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Fin Midterm Cheat Sheet

Managerial Finance II (Toronto Metropolitan University)

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Fin 401 Midterm Crib Sheet- SSD #2) 213856/ (1-.34) = 324024 so going back to original $32500, so its more expensive to lease with this one
. WACC . -Suppose your firm doesn’t pay tax for next 5 years, whats the NAL now
Weighted Average Cost of Capital WACC=We x Re + Wd x Rd x (1-tax) + Wp x Rp T=0 I= 8 x (1-0)=8% PMT=325000 x (1-0)=325000
V= D + E + P……Value of Firm= Debt Bound + Equity of common shares + Preferred Shares PVCCATS= 0, so you can just skip this question, so salvage value will change, same steps with different I%
-We= Weight of Equity= E/V -Re= Cost(return) of Equity You own a high-tech manufacturing entity. You would like to expand your operations but to do so you need to
-Wd= Weight of debt = D/V -Rd= Delayed Cost(return) of Debt (YTM) either lease or buy a $1.5 million piece of equipment for the next five years. The equipment would generate
-Wp= Weighted of Preferred shares = P/V -Rp= Cost(return) of Preferred Shares additional sales by $30,000 per year for five years. If you choose to lease, the lease payments would be $325,000 a
-Titan Mining Corporation has 9 million common shares outstanding, 0.5 million 7% preferred shares ($100 par year for the five years and the payments are due at the beginning of each year. Alternatively, you can choose to
value), and 120,000 8.5% semi-annual coupon bonds outstanding with a par value of $1,000 each. purchase this equipment, which belongs to a category with a CCA rate of 30%. The equipment would have a
-The common stock currently sells for $34 per share and has a beta of 1.2, the preferred stock currently sells for salvage value of $200,000 at the end of the fifth year. Your firm has a tax rate of 34%. arrange a bank loan at 8%.
$83 per share and the bonds have 15 years to maturity and sell for 93% of par. 10.What is the after-tax cost of debt for your firm? I%=5.28
-The market risk premium is 10%, T-Bills are yielding 5%, and Titan’s tax rate is 35%. 11.What is the present value of all future CCA tax shields, including the impact of the salvage on the CCA tax
-Find the firm’s hurdle rate for projects with the same risk as the firm itself. benefit? PVCCATS=378092.02
Step #1, Find the V 12.What is the present value of all after-tax lease payments? +970185.23
-E(common shares)=9000000 shares x $34 = 306 mil (+) -P (preferred shares) = 50000 shares x $83 = 41.5 mil (+) 13.What is the net advantage to leasing amount? NAL=-2909
-D (bonds)= 120000 bonds x 930 (93% of 1000= 0.93x1000)= 111.6 million (+) 14.Amount would the lease payment have to be for your firm to be indifferent between leasing and buying? 324025
Re is Cost Return of Equity = Risk free rate + Beta (expected return on market- Risk Free Rate) RM-Rf Premium 15.If the NAL of this project was negative, what should you do? You should buy
Re= Rf + B (Rm Rf) Re= 0.05 + 1.2 (0.01) = 17 NAL= COL-COB
Rp is Cost of Preferred Shares= Dividend of Preferred Share/ Current Preferred Share price #1) Initial Cost (-)= -1500000
Rp= 7/ 88= 0.0843 If Dividend is not given = Preferred rate x 100, so Dividend= 7%x100=7 #2) PV of CCA (+)= initial cost=1500000, CCA= 0.30, Tax= 0.34, Discount= 0.08x(1-.34)=.0528,
Rd- Pretax Cost of Dist (Yield To Maturity) Salvage=200000, N=5, therefore PVCCATS= 378092.03
N=15x 2(semi)=30, I=?, PV= -930 (93% of 1000), PMT= 0.085 x 1000/2= 42.50 (coupon), FV= 1000 (face),p=2 #3)PV of After Tax (begin Mode): N=5, I=5.28%, PV=?, PMT=0, FV=200000, P=1, C=1 therefore PV=15463244
Calc, I=9.3%, make it after tax right Away, AFTER TAX= PRETAX x (1-tax) COB= -1500000+378092.02+15463244=967265.54
=0.0938 x (1-0.35) =6.09%, which is 0.0609 COL= PV of After Tax Lease PMTs (-), in begin mode
CALC List 1 (weights): 306, 41.5, 111.6 List 2 (returns): 0.17(re), 0.0843 (Rp) , 0.0609 …Calc, 2Var, x= 0.1357 N=5, I=5.28, PV=?, PMT= 325000x(1-.34)=214500, FV=0, therefore PV= -970185.02, therefore don’t lease
Calculating the W ACC, In Problem 12, suppose the most recent dividend was $4.10 and the dividend NAL=COL-COB= -970185.02-(-967275.54)= -2909 then 213856/(1-.34)=324025
growth rate is 6 percent. Assume that the overall cost of debt is the weighted average of that implied by the two BREAKEVEN: COB=PV in this part
outstanding debt issues. Both bonds make semiannual payments. The tax rate is 35 percent. What is the N=5, I=5.28, FV=0, PMT=0, PV=-967275.54, therefore PMT=213856
company's WACC? Calculate Cost of Equity, another way using David Model D1= Next Years Dividen 16.What net advantage to leasing if firm, does not have to pay any taxes for at least the next five years?
