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essentials corporate finance
Corporate Finance 4th Edition David Hillier - Solutions
20 MM and Taxes In the previous question, suppose the corporate tax rate is 28 per cent. What is EBIT in this case? What is the WACC? Explain.
21 Calculating WACC Strade plc is an all equity financed company. The finance director suggested in a recent meeting with the board of directors a capital restructuring to introduce some debt in the company’s financing to take advantage of the tax benefits of debt. With a corporate tax rate of 40
24 MM and Taxes In problem 23, what is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision?
25 MM Proposition I Levered plc and Unlevered plc are identical in every way except their capital structures.Each company expects to earn £96 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value
28 MM Proposition I with Taxes Bigelli SpA is financed entirely with equity. The company is considering a loan of €1 million. The loan will be repaid in equal instalments over the next two years, and it has an 8 per cent interest rate. The company’s tax rate is 35 per cent. According to MM
29 MM Proposition I without Taxes Alpha NV and Beta NV are identical in every way except their capital structures. Alpha NV, an all-equity firm, has 5,000 shares of equity outstanding, currently worth €20 per share.Beta NV uses leverage in its capital structure. The market value of Beta’s debt
30 Cost of Capital Acetate SA has equity with a market value of €20 million and debt with a market value of€10 million. Treasury bills that mature in one year yield 8 per cent per year, and the expected return on the market portfolio over the next year is 18 per cent. The beta of Acetate’s
31 Homemade Leverage The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The market value of Knight Company’s 6 per cent bonds is SKr1 million.Financial information for the two firms appears here. All earnings streams are perpetuities.
32 MM Propositions Locomotive plc is planning to repurchase part of its ordinary share equity by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 40 per cent to 50 per cent.The firm currently has £7.5 million worth of debt outstanding. The cost of this
33 Share Value and Leverage Green Manufacturing plc plans to announce that it will issue £2 million of perpetual debt and use the proceeds to repurchase equity. The bonds will sell at par with a 6 per cent annual coupon rate. Green is currently an all-equity firm worth £10 million with 500,000
34 MM with Taxes Williamsen GmbH has a debt–equity ratio of 2.5. The firm’s weighted average cost of capital is 15 per cent, and its pre-tax cost of debt is 10 per cent. Williamsen is subject to a corporate tax rate of 35 per cent.(a) What is Williamsen’s cost of equity capital?(b) What is
35 Weighted Average Cost of Capital In a world of corporate taxes only, show that the RWACC can be written as RWACC = RA × [1 – tC (B/V)].
36 Cost of Equity and Leverage Assuming a world of corporate taxes only, show that the cost of equity, RS, is as given in the chapter by MM Proposition II with corporate taxes.
38 Shareholder Risk Suppose a firm’s business operations mirror movements in the economy as a whole very closely – that is, the firm’s asset beta is 1.0. Use the result of the previous problem to find the equity beta for this firm for debt–equity ratios of 0, 1, 5 and 20. What does this
39 Unlevered Cost of Equity Beginning with the cost of capital equation – that is:R WACC = E ____ _ D + E R E + D ____ _ D + E R D show that the cost of equity capital for a levered firm can be written as follows:R E = R A + D __ E( R A − R D )
1 Calculate the return on equity of Sapphire before and after the restructuring. (20 marks)Sapphire is an all-equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15 per cent. The company has decided to modify its capital structure to
2 Write a brief report to the management of Sapphire explaining why the return on equity has changed as a result of restructuring. (20 marks)Sapphire is an all-equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15 per cent. The
3 What is meant by gearing? How does gearing affect the financial risk of a firm? (20 marks)Sapphire is an all-equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15 per cent. The company has decided to modify its capital structure to
4 Assume that the corporate tax rate is 35 per cent, capital gains tax is zero and the personal income tax rate is 45 per cent. What is the value of Sapphire before the restructuring? What is its value after? (20 marks)Sapphire is an all-equity financed company, which is valued at €250 million.
