40%. Q Corp. has a cost of capital of 15%.
(20 marks total)
a.
What is Q’s firm value?
(2 marks)
b.
What is R’s firm value?
(2 marks)
c.
What is R’s equity value?
(1 mark)
d.
What is Q’s cost of equity capital?
(1 mark)
e.
What is R’s cost of equity capital?
(2 marks)

f.
What is Q’s WACC?
(1 mark)
g.
What is R’s WACC?
(3 marks)
h.
Compare the WACC of the two companies. What do you
conclude?
(1 mark)
i.
What principle have you proven in this case?
(1 mark)
j.
Both companies are now evaluating a project that
requires an initial investment of $1.15 million and that will
yield cash inflows of $500,000 per year for the next three
years. Assume that this project has the same risk level as the
individual firm’s assets. Should Q invest in this project?

Should R invest in this project?
(5 marks)
k.
Based on your results for part (j), discuss the effects of
leverage and its tax shields effects on the future value of the
two firms.
(1 mark)
8.
Mr. Toriop owns 5,000 shares of stock in Yummy
Corporation. The company has announced that it will pay a
dividend of $5 per share in one year and a liquidating
dividend of $50 per share in two years. The required return
on ABC stock is 12%.
(21 marks total)
a.
What is the current share price of your stock?
(1 mark)
b.
What will be the company’s share price in one year’s
time?

(1 mark)
c.
Mr. Toriop wishes to have equal amounts of dividend
income for the next two years. How can he use homemade
leverage on Yummy Corporation’s dividends to achieve this
goal? Check that the present value of the cash flows will be
the same as it is before the homemade leverage. (Hint:
Dividends will be in the form of an annuity.)
(8 marks)
d.
Suppose Mr. Toriop is thinking about buying a house for
$220,000 in one year. How can he use homemade leverage on
Yummy Corporation’s dividends to purchase the house at this
price? Check that the present value of the cash flows will be
the same as it is before the homemade leverage.
(5 marks)
e.