Need help with the attached questions from finance major

Assignment 3 Questions 1. Anle Corporation has a current price of $27, is expected to pay a dividend of $2 in one year, and its expected price right after paying that dividend is $28. a. What is Anle's expected dividend yield? b. What is Anle's expected capital gain rate? c. What is Anle's equity cost of capital? a. What is Anle's expected dividend yield? Anle's expected dividend yield is ______%. (Round to two decimal places.) 2. Krell Industries has a share price of $22.06 today. If Krell is expected to pay a dividend of $1.12 this year, and its stock price is expected to grow to $23.46 at the end of the year, what is Krell's dividend yield and equity cost of capital? What is Krell's dividend yield? Krell's dividend yield is _______ %. (Round to one decimal place.) 3. Summit Systems will pay a dividend of $1.50 one year from now. If you expect Summit's dividend to grow by 6.0% per year, what is its price per share if its equity cost of capital is 11.0%? The price per share is $ _____ . (Round to the nearest cent.) 4. Halliford Corporation expects to have earnings this coming year of $ 2.61 per share. Halliford plans to retain all of its earnings for the next two years. For the subsequent two years, the firm will retain 51% of its earnings. It will then retain 21% of its earnings from that point onward. Each year, retained earnings will be invested in new projects with an expected return of 25.44% per year. Any earnings that are not retained will be paid out as dividends. Assume Halliford's share count remains constant and all earnings growth comes from the investment of retained earnings. If Halliford's equity cost of capital is 8.6%, what price would you estimate for Halliford stock? The price per share is $ . Round to the nearest cent.) 5. The figure in the popup window,, shows the one-year return distribution for RCS stock. Calculate: a. The expected return. b. The standard deviation of the return. Note: Make sure to round all intermediate calculations to at least five decimal places. a. The expected return. The expected return is _______ %. (Round to two decimal places.) 6. Given the data from the following table: (Click on the Icon located on the top-right corner of the data table below in order to copy its contents into a spreadsheet.) Yearly returns from 1926-2014 for the S&P 500, small stocks, corporate bonds, world portfolio, Treasury bills, and inflation (as measured by the CPI) Year 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945 S&P 500 0.11138 0.37126 0.43308 0.08907 0.25257 0.43858 0.08861 0.52895 0.02341 0.47208 0.32801 0.35258 0.33199 0.00910 0.10082 0.11767 0.21076 0.25758 0.19694 0.36461 Small Stocks 0.07200 0.25754 0.46872 0.50467 0.45583 0.50216 0.08696 1.87200 0.25209 0.64739 0.87508 0.53403 0.26275 0.00184 0.12340 0.13728 0.52504 1.00000 0.60408 0.82665 Corp Bonds 0.06285 0.06550 0.03377 0.04321 0.06343 0.02380 0.12198 0.05255 0.09728 0.06860 0.06220 0.02546 0.04357 0.04247 0.04512 0.01788 0.03119 0.03365 0.03101 0.03512 World Portfolio 0.22800 0.25326 0.33463 0.07692 0.22574 0.39305 0.03030 0.66449 0.02552 0.22782 0.19283 0.16950 0.05614 0.01441 0.03528 0.18744 0.01189 0.19895 0.10240 0.11032 Treasury Bills 0.03194 0.03125 0.03824 0.04737 0.02347 0.01023 0.00806 0.00293 0.00155 0.00165 0.00175 0.00319 0.00041 0.00008 0.00058 0.00042 0.00262 0.00340 0.00321 0.00321 CPI 0.01188 0.02163 0.01229 0.00746 0.06420 0.09235 0.10465 0.00974 0.01286 0.03175 0.01231 0.03040 0.02950 0.00000 0.00912 0.09940 0.09041 0.02764 0.02445 0.02148 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 0.08180 0.05240 0.05099 0.18065 0.30579 0.24553 0.18501 0.01099 0.52404 0.31429 0.06627 0.10853 0.43344 0.11904 0.00483 0.26811 0.08784 0.22691 0.16358 0.12356 0.10105 0.23942 0.11002 0.08466 0.03986 0.14325 0.18936 0.14791 0.26539 0.37250 0.23675 0.07388 0.06440 0.18353 0.32266 0.05053 0.21483 0.22500 0.06152 0.31648 0.18603 0.05171 0.16608 0.31686 0.03104 0.30466 0.07619 0.10079 0.01320 0.12608 0.02658 0.06609 0.21502 0.45908 0.09767 0.06472 0.05985 0.65232 0.22110 0.03459 0.15053 0.70923 0.18680 0.05004 0.30836 0.12950 0.18093 0.19405 0.36365 0.07302 0.77916 0.47611 0.32219 0.04503 0.16347 0.04222 0.35936 0.27327 0.82769 0.57116 0.19915 0.20420 0.39698 0.29141 0.14617 0.32250 0.48048 0.02495 0.29125 0.05908 0.09204 0.20288 0.01488 0.36325 0.41799 0.22075 0.13792 minus0.01096 0.02558 0.00450 0.03707 0.04327 0.01891 0.00210 0.03427 0.02061 0.04658 0.01075 0.01792 0.04469 0.00849 0.00157 0.06722 0.03681 0.06204 0.03167 0.03988 0.02082 0.00255 0.01162 0.22457 0.02459 0.11179 0.09682 