Reference no: EM132999095

Use Modigliani-Miller theorem:

• The Modigliani-Miller theorem states that a company's capital structure is not a factor in its value.
• Market value is determined by the present value of future earnings, the theorem states.

Before the Fukushima Nuclear Accident

ABC Inc. is a levered company. Based on financial statements we know that the firm has $250 million bonds outstanding with a term to maturity of 20 years remaining and an annual coupon rate of 5%. The bonds have a face value of $1,000. These bonds have an average YTM of 4.5%. ABC Inc. has 400 million shares outstanding with a price of $6.25 per share and a beta of 1.2.  Corporate tax rate is assumed to be 25%. The risk free rate is 2% and the expected return on the market portfolio is 10%. Given the portfolio of assets currently managed by the firm, a stream of perpetual EBIT in the amount of $434.59 million per annum is expected.

1) Use the WACC method to find the value of ABC Inc. {Warning: Failure to use the WACC method will result in severe penalty even if the answer is correct.}

After the Fukushima Nuclear Accident

ABC Inc. is the nuclear power generating business. The Fukushima Nuclear Accident has caused market participants to reassess the risk of companies in the nuclear power generating business. As a consequence, ABC's bonds have recently been downgraded and there is a corresponding increase in the yield. The current YTM for ABC's bond is 5.125%. 

2) Use the WACC method to find the value of ABC Inc. after the Fukushima Nuclear Accident. {Simplifying assumption: You may assume that all other factors, including shareholder return, remain unchanged.}

3) The simplifying assumption is Q2 is unrealistic. Explain how shareholder return will be affected a debt downgrade.