Capital Structure in a Perfect Market
MBA 509 Recommended Chapter Questions
These questions are the focus of what I am covering on the final exam. Understand the answers to these questions and should not be surprised by anything on the exam.
Chapter 14: Capital Structure in a Perfect Market 14-5. Suppose Alpha Industries and Omega Technologies have identical assets that generate identical cash flows. Alpha Industries is an all-equity firm, with 10 million shares outstanding that trade for a price of$22 per share. Omega Technologies has 20 million shares outstanding as well as debt of $60 million. 14-5-a. According to MM Proposition I, what is the stock price for Omega Technologies?
V(alpha) = 10 x 22 = 220m = V(omega) = D + E E = 220 – 60 = 160m p = $8 per share.
14-5-b.Suppose Omega Technologies stock currently trades for $11 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity? Omega is overpriced. Sell 20 Omega, Buy 10 alpha and borrow 60. Initial = 220 – 220 + 60 = 60. Assumes we can trade shares at current prices & Assumes we can borrow at same terms as Omega (or own Omega debt and can sell at same price). 14-6. Cisoft is a highly profitable technology firm that currently has $5 billion in cash. The firm has decided to use this cash to repurchase shares from investors, and it has already announced these plans to investors. Currently, Cisoft is an all equity firm with 5 billion shares outstanding. These shares currently trade for $12 per share. Cisoft has issued no other securities except for stock options to its employees. The current market value of these options is $8 billion. 14-6-a. What is the value of Cisoft’s non-cash assets? Assets = cash + non-cash, Liabilities = equity + options. non-cash assets = equity + options – cash = 12 × 5 + 8 – 5 = 63 billion 14-6-b.With perfect capital markets, what is the market value of Cisoft’s equity after share repurchase? What is the value per share?
Equity = 60 – 5 = 55. Repurchase
These questions are the focus of what I am covering on the final exam. Understand the answers to these questions and should not be surprised by anything on the exam.
Chapter 14: Capital Structure in a Perfect Market 14-5. Suppose Alpha Industries and Omega Technologies have identical assets that generate identical cash flows. Alpha Industries is an all-equity firm, with 10 million shares outstanding that trade for a price of$22 per share. Omega Technologies has 20 million shares outstanding as well as debt of $60 million. 14-5-a. According to MM Proposition I, what is the stock price for Omega Technologies?
V(alpha) = 10 x 22 = 220m = V(omega) = D + E E = 220 – 60 = 160m p = $8 per share.
14-5-b.Suppose Omega Technologies stock currently trades for $11 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity? Omega is overpriced. Sell 20 Omega, Buy 10 alpha and borrow 60. Initial = 220 – 220 + 60 = 60. Assumes we can trade shares at current prices & Assumes we can borrow at same terms as Omega (or own Omega debt and can sell at same price). 14-6. Cisoft is a highly profitable technology firm that currently has $5 billion in cash. The firm has decided to use this cash to repurchase shares from investors, and it has already announced these plans to investors. Currently, Cisoft is an all equity firm with 5 billion shares outstanding. These shares currently trade for $12 per share. Cisoft has issued no other securities except for stock options to its employees. The current market value of these options is $8 billion. 14-6-a. What is the value of Cisoft’s non-cash assets? Assets = cash + non-cash, Liabilities = equity + options. non-cash assets = equity + options – cash = 12 × 5 + 8 – 5 = 63 billion 14-6-b.With perfect capital markets, what is the market value of Cisoft’s equity after share repurchase? What is the value per share?
Equity = 60 – 5 = 55. Repurchase