0.08323 0.02987 0.00233 0.11039 0.14557 0.05510 0.01833 0.01558 0.04976 0.08977 0.34898 0.07317 0.17103 0.29486 0.20913 0.01578 0.13793 0.15310 0.08606 0.15869 0.10642 0.14662 minus0.02435 0.15124 0.03196 0.05730 0.05421 0.25477 0.22446 0.15822 0.04838 0.49823 0.24739 0.06581 0.06017 0.34456 0.23303 0.03492 0.20778 0.06212 0.15381 0.11247 0.09832 0.10116 0.21283 0.13941 0.03858 0.01984 0.19567 0.23547 0.14506 0.24480 0.34493 0.14712 0.02002 0.18216 0.12671 0.27721 0.03305 0.11272 0.23280 0.05773 0.41770 0.42799 0.16764 0.23950 0.17194 0.16517 0.18966 minus0.04660 0.23129 0.05584 0.00352 0.00461 0.00979 0.01106 0.01213 0.01483 0.01642 0.01780 0.00863 0.01555 0.02422 0.03129 0.01415 0.02815 0.02582 0.02159 0.02724 0.03151 0.03518 0.03962 0.04705 0.04147 0.05294 0.06591 0.06383 0.04317 0.03891 0.07059 0.08078 0.05821 0.05156 0.05152 0.07308 0.10690 0.11523 0.14856 0.10664 0.08847 0.09956 0.07677 0.06057 0.05384 0.06323 0.08221 0.07680 0.05507 0.03401 0.02899 0.03880 0.18224 0.08893 0.02904 0.02116 0.05946 0.06122 0.00641 0.00796 0.00790 0.00478 0.02853 0.02928 0.01796 0.01765 0.01301 0.00713 0.01275 0.01678 0.00963 0.01907 0.03476 0.03101 0.04637 0.06228 0.05524 0.03312 0.03413 0.08700 0.12328 0.06962 0.04824 0.06720 0.09035 0.13308 0.12521 0.08912 0.03797 0.03833 0.03943 0.03793 0.01089 0.04423 0.04420 0.04656 0.06100 0.03081 0.02897 0.02755 0.02652 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0.37578 0.22960 0.33363 0.28579 0.21042 minus0.09104 minus0.11886 minus0.22101 0.28685 0.10882 0.04911 0.15795 0.05494 minus0.36998 0.26464 0.15064 0.02112 0.16003 0.32388 0.13688 0.20056 0.21511 0.32080 minus0.11975 minus0.01260 minus0.02490 0.32781 minus0.05624 0.69151 0.31392 0.03988 0.26379 minus0.11100 minus0.45864 1.12127 0.33610 minus0.07155 0.21311 0.50814 minus0.04541 0.21991 0.04239 0.10847 0.10908 minus0.03037 0.11694 0.11461 0.11181 0.09229 0.06510 0.07734 0.04167 0.04742 0.13449 0.00018 0.07972 0.14703 0.04513 minus0.03067 0.11658 0.21318 0.13993 0.16227 0.24795 0.25354 minus0.12928 minus0.16521 minus0.19541 0.33761 0.15247 0.10023 0.20652 0.09566 minus0.40334 0.30793 0.12339 minus0.05017 0.16537 0.27365 0.05504 0.05532 0.05145 0.05082 0.04781 0.04561 0.05756 0.03779 0.01634 0.01018 0.01200 0.02963 0.04786 0.04675 0.01474 0.00097 0.00122 0.00043 0.00057 0.00028 0.00016 0.02555 0.03322 0.01688 0.01607 0.02697 0.03384 0.01563 0.02357 0.01880 0.03275 0.03417 0.02526 0.04086 0.00101 0.02709 0.01496 0.02967 0.01733 0.01518 0.00748 What if the period from 1990 to 2014 had been "normal"? a. Calculate the arithmetic average return on the S&P 500 from 1926 to 1989. b. Replace the actual returns from 1990 to 2014 with the average return from (a). Use the actual returns from 1926 to 1989 and then continue the growth at the assumed rate.) c. Do the same for small stocks. a. Calculate the arithmetic average return on the S&P 500 from 1926 to 1989. The arithmetic average return of the S&P 500 from 1926 to 1989 is ________ %.(Round to two decimal places.) 7. Consider two local banks. Bank A has 100 loans outstanding, each for $1.0 million, that it expects will 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Which bank faces less risk? Why? (Select the best choice below.) A. The expected payoffs are the same, but Bank A is less risky. I prefer Bank A. B. The expected payoffs are the same, but Bank A is riskier. I prefer Bank B. C. In both cases the expected loan payoff is the same: $100 million0.95=$95.0 million. Consequently, I don't care which bank I own. D. The expected payoff is higher for Bank A, but is riskier. I prefer Bank B. 8. Suppose the risk-free interest rate is 5%, and the stock market will return either +40% or 20% each year, with each outcome equally likely. Compare the following two investment strategies: (1) invest for one year in the risk-free investment, and one year in the market, or (2) invest for both years in the market. a. Which strategy has the highest expected final payoff? b. Which strategy has the highest standard deviation for the final payoff? c. Does holding stocks for a longer period decrease your risk? a. Which strategy has the highest expected final payoff? The two possible outcomes for investment (1) are ______ % or ______ %. (Enter the outcomes from largest to smallest and round to one decimal place.) 