-Re is Cost of Equity , use this when no BETA Po=Current Common Stock Price
Re= (D1/Po) + g g= Growth rate
D1= Do x (1+g) note: D1=Do x (1+g0 #1) After Tax Cost of Debt, if tax=0, then 0.08 is the discount rate (I%) NAL=COL-COB
D1= 4.10 x (1.06) =4.346 so Re= (4.346 + 0.06)/73= 119.5 -Just Period/ Most resent dividend COB, #1) Initial Cost=-1500000 #2) PVCCATS=0 NAL=-1401441-(-1363883)
Filer Manufacturing has 3 million shares of common stock outstanding. The current share price is $50, and the book #3) Pv of Salvage (+)= N=5, I=8, PV=?, PMT=0, FV=200000=+136117, NAL= 317557.86
value per share is $5. The firm recently paid a dividend of $4.00. The dividend is expected to grow at 5% per year COL, #1) PV of After Tax= N=5, I=8, PV?, PMT=325000x(1-0), FV=0, therefore COL=-1401441
indefinitely. Filer has 2 million preferred shares outstanding that pay an annual dividend of $2.00 per share, which are Capital structure: Unlevered: all equity firm (uses no debt) Levered: uses debt and equity
currently trading at $25.00 per share. Filer also has two bond issues outstanding. The first issue has a face value of Restructuring/ Recapitalization: adding debt to firm note: RU= WACC in an unlevered firm
$75 million, an 6% coupon, sells for 92% of par and matures in 10 years. The second issue has a face value of $60 Value of Unlevered Firm= (Earnings Before Interest Tax) x (1-tax)/ Cost (return) of equity (capital) of unlevered
million, a 7.5% coupon, sells for 95% of par and matures in 6 years. The corporate tax rate is 40%. What is the VU= EBIT x (1-T) / RU
WACC? E= 3000000 x 50 = 150000000 P= 2000000 x 25 = 5000000 UNLEV has an expected perpetual EBIT = $4,000. The unlevered cost of capital = 15% and there are 20,000
D1= (.92 x 75000000) = 69000000 D2= (.95 x 60000000) = 57000000 D1+D2= 126000000 shares of stock outstanding. The firm is considering issuing $8,800 in new par bonds to add financial leverage to
V= E+P+D= 326000000 the firm. The proceeds of the debt issue will be used to repurchase equity. The cost of debt = 10% and the tax rate
TTC Enterprises has 12,000 units of bonds outstanding that have a 6% coupon rate. The par value of each unit is = 34%. There are no flotation costs. (use for #124-130)
$1,000. The bonds are selling at 98% of face value, pay interest semi-annually, and mature in 28 years. In addition, 126. What is the value of UNLEV before the restructuring? Assume there are no taxes.
there are 1.40 million shares of common stock outstanding with a market price of $54 a share. The common shares -Expected Perpetual EBIT=4000 is EBIT -Unlevered Cost of Capital = 15% is RU
were sold at $60 per share when first issued. The stock just paid a dividend of $1.80 per share and expects to -Shares of Stock outstanding = 2000 is Shares -Consider issuing New Par Bonds= 8800 is Debt
increase those dividends by 4% annually. The firm's tax rate is 34%. -The Cost of Debt= 10% is Rd(cost of debt) -Tax rate = 34% is Tax
3.What is the after-tax cost of debt financing? 4.06% VU= EBIT x (1-T) / RU VU= 4000 x (1-t) / 0.15= 26667
4.What is the market value of the common stock? 756000000 127. What is the value of UNLEV before the restructuring?