5 What would the personal rate of tax on interest income have to be to push the tax advantage of debt to zero? (20 marks)Sapphire is an all-equity financed company, which is valued at €250 million. The firm’s shares are expected to produce a return of 15 per cent. The company has decided to
1 If Stephenson wishes to maximize its total market value, would you recommend that it issue debt or equity to finance the land purchase? Explain.Stephenson Real Estate was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings,
2 Construct Stephenson’s market value balance sheet before it announces the purchase.Stephenson Real Estate was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a
4 Suppose Stephenson decides to issue debt to finance the purchase.(a) What will be the market value of the Stephenson company if the purchase is financed with debt?(b) Construct Stephenson’s market value balance sheet after both the debt issue and the land purchase.What is the price per share of
5 Which method of financing maximizes the per-share price of Stephenson’s equity?Stephenson Real Estate was founded 25 years ago by the current CEO, Robert Stephenson. The company purchases real estate, including land and buildings, and rents the property to tenants. The company has shown a
1 Locate the annual balance sheets for three firms from your country. For each company calculate the long-term debt–equity ratio for the prior two years. Why would these companies use such different capital structures?
2 Download the annual income statements for another country. For the most recent year, calculate the average tax rate and EBIT, and find the total interest expense. From the annual balance sheets calculate the total long-term debt (including the portion due within one year). Using the interest
1. The Cost of Equity Capital Explain what is meant by the cost of equity capital. How is the cost of equity capital linked to the risk of the assets of a firm? How would you use cost of equity in a capital budget analysis?
1. Determinants and Estimation of Beta What factors determine the beta of a security? Define and describe each. Explain why an equity’s beta is important in capital budgeting. How do you calculate beta and what are the pitfalls you may face in its calculation? Can you foresee any problems with
1. The Capital Budgeting Process What are the six major steps involved in the capital budget process?
1. Extensions of the Basic Model How would you estimate the cost of capital for a project if its risk is different from the rest of the company? Similarly, how would you estimate the cost of capital for a project when the company has debt in its capital structure? When estimating the cost of debt,
1. Practical Concerns What are the main issues you need to consider when estimating the cost of capital of a project in practice? State any potential problems or challenges you may face.
1. Reducing the Cost of Capital Why would a firm wish to reduce its cost of capital? Review different ways in which this can be done. Which way do you think is the most effective? Explain.
1. Estimating the Cost of Capital in Practice Corporations use many methods to estimate the cost of capital. Why do you think there is no consensus on the best method? If you were estimating the cost of capital in an emerging market, what method would you use? Explain.
1. EVA Explain what is meant by economic value added and show how it can be used to evaluate the performance of a firm.REGULAR
1. Project Risk ‘My company can borrow at 5 per cent so it means that its cost of capital for all new projects is 5 per cent.’ Do you agree with this statement? Explain.
1. Company Beta The beta of Ericsson, the Swedish communications technology firm, is 0.38. What do you think is the main determinant of Ericsson’s beta and why? Why do you think Ericsson’s beta is so low?
1. SML Cost of Equity Estimation If you use the equity beta and the security market line to compute the discount rate for a project, what assumptions are you implicitly making? What are the advantages of using the SML approach to finding the cost of equity capital? What are the disadvantages? What
1. Industry Beta What are the benefits of using an industry beta instead of a company beta when undertaking a capital budgeting analysis? Explain, using an example.
1. Cost of Capital How would a manager of a new stock exchange-listed company reduce its cost of equity capital?
Company Risk versus Project Risk Both AstraZeneca plc, a large pharmaceutical firm, and Takeda plc, a major prescription medicine manufacturer, are thinking of investing in an Indian generic drugs company.Assume that both AstraZeneca and Takeda have no debt and both firms are considering identical
SML and Cost of Capital An all-equity firm is considering the following projects:Project Beta Expected Return A 0.6 11%B 0.9 13%C 1.2 14%D 1.7 16%The expected return on the market is 12 per cent, and the current rate on UK gilts is 5 per cent.(a) Which projects have a higher expected return than
1. Calculating Cost of Equity The Dybvig Corporation’s equity has a beta of 1.3. If the risk-free rate is 4.5 per cent and the expected return on the market is 12 per cent, what is Dybvig’s cost of equity capital?