9. What does the beta of a stock measure? (Select the best choice below.) A. Beta measures leverage. B. Beta measures the amount of systematic risk in a stock. C. Beta measures the use of debt. D. Beta measures interest rate risk. 10. Suppose the market portfolio is equally likely to increase by 30% or decrease by 10%. Also suppose that the risk-free interest rate is 4%. a. Use the beta of a firm that goes up on average by 43% when the market goes up and goes down by 17% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? b. Use the beta of a firm that goes up on average by 18% when the market goes down and goes down by 22% when the market goes up to estimate the expected return of its stock. How does this compare with the stock's actual expected return? a. Use the beta of a firm that goes up on average by 43% when the market goes up and goes down by 17% when the market goes down to estimate the expected return of its stock. How does this compare with the stock's actual expected return? The beta of the stock is _______ . (Round to two decimal places.) 11. You are considering how to invest part of your retirement savings. You have decided to put $200,000 into three stocks: 50% of the money in GoldFinger (currently $25/share), 25% of the money in Moosehead (currently $80/share), and the remainder in Venture Associates (currently $2/share). If GoldFinger stock goes up to $30/share, Moosehead stock drops to $60/share, and Venture Associates stock rises to $3 per share. a. What is the new value of the portfolio? b. What return did the portfolio earn? c. If you don't buy or sell any shares after the price change, what are your new portfolio weights? a. What is the new value of the portfolio? The number of shares of GoldFinger is ______ shares (Round to the nearest integer.) 12. Using the data in the following table, estimate the: Year 2010 2011 2012 2013 Stock A 10% 20% 5% 5% Stock B 21% 7% 30% 3% 2014 2% 8% 2015 9% 25% a. Average return and volatility for each stock. b. Covariance between the stocks. c. Correlation between these two stocks. a. Estimate the average return and volatility for each stock. The average return of stock A is ________ %. (Round to two decimal places.) 13. A hedge fund has created a portfolio using just two stocks. It has shorted $35,000,000 worth of Oracle stock and has purchased $85,000,000 of Intel stock. The correlation between Oracle's and Intel's returns is .65. The expected returns and standard deviations of the two stocks are given in the table below: Standard Expected Return Deviation Oracle 12.00% 45.00% Intel 14.50% 40.00% a. What is the expected return of the hedge fund's portfolio? b. What is the standard deviation of the hedge fund's portfolio? a. What is the expected return of the hedge fund's portfolio? The expected return of the hedge fund's portfolio is ____%(Round to two decimal places.) 14. You expect HGH stock have a 20% return next year and a 30% volatility. You have $25,000 to invest, but plan to invest a total of $50,000 in HGH, raising the additional $25,000 by shorting either KBH or LWI stock. Both KBH and LWI have an expected return of 10% and a volatility of 20%. If KBH has a correlation of +0.5 with HGH, and LWI has a correlation of 0.5 with HGH, which stock should you short? Which portfolio is superior? Why? (Select the best choice below.) A. Both portfolios have the same expected return, but shorting LWI is better because we should seek to hold stocks that are positively correlated to reduce volatility. B. Both portfolios have the same expected return, but shorting KBH is better because we should seek to hold stocks that are positively correlated to reduce volatility. C. Both portfolios have the same expected return, but by shorting KBH, we achieve a lower volatility because it has a positive correlation with HGH. By shorting KBH, some of the common risk shared by the stocks is reduced. D. Both portfolios have the same expected return, but shorting LWI is better because we should seek to hold stocks that are negatively correlated to reduce volatility. 15. Assume the risk-free rate is 4%. You are a financial advisor, and must choose one of the funds below to recommend to each of your clients. Whichever fund you recommend, your clients will then combine it with risk-free borrowing and lending depending on their desired level of risk. Expected Return Volatility Fund A 10% 10% Fund B 15% 22% Fund C 6% 2% Fund A Fund B Fund C Expected Return 10% 15% 6% Volatility 10% 22% 2% Which fund would you recommend (without knowing your client's risk preferences)? The fund you should recommend to each of your clients is Fund A, B or C? 16. In addition to risk-free securities, you are currently invested in the Tanglewood Fund, a broad-based fund of stocks and other securities with an expected return of 12% and a volatility of 25%. Currently, the risk-free rate of interest is 4%. Your broker suggests that you add a venture