5.What weight should be given to debt in the WACC computation? 13.46% VU= EBIT x (1-T) / RU Vu= 4000 x (1-0.34) / 0.15= 17600
6.What is the weighted average cost of capital of the firm? 7.01% 128. What is the value of UNLEV after the restructuring?
Value of Levered Firm= VU + Amount of Debt at Market Value x Tax
VL= VU + D x T VL= 17600 + 8800 x 0.34= 20592
Step #1, Find the V 129. What is the value of UNLEV's equity after the restructuring?
-E=1400000 x 54=756000000 (+) -P= ignore(+)-D= 12000 bonds x 980 (98% of 1000= 0.98x1000)=11760000 (+) VL = D + E +P (ignore P) 20592= 8800 + E, therefore E= 11792
Re is Cost Return of Equity = when no Beta use Dividend method D1= Next Years Dividen 130. What’s UNLEV's cost of equity after restructuring? Assume firm market value is $20,592 after restructuring.
Re= (D1/Po) + g Po=Current Common Stock Price Re= RU + (RU-Rd) (D/E)(1-T) Re= 0.15 + (0.15 – 0.10) (8800/1792) (1-0.34) therefore Re= 17.5%
D1= Do x (1+g) g= Growth rate David’s Question: What’s the WASS after Restructure?
D1= 1.80 x (1 +0.04) =1.872 so Re= ((1.872)/54) + 0.04= 0.0746 note: D1=Do x (1+g0 WACC= EBIT x (1-T) / VL WACC= 4000 x (1-0.34) / 20592 therefore WACC is 0.128 which is 12/82%
Rd- Pretax Cost of Dist (Yield To Maturity) David’s Question: What is WACC after restructure, assume tax is 0%
N=28 x 12= 56, I=?, PV= -980 (98% of 1000), PMT= 0.06 x 1000/ 2= 30 (coupon), FV= 1000 (face) P= 2, C=2 -if tax=0, WACC and firm value don’t change, so WACC= RU in unlevered firm
Calc, 6.15%, male it after tax right Away, so AFTER TAX= PRETAX x (1-tax) -since WACC doesn’t change if t=0%, the WACC after restructure is still 15%
CALCULATOR =0.0615 x (1-0.34) =64.059%, which is 0.0406
Ryerson Inc. is contemplating changing its capital structure. Currently the company has no debt. It is considering
List 1 (weights): 75600000, 11760000 List 2 (returns): 0.074666, 0.0406 so Calc, 2Var, x= 0.0706 which is 7.01%
issuing $50,000,000 of perpetual debt. If the company issued the debt, it would have an interest rate of 8%. The
To find weight in debt we do D/V= 11760000/ (75600000 + 11760000)= 0.1346 which is 13.46%
proceeds of the debt issue would be used to repurchase the company's stock. The corporate tax rate is 40%. The
. Leasing, Find Out What’s Cheaper . company's EBIT is $20,000,000, and will not be affected by the change in the capital structure. The company's
- reasons to lease: 1)taxes may be reduced, 2) transaction costs can be lower by leasing vs current required rate of return on the equity is 15%. There are 1,000,000 shares outstanding of the company's stock.
buying
-NOT a positive aspect of leasing: capital expenditure controls set by top management can
by circumvented Currently No Debt= Unlevered (all Equity)
-debt ratios increase when a firm enters a capital lease, but they are UNAFFECTED D=50000000 (amount of Debt), Rd= 0.08 cost of debt, Tax=0.40, EBIT=20000000, 1000000 outstanding shares
when a firm operating lease Return On Equity (Ru)=0.15 is unlevered cost/return of capital
-a capital lease is 1) lease term is for 75% or MORE of the life of asset; 2) lessee can buy 29.What will be the firm value after the capital restructuring? VL=VU + D + T, where Vu=value of unlevered firm
asset at BELOW market price (bargain price); 3) PV of lease payments is MORE than Vu= [EBITx(1-t)]/Ru [20000000 x (1-.40)]/.15 = 80000000 VL=80000000+50000000 x .4= 100000000
90% of fair market value at the start of the lease 30.What will be the required rate of return by shareholders after the capital restructuring?
NAL= COL= COB Net Advantage of Leasing= Cost of Leasing= Cost of Buying Re= Ru + (Ru – Rd) (D/E) (1-t), but we are missing E, so V=D+E so 100000000=50000000+E, so E=50000000
-if NAL is (+) then Lease, but if NAL is (-), then its better to buy Re= 0.15 +(0.15 – 0.08) ( 50mill/50mill) (1-.40) so Re=19.2
NAL Lessor = COB-COL 31.What will be the firm's overall cost of capital after the capital restructuring?
