth broken down into cash, shares, and price per
share?
d.
Suppose the firm invests $25,000 in a zero-NPV project.
What will be the total
shareholder wealth broken down into cash, shares, and price per share.
e.
Suppose the firm invests $10,000 in a project with NPV of $5,000.
What will be
the shareholder wealth broken down into cash, shares, and price per share?
f.
Continuing with e. and assuming that your answer in e. shows that shareholder
wealth increases, suppose the firm then pays a special dividend of $4 a share and
then repurchases 200 shares.
What will be shareholder wealth broken down into
cash, shares, and price per share?
g.
Continuing with f., how much of the increase in shareholder wealth over the
original case (1,000 shares at $50) is a result of the dividend and how much is a
result of the share repurchase.
2.
Consider a company worth $100,000.
It is considering financing it at 70% equity or
30% equity with the remainder borrowed at 6% interest.
The company is a perpetuity
and is expected to generate a return on its operating assets of 12% a year.
There are
no taxes.
a.
What is the expected annual distribution of the firm’s total operating income to
the two suppliers of capital and what is their expected annual rate of return?
b.
If the stockholders can borrow and lend at the risk-free rate, show why the 30%
equity plan, even though it offers a higher expected rate of return, is not better
than the 70% equity plan.
c.
If the stockholders can borrow and lend at the risk-free rate, show why the 70%
equity plan, even though it has a lower expected rate of return, is not worse than
the 30% plan.
3.
Consider two companies X and Y that have operating assets valued at $500,000, each
with expected returns of 20%.
X finances with 80% debt and 20% equity while Y
finances with 20% debt and 80% equity.
a.