capital fund to your current portfolio. The venture capital fund has an expected return of 20%, a volatility of 80%, and a correlation of 0.2 with the Tanglewood Fund. Assume you follow your broker's advice and put 50% of your money in the venture fund: a. What is the Sharpe ratio of the Tanglewood Fund? b. What is the Sharpe ratio of your new portfolio? c. What is the optimal Sharpe ratio you can obtain by investing in the venture fund? (Hint: Use Excel and round your answer to two decimal places.) a. What is the Sharpe ratio of the Tanglewood Fund? (Round all intermediate values to five decimal places as needed.) The Sharpe ratio of the Tanglewood Fund is _____? (Round to two decimal places.) 17. Suppose the risk-free return is 2.8% and the market portfolio has an expected return of 11.9% and a volatility of 14.7%. Merck & Co. (Ticker: MRK) stock has a 21.6% volatility and a correlation with the market of .052. a. What is Merck's beta with respect to the market? b. Under the CAPM assumptions, what is its expected return? a. What is Merck's beta with respect to the market? Merck's beta with respect to the market is ______?(Round to three decimal places.) 18. Suppose Pepsico's stock has a beta of 0.57. If the risk-free rate is 3% and the expected return of the market portfolio is 8%, what is Pepsico's equity cost of capital? Pepsico's equity cost of capital is _____? (Round to two decimal places.) 19. Suppose all possible investment opportunities in the world are limited to the five stocks listed in the table: Stock Price/Share ($) Number of Shares Outstanding (millions) A B C D E 10 20 8 50 45 10 12 3 1 20 . What does the market portfolio consist of (what are the portfolio weights)? Enter the percentage that each stock makes up of the total portfolio. (Round to two decimal places.) _____________Stock__________________Portfolio Weight A ________% 20. You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns: Year Risk-free Return 201 4% 1 201 1% 2 Market Return XYZ Return 6% 8% 41% 44% . a. What was XYZ's average historical return? b. Compute the market's and XYZ's excess returns for each year. Estimate XYZ's beta. c. Estimate XYZ's historical alpha. d. Suppose the current risk-free rate is 4%, and you expect the market's return to be 9%. Use the CAPM to estimate an expected return for XYZ Corp.'s stock. e. Would you base your estimate of XYZ's equity cost of capital on your answer in part (a) or in part (d)? a. What was XYZ's average historical return? XYZ's average historical return was ____? (Round to one decimal place.) 21. In mid-2012, Ralston Purina had AA-rated, 10-year bonds outstanding with a yield to maturity of 1.57%. a. What is the highest expected return these bonds could have? b. At the time, similar maturity Treasuries had a yield of 0.57%. Could these bonds actually have an expected return equal to your answer in part (a)? c. If you believe Ralston Purina's bonds have 0.5% chance of default per year, and that expected loss rate in the event of default is 52%, what is your estimate of the expected return for these bonds? a. What is the highest expected return these bonds could have? The highest expected return these bonds could have is _____? (Round to two decimal places.) 22. During the recession in mid-2009, homebuilder KB Home had outstanding 6-year bonds with a yield to maturity of 8.5% and a BB rating. If corresponding risk-free rates were 3.0%, and the market risk premium was 5.0%, estimate the expected return of KB Home's debt using two different methods. How do your results compare? (Note: the average loss rate for unsecured debt is about 60%. See annual default rates by debt rating here TABLE 12.2 Annual Default Rates by Debt Rating (1983-2011) Rating:____________AAA DEFAULT RATE: AVERAGE 0.0% IN RECESSIONS 0.0% AA _____A_____BBB___BB_____B_____CCC_____CC-C 0.1% 1.0% 0.2% 3.0% 0.5% 3.0% 2.2% 8.0% 5.5% 12.2% 16.0% 48.0% 14.1% 79.0% Source: \"Corporate Defaults and Recovery Rates, 1920-2011,\" Moody's Global Credit Policy, and average debt betas by rating and maturity here TABLE 12.3 Average Debt Betas by Rating and Maturity By Rating________A and above______BBB_______BB_____ B_______ CCC Avg Beta 15 Avg Beta 0.01 0.06 0.07 0.14 Considering the probability of default, the expected return of the bond is _____%. (Round to two decimal places.) 23. In mid-2015, Cisco Systems had a market capitalization of $130 billion. It had A-rated debt of $25 billion as well as cash and short-term investments of $60 billion, and its estimated equity beta at the time was 1.11. a. What is Cisco's enterprise value? b. Assuming Cisco's debt has a beta of zero, estimate the beta of Cisco's underlying business enterprise. a. What is Cisco's enterprise value? Cisco's enterprise value is $ _____ billion. (Round to the nearest integer.) 