At the beginning of year 1, the firm needs to raise $10M of capital to expand. Assume
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Question:
At the beginning of year 1, the firm needs to raise $10M of capital to expand.
Assume the following data:
- Projected year 1 Income, post-financing = $4M
- Shares outstanding, pre financing = 4M
- The company pays no dividends, the interest rate is 5%
and volatility is 35%
- Annual Rate of earnings growth - after year 1 =20%
(Note this is not necessarily the rate of
EPS growth)
- Assumed PE multiple on earnings for equity valuation = 20X next years earnings.
- Tax rate =40%
There are three financing approaches
- Sell $10M of straight equity
- Sell $10M of 5-year at-the-money warrants
- Sell $10M of straight bonds. The bonds have an interest rate of 8%.
Required:
For each of the first 5 years, compute projected EPS under each financing approach.
Each year, you will need to compute the following:
- Enterprise value (based on earnings growth)
- The stock plus warrant value (using Black-Scholes).
- Note that the stock, debt, and warrant values combined must equal enterprise value.
- When the options are first issued, they must have a value of $10M.
Related Book For
Intermediate Accounting
ISBN: 978-0324592375
17th Edition
Authors: James D. Stice, Earl K. Stice, Fred Skousen
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