1. Calculating Cost of Debt Advance plc is trying to determine its cost of debt. The firm has a debt issue outstanding with seven years to maturity that is quoted at 92 per cent of face value. The issue makes semi-annual payments and has a coupon rate of 4 per cent annually. What is Advance’s
1. Calculating Cost of Debt Shanken NV issued a 30-year, 10 per cent bond seven years ago. The bond currently sells for 108 per cent of its face value. The company’s tax rate is 35 per cent.(a) What is the pre-tax cost of debt?(b) What is the after-tax cost of debt?(c) Which is more relevant, the
1. Calculating Cost of Debt For the firm in the previous problem, suppose the book value of the debt issue is €20 million. In addition, the company has a second debt issue on the market, a zero coupon bond with seven years left to maturity; the book value of this issue is €80 million and the
1. Calculating WACC Mullineaux Corporation has a target capital structure of 55 per cent equity and 45 per cent debt. Its cost of equity is 16 per cent, and the cost of debt is 9 per cent. The relevant tax rate is 35 per cent. What is Mullineaux’s WACC?
1. Calculating Beta The returns of Siracha plc have a standard deviation of 40 per cent per annum and have a correlation with the FTSE 100 of 0.65. The standard deviation of the FTSE 100 is 20 per cent. What is Siracha’s beta?
1. Leverage Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market line? Why/why not?
1. Finding the Capital Structure Fama’s Llamas has a weighted average cost of capital of 11.5 per cent. The company’s cost of equity is 16 per cent, and its cost of debt is 8.5 per cent. The tax rate is 35 per cent. What is Fama’s debt–equity ratio?
1. Book Value versus Market Value Filer Manufacturing has 9.5 million shares of equity outstanding.The current share price is £53, and the book value per share is £5. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of £75 million and an 8 per cent
1. Calculating the WACC In the previous problem, suppose the company’s equity has a beta of 1.2. The risk-free rate is 5.2 per cent, and the market risk premium is 9 per cent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make
1. WACC Kose SA has a target debt–equity ratio of 0.80. Its WACC is 10.5 per cent and the tax rate is 35 per cent.(a) If Kose’s cost of equity is 15 per cent, what is its pre-tax cost of debt?(b) If instead you know that the after-tax cost of debt is 6.4 per cent, what is the cost of equity?
1. Finding the WACC Given the following information for Huntington Power, find the WACC. Assume the company’s tax rate is 28 per cent.Debt: 40,000 7 per cent coupon bonds outstanding, £100 par value, 20 years to maturity, selling for 103 per cent of par; the bonds make semi-annual
1. Finding the WACC The power systems firm, Raging Volts, has a market value of equity of £15.77 billion and total debt of £1.21 billion. The cost of equity capital is 19.96 per cent and the cost of debt is 5 per cent.If the company has a marginal tax rate of 24 per cent, what is its WACC?
WACC and NPV Och SpA is considering a project that will result in initial after-tax cash savings of€3.5 million at the end of the first year, and these savings will grow at a rate of 5 per cent per year indefinitely. The firm has a target debt–equity ratio of 0.65, a cost of equity of 15 per
Preference Shares and WACC Bottled Water is a listed European company, which has a corporate finance structure as shown below. What is the company’s WACC?Debt: 50,000 bonds with a quoted price of 119.80, providing an 8 per cent coupon rate.The bonds have 25 years to maturity. There are also
Project Evaluation This is a comprehensive project evaluation problem bringing together much of what you have learned in this and previous chapters. Suppose you have been hired as a financial consultant to Defence Electronics International (DEI), a large, publicly traded firm that is the market
Fresnillo plc explores and mines gold and silver in Mexico. The gold production accounts for 55 per cent of the activities of the firm, with the rest of the effort involved in silver mining. Other gold-mining firms have an average beta of 0.8 and a debt to equity ratio of 1/3. Silver mining is less
1. Discuss the primary determinants of beta and how they can be measured. In Fresnillo’s case, what do you think will be the most important determinant? Explain. (30 marks)
How could Fresnillo reduce its equity cost of capital? Explain, using examples to illustrate your answer.(30 marks)
1 Go to Ryanair’s website and download its most recent financial accounts. Seek out the details on its borrowings and look for the coupon on its debt. If you cannot find it, you will need to go on to the internet to seek out similar budget airline debt issues. The objective is to find an
2 To estimate the cost of equity for MA, go to www.reuters.com and enter the ticker symbol ‘RYA.L’. Follow the various links to find answers to the following questions: What is the most recent share price listed for Ryanair? What is the market value of equity, or market capitalization? How many
3 We now need to estimate the historical market risk premium. Go to Yahoo! Finance, download the monthly historical prices for the FTSE 100 index for the last five years. Calculate the monthly returns, take the average and multiply this by 12 to get the annualized historical return on the FTSE 100.