24. Your company operates a steel plant. On average, revenues from the plant are $30 million per year. All of the plant's costs are variable costs, and are consistently 80% of revenues. (This includes the energy costs associated with powering the plant which represent one quarter of the plant's costs, or an average of $6.00 million per year.) Suppose the plant has an asset beta of 1.25, he risk-free rate is 4%, and the market risk premium is 5 %. The tax rate is 40%, and there are no other costs. a. Estimate the value of the plant today assuming no growth. b. Suppose you enter a long-term contract which will supply all of the plant's energy needs for a fixed cost of $3 million per year (before tax). What is the value of the plant if you take this contract? c. How would taking the contract in (b) change the plant's cost of capital? Explain. a. Estimate the value of the plant today assuming no growth. The value of the plant today assuming no growth is ____ million (Round to two decimal places.) Assignment 4 1. Consider a project with free cash flows in one year of $130,000 or $180,000, with each outcome being equally likely. The initial investment required for the project is 100,000, and the project's cost of capital is 20%. The risk-free interest rate is 10%. a. What is the NPV of this project? b. Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flows of the project in one year. How much money can be raised in this waylong dashthat is, what is the initial market value of the unlevered equity? c. Suppose the initial $100,000 is instead raised by borrowing at the risk-free interest rate. What are the cash flows of the levered equity, what is its initial value and what is the initial equity according to MM? a. What is the NPV of this project? The NPV is $_____? Round to nearest dollar 2. Cisoft is a highly profitable technology firm that currently has $9 billion in cash. The firm has decided to use this cash to repurchase shares from investors, and it has already announced these plans to investors. Currently, Cisoft is an all-equity firm with 4 billion shares outstanding. These shares currently trade for $18 per share. Cisoft has issued no other securities except for stock options given to its employees. The current market value of these options is $8 billion. a. What is the market value of Cisoft's non-cash assets? b. With perfect capital markets, what is the market value of Cisoft's equity after the share repurchase? What is the value per share? a. What is the market value of Cisoft's non-cash assets? The market value of Cisoft's non-cash assets is $____billion (round to nearest integer) 3. Zetatron is an all-equity firm with 140 million shares outstanding, which are currently trading for $17.04 per share. A month ago, Zetatron announced it will change its capital structure by borrowing $360 million in short-term debt, borrowing $391 million in long-term debt, and issuing $318 million of preferred stock. The $1,069 million raised by these issues, plus another $76 million in cash that Zetatron already has, will be used to repurchase existing shares of stock. The transaction is scheduled to occur today. Assume perfect capital markets. a. What is the market value balance sheet for Zetatron i. Before this transaction? ii. After the new securities are issued but before the share repurchase? iii. After the share repurchase? b. At the conclusion of this transaction, how many shares outstanding will Zetatron have, and what will the value of those shares be? a.i. What is the market value balance sheet for Zetatron before this transaction? ________Account_____________________________Amount_____ Cash $_____million (round to nearest integer) Non Cash Assets $_____million (round to nearest integer) Total Assets $_____million (round to nearest integer) Total Liabilities $_____million (round to nearest integer) Total Equity $_____million (round to nearest integer) 4. In mid-2015, Qualcomm Inc. had $14billion in debt, total equity capitalization of $91billion, and an equity beta of 1.43 (as reported on Yahoo! Finance). Included in Qualcomm's assets was $22 billion in cash and risk-free securities. Assume that the risk-free rate of interest is 3.1 % and the market risk premium is 4.1%. a. What is Qualcomm's enterprise value? b. What is the beta of Qualcomm's business assets? c. What is Qualcomm's WACC? a. What is Qualcomm's enterprise value? Qualcomm's enterprise value is $ billion(Round to the nearest whole number.) 