CORPORAT

GROUP 3
Maria Antonova
Ksenia Denissenko
Timucin Tardu
Caglar Ozyesil
QUESTION 1

1-)Regarding Smith's point of view the following data can be used as counter argument:
1)In general divident iniations are associated with higher future earnings growth
2)Since Medical Instruments (MI) has a negative 84 M$ cashflow from investing securities, it bac
NPV projects. As a result company MI has big growth opportunities
3)Since during the past three years, MI has made significant share repurchases, the investors al
0.40 per share would be perceived as a continuation of the ongoing company policy rather than
4)The five year forecast looks very positive with 8% annually sales growth and 11% annually ea

2-) When a a stock dividend happens it should have no effect on shareholder wealth. Because c
the dividend paid or after the dividend paid (company percentage plus earnings). Considering th
compensated by the greater number of shares owned.

2-) When a a stock dividend happens it should have no effect on shareholder wealth. Because c
the dividend paid or after the dividend paid (company percentage plus earnings). Considering th
compensated by the greater number of shares owned.

3-) The statement of cash flows shows that the 0.40$ per share annual dividend reflects a total
projects, which is a sign that MI will continue to invest and grow while realizing the 0.40$ per sh
will continue forever, the company MI should entertatin the possibility of impelementing a resid
consider funding the positive NPV projects first, and then with the remaining cashflow they shou

QUESTION 2
Copper Co. provides copper-wired components for cellular telephone manufactures globally. Cop
structure that would minimize its cost of capital for the subsidiary. The company wants to evalu
percent debt and possible 50 percent debt or 80 percent debt. The companys marginal tax rate
-The cost of equity rises with increased levels of debt from 15 percent to 18 percent to 24 perce
- The company can borrow at 12percent on 50 percent debt or at 16 percent on 80 percent debt
- Which capital structure is expected to have the lowest cost of capital?

Tax Rate

Assets
Debt
Equity
Debt/Equity
Debt Proportion
Equity Proportion
Cost of debt before Tax
Cost of Equity
After Tax Cost of Debt

35%

$
$
$

Weighted Average Cost of

No Debt
50% Debt
3,000,000,000
###
- $ 1,500,000,000
3,000,000,000 $ 1,500,000,000
0
1
0
50%
100%
50%
0
12%
15%
18%
0
7.8%
15.0%

12.9%

50% Debt capital structure yields the lowest cost of capital

QUESTION 3
Bay Transport Systems (BTS) currently has $30 million in debt outstanding. In addition to 6.5% i
and if the interest tax shields have the same risk as the loan, what is the present value of the in
Debt
Interest Rate
Repayment
Marginal Corporate Tax Rate

30,000,000
6.5%
5%
40%

Interest Tax Shield @ 1 year

780,000

Since the outstanding balance will decline, the interest tax shield will also. So we can consider i
g
r

Growth Rate
Present Value

5.0%
6.5%

6,782,609

QUESTION 4
Suppose The Washington Post Company (WPO) has no debt and an equity cost of capital of 9.2%
the average amount of debt for its industry at a cost of debt of 6%?
Equity cost of Capital
Avrg. Debt to Value Ratio
Cost of Debt

9.2%
13.0%
6.0%

re=rc+(D/E)*(ru-rd)
re=

9.68%

QUESTION 5
Rogot Instruments makes fine violins and cellos. It has $1 million in debt outstanding, equity va
7%.
a. What is Rogots pretax WACC?
b. What is Rogots (effective after-tax) WACC?
Debt outstanding
Equity
Corporate income tax
Cost of Equity
Cost of Debt
Pretax WACC
Effective after tax WACC

$
$

1,000,000
2,000,000
35.0%
12.0%
7.0%
10.33%
9.52%

QUESTION 6
Summit Builders has a market debt-equity ratio of 0.65 and a corporate tax rate of 40%, and it p

Debt Equity Ratio

0.65

Corporate Tax
Interest on Debt

40%
7%

WACC=Pretax WACC-D/(D+E)*Interest*Corporate Tax

1.1%

QUESTION 7
Luther Industries has no debt, a total equity capitalization of $20 billion, and a beta of 1.8. Inclu
1) What is Luther's enterprise value?
2) Considering the fact that Luther's Cash is risk-free, Calculate Luther's unlevered beta?

