Construct an investment strategy

Reference no: EM13525958

1. calculating WACC. -Shadow Corp. has no debt but can. borrow at 7 percent. The firm's WACC is currently 11 percent, and the tax rate is 35 percent.

a. What is Shadow's cost of equity?

b. If the fum converts to 25 percent debt, what willits Cest of equity be?

c. If the firm converts to 50 percent debt, what will its cost of equity be?

d. What is Shadow's WACC in part (b)? In pare(c)?

2. MM and Taxes Bruce & Co. expects its EBIT to be $140,000 every year forever. The firm can borrow at 9 percent. Bruce currently has no debt, and its cost of equity is.17 percent. If the tax rate is 35 percent, what is the value of the firm? What will the value be if Bruce borrows $135,000 and uses the proceeds to repurchase shares?

3. MMandTaxes what is thecoat of equity after recapitalization?What is the WACC? What are the implications for the firm's capital structure decision?

4. MMProposition I Levered, Inc., arid Unlevered, Inc., are identical in every way except their capital, structures. Each company expects to earn $65 million before interest per year ittperpertlity, with each-company distributing all its earnings as dividends. Levered's perpetual debt hat a market valise of $185 million and costs 8 percent per 'year. Levered has IA' million shares outstanding, currently worth $100 per share. Unlevered has iao 'debt and 7 million shares outstanding, currently worth $80 per share. Neither firm pays 4axes. Is Levered's stock a better buy than .Unlevered's stock?

5. MM Tool Manuficturinglasan expected EBIT of $42,000 in perpetuity and a tax ' . rate of 35 percent The firm has $70,000 in outstanding debt at an interest rate of 8 percent, and its unleveredeost of capital is 15 percent. What is the value of the firm according to MM Proposition with taxes?Should Tool change its debt-equity ratio if the goal is to maximize the value of the firm?

6. Explain FirmValue Old ,Schobl Corporation expects an EBTT of $15,000 every year for¬ever. Old School cunt ntly has no debt, and its cost of equity is 17 percent. The firm can bcrrownt 10 percent. If the corporate tax rate is 35 percent, what is the value of the firm? What will the value be if Old School converts to 50 percent debt? To 100 percent debt?

7. MM Proposition I with Taxes The Maxwell Company is financed entirely with equity. The company is considering a loan of $1.4 million. The loan will be repaid in equal installments over the next two years, and it has an 8 percent interest rate. The company's tax rate is 35 percent. According to MM Proposition I with taxes, what would be the increase in the value of the company after the loan?

8. MM. Proposition I without Taxes. Alpha Corporation and Beta Corporation are identical in every except their capital structures. Alpha Corporation, an all-equity Grin, has 10,000 shares.of stock outstanding, currently worth $20 per share. Beta Corporation uses leverage is its capital structure. The market value of Beta's debt is $50,000, and its tog of debt is 12 percent. Each firm is expected to have earn¬.. bigs.before interest of $55,000 in perpetuity..Neither firm pays taxes. Assume that every investor earl. borrow at 12 percent per year.

a. What is the value of Alpha Corporation?

b. What is the value of Beta Corporation?

c. What is the market value of Beta Corporation's equity?

d. Bow much will it cost to purchase 20,percent of each fun's equity? e,Assuming eachlarto meets its.earnings estimates what will be the dollar return to eadhPosition in part (d) over the next year?

f. Construct an investment strategy in which an investor purchases 20 percent of Alpha's equity. and replicates both thecost and dollar return of purchasing 20 percent pf Beta's equity

g. Is Alpha's equity more or less risky than Beta's equity? Explain.

Reference no: EM13525958

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