5. Indell stock has a current market value of $ 120 million and a beta of 1.50. Indell currently has risk-free debt as well. The firm decides to change its capital structure by issuing $ 30.00 million in additional riskfree debt, and then using this $ 30.00million plus another $ 10 million in cash to repurchase stock. With perfect capital markets, what will the beta of Indell stock be after this transaction? The beta of Indell stock after the recapitalization is _____. (Round to two decimal places.) 6. Zelnor, Inc., is an all-equity firm with 100 million shares outstanding currently trading for $ 8.50per share. Suppose Zelnor decides to grant a total of 10 million new shares to employees as part of a new compensation plan. The firm argues that this new compensation plan will motivate employees and is better than giving salary bonuses because it will not cost the firm anything. Assume perfect capital markets. a. If the new compensation plan has no effect on the value of Zelnor's assets, what will be the share price of the stock once this plan is implemented? b. What is the cost of this plan for Zelnor investors? Why is issuing equity costly in this case? a. If the new compensation plan has no effect on the value of Zelnor's assets, what will be the share price of the stock once this plan is implemented? If the new compensation plan has no effect on the value of Zelnor's assets, the new share price will be $ _____? (Round to the nearest cent.) 7. Pelamed Pharmaceuticals has EBIT of $ 325 million in 2012. In addition, Pelamed has interest expenses of $ 125million and a corporate tax rate of 40 %. a. What is Pelamed's 2012 net income? b. What is the total of Pelamed's 2012 net income plus interest payments? c. If Pelamed had no interest expenses, what would its 2012 net income be? How does it compare to your answer in part (b)? d. What is the amount of Pelamed's interest tax shield in 2012? a. What is Pelamed's 2012 net income? Pelamed's 2012 net income is $ ______ million. (Round to the nearest integer.) 8. Braxton Enterprises currently has debt outstanding of $15million and an interest rate of 7 %. Braxton plans to reduce its debt by repaying $ 3 million in principal at the end of each year for the next five years. If Braxton's marginal corporate tax rate is 35 %, what is the interest tax shield from Braxton's debt in each of the next five years? The interest tax shield in year one is $_______ million. (Round to three decimal places.) 9. Arnell Industries has just issued $ 10 million in debt (at par). The firm will pay interest only on this debt. Arnell's marginal tax rate is expected to be 35 %for the foreseeable future. a. Suppose Arnell pays interest of 6 %per year on its debt. What is its annual interest tax shield? b. What is the present value of the interest tax shield, assuming its risk is the same as the loan? c. Suppose instead that the interest rate on the debt is 5 %. What is the present value of the interest tax shield in this case? a. Suppose Arnell pays interest of 6 % per year on its debt. What is its annual interest tax shield? If Arnell pays interest of 6 % per year on its debt, the annual interest tax shield is $______ million. (Round to three decimal places.) 10. Safeco Inc. has no debt, and maintains a policy of holding $10 million in excess cash reserves, invested in risk-free Treasury securities. If Safeco pays a corporate tax rate of 35 %, what is the cost of permanently maintaining this $ 10 million reserve? (Hint: What is the present value of the additional taxes that Safeco will pay?) The cost of permanently maintaining this reserve is $ _____ million. (Round to two decimal places. Enter the expenses as a negative number.) 11. Suppose the corporate tax rate is 40 %, and investors pay a tax rate of 15 % on income from dividends or capital gains and a tax rate of 33.3 % on interest income. Your firm decides to add debt so it will pay an additional $ 15million in interest each year. It will pay this interest expense by cutting its dividend. a. How much will debt holders receive after paying taxes on the interest they earn? b. By how much will the firm need to cut its dividend each year to pay this interest expense? c. By how much will this cut in the dividend reduce equity holders' annual after-tax income? d. How much less will the government receive in total tax revenues each year? e. What is the effective tax advantage of debt *? a. How much will debt holders receive after paying taxes on the interest they earn? After paying taxes on the interest, debt holders will receive $ _____ million. (Round to two decimal places.) 