Quiz 2a: Casco in problem 1

FIN630 Summer 2012, Quiz 3

Problem 1
a. False. It has to be weighed off against the increase in both costs
b. True. It will reduce the marginal tax advantage of debt
c. True. The net operating loss carry forward will reduce the tax benefit of the debt. (No matter how the
the argument is structured, the firm without net operating losses will be able to borrow more money and get
a larger tax savings. The NOL will reduce the income available from which interest expenses can be deducted.
However, you could argue that at lower levels of debt, this would not be a constraint and the benefit of debt would be equal.)
d. False. If you are more uncertain about future investment needs, you will value flexibility more and borrow less.

Problem 2
Old Re (and old WACC) 8.40%

New beta = 1.12 ! Errors levering Beta: -1 point

Cost of equity = 10.16% ! Cost of Equity errors: -0.5 points

$Debt $ 260.00 ! Incorrect debt level: -0.5 points

Interest $ 13.00

Interest coverage ratio = 5.77

Rating = A- ! Did not find correct rating: -1 point
Cost of debt = 5.00%
After-tax cost of debt = 3.00%

Cost of capital = 7.296% ! Cost of Capital errors: -1 points

! Note: It may have taken several iterations to get to the correct cost of debt. I am interested in your final calcuations.

Problem 3
Duration of Corleone = 8 ! Duraton of assets incorrect: -1 point
Duration of the Tattaglia = 2 ! (used wrong weights): -0.5 points
Value of Corleone equity, pre-a 2000 ! Duration of existing debt incorrect: -1 point
Value of Corleone debt, pre-acq 500 ! Did not solve for new debt correctly: -1/2 to -1 point
Value of Corleone pre-acquisito 2500 ! Value of equity + Value of debt
Value of Tattaglia pre-acquisiti 1500
Duration post-acquisition 5.75 ! 8 (2500/4000) + 2 (1500/4000)

Existing debt
Duration of existing debt = 2 ! 0.5 (3) + 0.5 (1)
Value of new debt = 1500 ! Set equal to acquired company
(500/2000) (2) + (1500/2000)(X) = 5.75
Duration of new debt = 7