Market value of equity 400 2 did not set up for new

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