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INDIAN INSTITUTE OF MANAGEMENT LUCKNOW
PGP TERM IV (JULY 2009) MID TERM EXAMINATION
CORPORATE VALUATION AND RESTRUCTURING
Time Allowed: 2 hours MM: 25 Marks
Instructions
1. Answer all the five questions.
2. Ideally I would prefer if the questions are answered in the same sequence as they appear in the question paper. In any case attempt all parts of a question at one place.
3. Make assumptions that you find absolutely necessary and state them clearly. Unreasonable assumptions will be penalized.
4. Make sure you don't waste time on questions that you are not confident of tackling. Manage your time!
5. Brevity of expression is an asset. Capitalize it!
6. No queries will be entertained during the exam.
Question 1:
Ambani Ltd is considering the question of whether it has any excess debt capacity. The firm has Rs. 660 million in market value of debt outstanding and 1.74 billion in market value of equity. The firm has Earnings Before Interest and Tax of Rs. 131 million and faces a current corporate tax rate of 40%. The company’s bonds are rated BBB and the cost of debt is 8%. At this rating the firm has a probability of default of 2.7% and the cost of bankruptcy is expected to be 35% of the firm value.
a. Estimate the unlevered value of the firm from the current market value of the firm.
b. Estimate the levered value of the firm using the adjusted present value approach at a debt ratio of 50%. At that ratio the firms bond ratings will be CCC and the probability of default will increase to 36.78% of unlevered firm. The cost of bankruptcy will remain the same. (2 + 3 = 5 Marks)
Question 2:
Assume that you are in U.S and you are reviewing the cost of equity computation that an analyst has made for Luo Tang, a Vientamese company. The analyst has estimated a cost of equity of 18% for the company in Vienamese Dong (VND). In making this estimate, the analyst used the following information:
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PGP TERM IV (JULY 2009) MID TERM EXAMINATION
CORPORATE VALUATION AND RESTRUCTURING
Time Allowed: 2 hours MM: 25 Marks
Instructions
1. Answer all the five questions.
2. Ideally I would prefer if the questions are answered in the same sequence as they appear in the question paper. In any case attempt all parts of a question at one place.
3. Make assumptions that you find absolutely necessary and state them clearly. Unreasonable assumptions will be penalized.
4. Make sure you don't waste time on questions that you are not confident of tackling. Manage your time!
5. Brevity of expression is an asset. Capitalize it!
6. No queries will be entertained during the exam.
Question 1:
Ambani Ltd is considering the question of whether it has any excess debt capacity. The firm has Rs. 660 million in market value of debt outstanding and 1.74 billion in market value of equity. The firm has Earnings Before Interest and Tax of Rs. 131 million and faces a current corporate tax rate of 40%. The company’s bonds are rated BBB and the cost of debt is 8%. At this rating the firm has a probability of default of 2.7% and the cost of bankruptcy is expected to be 35% of the firm value.
a. Estimate the unlevered value of the firm from the current market value of the firm.
b. Estimate the levered value of the firm using the adjusted present value approach at a debt ratio of 50%. At that ratio the firms bond ratings will be CCC and the probability of default will increase to 36.78% of unlevered firm. The cost of bankruptcy will remain the same. (2 + 3 = 5 Marks)
Question 2:
Assume that you are in U.S and you are reviewing the cost of equity computation that an analyst has made for Luo Tang, a Vientamese company. The analyst has estimated a cost of equity of 18% for the company in Vienamese Dong (VND). In making this estimate, the analyst used the following information:
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