-ignore cash flow benefits in leasing ( increase revenues or decrease in Operating Cost) WACC= [EBIT x (1-t)]/VL, so [20000000 x (1-.4)]/100000000= 12%
-discount rate (I%) in leasing is the after tax cost of debt (borrowing) in general After Tax= PreTax x (1-Tax) 32.What will be the price per share after the capital restructuring?
Cost of Buying COL, Cost of Leasing
#1) Initial Cost (-) #1) PV of After Tax Lease PMTS (-)= COL
#2) PV of CCA (Dep) Tax Shield (+) =VL/Current # of shares, so 100000000/100000, which is 100
#3) PV of Salvage (+) add all to get COB M &M Proposition #1, Without tax
Leasing Question: You own a high-tech manufacturing entity. You would like to expand your operations but to do -if firm adds debt, WACC and firm value don’t change, therefore capital structure is irrelevant
so you need to either lease or buy a $1.5 million piece of equipment for the next five years. The equipment would M & M Proposition #1, With Tax
generate additional sales by $30,000 per year for five years. If you choose to lease, the lease payments would be -if you add, firm value increases and WACC decreases, therefore firm should be 100% debt
$325,000 a year for the five years and the payments are due at the beginning of each year. Alternatively, you can --Proof: VU was 17600, VL=20592, therefore value increase, WACC was 15% (Ru=WACC) then to 12.8%
choose to purchase this equipment, which belongs to an asset class with a CCA rate of 30%. The equipment would M & M Proposition #2, With or Without Tax
have a salvage value of $200,000 at the end of the fifth year. firm has a tax rate of 34%.arrange a bank loan at 8%. -if you add debt, the cost (return) of equity increases, Proof: Ru was 15%, then increased to 17.56%
#1) Find I% (after tax cost of borrowing)=Initial Cost = -1500000, N= 5 years 124. Assume a stockholder owns 1,000 shares of UNLEV before the restructuring. The stockholder prefers a
30000, we ignore it’s a cash flow benefit AFTER Tax Debt= 0.08 x (1-0.34) debt/equity ratio = 1.0. How could the stockholder use homemade leverage to achieve the restructuring without the
Lease PMT= 325000 (Beg mode), I%= 0.0528, CCA= 0.3,Salvage=200000, Tax= 0.34, Cost of Debt= 0.08 help of UNLEV? Assume there are no taxes.
COB #1) Initial Cost (-)= -1500000 #1) Determine Desired Debt Equity Ratio
#2) PVCCATS (+)= Initial Cost=1500000, CCA= 0.30, Tax= 0.34, Discount= 0.0528, Salvage= 200000, N= 5 #2) Multiply Debt Equity by $amount to equity, investor owns to see how much to borrow use borrowing to buy
PVCCATS= 378092.0204 Discount=Aftertax=pretax(1-tax) #1) find share price, so Share Price= Equity/ # of Shares Therefore investor owns $1330 (1.33 x shares)
#3) PV of Salvage (+) =N=5, I=5.28, PV=?, PMT=0, FV=200000, so PV= +154632.44 therefore COB= -967276 SP= 26667/20000 shares= $1.33
COL #1) PV of After Tax Lease PMTs (-) #2) (D/E) x (Amount of Equity) which is 1x1330=1330 borrow Therefore buy 1330/1.33=1000 more shares
N= 5, I%=5.28, PV=?, PMT= 325000 x (1-0.34) = 214500, FV=0, Change: (begin mode) COL= 970185.2288 125. Assume a stockholder owns 1,000 shares of UNLEV before the restructuring.assume UNLEV's
Theres No advantage to Leasing the #, must be negative, buying is cheaper debt /equity ratio will be 0.493 after restructuring. How could stockholder use homemade leverage to unlever her
NAL Lesser= COL-COB =-970185- (-967276) = -2909 don’t lease, since NAL is (-) investment in the firm after the restructuring? Assume there are no taxes.
