Problem 20.6
20.6 KIC, Inc., plans to issue $5 million of perpetual bonds.The face
value of each bond is $1,000. The annual coupon on the bonds is 12
percent. Market interest rates on one-year bonds are11 percent.With
equal probability, the long-term market interest rate will be either
14 percent or 7 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are noncallable,what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their
price be greater than
or less than the price you computed in (a)? Why?
Problem 15.2
15.2 Acetate, Inc., has equity with a market value of $20 million and
debt with a market value of$10 million.The cost of the debt is 14
percent per annum.Treasury bills that mature in one year yield 8
percent per annum, and the expected return on the market portfolio
over the next year is 18 percent.The beta of Acetate?s equity is
0.9.The firm pays no taxes.
a. What is Acetate?s debt-equity ratio? 2:1 or 200%
b. What is the firm?s weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?
Problem 15.6
15.6 Rayburn Manufacturing, Inc., is currently an all-equity firm that
pays no taxes. The market value of the firm?s equity is $2 million.
The cost of this unlevered equity is 18 percent per annum. Rayburn
plans to issue $400,000 in debt and use the proceeds to repurchase
stock. The cost of debt is 10 percent per annum.
a. After Rayburn repurchases the stock,what will the firm?sweighted
average cost of capital be?
b. After the repurchase, what will the cost of equity be? Explain.
c. Use your answer to (b) to compute Rayburn?s weighted average cost
of capital after the
repurchase. Is this answer consistent with (a)?
Quiz Question 1
1. A10-year Treasury bond is issued with a face value of $1,000,
paying interest of $60 a year. If market yields increase shortly
after the T-bond is issued, what happens to the bond?s:
a. coupon rate?
b. price?
c. yield to maturity?
2. A bond with a coupon rate of 8 percent
Quiz Question 8
8. Company Z-prime is like Z in all respects save one: Its growth will
stop after year 4. In
year 5 and afterward, it will pay out all earnings as dividends. What
is Z-prime?s stock
price? Assume next year?s EPS is $15.
f. Present Value Lease Problem?Calculating Annual Payments
Leases R Us, Inc. (LRU) has been contracted by Robotics of Beverly
Hills (RBH) to provide lease financing for a machine that would assist
in automating a large part of their current assembly line. Annual
lease payments will start at the beginning of each year. The purchase
price of this machine is $200,000, and it will be leased by RBH for a
period of 5 years. LRU will utilize straight line depreciation of
$40,000 per year with a zero book salvage value. However, salvage
value is estimated to actually be $35,000 at the end of 5 years. LRU
is required to earn a 14%, after-tax rate of return on the lease. LRU
uses a marginal tax rate of 40%. Calculate the annual lease payments.
(Remember, these payments are to be considered at the beginning of
each year?annuity due.)
Hints for students:
There are 3 major steps that need to be accomplished in order to
calculate the annual lease payment.
Step A: You need to calculate the amount to be amortized. This would
be the cost of the machine less the PV of the after tax salvage value
of the machine and less the PV of the depreciation tax shield
Step B: You need to calculate the annual after-tax required lease
income. (Remember, in this step, you need to calculate it as an
annuity due?a beginning of the year payment.) Take your answer from
Step A as a present value, and using the number of years and the
required rate of return, calculate the payment.
Step C: Calculate the lease payment. You need to adjust for the
appropriate tax rate. Therefore, take your answer in Step B and divide
it by (1 - the tax rate). This will give you the required lease
payment.
3. Capital Valuation Models Critique
Using the University Library or other sources, conduct research to
find an example of new venture financial management where the
capital-raising process has been initiated or completed. Assume the
role of an entrepreneur, an investor, or a corporate new venture
manager. From the perspective of your assumed role, prepare a
350-700-word paper in which you analyze the initial offering process
and the financial outcomes, critique your chosen example, and offer
recommendations. Within your critique and recommendations, be sure to
include the stages of raising capital and any pricing strategies that
went into the IPO. Provide the URL for the article you used for this
report. |
