Consider a Modigliani and Miller (1958, 1963) economy, but with the existence of different risk classes....

 

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Consider a Modigliani and Miller (1958, 1963) economy, but with the existence of different risk classes. The pre-tax cost of debt is 4%, the rate of corporation tax is 35%, and the return on the market portfolio is 13%. You are given the following data upon four companies in this economy: Delta Echo Foxtrot Golf Market value of equity (€'m) Market value of debt (€'m) CAPM beta (leveraged) 60 35 145 45 105 17 35 67 1.4 1.5 1.1 0.9 Delta is an electronic goods manufacturing company; Echo is a navigation technology company; Foxtrot is a car-parts manufacturing company; and Golf is a highly diversified company with overall business risk approximately equal to the average business risk across the economy. Delta is considering undertaking a new project which involves the manufacture and sale of a new car satellite navigation system. The project will require an up-front investment of €16m and would increase Delta's pre- tax net operating income by 15% above its current level. The investment would be funded by the issue of €10m equity and €6m debt. Estimate and discuss the impact that the project would have on the value of Delta; and advise the company. Consider a Modigliani and Miller (1958, 1963) economy, but with the existence of different risk classes. The pre-tax cost of debt is 4%, the rate of corporation tax is 35%, and the return on the market portfolio is 13%. You are given the following data upon four companies in this economy: Delta Echo Foxtrot Golf Market value of equity (€'m) Market value of debt (€'m) CAPM beta (leveraged) 60 35 145 45 105 17 35 67 1.4 1.5 1.1 0.9 Delta is an electronic goods manufacturing company; Echo is a navigation technology company; Foxtrot is a car-parts manufacturing company; and Golf is a highly diversified company with overall business risk approximately equal to the average business risk across the economy. Delta is considering undertaking a new project which involves the manufacture and sale of a new car satellite navigation system. The project will require an up-front investment of €16m and would increase Delta's pre- tax net operating income by 15% above its current level. The investment would be funded by the issue of €10m equity and €6m debt. Estimate and discuss the impact that the project would have on the value of Delta; and advise the company.

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