BREAKEVEN LEASING #1) Determine D/V (like what is % of firm debt) Therefore D/V= 0.493/ 1.493= 0.33 which is 33%
Old Exam Question #1) After Tax Cost of Debt #2) % of Future CCA Tax D/E= 0.493/1 (useless because E=1 always) -so firm is 33% debt, but you don’t want debt
#3) PV of After Tax Lease Payment= -970185.288 #4) What is NAL= -2909 V=D + E +P (ignore P) which is V= 0.493 + 1= 1.493
Indifferent AKA, Breakeven AKA May Lease PMTS -therefore, sell 33% of equity and lend out the procees, do opposire of what the firm did (borrow to become 33%
#1) PV= COB, N=, I=, FV=,PMT= solve if lease PMT are at Beginning of year, then change to Begin Mode -sell 330 shares (.33 x 1000 shares) , at price of $1.33, so lend out $1439 (1.33 x 330 shares)
#2) David PMT by (1- tax) to make it Pretax Capital Structure: Break Even / Indifferent/ Min Level of EBIT
#1) PV= -967276 N= 5 I%=5.28 FV=0 PMT= Solve, so PMT= 213856 Current Structure Proposed Structure

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(EBIT-Interest expense)(1-tax) = (EBIT-Interest Expense)(1-tax) new machine is expected to reduce operating expenses by $50,000 per year. The firm’s tax rate is 40% and its cost
Original # of shares New # of Shares of capital is 15%. Both machines belong to class 10 with a CCA rate of 30%. Should the firm replace its older
-interest expense= D x Coupon (interest) rate where D= amount of debt machine? Initial cost=-25000, N=8, Salvage new=85000, old machine worth=50000, old salvage=15000, cash
-New # of Shares= Original # of Shares x (1-(D/P)) flow=50000, Tax=0.40, I=0.15, CCA=0.30
101. An unlevered firm with a market value of $1 million has 50,000 shares outstanding. firm restructures itself by #1) Initial Cost (-)= -350000 + 50000= -300000 -300000=new salvage-old salvage
issuing 200 new par bonds with face value $1,000 and an 8% coupon. firm use proceeds to repurchase outstanding #2) Pv of After Tax Cash Flow(+):N=8, I=15, PV=?, FV=0, P=1,C=1, PMT=50000x(1-.04) Calc: PV= +134620
stock. considering the newly levered versus formerly unlevered firm, what is the breakeven EBIT? Ignore taxes. #3) PVCCATS(+): Initial=+300000, CCA=0.3-, Tax=0.40, Discount=0.15, Salvage=(85000-15000=70000), N=4
Current Structure Proposed Structure (200000=200x1000) =68680.44
(EBIT-Interest expense)(1-tax) = (EBIT-Interest Expence)(1-tax) (40000=50000 x (1-200000) #4) PV of Salvage (+): N=8, I=15, PV=?, PMT=0, FV=(85000-15000=70000), Calco=22883.12
Original # of shares New # of Shares ( 1000000) NPV= -300000 + 134620 + 68680 + 22883= -73817, therefore don’t replace machine
(EBIT-0)-(1-0) = (EBIT-2000000 x 0.08)(1-0) BID PROBLEM: We have been requested by a large retailer to submit a bid for a new point-of-sale credit checking
50000 shares 40000 shares system. The system would be installed, by us, in 20 stores per year over the next 3 years. We would need to
Type into EQUA, therefore EBIT = 80000, left and right is 1.6 which is the Break Even Earnings Per Share purchase $250,000 worth of specialized equipment. The CCA rate is 25%. We will sell the equipment is three
Use table for #119-123 years fro approximately $125,000. Labor and material costs to install the system is about $35,000 per site. Finally,
Current Cap Proposed Cap There are no taxes. EBIT is expected to be $2.5 we need $60,000 in working capital tems. The relevant tax rate is 44%. What price per system should we bid if we
Assets $15 mil $15 mill million, but could be as high as $3.5 million if an require a 16% return on our investment?
Debt $0 $6 mill economic expansion occurs, or as low as $2 million -in a BIP problem NPV is always “0”, to see what is the lowest price we can change but make a profit
Equity $15 mill $9 Mill if a recession occurs. All values are market values. Template
Share Price $2500 $22.5 N= PV= Initial Cost (-) + PVCCATS(+) + NWC as given(-) and we solve for PMT
Share Price= Equity/ # of shares
Shares $600000 ( )?
