f39a99a2c53a7bd16fdaa93ab31faf09 8c168b
1. ABC Corp. is considering expansion of its production capacity by investing in a project with the following unlevered cash flows (UCF):
Year 0: -$20 million
Year 1: +$5 million
Year 2: +$8 million
Year 3 and all future years: +$10 million
ABC Corp. will finance this expansion both with internal cash and by selling $10 million in bonds. The bonds pay interest of 10%. The expected return on ABC’s stock is 20% and firm is expected to maintain a debt-equity ratio of 1 for the foreseeable future. The corporate income tax rate is 20%. Ignoring the costs of financial distress and issue costs; calculate the net present value of this project using the Flow-To-Equity (FTE) approach. 2. Thani Mint Company has a debt to equity ratio of 0.30. The required return on the company’s unlevered equity is 15 percent, and the pretax cost of the firm’s debt is 9 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $23,500,000. Variable costs amount to 60 percent of sales. The tax rate is 40 percent and the company distributes all its earnings as dividends at the end of each year. (a) If the company were financed entirely by equity, how much would it be worth?
(b) Use the WACC method to calculate the value of the company under the current capital structure. 3. Green Devil Corporation stock, of which you own 100 shares, will pay a $2 per share dividend one year from today. Two years from now Green Devil will close its doors and stockholders will receive a liquidating dividend of $11 per share. The required rate of return on Green Devil stock is 10 percent. (a) What is the current price of Green Devil stock?
(b) If you prefer to receive $5 per share dividend (total $500 cash) one year from today, how can you receive the desired amount of cash flow? Explain your strategy.
(c) If you prefer to receive equal amounts of money in each of the next two years, how can you accomplish this? Explain your strategy.
4.
Year 0: -$20 million
Year 1: +$5 million
Year 2: +$8 million
Year 3 and all future years: +$10 million
ABC Corp. will finance this expansion both with internal cash and by selling $10 million in bonds. The bonds pay interest of 10%. The expected return on ABC’s stock is 20% and firm is expected to maintain a debt-equity ratio of 1 for the foreseeable future. The corporate income tax rate is 20%. Ignoring the costs of financial distress and issue costs; calculate the net present value of this project using the Flow-To-Equity (FTE) approach. 2. Thani Mint Company has a debt to equity ratio of 0.30. The required return on the company’s unlevered equity is 15 percent, and the pretax cost of the firm’s debt is 9 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $23,500,000. Variable costs amount to 60 percent of sales. The tax rate is 40 percent and the company distributes all its earnings as dividends at the end of each year. (a) If the company were financed entirely by equity, how much would it be worth?
(b) Use the WACC method to calculate the value of the company under the current capital structure. 3. Green Devil Corporation stock, of which you own 100 shares, will pay a $2 per share dividend one year from today. Two years from now Green Devil will close its doors and stockholders will receive a liquidating dividend of $11 per share. The required rate of return on Green Devil stock is 10 percent. (a) What is the current price of Green Devil stock?
(b) If you prefer to receive $5 per share dividend (total $500 cash) one year from today, how can you receive the desired amount of cash flow? Explain your strategy.
(c) If you prefer to receive equal amounts of money in each of the next two years, how can you accomplish this? Explain your strategy.
4.