F2 Q6-10

6.

Note: Questions 6 10 are based on the same mega problem. For convenience we have included the entire set of information in every question. For purposes of the questions that follow, assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other. This is the assumption we made in most of the videos to focus on valuation effects of borrowing and taxes and to figure out the key differences between alternative valuation methods.

ABC, Inc.s revenues have been $300,000 and total costs have been $150,000; both costs and revenues are expected to remain the same in perpetuity. ABC, Inc. is an all equity firm (i.e., it has no debt) and has 75,000 shares outstanding. The market knows that the company has no other investment (or growth) opportunities. ABC, Inc. currently pays out all its earnings as dividends (100% payout) and is expected to do so forever. The dividends on the basis of last years earnings have just been paid out. If the appropriate discount rate for ABC, Inc. is 6.50%, what is the market value of ABC, Inc.? For this question, assume taxes are zero. (Enter the nearest rounded dollar number without any $ or comma sign.)

7.

ABC, Inc.s revenues have been $300,000 and total costs have been $150,000; both costs and revenues are expected to remain the same in perpetuity. ABC, Inc. is an all equity firm (i.e., it has no debt) and has 75,000 shares outstanding. The market knows that the company has no other investment (or growth) opportunities. ABC, Inc. currently pays out all its earnings as dividends (100% payout) and is expected to do so forever. The dividends on the basis of last years earnings have just been paid out. If the appropriate discount rate for ABC, Inc. is 6.50%, what is its price to earnings ratio? For this question, assume taxes are zero. (Enter the number with no more than two decimals.)

8.

ABC, Inc.s revenues have been $300,000 and total costs have been $150,000; both costs and revenues are expected to remain the same in perpetuity. ABC, Inc. is an all equity firm (i.e., it has no debt) and has 75,000 shares outstanding. The market knows that the company has no other investment (or growth) opportunities. ABC, Inc. currently pays out all its earnings as dividends (100% payout) and is expected to do so forever. The dividends on the basis of last years earnings have just been paid out. The appropriate discount rate for ABC, Inc. is 6.50%. The CEO of ABC, Inc. has a very exciting plan to make his company look more attractive to investors. He suggests to his CFO that if the firm gets into a riskier (higher beta asset) business, the required return on assets and equity of ABC, Inc. will both go up and it will make the firm more attractive to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the logic behind it. Frustrated with his CFOs argumentative stance, the CEO finally simply states: I do not have to convince you, Margaret, especially since my plan is fool proof. My aggressive strategy will make our company attractive to any acquirer because it will increase both the return on assets and equity and, consequently, make them offer us a lot more money for our assets than they would otherwise. Is the CEO correct in believing that the return on equity of ABC, Inc. will go up? For this question, assume taxes are zero.

a. Yes.

b. It depends.

c. No.

9.

Note: Questions 6 10 are based on the same mega problem. For convenience we have included the entire set of information in every question. For purposes of the questions that follow, assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other. This is the assumption we made in most of the videos to focus on valuation effects of borrowing and taxes and to figure out the key differences between alternative valuation methods.

ABC, Inc.s revenues have been $300,000 and total costs have been $150,000; both costs and revenues are expected to remain the same in perpetuity. ABC, Inc. is an all equity firm (i.e., it has no debt) and has 75,000 shares outstanding. The market knows that the company has no other investment (or growth) opportunities. ABC, Inc. currently pays out all its earnings as dividends (100% payout) and is expected to do so forever. The dividends on the basis of last years earnings have just been paid out. The appropriate discount rate for ABC, Inc. is 6.50%. The CEO of ABC, Inc. has a very exciting plan to make his company look more attractive to investors. He suggests to his CFO that if the firm gets into a riskier (higher beta asset) business, the required return on assets and equity of ABC, Inc. will both go up and it will make the firm more attractive to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the logic behind it. Frustrated with his CFOs argumentative stance, the CEO finally simply states: I do not have to convince you, Margaret, especially since my plan is fool proof. My aggressive strategy will make our company attractive to any acquirer because it will increase both the return on assets and equity and, consequently, make them offer us a lot more money for our assets than they would otherwise. Is the CEO correct in believing that acquiring a riskier business will make ABC, Inc. more attractive to acquirers? For this question, assume taxes are zero.

a. No.

b. Not necessarily.

c. Yes.

10.

Note: Questions 6 10 are based on the same mega problem. For convenience we have included the entire set of information in every question. For purposes of the questions that follow, assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other. This is the assumption we made in most of the videos to focus on valuation effects of borrowing and taxes and to figure out the key differences between alternative valuation methods.

ABC, Inc.s revenues have been $300,000 and total costs have been $150,000; both costs and revenues are expected to remain the same in perpetuity. ABC, Inc. is an all equity firm (i.e., it has no debt) and has 75,000 shares outstanding. The market knows that the company has no other investment (or growth) opportunities. ABC, Inc. currently pays out all its earnings as dividends (100% payout) and is expected to do so forever. The dividends on the basis of last years earnings have just been paid out. The appropriate discount rate for ABC, Inc. is 6.50%. The CEO of ABC, Inc. has a very exciting plan to make his company look more attractive to investors. He suggests to his CFO that if the firm gets into a riskier (higher beta asset) business, the required return on assets and equity of ABC, Inc. will both go up and it will make the firm more attractive to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the logic behind it. Frustrated with his CFOs argumentative stance, the CEO finally simply states: I do not have to convince you, Margaret, especially since my plan is fool proof. My aggressive strategy will make our company attractive to any acquirer because it will increase both the return on assets and equity and, consequently, make them offer us a lot more money for our assets than they would otherwise. In spite of objections from the CFO, the CEO announces that the firm will use raise $1.50M debt at an interest rate of 3.50% in a riskier business with a higher return on assets than the current 6.50%. For this question, assume taxes are zero. The price per share of ABC, Inc. will:

a. Will remain unchanged.

b. Decrease at this announcement.

c. Increase at this announcement.

d. Not enough information available to analyze the impact.