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a. For Vencidario Inc, since D: V D E β β D E β r r E E+ D r D E+D r D E β β D E β r r E E+ D r D E+ D r
a. For Vencidario Inc, since D: V D E β β D E β r r E E+ D r D E+D r D E β β D E β r r E E+ D r D E+ D r
a. For Vencidario Inc, since D: V D E β β D E β r r E E+ D r D E+D r D E β β D E β r r E E+ D r D E+ D r
D D
a. For Vencidario Inc, since =0.5, it suggests that =1
V E
βE 1.5
β A= = =0.75
D 1+1
1+
E
β D =0
r E=10 % +1.5 × ( 18 %−10 % )=22 %
E D
r A= r E+ r =0.5× 22 %+0.5 × 12%=17 %
E+ D E+ D D
D D 3
b. Since, =0.3 andr D=11 %, suggesting that = .
V E 7
β
Still A =0.75
D
( )
β E =β A 1+ =1.07
E
β D =0
r E=10 % +1.07 × ( 18 %−10 % )=18.56 %
E D
r A= r E+ r =0.7 ×18.56 %+ 0.3 ×11%=16.29 %
E+ D E+ D D
D
c. If firm leverage measured by decreases from 0.5 to 0.3,
V
It suggests a reduction in corporate financial distress risk. Therefore, creditors will
require a lower level of risk premium. From a- b, cost of equity decreased from
22% to 18.56%. If there is no reduction on the cost of debt, cost of equity will still
be 18.56% since it is unaffected by the cost of debt.
d. When D/V is reduced from 50% to 30%, EPS will increase.
With lower leverage, equity of the firm will become less risky, suggesting lower
expected value of the firm due to raising discount rate. However, equity share
price is not going to change and enterprise value is the same. Therefore, EPS will
decrease.
Question 2
a. Firstly, compute the forward rates for each year.
0 1 2 3 4 5
6.200 6.441 6.691 6.951 7.221 7.501
b. We calculate the project value in euros. It suggests that project value is 327.6596
euros, which is equivalent to 2031.48928 Brazilian reals.
CF (in
-1000 290 320 370 400 400
euros)
Discount 0.90909 0.82644 0.75131 0.68301 0.62092
factor 1 1 6 5 3 1
263.636 264.462 277.986 273.205 248.368
PV -1000 4 8 5 4 5
327.659
sum of PV 6
Question 3
a. The expected value of Skylift’s assets is 360 pre-equity issues. This is the
value of the Kites asset (340) plus the NPV of the helicopter project (20).
After the equity issue, the asset value will rise to 400, including the cash from
the equity issue. Since the new equity holders will demand £40 of equity for
£40 of cash, they will require 10% of the equity (40/400)
b. When deciding whether to issue equity and fund the project, the managers will
look at how the funding (equity issue) and investment decision will change the
wealth of old shareholders. Given that the original shareholders retain 90% of
the equity; their wealth post issue would be higher in every state except state
3. In state 3, managers will choose not to issue equity and invest for securities
worth .9*£630=£567 because the wealth of the original shareholders is higher
when they do nothing (£580).
c. If managers issue and invest, the market infers that the true state must be
either state 1, 2, or 4. New shareholders will demand 40/323.33 = 12.37%. The
resulting value of equity retained by old shareholders in these three states
(127.06, 135.82, and 587.11) is greater than choosing not to issue and invest
(100, 100, and 580), so this is equilibrium.
d. Before the announcement, Skylift was worth (105+115+580+630)/4=357.50.
After the announcement, Skylift is worth (105+115+630)/3=283.33. This is an
announcement return of -20.75%
e. These include maintain financial slack (either keeping cash inside the firm or
having low enough leverage so that the firm can issue relatively
informationally-insensitive debt securities), establishing a relationship with a
bank to avoid the information asymmetry, or raising equity via a rights issue.
Question 4
a. Item X is the current assets which is basically the treasury stocks. Buybacks
tend to boost share prices in the short-term, as the buying reduces the supply
out outstanding shares and the buying itself bids the share higher in the
market. Shareholders may view buybacks as a signal of corporate health and
optimism from company managers that their shares are under-valued.
b. Debt overhang refers to a debt burden so large that an entity cannot take on
additional debt to finance future projects. This includes entities that are
profitable enough to be able to reduce indebtedness over time. Debt financing
is the best method of financing when it comes to agency costs.
c. Commercial loans are funds lent by commercial banks and other financial
institutions and are usually the main source of debt financing. Bridge
financing is a short-term financing arrangement (e.g., for the construction
period or for an initial period) which is generally used until a long-term
financing arrangement can be implemented. Bonds are long-term interest
bearing debt instruments purchased either through the capital markets or
through private placement Subordinate loans are similar to commercial loans
but they are secondary or subordinate to commercial loans in their claim on
income and assets of the project.
The other sources of project finance include grants from various sources,
supplier's credit, etc. Government grants can be made available to make PPP
projects commercially viable, to reduce the financial risks of private investors,
and to achieve socially desirable objectives such as to induce economic
growth in lagging or disadvantaged areas. Many governments have established
formal mechanisms for the award of grants to PPP projects. Where grants are
available, depending on government policy they may cover 10 to 40 per cent
of the total project investment.