22.50 = 9000000/#0f shares I= FV= Salvage(+) + NWC as Given (+)
Bound Coup N/A 85
using solver # of shares= 4000000 N=3, I=16
120. What is EPS under the current capital structure if there is a recession? PV= Initial Cost (-)= 250000
EPS= (EBIT- Interest expense)(1-tax) EPS= (2000000-0)(1-0) = $3.33 PVCCATS:= Initial cost= 250000, CCA= 0.25, Tax=0.44, Discount=0.16, Salvage=125000, N=3, =40961.96
# of shares 600000 shares PV=-250000 + 40961.92 – 60000= 269038
121. What is EPS during an expansion for the proposed capital structure? PMT= solvw
EPS= (EBIT- Interest expense)(1-tax) EPS= (3500000-6000000 x 0.08)(1-0) = $7.55 FV= 125000 + 60000 = 185000, therefore PMT= 67018, after tax cash flow
# of shares 400000 shares -AFTER TAX CASH FLOW= (price x (# of units) – FC –VC x # of Units) (1-tax)
(price x 20 stores – 0-35000 x 20 stors) (1-.44)= 67019, use solver, Price=40983.83
122. What is ROE for the proposed capital structure if the expected state occurs?
ROE= (EBIT- Interest expense)(1-tax) ROE= (2500000-6000000 x 0.08)(1-0) = 22.4% Unequal lives A firm must choose between two projects. The machines in each project belong to asset class 8
Equity 900000 shares (CCA rate = 20%). Each machine is designed differently but has identical capacity and does exactly the same job.
Machine A cost $15,000 and will last 8 years. Machine B costs $10,000 and will last 6 years. Neither machine has
123. What is the breakeven EPS for these two capital structures?
any salvage value at the end of the its economic life. The before tax operating cash flows for projects A and B are
Current Structure Proposed Structure Current Structure Proposed Structure
$6,500 and $5,750 respectively. The cost of capital is 10% and the tax rate is 40%. Which machine should the
(EBIT-Interest expense)(1-tax) =(EBIT-Interest Expense)(1-tax)…(EBIT-0)(1-0) = (EBIT-6000000 x 0.08)(1-0)
firm choose?
Original # of shares New # of Shares 600000 400000 shares
#1) Find NPV using template #2) PV=NPV from step #1, solve PMT
Use solver, EBIT=1440000, so Left and Right =2.4 for Break Even
MACHINE A#1) #1) Initial Cost (-)= (-15000)
Rogers Inc. is debating whether to keep its current capital structure or to convert to a proposed one. Information
#2) PV of After Tax (+)= N=8, I=10, PV=?, PMT= 6500x(1-.40), FV=0, therefore PV= +20806
about these two capital structures are following.
#3) PVCCATS (+)= Initial cost=15000, CCA=0.2, Tax= 0.4, Discount=0.10, Salvage=0, N=8, so it is +20806
Current Proposed There are no taxes. EBIT is expected to be $2.5 million, but NPV= -15000 +20806 +3818= 9624
Assets $25 mill $25 mill could be as high as $3.5 million if an economic expansion
Debt $0 $5 mill #2) N=8, I=10, PV=-9624 (always enter Pv as a -#), PMT=?, FV=0, so PMT=1803
occurs, or as low as $2 million if a recession occurs. All values Do the same for Machine 2, pick the one with high PMT
Equity $25 mill $20 mill are market values
Share Price $50.00 $50.00 Pecking Firm uses own cash 1sy, then they go to debt, then last resort is equity
Shares ?? ??? -Alternative to the Static Tradeoff Theory
Bond Coupon N/A 8% -The key is the timing of new equity and debt issues and asymmetric information between issuers and investors.
1)How many shares are outstanding under the current and proposed capital structure? -Firm’s have an incentive to issue new securities (debt or equity) when the manager’s think they are overvalued.
2)If you own 100 shares of the firm, what will be your total earnings under the current capital structure if there is a -Investors, knowing that the firm’s manages have better information about the firm’s prospects, actually believe
recession? Coupon=I that new securities are only issued when they are overvalued and thus are willing to pay less than they might
3)If you own 100 shares of the firm, what will be your ROE during an expansion for the proposed capital structure? otherwise be worth.
4)Suppose the firm does convert, but you prefer the current all-equity capital structure, how could you undo the Pecking Order:firms prefer using $ in this order: 1) internal funds (retained earnings); 2)
leverage to create the current capital structure? Assume you start with 100 shares of the firm. debt; then 3) selling (issuing) equity (common shares)  pecking order implies firms
5)Suppose the firm maintains the current capital structure, but you prefer the proposed capital structure, what could don’t have optimal capital structure (i.e., no optimal D/E ratio)
you do to create the proposed capital structure? Assume you start with 100 shares of the firm. -What’s a manager to do? Rules:
#1) Equity, E= Share Price x # of shares 1) Use internal financing.
