Questions: 1. (a) States what is the pecking order theory? (3%) (b) Are CEOs subject to...

Transcribed Image Text:

Questions: 1. (a) States what is the pecking order theory? (3%) (b) Are CEOs subject to agency problem in the pecking order theory? (2%) (c) In the pecking order theory, what is the factor CEO considers in determining how to finance firm's projects? (2%) (d) What are the implications arising from 6 Coventitial sett the pecking order theory? That is, what are the predictions of the pecking order theory? (3%). 2. Discuss MM Propositions I and II in a world without taxes. List (a) the basic assumptions (2%), (b) results (=predictions), (2%) and (c) intuition of the model. (2%) 3. Discuss MM Propositions I and II in a world with taxes. List the basic assumptions (2%), (b) results (2%) (c), and intuition of the model. (2%) 4. States or defines (a) trade-off hypothesis of capital structure (3%) (b) signaling hypothesis of capital structure (3%) (c) free cash flow hypothesis of capital structure(3%). 5. The indirect costs of financial distress include impaired ability to conduct business and the agency cost between shareholders and debtholders, which is magnified when financial distress is incurred. Illustrate three kinds of selfish strategies that shareholders use to hurt the bondholders and help themselves. (6%). 6. Note: (You must demonstrate how you get the answer. That is, write the procedure of calculation for the question. You can't get the score if you don't show your calculation of the answer.) Black Co. is considering a $10 million project that last five years, implying straight-line depreciation per year of $2 million. The cash revenues less cash expenses per year are $3,500,000. The corporate tax rate is 21 percent. The risk-free rate is 10 percent, and the cost of unleveraged equity is 20 percent. The present values of a 5-year annuity of $1 per year with discounted rate of 10% and 20% are 3.7908 and 2.9906, respectively. The present values of $1 to be received after 5 years with discounted rate of 10% and 20% are 0.6209 and 0.4019, respectively. Additional information is as follows: (1) Black Co. can obtain a 5-year, nonamortizing loan for $7,500,000 after flotation costs at the risk-free rate of 10%. The flotation cost is 1 percent of the gross proceeds of its loan. (2) Suppose that the project of Black Co. is deemed socially beneficial and the state of New Jersey grants the firm a $7,500,000 loan at 8% interest. The flotation costs are absorbed by the state. Requirements: (1) What is the value of the project if the project is financed with all equity? (2%) (2) If Black Co. also finances its project with debt, (a) how much are total debt needed to be financed (2%) and its flotation costs (2%)? (3) What are the NPV of the loan (2%) and the adjusted NPV (2%) when considering the debt financing to conduct the project? (4) Alternatively, if the debt is borrowed from the New Jersey, what are the value of loan from the state (2%) and the adjust NPV of the project (2%)? Questions: 1. (a) States what is the pecking order theory? (3%) (b) Are CEOs subject to agency problem in the pecking order theory? (2%) (c) In the pecking order theory, what is the factor CEO considers in determining how to finance firm's projects? (2%) (d) What are the implications arising from 6 Coventitial sett the pecking order theory? That is, what are the predictions of the pecking order theory? (3%). 2. Discuss MM Propositions I and II in a world without taxes. List (a) the basic assumptions (2%), (b) results (=predictions), (2%) and (c) intuition of the model. (2%) 3. Discuss MM Propositions I and II in a world with taxes. List the basic assumptions (2%), (b) results (2%) (c), and intuition of the model. (2%) 4. States or defines (a) trade-off hypothesis of capital structure (3%) (b) signaling hypothesis of capital structure (3%) (c) free cash flow hypothesis of capital structure(3%). 5. The indirect costs of financial distress include impaired ability to conduct business and the agency cost between shareholders and debtholders, which is magnified when financial distress is incurred. Illustrate three kinds of selfish strategies that shareholders use to hurt the bondholders and help themselves. (6%). 6. Note: (You must demonstrate how you get the answer. That is, write the procedure of calculation for the question. You can't get the score if you don't show your calculation of the answer.) Black Co. is considering a $10 million project that last five years, implying straight-line depreciation per year of $2 million. The cash revenues less cash expenses per year are $3,500,000. The corporate tax rate is 21 percent. The risk-free rate is 10 percent, and the cost of unleveraged equity is 20 percent. The present values of a 5-year annuity of $1 per year with discounted rate of 10% and 20% are 3.7908 and 2.9906, respectively. The present values of $1 to be received after 5 years with discounted rate of 10% and 20% are 0.6209 and 0.4019, respectively. Additional information is as follows: (1) Black Co. can obtain a 5-year, nonamortizing loan for $7,500,000 after flotation costs at the risk-free rate of 10%. The flotation cost is 1 percent of the gross proceeds of its loan. (2) Suppose that the project of Black Co. is deemed socially beneficial and the state of New Jersey grants the firm a $7,500,000 loan at 8% interest. The flotation costs are absorbed by the state. Requirements: (1) What is the value of the project if the project is financed with all equity? (2%) (2) If Black Co. also finances its project with debt, (a) how much are total debt needed to be financed (2%) and its flotation costs (2%)? (3) What are the NPV of the loan (2%) and the adjusted NPV (2%) when considering the debt financing to conduct the project? (4) Alternatively, if the debt is borrowed from the New Jersey, what are the value of loan from the state (2%) and the adjust NPV of the project (2%)?