Question 1 (25%),First Inc. currently has 25,000 shares outstanding, selling at $80 per share. Its 8% perpetual debts have a par value of $800,000 and are trading at 125. The EBIT is expected to be $540,000 forever. The company is considering a new issue of perpetual debts of $1,000,000 to buy back its stocks. The new debts will have the same yield as the existing debts. The tax rate is of 30%.,a. What is the debt equity ratio before the new debt issue?,b. What is the cost of equity before the new debt issue if First is all equity financed?,c. What is the WACC before the new debt issue?,d. What is the debt equity ratio after the new debt issue?,e. What is stock price after the new debt issue?,f. What is the WACC after the new debt issue?,g. Determine the breakeven EBIT between the existing and the proposed capital structures.,,,Question 2 (25%),Second Inc. is considering a 6-year project which requires the purchase of a $200,000 machine. This machine will be deprecated at a CCA rate of 30% and be sold for $10,000 when the project ends. Assume there is no CCA recapture or terminal loss. The project is expected to generate earnings before tax and depreciation of $40,000 per year for 6 years. If the project is finance by all equity, the cost of capital would be 12%. The corporate tax rate is 30%. Second only has $40,000 available and needs to borrow the balance at a subsidized rate of 2% which is 4% lower than the market borrowing rate. The bank will charge 10% of the amount borrowed as floatation costs and require Second to repay one third of the loan at year 4 and the remaining balance at year 6.,a. Using the adjusted present value method, determine whether Second should undertake the project.,b. Repeat part a if Second’s effective tax rate is zero.,,,Question 3 (25%),Third Inc is an all-equity firm. Its assets have a market value of $100 million and there are 4 million shares outstanding. The firm plans to raise a fixed amount of permanent debt and use the proceeds to repurchase its shares. The interest rate is 8% for any amount up to $50 million. The upfront floatation costs will be 5% of the amount of debt raised and will be paid by cash currently held by the firm. The present value of bankruptcy costs are $0.3 million, $1.8 million, $4.3 million, $7.5 million, and $11.3 million for debt amount of $10 million, $20 million, $30 million, $40 million, and $50 million respectively. The tax rate is 35%.,a. How much should Third borrow so as to maximize the value of the firm?,b. Find the number of shares outstanding and the stock prices under different recapitalization options?,,,Question 4 (25%),Fourth Inc. has the following financing outstanding:,Debt: Par value of $100,000; 8-year bonds with 10% coupon rate (coupon paid annually); priced to have a yield of 8.2437%; the debt beta is 0.2,Common stock: 5,000 shares outstanding; the price is $33; the stock beta is 1.25.,The company pays 30% tax. The risk-free rate is 5%. Assume that Fourth has $100,000 free cash flow for investments and the following projects are available:,Initial investment Profitability Index,Project A 20,000 1.5,Project B 30,000 1.4,Project C 25,000 1.4,Project D 15,000 1.2,Project E 10,000 0.9,Project F 20,000 0.9,Project G 10,500 0.7,a. Determine the WACC.,b. If Fourth follows a residual dividend policy and do not issue any new debt or equity, determine the dividend per share and the new debt-equity ratio after the investment announcement and dividend payment.,END
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