Market value of equity = 400 2. Did not set up for new cost of capital: -1 point
Sheet1 Page 14 Value of the firm = 500 3. Used new firm value in computation: -1/2 point The next step is to compute the value gained by stockholders in the buyback 4. Math errors: -1/2 point each Number of shares bought back = 5 Premium paid on buyback = 5 Value gained by buyback investors 25 Remaining shares = 11 Premium on remaining shares = 2 Value gained by remaining shares 22 Total value gained = 47 The third step is to set the value gain, relative to the original firm value (.09 - New Cost of capital)* 500/ New cost of capital = 47 New cost of capital = 8.23% You could also solve the problem this way Number of shares outstanding after the buyback 11 Price per share after buyback = 27 Value of equity = 297 Debt outstanding after buyback = 250 Value of firm after buyback = 547 Change in value = 47 Then, use the same third step as before to get the same answer Problem 3 a. Duration of assets = 6.8 1. All or nothing, unless egregious math error b. Duration of debt = 6.4 1. All or nothing, unless egregious math error c. After acquisition of new business 1. Did not compute new asset duration: -1 point Duration of assets = 7.25 2. Did not set up for new debt duration: -1 point To set the duration of the debt to 7.25 years after the debt issue 3. Math errors: -1/2 point each Let the value of new bonds issued be X (Here is a test of the second part. If you plug in 7.25 Debt oustanding after = 5+X and don't get the right answer, the second part of (3/(5+X)) *4+ (2+X)/ (5+X) *10 = 7.25 the problem is set up incorrectly) Solving for X X = $1.55 Check the answer 7.25 Spring 2014 Problem 1 Grading template a. Current cost of capital Current levered beta = 1.15 1. Wrong debt ratio: -1/2 point Cost of equity = 8.7500% ! 3% + Beta *5% 2. Math errors: -1/2 point each After-tax cost of debt = 3.00% ! Pre-tax cost of debt (1-.40) Debt to capital ratio = 20% Cost of capital = 7.600% b. New cost of capital
Sheet1 Page 15 New debt to capital ratio = 60% 1. Wrong debt ratio: -1/2 point New debt to equity ratio = 1.5 2. Did not adjust tax rate: -1 point Unlevered beta = 1.00 3. Did not relever beta: -1 point 4. Other math errors: -1/2 point each Interest expense on debt = 48 Operating income = 36 Maximum tax benefit on debt = 14.4 Tax benefit on debt = 30.00% !Max Tax Benefit/ Interest expense Levered beta = 2.05 New cost of equity = 13.2500% New cost of debt = 5.60% New cost of capital = 8.6600% Problem 2 Value of firm before buyback = 2400 Cost of capital before buyback = 10% Growth rate in perpetuity = 2% Approach 1: Value generated from buyback Number of shares bought back = 40 1. Change in firm value incorrect: -1 point Premium per share = $5 2. Firm value incorrect: -1 point Premium paid on buyback = $200 3. Did not factor in growth: -1/2 point 4. Used wrong cost of capital in discounting: -1/2 point Remaining shares = 60 Premium per share = 10 Premium to remaining shareholders 600 Total value added by buyback = $800 Value added by buyback = 800 = 2400 *(.10-X)/(X -.02) Solving for X Cost of capital after buyback = 8.00% Approach 2: Firm valuation Value before = 2400 = Cash flow next year / (.10-.02) Expected cash flow next year = 192 Value of equity after buyback = 1680 Value of debt after buyback = 1520 Total value after buyback = 3200
Sheet1 Page 16 Value after buyback = 3200 = 192/(X -.02) Solve for X Cost of capital after = 8.00% Problem 3 a. Duration of assets today Duration Weight Value Hotel business 20 60% 600 ! Value of business = Debt + Equity = 800 + 200 = 1000 Travel business 2 40% 400 1. Weights incorrect: -1/2 point Company assets 12.8 2. Math errors: -1/2 point b. Duration of debt today
You've reached the end of your free preview.
Want to read all 38 pages?