40 q corp has a cost of capital of 15 20 marks total

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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.

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