12. Markum Enterprises is considering permanently adding an additional $ 100 million of debt to its capital structure. Markum's corporate tax rate is 35%. a. Absent personal taxes, what is the value of the interest tax shield from the new debt? b. If investors pay a tax rate of 40 % on interest income, and a tax rate of 20% on income from dividends and capital gains, what is the value of the interest tax shield from the new debt? a. Absent personal taxes, what is the value of the interest tax shield from the new debt? In the absence of personal taxes, the value of interest tax shield from new debt should be $ _____ million. (Round to two decimal places.) 13. Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of four values next year: $ 150 million, $ 135million, $ 95 million, and $ 80 million. These outcomes are all equally likely, and this risk is diversifiable. Gladstone will not make any payouts to investors during the year. Suppose the risk-free interest rate is 5.0% and assume perfect capital markets. a. What is the initial value of Gladstone's equity without leverage? Now suppose Gladstone has zero-coupon debt with a $ 100million face value due next year. b. What is the initial value of Gladstone's debt? c. What is the yield-to-maturity of the debt? What is its expected return? d. What is the initial value of Gladstone's equity? What is Gladstone's total value with leverage? a. What is the initial value of Gladstone's equity without leverage? The initial value of Gladstone's equity without leverage is $ _____ million. (Round to two decimal places.) 14. Which type of firm is more likely to experience a loss of customers in the event of financial distress: a. Campbell Soup Company or Intuit, Inc. (a maker of accounting software)? b. Allstate Corporation (an insurance company) or Adidas AG (maker of athletic footwear, apparel, and sports equipment)? a. Campbell Soup Company or Intuit, Inc. (a maker of accounting software)? In the event of financial distress, which company is more likely to experience a loss of customers? (Select the best choice below.) Campbell Soup Company Intuit, Inc. 15. Facebook, Inc. has no debt. By issuing debt, Facebook can generate a very large tax shield potentially worth nearly $2 billion. Given Facebook's success, one would be hard pressed to argue that Facebook's management are nave and unaware of this huge potential to create value. A more likely explanation is that issuing debt would entail other costs. Which of the following costs of debt is unlikely to explain Facebook's policy? (Select the best choice below.) A. Asset substitution B. Cash flow volatility C. Cash flow risk D. Human capital risk 16. Petron Corporation's management team is meeting to decide on a new corporate strategy. There are fouroptions, each with a different probability of success and total firm value in the event of success, as shown here: . Assume that for each strategy, firm value is zero in the event of failure. Also, suppose Petron Corp. must pay a 25% tax rate on the amount of the final payoff that is paid to equity holders. It pays no tax on payments to, or capital raised from, debt holders. a. Which strategy will Petron choose with no debt? Which will it choose with a face value of $11 million, $33 million, or $55 million in debt? (Assume management maximizes the value of equity, and in the case of ties, will choose the safer strategy.) b. Given your answer to (a), show that the total combined value of Petron's equity and debt is maximized with a face value of $55 million in debt. c. Show that if Petron has $33 million in debt outstanding, shareholders can gain by increasing the face value of debt to $55 million, even though this will reduce the total value of the firm. d. Show that if Petron has $55 million in debt outstanding, shareholders will lose by buying back debt to reduce the face value of debt to $33 million, even though that will increase the total value of the firm. Which strategy will Petron choose with no debt? Which will it choose with a face value of $11 million, $33 million, or $55 million in debt? (Assume management maximizes the value of equity, and in the case of ties, will choose the safer strategy.) Calculate the equity values below (millions):(Round to two decimal places.) Equity Value Debt Face Value_________________A______________B___________C_______________D________ $0 $______ $______ $_____ $________ 17. Empire Industries forecasts net income this coming year as shown here (in thousands of dollars): See data table. Approximately $250,000 of Empire's earnings will be needed to make new, positive-NPV investments. Unfortunately, Empire's managers are expected to waste 10% of its net income on needless perks, pet projects, and other expenditures that do not contribute to the firm. All remaining income will be returned to shareholders through dividends and share repurchases. a. What are the two benefits of debt financing for Empire? b. By how much would each $1 of interest expense reduce Empire's dividend and share repurchases? c. What is the increase in the total funds Empire will pay to investors for each $1 of interest expense? a. What are the two benefits of debt financing for Empire?