-in Current E= 25000000=50 x # of shares, and #of shares = 500000 2) Issue the safest (i.e. debt) securities first.
-Proposed E= 200000000= 5 x # of shares which is 400000 we get 5=25/50 Although investors fear mispricing of both debt and equity , the fear is much greater for equity. So, only issue
#2)Your Earnings = # of Shares you own x Warnings Per Share equity as a last resort.
EPS= (EBIT- Interest expense)(1-tax) EPS= (2000000-0)(1-0) = $4, you own 100 shares x 4=400 Implications:
# of shares 500000 shares -no debt =no intrest 1) There is no target D/E ratio – based on financing needs
#3) ROE= (EBIT- Interest expense)(1-tax) ROE= (3500000-5000000 x 0.08)(1-0) =15.5% 2) Profitable firms use less debt – generate cash internally.
Equity 2000000 shares 3) Companies like financial slack – save the cash ahead of time.
#4) Invester Prefers All equity (unlevered) firm THEORY1.The appropriate cost of capital for a project depends on the risk associated with the project
#1) Find D/V (what % of firm is debt)= 5000000/25000000 is assets= value=20% 2.which of following cases would it most likely be appropriate to use the WACC that relates to existing operations?
so 20% debt, but you don’t like debt, so you sell 20% of shares and lend out procedes, so 20% x 100shares=20 A manufacturer of garbage bags is considering expanding production capacity to meet increasing demand
shares at $50, you lend out $1000 (20x50) 3.Which of the following are considered examples of leasing to reduce uncertainty?
#5) Investor Prefers Debt (levered) firm I. Leasing a piece of equipment due to concerns over the residual value
#1) Determine Desired D/E ratio, D/E= 5000000/20000000=0.25 III. Leasing a computer due to obsolescence concerns
#2 Multiply D/E by the $amount of equity owned to see hw much to borrow use borrowings to buy more 4.In a world without taxes, M&M Proposition I contends that:
-$Amount of Equity=100 shares x $50=5000 so 0.25x5000=1250 borrow B)The total value of the firm remains constant regardless of the debt-equity mixture applied.
M&M . Merix Corp. is considering issuing $500 million of additional debt and using the proceed to buy 5.Business arises from decisions that affect the left-hand side of the balance sheet, while FINANCIAL RISKarises
back some outstanding shares. from decisions that affect the right-hand side of the balance sheet.
-Merix shares are currently trading at $45 per share and there are 30 million shares outstanding. 6.Which of the following statements is/are true regarding corporate borrowing when EBIT is positive?
-Merix also has $850 million of debt outstanding which is trading at par at a yield of 9.5%. I.Increasing financial leverage increases the sensitivity of EPS and ROE to changes in EBIT
-Analysts are forecasting that Merix shares will pay a dividend of $1.20 in one year and that the dividend will grow 7.Of the following, all are conclusions that can be drawn from the capital structure puzzle EXCEPT:
at 10% per year for the foreseeable future. B)In the framework of the static theory of capital structure, a firm can precisely identify its optimal capital
-Merix has a corp. tax rate of 46% structure.
-What is the WACC assuming Merix’s current capital structure? 8.Which of the following are indirect costs of bankruptcy?
-Find the value of the the equivalent unlevered firm and the required return on unlevered’s assets. Loss of key employees, Foregone profitable projects due to debt restrictions
-Find the value of Merix if it undertakes the restructuring. Find the new value of the equity. Loss created by sale of assets which was required to improve liquidity
-What is the new value of the shares and how many shares could be repurchased?
-Find the WACC of Merix under the new capital structure.
#1:V= D + E + P(ignore) . CCA WITH HALF YEAR RULE
E (common shares): 30000000 shares x 45= 1350000000 .
D(bounds): 850000000, this is trading as par/ book/face value, market rate = book value The Whilst Co. is analyzing a project that has projected sales of $230,000 per year and costs of $110,000 per year.
V= 1350000000 + 850000000= 2200000000 The project requires an initial up front investment in inventory of $15,000 plus another $28,000 in accounts
#2Find the value of the equivalent unlevered firm and the required return on unlevered assets, find the cost return receivable. Fixed assets of $120,000 are needed and belong in a 30% CCA class. Assume that the asset class will
Rd =pretax cost of debt (YTM)=9.5%,Make after tax, After Tax= Pretax x (1-t)= 0.095 x (1-0.46)= 0.0513 remain open. Accounts payable will increase by $36,000. An interest expense of $11,000 will be incurred annually.
