Problem 1
Before restrucAfter restructuring
Market Value of Debt
$800.00
$400.00
Market Value of Equity
$200.00
$800.00
Interest Expense
$100.00
$30.00
Operating Income
$75.00
$100.00
Part a.
Current beta =
3.04
Cost of equity =
17.200%
Pre-tax cost of debt =
0.125
Effective tax rate =
0.3
After-tax cost of debt =
0.0875
Debt to Capital =
80.00%
Cost of capital =
10.44%
Part b
Unlevered beta =
0.80
New D/E ratio =
0.5
Levered beta =
1.04
Cost of equity =
7.2000%
Cost of debt =
0.075
After-tax cost of debt -
0.045
Debt to Capital =
33.333%
Cost of capital =
6.30%
Problem 2
EV before buyback =
2000
! All equity
Number of shares =
100
Cost of capital before =
12%
Cost of capital after =
10%
Change in value =
300
EV after buyback =
$2,300.00
Debt outstanding
$1,200.00
Value of equity
$1,100.00
Value per share
$25.00
Number of shares outstan
44
Shares bought back =
56
Buyback price=
$21.43
Problem 3
Acquiring firmTarget firm
Market value of Equity
$1,000
$500
Net Debt outstanding
$400
$100
Duration of assets
4
10
Duration of debt
2
15
Enterprise Value (Value o
$1,400
$600

Duration of assets after a
5.8
New Debt issued for acqu
500
Total Debt outstanding af
1000
Duration of new debt =
7

Grading Template
1. Did not adjust tax rate: - 1 point
2. Did not compute cost of equity correctly: -1/2 point
3. Did not compute pre-tax cost of debt: -1/2 point
1. Did not unlever beta: -1 point
2. Did not compute cost of equity correctly: -1/2 point
3. Did not compute after-tax cost of debt: -1/2 point
1. Did not compute change in firm value correctly: -1 point
2. Did not set up for computing buyback price: -1 point
3. Math errors: -1/2 point each

1. Did not compute duration of assets after merger: -1 point
2. Did not compute weighted duration of new debt: -1 point
3. Math errors: -1/2 point each

Problem 1
Old Equity
150
Current Cost of equity
7.40%
! Equal to cost of capital
Beta
0.9
! (Cost of equity - Risk free rate)/ ERP
New Debt =
50
New Equity =
100
! After special dividends
D/E ratio =
0.5
Debt/Capital ratio =
0.33333333
Note
New levered beta =
1.17
If you left equity unchanged
Cost of equity =
9.0200%
I do, but for all the wrong re
Let X be the new cost of debt
debt ratios you used in your
9.02% (1-.3333) + X (1-.4) (.3333) = 7.40%
Debt/Capital will 0.25, and t
X (Pre-tax cost of debt) =
6.9333%
! Your solution may match this, but you still
Problem 2
Equity
$
200.00
Debt
$
800.00
Firm Value
$
1,000.00
Cost of capital
currently
10%
Equity Issued in recap =
$
300.00
Cost of capital after =
9.00%
Increase in value =
$
111.11
Value of firm after recap =
$
1,111.11 ( You can arrive at the same answer
Debt outststanding after recap =
$
500.00 by dividing your increase in value by
Value of equity affer recap
$
611.11 total number of shares outstanding,
# Shares after recap
50
and adding to the prior price)
Value per share
$
12.22
Problem 3
Market cap =
1000
Debt
500
Value of firm =
1500
Duration of assets
10
Duration of current debt =
5
Value of target
1000
Duration of target firm assets
4
Duration of assets after merger
7.6
! (1500/2500)*10+(1000/2500)*4
New Debt =
1000
(500) *5 + (1000)* X = 7.6
! X is the duration of new debt
Duration of new debt
8.9

Grading template
1. Did not reduce equity for special dividend: -1 point
2. Did not back out beta from cost of equity: -1 point
3. Did not relever beta after recap: -1 point
4. Forgot to after-tax cost of debt: -1/2 point
5. Math errrors: -1/2 point each
d after the special dividend, you may get the same answer that
easons. So, please don't check the final answer but also the

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