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15 views2 pages

Assignment 1 Online-3

Uploaded by

Ushanthini Nithanthan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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FIN 643 Corporate Financial Policy

(Spring 2024) Online


Assignment 1
Total 100 points (5% of overall grade)

▪ To be submitted online through Canvas in ONE document (excel/word/pdf format)


▪ Typing out answers on Word or Excel is preferred but scanned handwritten work is also
acceptable provided the answers are written legibly.
▪ Show intermediate steps for part mark in case your final answer is wrong. Note that you
will get some points as long as you attempt a question with some effort.

Question 1 (10 Points)


Brannan Manufacturing has a target debt-equity ratio of .35. Its cost of equity is 12.6 percent, and
its pretax cost of debt is 7.3 percent. If the tax rate is 21 percent, what is the company’s WACC?

Question 2 (10 Points)


Fama’s Llamas has a weighted average cost of capital of 9.9 percent. The company’s cost of equity
is 13.5 percent, and its pretax cost of debt is 8.1 percent. The tax rate is 24 percent. What is the
company’s debt-equity ratio?

Question 3 (20 Points)


Dani Corporation has 7 million shares of common stock outstanding. The current share price is
$67, and the book value per share is $6. The company also has two bond issues outstanding. The
first bond issue has a face value of $60 million, a coupon rate of 7 percent, and sells for 92 percent
of par. The second issue has a face value of $45 million, a coupon rate of 6 percent, and sells for
104 percent of par. The first issue matures in 22 years, the second in 7 years.

Suppose the most recent dividend was $4.15 and the dividend growth rate is 4.2 percent. Assume
that the overall cost of debt is the weighted average of that implied by the two outstanding debt
issues. The tax rate is 23 percent. What is the company’s WACC?

(Hint: You will need to find the yield to maturity (YTM) of each bond assuming semi-annual
coupon payout, see textbook Chapter 8; You can also safely assume the par value of the bonds are
close enough to their market value)

1
Question 4 (30 Points)
Foundation Corporation is comparing two different capital structures, an all-equity plan (Plan I)
and a levered plan (Plan II). Under Plan I, the company would have 195,000 shares of stock
outstanding. Under Plan II, there would be 145,000 shares of stock outstanding and $2.1 million
in debt outstanding. The interest rate on the debt is 8 percent and there are no taxes.
Answer the followings:
a. If EBIT is $550,000, what is the earnings per share (EPS = Net income/no. of shares) for each plan?
b. If EBIT is $800,000, what is the EPS for each plan?
c. What is the break-even EBIT?

(Hints: To find EPS, you need to calculate Net Income from EBIT)

Question 5 (10 Points)


Foundation Corporation is comparing two different capital structures, an all-equity plan (Plan I)
and a levered plan (Plan II). Under Plan I, the company would have 205,000 shares of stock
outstanding. Under Plan II, there would be 155,000 shares of stock outstanding and $2.17 million
in debt outstanding. The interest rate on the debt is 6 percent and there are no taxes.
What is the value of the firm under each of the two proposed plans?

Question 6 (20 Points)


Good Time Company is a regional chain department store. It will remain in business for one more
year. The probability of a boom year is 70 percent and the probability of a recession is 30 percent.
It is projected that the company will generate a total cash flow of $187 million in a boom year and
$78 million in a recession. The company's required debt payment at the end of the year is $112
million. The market value of the company’s outstanding debt is $85 million. The company pays
no taxes.

a. What payoff do bondholders expect to receive in the event of a recession?


b. What are the promised and expected returns on the company's debt to the bondholders
respectively?

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