4 Go to www.reuters.com and find the list of competitors in the industry. Find the beta for each of these competitors, and then calculate the industry average beta. Using the industry average beta, what is the cost of equity? Does it matter if you use the beta for Ryanair or the beta for the
5 You now need to calculate the cost of debt for Ryanair. Use the information on Ryanair bonds to find the weighted average cost of debt for Ryanair using the book value weights. Try to find bond prices for Ryanair debt. What should you do if no information is available? Does it make a difference
6 You now have all the necessary information to calculate the weighted average cost of capital for Ryanair.Calculate the weighted average cost of capital for Ryanair using book value weights and market value weights, assuming Ryanair has a 24 per cent tax rate. Which cost of capital number is more
7 You used Ryanair as a representative company to estimate the cost of capital for MA. What are some of the potential problems with this approach in this situation? What improvements might you suggest?You have recently been hired by Martyn Airlines (MA), a budget airline based in and around the
1 The Basic Forms of Acquisitions Describe the three main types of acquisitions and provide a real-life example of each. Which type of merger do you think creates more value for shareholders? Explain.
2 Synergy Explain the concept of synergy and provide examples of sources of synergy. Where does synergy come from? Is it possible that a merged company will not benefit from synergies? Discuss.
3 M&A Waves Why do you think that M&A activity often clusters in time, causing M&A waves? What M&A waves can you identify from history? Are there any factors that you think are uniquely favourable to M&A activity today? Explain.
4 Bad Reasons for Mergers(a) Many explanations and justifications are made by acquiring (and sometimes target) managers for a merger. Review these justifications and discuss whether they are good or bad for shareholders.(b) An argument has been made that financial mergers are bad for shareholders
5 Method of Payment in M&As Outline the two broad methods of payment in M&A transactions. What might determine the method of payment, and what impact does this have on both the acquiring and the target firm?
6 NPV of a Merger Describe the main uncertainties that are involved in a merger analysis. Are mergers an ideal activity in which to use real option valuation? Discuss some of the ways in which a real option analysis could be used to value a merger.
7 Merger Valuation in Practice Discuss the main steps that are involved in a merger analysis.
8 Friendly versus Hostile Takeovers What types of actions might the management of a firm take to fight a hostile acquisition bid from an unwanted suitor? How do the target firm shareholders benefit from the defensive tactics of their management team? How are the target firm shareholders harmed by
9 Defensive Tactics Review the various tactics that a target firm’s management may use when trying to deter a hostile takeover attempt. For each tactic, provide a balanced discussion of whether it is good or bad for the target’s shareholders.
10 The Diary of a Takeover Compare and contrast a successful merger or acquisition with a failed one.What were the factors that contributed to the success and failure of the deals?
11 Managerial Motives for Takeovers Outline the managerial motives for takeovers.
12 Accounting for Mergers and Takeovers Explain the acquisition method of accounting for mergers and acquisitions. What effect does expensing merger costs have on the viability of a potential merger or acquisition?
13 Divestitures Why would a firm wish to sell off its assets? If the sold divisions are so bad, why are buyers found for them?REGULAR
15 Merger Rationale During the financial crisis that engulfed most of Europe, two large banks, Lloyds TSB Group and HBOS, merged in order to diversify risk. Is this a good or bad idea? Explain.
16 Corporate Split In 2019, the African conglomerate, Naspers Ltd, announced that it planned to spin off a new company that included its tech investments, ranging from food delivery to auction platforms for second-hand goods. What is the benefit of a spin-off of this type for a conglomerate? Why
17 Shareholder Rights Plans Are shareholder rights plans good or bad for equityholders? How do you think acquiring firms are able to get around them? What effect do you think the legal dubiety of shareholder rights plans in Europe has had on hostile takeovers?
18 Merger and Taxes Many commentators have argued that differences in tax regulations, especially regarding mergers and acquisitions, have reduced the viability of this corporate activity. Do you agree with this? Explain.
