3. There are no corporate taxes in this question. F is an all-equity firm. EBIT (=...
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3. There are no corporate taxes in this question. F is an all-equity firm. EBIT (= operating cash-flows) in one year (end of year 1) depends on the entry of a competitor: - If a rival enters the market (probability 0.3), year-1 EBIT is $30,000, - If no rival enters (probability 0.7), year-1 EBIT is $100,000. Expected EBIT in the subsequent years (years 2,3,4...) is equal to the year-1 EBIT. Bankruptcy costs are 15%, expected return on equity is 7%. = F decides to issue 750 perpetual bonds, face value $1,000, coupon 4.50%. The proceeds from the issuance are paid to stockholders. Cost of debt is rB 3.70%. Assume that if the firm does not default at the end of year 1, it will never default in the subsequent years.4 (a) Suppose that possibility of bankruptcy does not affect the systematic risk of F's assets. Compute F's equity value after the operation. Does the operation create value for stockholders? (Hint: compute market value of debt B and total firm value before and after the operation). (b) Compute the expected return on equity after the operation. 3. There are no corporate taxes in this question. F is an all-equity firm. EBIT (= operating cash-flows) in one year (end of year 1) depends on the entry of a competitor: - If a rival enters the market (probability 0.3), year-1 EBIT is $30,000, - If no rival enters (probability 0.7), year-1 EBIT is $100,000. Expected EBIT in the subsequent years (years 2,3,4...) is equal to the year-1 EBIT. Bankruptcy costs are 15%, expected return on equity is 7%. = F decides to issue 750 perpetual bonds, face value $1,000, coupon 4.50%. The proceeds from the issuance are paid to stockholders. Cost of debt is rB 3.70%. Assume that if the firm does not default at the end of year 1, it will never default in the subsequent years.4 (a) Suppose that possibility of bankruptcy does not affect the systematic risk of F's assets. Compute F's equity value after the operation. Does the operation create value for stockholders? (Hint: compute market value of debt B and total firm value before and after the operation). (b) Compute the expected return on equity after the operation.
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