Q # 2: Consider the following information for

an unlevered firm U: EBIT = BDT 1.6

million annually
Unlevered value
VU = BDT4
million Tax rate
= 25%
Cost of debt = 12%
A levered firm L in the same business risk class has a debt-to-equity ratio of 0.5. Use the MM propositions to
determine:
a. The after-tax cost of equity for firms U and L.
b. The after-tax WACC for both firms.

Answer:

a. Ke(u)=(EBIT-Int)*(1-tc)/Vu
= (1600000-0)(1-0.25)/4000000
= 0.30
= 30%
b. Ke(L)= Ke(u)+VD/VE(Keu-Kd)(1-tc)
= 0.30+0.5(0.30-0.12)(1-0.25)

= 0.3675

= 36.75%

C. KwL= 0.3675*(1/1.5)+ 0.12(0.5/1.5)

= 0.245+0.04

= 0.285

= 28.5%
 Q # 1: Grant Grocers is considering the following independent, average-risk investment projects:
Project Size of Project Project IRR
Project V $1.0 million 12.0%
Project W 1.2 million 11.5
.5Project X 1.2 million 11.0
Project Y 1.2 million 10.5
Project Z 1.0 million 10.0
The company has a target capital structure that consists of 50 percent debt and 50 percent equity. Its after-tax
cost of debt is 8 percent, its cost of equity is estimated to be 13.5 percent, and its net income is $2.50 million. If
the company follows a residual dividend policy, what will be its payout ratio?

Answer:

Given Information
WD= 0.5, WE=0.5, Kd= 0.08, Ke= 0.135

WACC= (WD*Kd)+(WE*Ke)

= (0.5*0.08)+(0.5*0.135)

=0.1075

=10.75%

IRR of these project is avobe the WACC . So Investment should be =($1M+$1.2M+$1.2M)

= $3.4M

So residual profit after profitable investment= ($2.5M-$1.7M)=$0.8M

So Dividend payout ratio= $0.8M/$2.5M=0.32

Q # 3: Tangshan Mining Company must choose its optimal capital structure. Currently, the firm has a 40 percent
debt ratio and the firm expects to generate a dividend next year of $4.89 per share and dividends are expected
to grow at a constant rate of 5 percent for the foreseeable future. Stockholders currently require a 10.89
percent return on their investment. Tangshan Mining is considering changing its capital structure if it would
benefit shareholders. The firm estimates that if it increases the debt ratio to 50 percent, it will increase its
expected dividend to $5.24 per share. Because of the additional leverage, dividend growth is expected to
increase to 6 percent and this growth will be sustained indefinitely. However, because of the added risk, the
required return demanded by stockholders will increase to 11.34 percent.
(a) What is the value per share for Tangshan Mining under the current capital structure?
(b) What is the value per share for Tangshan Mining under the proposed capital structure?
(c) Should Tangshan Mining make the capital structure change? Explain.

Answer:

a. Po= 4.89/(o.1089-0.05)= $83.02 (Current price)

b. Po=5.24/(0.1134-0.065)= $108.26 (price of stock if the capital structure charge)
c. Yes Tangshan Mining should make the change because it will maximize share price