Equity
Beta
Asset

$
$

20,000,000,000
1.8
4,000,000,000

Enterprise value = Market value of equity+ Debt - Cash

$ 16,000,000,000

Bu=Be * E/E+D + Bd * D/E+D

2.25

GROUP 3
In mid-2012, AOL Inc. had $100 million in debt, total equity capitalization of $3.1 billion, and an
securities. Assume that the risk-free rate of interest is 3% and the market risk premium is 4%.
a. What is AOLs enterprise value?
b. What is the beta of AOLs business assets?
c. What is AOLs WACC?

Debt
Equity
Beta
Assets
Risk free Interest Rate
Market Risk Premium

$
$
$

100,000,000
3,100,000,000
0.9
1,500,000,000
3%
4%

Enterprise Value = Market Capitalization + Debt + Shared Capital + Minority Interest - Cash Eq
Enterprise Value =
$
1,700,000,000

Ba = Be * E/D+E +Bd* D/D+E

0.87

WACC=(E/V)*Re+(D/V)*Rd*(1-Tc)

Tax rate @ 2012 (From AOL 2012

39.50%
3.90%
4.00%
3.85%

CORPORATE FINANCE GROUP WORK

s counter argument:
nings growth
m investing securities, it backs up the knowledge that MI is highly profitable and has substantial positive Free C

epurchases, the investors already know that the company is distributing cash to its shareholders and the initiat
company policy rather than a negative indicator
growth and 11% annually earnings growth

areholder wealth. Because considering the same amount of shares a shareholder owns, their wealth due to the c
lus earnings). Considering the other variables constant, the price of the stock may decrease due to the dividend

ual dividend reflects a total amount of $15M (proposed dividend) considering the company MI used $84M of fre
le realizing the 0.40$ per share annual dividend strategy. Furthermore instead of making this 0.40$ per share a
ty of impelementing a residual divident policy rather than stable dividend policy. Which means for the following
emaining cashflow they should decide whether to change or continue with the same 0.40$ per share ratio.

e manufactures globally. Copper Co. is going to establish a subsidiary that would require assets of 3 Billion USD,
he company wants to evaluate a target leverage structure and uses a scenario approach to evaluate the cost o
companys marginal tax rate is 35 percent. The following information is available regarding the cost of capital:
ent to 18 percent to 24 percent
6 percent on 80 percent debt.
tal?

80% Debt
$ 3,000,000,000
$ 2,400,000,000
$
600,000,000
4
80%
20%
16%
24%
10.4%
13.1%

anding. In addition to 6.5% interest, it plans to repay 5% of the remaining balance each year. If BTS has a margi
s the present value of the interest tax shield from the debt?

ill also. So we can consider interest tax rate as a growing perpetuity.

equity cost of capital of 9.2%. The average debt-to-value ratio for the publishing industry is 13%. What would it

debt outstanding, equity valued at $2 million, and pays corporate income tax at a rate of 35%. Its cost of equity

rate tax rate of 40%, and it pays 7% interest on its debt. The interest tax shield from its debt lowers Summits W

D/(D+E)

0.394

lion, and a beta of 1.8. Included in Luther's assets are $4 billion in cash and risk-free securities.

her's unlevered beta?

zation of $3.1 billion, and an equity beta of 0.90 (as reported on Yahoo! Finance). Included in AOLs assets was $
market risk premium is 4%.

Minority Interest - Cash Equivalents

tantial positive Free Cash Flow after funding positive

holders and the initiation of an annual dividend of $

eir wealth due to the company stocks are equal before

y MI used $84M of free cash flow for positive NPV

ssets of 3 Billion USD, and it wants to select a capital

ear. If BTS has a marginal corporate tax rate of 40%,

is 13%. What would its cost of equity be if it took on

35%. Its cost of equity is 12% and its cost of debt is

ebt lowers Summits WACC by what amount?

urities.

in AOLs assets was $1.5 billion in cash and risk-free