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Assignment 1 - Corporate Finance
Assignment 1 - Corporate Finance
Assignment 1 - Corporate Finance
EPS (x-50)(1-.34)/95
(x-71)(1-.34)/80
Q2
Ms Kraft owns $100,000/$16 million=0.00625 ofCopperhead’s equity
Q3
Rs = Ro + B/S (Ro - Rb) Ro = 0.13
Rs = .13 + 20/60(.13- 0.08)
14.67%
Q4
a True. MM Propositions have few assumptions and among them one of them says that there are no taxe
b Yes, this is true. As long as the return earned by the company is greater than the interest payment, ear
c This is False. The cost of equity increases with the ratio D/E.
d False. As the debt in the capital structure increases, the cost of borrowing will increase and so will the f
e False. Borrowing does increase the financial risk and cost of equity. Leverage in the capital structure m
f False. MM theory says that the borrowing does not affect the value of firm, however it says that the cor
Q5
Step 1 The value of the both the firms is equal and each of their value is represented by V.
To purchase one percent of Company B's equity (0.009V) and the company borrows an amount equal
0.01 x (DA - DB) = 0.002 V
This investment requires a net cash outlay of (0.007 V) and it provides a net cash return of:
(0.01 x Profits) - (0.003 × rf × V)
Here rf is the risk-free rate of interest on debt. And therefore the two investments are identical.
Step 2 In this case the company can buy two percent of company A's investment and lend an amount equal to
0.02 x (DA DB) = 0.004 V
This investment requires a net cash outlay of (0.018 V) and provides a net cash return of:
(0.02 × Profits) – (0.002 × rf × V)
Therefore the two investments are identical.
Q6
A. Stock price remains same , market price of stock not affected by the announcement.
Because Market price of stock affected by return on investments etc.
Q7
a. Value of Equity = 550 Million
Value of Debt = 200 million
WACC 10.01333
b. In this case the WACC would be same as cost of equity i.e. 12%. It would be higher by almost 2%
Q8
a. Relative Tax Advantage of Corporate Debt = (1-Tp)/((1-Tpe)(1-Tc)
= (1-0.35)/((1-0)*(1-0.39))
1.065574
them says that there are no taxes and there is symmetry of information.
r than the interest payment, earnings per share increase, but the P Falls to reflect the higher risk.
ng will increase and so will the financial distress cost. The cost of equity also increases as the debt level increases
verage in the capital structure magnifies the return on equity. Profits and Losses will also be maginified
rm, however it says that the corporate borrowing increases earning per share as long as rate of return is greater than the interest paid
sented by V.
announcement.