Re= Cost of Equity = (D1/Po)+g where D1=nest years dividend, Po= Current share price, g=growth rate The project has a life of 4 years. At the end of the four years, the equipment has an estimated market value of
Re= (1.20/45) + 0.10= 0.1267 $40,000. The company has a cost of capital of 14% and is in the 40% marginal tax bracket. Assume that net
List 1 (value weights): 1350000000 (E), 850000000 (D) List 2 (return): 0.1267 (Re), 0.0513 (Rd)(1-t) working capital will be recovered at the end of the project and that the half-year rule is in effect.
Calc, 2-var, X= WACC= 0.097568, which is 9.75% 1) what is the present value of the after-tax operating cash flow ignoring the impact of depreciation? 209787
To find weight of equity, E/V= 1350000000/ 2200000000= 2) What is the PV value of the CCA Tax Shield, Use the PVCATS On calc, ignore half year rule
. Capital Budgeting . 3) What is the total amount of CCA in the frist 2 years?
#1) Initial Cost of Fixed (already at PV) Assets (-) #2) PV of After Tax Cash Flow (+) Beg UCC CCA Ending UCC
#3) PV of CCA (Dep) Tax Shield (+) #4) PV of Salvage (+) 1 120000 (120000x.3)/2= 18000 120000-18000=102000
#5) NWC Investment (-) #6) PV of NWC Recovery, add all up and get NPV, selling on credit 2 102000 102000x.3=30600 102000-30600=71400
Question: Your firm is considering buying a new machine for $120,000. It has a useful life of 4 years and an So to get the CCA for first 2 years we do: 18000+30600=$48600
estimated salvage value of $40,000. The machine falls in asset class 8 with a CCA rate of 20%. The asset class will 4) What is the present value of the net investment in net working capital including recapture?
always remain open. Incremental revenues are expected to be $80,000 per year and incremental expenses are NWC=CA-CL Cash outflow=CA increase, while Cash inflow when CL increase
expected to be $30,000. The firm’s tax rate is 40% and the cost of capital is 10%.What is the NPV of this project? 1|(-15000)+(-28000)+36000=7000 SO use TMV, Cash Flow with I=10, and NPV=-2855
#1) Initial Cost (-)= -120000 the 50000 is after tax value 2|0 3|0 4|(15000)+(28000)+(-36000)=-7000
#2) Pv of After Tax Cash Flow(+):N=4, I=10, PV=?, FV=0, P=1,C=1, PMT=50000x(1-.04).Calc:PV= 95095.96 How Dividens are Paid
#3) PVCCATS(+): Initial=+20000, CCA=0.2-, Tax=0.40, Discount=0.10, Salvage=4000, N=4 =23259.977 1) Declaration Date: Board declares the dividend
#4) PV of Salvage (+): N=4, I=10, PV=?, PMT=0, FV=40000, Calco=27321 2)Ex-dividend Date: Occurs two business days before date of record,If you buy stock on or after this date, you will
NPV= -120000 + 95096 + 23260 + 27321 =25677 not receive the dividend
REPLACE A firm is considering the purchase of a new machine, priced at $350,000 to replace an older machine. 3)Date of Record: Holders of record are determined and they will receive the dividend payment
The economic life of the machine is 8 years at which time the estimated salvage value is $85,000. The present 4)Date of Payment : Cheques are mailed
market value of the older machine is $50,000 and is expected to have a salvage value of $15,000 in 8 years. The Additional Factors Affecting Dividend Policy

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1)Dividend Signalling
-Asymmetric information: managers have more information about the health of the company than investors
-Changes in dividends convey information
-dividend increase is a signal of a healthy, growing firm , and decrease is a signal of financial distress
2)Clientele Effect
-Some investors prefer low dividend payouts and will buy stock in companies that offer low dividend payouts
-Some investors prefer high dividend payouts and will buy stock in those companies that offer high dividend
payouts
-Investors will self-select into the stocks have their preferred payout policy
-Managers should focus on capital budgeting decisions and ignore investor preferences
-IPO : Initial Public Offering, A company’s first equity issue made available to the public.
-SEO :Seasoned Equity Offering. A new issue for a company that has previously issued securities to the public.

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