Homework answers / question archive / Quccos College BUS 341 W: Intermediate Finance Instructor, Iuc Merest Full 2020 MIDTERM 1 PROBLEM Problem A carmaker is expecting to create a new cat that will be sold for 12 years

Quccos College BUS 341 W: Intermediate Finance Instructor, Iuc Merest Full 2020 MIDTERM 1 PROBLEM Problem A carmaker is expecting to create a new cat that will be sold for 12 years

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Quccos College

BUS 341 W: Intermediate Finance

Instructor, Iuc Merest

Full 2020

MIDTERM 1

PROBLEM

Problem

A carmaker is expecting to create a new cat that will be sold for 12 years. There are 3 possible different cars, with different investment and different time of production:

	Investment	FCFF
	t-0	t-1	2	3	4	5	6
Speedy A	-70	45	45
Family B	-120	30	30	30	30	30	30
Truck C	-50	36	31

 

Comparing A and B:

a/ Which project, A or B, provides n better NPV?

Cost of capital — 8%

Risk free rate — 3% (As mentioned in class you do not have to use the risk-free rate)

h/ What is the equivalent annual annuity for each project?

Comparing A and C:

c/Draw the NPV profile with A and C.

d/ If the cost of capital is 8% which project is better? No calculation but show on the graph.

Question: 

Looking at the problem above, you selected the projects depending on your calculation what issue may change your mind without any changes in the calculation? Explain why you will do the opposite selection?

Problem:

The firm LGM has 20% debt, 80% equity and no preferred stocks.

The cost of debt is 5%

Taxes = 40%

The firm had this capital structure for the last 4 years.

Based on 4 years of monthly data, you derive the following information for the firm LGM:

The following arc the historic returns for the LGM Company:

Year	LGM	SP500
1	14%	13
2	11	12
3	3	6
4	-2	1

 

a/ Compute the beta coefficient for the stock LGM.

b/ Assuming a risk-free rate of 3% and an expected return for the market portfolio of 8%,

Compute the expected required return for all the stocks and plot them on the SML.

c/ In terms of capital structure theory, we have taxes and bankruptcy cost.

The firm decides to increase its level of debt to 40% with still no preferred stocks.

What is the new WACC if the cost of debt is increasing to 6%?

Question: 

The firm above is increasing its debt level.

Is it a good sign or a bad sign? Explain

What should the firm do in terms of the capital structure if it a high-tech firm with a great prospects?

PROBLEM 3

Problem:

A Firm raised money through equity only.

The expectations for EBIT are:

22% chance that EBIT will be $32 million next year.

58% chance that EBIT will be $17 million next year

20% chance that EBIT will be $10 million next year.

It has 6 million shares. The price of the stock is $25.

The firm will not grow

All earnings are paid in dividend.

a/ What is the expected EBIT?

b/ What is the wacc unlevered?

c/ What is the market value of the firm?

d/ The firm decides to issue $75 million debt to repurchase stocks. What is the number of shares that the firm will buy?

e/ Then what is the new debt/equity ratio?

f/ Assume that the interest on the debt is 7%. What is the new cost of equity?

g/ Show on the graph of cost of capital with risk.

h/ What is the new EPS? We assume that the cash flow did not change when financing changed.

i/ What is the new price of the stock?

Question:

This firm is in a mature industry. Why do you think that they want to increase the level of debt?