(Select the best choice below.) A. Tax and interest cost benefits B. Interest cost benefits and reducing wasteful investment C. Dividend and tax benefits D.Tax benefits and reducing wasteful investment 18. According to the managerial entrenchment theory, managers choose capital structure so as to preserve their control of the firm. On the one hand, debt is costly for managers because they risk losing control in the event of default. On the other hand, if they do not take advantage of the tax shield provided by debt, they risk losing control through a hostile takeover. Suppose a firm expects to generate free cash flows of $88 million per year, and the discount rate for these cash flows is 9%. The firm pays a tax rate of 35%. A raider is poised to take over the firm and finance it with $790 million in permanent debt. The raider will generate the same free cash flows, and the takeover attempt will be successful if the raider can offer a premium of 26% over the current value of the firm. According to the managerial entrenchment hypothesis, what level of permanent debt will the firm choose? The permanent debt required to prevent a takeover is $_____million (round to the nearest integer) 19. ABC Corporation announced that it will pay a dividend to all shareholders of record as of Monday, April 2, 2012. It takes three business days of a purchase for the new owners of a share of stock to be registered. a. When is the last day an investor can purchase ABC stock and still get the dividend payment? b. When is the ex-dividend day? a. When is the last day an investor can purchase ABC stock and still get the dividend payment? The last day an investor can purchase ABC stock and still get the dividend payment is:(Select the best choice below.) A. March 29 B. April 3 C. March 31 D. April 4 20. Natsam Corporation has $275 million of excess cash. The firm has no debt and 500 million shares outstanding with a current market price of $20 per share. Suppose the board decided to do a one-time share repurchase, but you, as an investor, would have preferred to receive a dividend payment. How can you leave yourself in the same position as if the board had elected to make the dividend payment instead? Which of the following is true regarding the effect of a one-time share repurchase on the stock price? (Select the best choice below.) A. An open-market share repurchase decreases the stock price because the firm's assets decline by the amount of the purchases of the shares. B. An open-market share repurchase has no effect on the stock price. C. An open-market share repurchase increases the stock price due to the decrease in shares in the marketplace. D. An open-market share repurchase has no effect on the stock price, but the stock price is not the same as the cum-dividend price if a dividend were paid instead. 21. The HNH Corporation will pay a constant dividend of $2.00 per share, per year, in perpetuity. Assume all investors pay a 15% tax on dividends and that there is no capital gains tax. Suppose the other investments with equivalent risk to HNH stock offer an after-tax return of 12%. a. What is the price of a share of HNH stock? b. Assume that management makes a surprise announcement that HNH will no longer pay dividends but will use the cash to repurchase stock instead. What is the price of a share of HNH stock now? a. What is the price of a share of HNH stock? The price is ______per share (round to the nearest cent) 22. After the market close on May 11, 2001, Adaptec, Inc., distributed a dividend of shares of the stock of its software division, Roxio, Inc. Each Adaptec shareholder received 0.1646 share of Roxio stock per share of Adaptec stock owned. At the time, Adaptec stock was trading at a price of $10.55 per share (cum-dividend), and Roxio's share price was $14.23 per share. In a perfect market, what would Adaptec's ex-dividend share price be after this transaction? The ex-dividend share price would be $ _____ per share. (Round to the nearest cent.)