19 Economies of Scale Iberdrola, the Spanish electricity giant, has in recent years pursued an aggressive acquisition strategy throughout the world. Companies that have been acquired by the firm include Scottish Power (UK, 2006), Energy East (USA, 2008), Elektro (Brazil, 2011) and UIL Holdings
20 Bid Offers In 2019, GuestReady, a company that helps Airbnb hosts manage their properties, purchased the France and Portugal-based rival BnbLord outright. Both companies provide services such as cleaning, laundry, check-in/check-out services, listing generation, price management and other
21 Bid Offers Falcon plc and Thor plc have entered into a stock swap merger agreement whereby Falcon will pay a 30 per cent premium over Thor’s pre-merger price of £30. If Falcon’s pre-merger price was £40, what exchange ratio will Falcon need to offer?
22 Calculating Synergy Assume that ABC plc is planning to offer £30 billion cash for all of the equity in XYZ plc. Based on recent market information, XYZ is worth £20 billion as an independent operation. If the merger makes economic sense for ABC, what is the minimum estimated value of the
23 Balance Sheets for Mergers Consider the following pre-merger information about firm X and firm Y:Firm X Firm Y Total earnings (£) 74,000 35,000 Shares outstanding 21,000 10,000 Per share values:Market (£) 25 28 Book (£) 20 7 Assume that firm X acquires firm Y by paying cash for all the shares
24 Balance Sheets for Mergers Assume that the following balance sheets are stated at book value.Construct a post-merger balance sheet assuming that Reflection plc purchases Lhanger plc, and both sets of accounts are presented according to International Financial Reporting Standards.REFLECTION
25 Balance Sheets for Mergers Silver Enterprises has acquired All Gold Mining in a merger transaction.Construct the balance sheet for the new corporation. The following balance sheets represent the pre-merger book values for both firms:SILVER ENTERPRISES(£) (£)Current assets 6,600 Current
27 EPS, PE and Mergers The shareholders of Flannery SA have voted in favour of a buyout offer from Stultz plc. Information about each firm is given here:Flannery Stultz Price–earnings ratio 5.25 21 Shares outstanding 60,000 180,000 Earnings £300,000 £675,000 Flannery’s shareholders will
28 Merger Rationale Ziff Electrics (ZE) is a public utility that provides electricity to the whole Yorkshire region.Recent events at its Mile-High Nuclear Station have been discouraging. Several shareholders have expressed concern over last year’s financial statements.Income Statement Last
30 Cash versus Equity as Payment In problem 29, are the shareholders of firm T better off with the cash offer or the equity offer? At what exchange ratio of B shares to T shares would the shareholders in T be indifferent between the two offers?
31 Effects of an Equity Exchange Consider the following pre-merger information about firm A and firm B:Firm A Firm B Total earnings (DKr) 900 600 Shares outstanding 550 220 Price per share (DKr) 40 15 Assume that firm A acquires firm B via an exchange of equity at a price of DKr20 for each share of
35 Mergers and Shareholder Value Gentley plc and Rolls Manufacturing are considering a merger.The possible states of the economy and each company’s value in that state are shown here:State Probability Gentley Rolls Boom 0.45 £300,000 £260,000 Recession 0.55 £110,000 £80,000 Gentley currently
36 Calculating NPV Plant AG is considering making an offer to purchase Palmer AG. Plant’s vice president of finance has collected the following information:Plant Palmer Price–earnings ratio 12.5 9 Shares outstanding 1,000,000 550,000 Earnings €2,000,000 €580,000 Dividends €600,000
37 Mergers and Shareholder Value The Chocolate Ice Cream Company and the Vanilla Ice Cream Company have agreed to merge and form Fudge Swirl Consolidated. Both companies are exactly alike except that they are located in different towns. The end-of-period value of each firm is determined by the
1 Linfrae plc is a computer software development firm and is considering a hostile takeover of Jaffikake plc, a software distribution firm. Linfrae has been advised by its investment bankers that a combined development and distribution firm would lead to annual cost savings of £7 million for the
2 It has been proposed that Linfrae plc should bid for Jaffikake using equity instead of cash. Linfrae’s investment bankers advise Linfrae to offer three shares of Linfrae for every one share of Jaffikake. What is the percentage premium offered to Jaffikake’s shareholders? Evaluate the takeover
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