Reference no: EM132815919

Question 1 True/False and Explain:

Leo, a famous financial analyst, says that firms with leverage benefit from debt financing because debt provides a natural tax shield. It follows, therefore, that firm valuations will increase when tax rates increase (all else constant).

Question 2 True/False and Explain:

Yun, a professor of corporate finance, states that venture capitalists often describe their performance in terms of fund IRR's. However, she claims that funds with high IRR's don't necessarily represent better investment opportunities than funds with low IRR's.

Question 3 True/False and Explain:

Stav, a well-known equity investor, says that when a firm issues equity to retire its outstanding debt, its share price will decrease.

Question 4 True/False and Explain:

Zhaokailiu, a popular CEO, says that managers will not invest in projects where the weighted average cost of capital is greater than the IRR.

Question 5

Imagine that you are a venture capitalist at Argiro Ventures evaluating the following startup idea today (assume today's date is January 1, 2021). Your fund typically seeks a 25% IRR on its investments. The startup requires 4 rounds of financing over the next 7 years: $2 million today, $1 million in two years, $1 million in 3 years, and $3 million in 7 years. If the company has an IPO at the end of 10 years, the company will be worth $1.5 billion; the probability of an IPO is 10%. Otherwise, if the company is acquired by another company in 10 years (which happens with 25% probability), the expected acquisition value will be $1 billion. If the company does not get acquired, it will be worth 0. The founders of the company initially allocate 1,000,000 shares to themselves, and decide keep 350,000 shares in reserve in case they wish to hire any additional employees in the future.

a) Please provide the share price of the startup in each round of financing and the number of shares issued to investors in each round.

b) How do your answers to part a) change if the probability of acquisition is only 15% (assume all other information in the problem stays the same)? Please provide one sentence explaining intuition for how the results change.

c) Suppose the founders wish to understand how potential changes in the investment amounts would impact the share price in each round. If the share price in round 2 were to increase by 10%, due to a change of x% in the investment amount in the third year, what would x be? (assume all other information in the problems stays the same as originally posed, so the probability of acquisition is 25%. Also assume that the number of new shares issued to investors at time 0 stays the same as what you calculated in part a). If you are unable to answer this question, please explain why.

Question 6

Today is January 1, 2021. You are helping Felix make 10-year cash flow projections for a project in the electronics industry. The cost of financing for the project can be inferred from the following data. Analysts estimate that the typical cost of debt for electronics projects is approximately 5.1%. The projected beta of equity for the project is 1.20, and the firm is planning to maintain a constant debt-to-equity ratio (in market values) of 0.40. Using expert forecasts for stock market returns, you believe that the annual expected return for the entire market will be 8% for the next 10 years, and that the risk-free rate will be projected to remain at 4.5% over the entire life of the project. Assume a marginal tax rate of 25%, and that any tax loss can be carried forward indefinitely.

The project will have various investment needs. For example, the machinery needed for the project costs $3 million, and according to the tax authority, is depreciated using the straight line method over ten years. You can operate the machinery for 10 years. The pre-tax salvage value of the machinery at the end of the 10 years is expected to be $300,000. The purchase of the machinery is made today. You also expect to incur additional capital expenditures of $1.4 million for new computer equipment on December 31, 2027. This equipment is depreciated using the straight line method over the remaining life of the project, and is not expected to have any salvage value. The revenues from the project are expected to be $20 million first starting on December 31, 2021, and are expected to grow at a rate of 2.5% per year. Labor is expected to cost approximately $1.2 million every year, while COGS are estimated to be 15% of revenues each year.

The net working capital required for the project is given by the following data: Days sales outstanding will be 30 days (out of a 360 day cycle) and based entirely on annual revenues, while days payable outstanding will be 45 days (out of a 360 day cycle), and will only be relevant for labor costs (not for COGS or any other expenses). Inventory will be 7% of COGS each year. Assume net working capital is 0 as of today, and fully recovered by the end of the project (on December 31, 2030).

a) Please forecast the free cash flows for the project.

b) Please calculate the weighted average cost of capital for the project.

c) Suppose free cash flow were to increase by 15% at the end of the first year (i.e. December 31, 2021) because of an x% increase in revenues. Assume all other information in the problem remains the same (so Accounts Receivables will be based on the new revenues). Please solve for x.

Question 7
Qibei Dumplings is a famous dim sum restaurant chain. The company has total debt outstanding of 300 million dollars, and the cost of debt is 4%. The debt interest payments are perpetual, and have a beta of 0. The firm's perpetual EBIT is 70 million dollars, its assets are fully depreciated, and the tax rate is 30%. Qibei Dumplings' current value of equity is 400 million dollars. The firm's next cash flow will occur at the end of the year. The expected market return every year is 10%.

Compute the equity beta for this firm. If there is not enough information to calculate this value, please explain why, and describe the information you would need in order to calculate this value.

Question 8
Plastics R' Us, a firm owned by Xiaolin, has expected annual earnings before interest and taxes of $44 million per year. Expected annual depreciation is $7 million, while the annual capital expenditure is $9 million. Cash flows are expected to continue perpetually, with no growth. Its cost of debt is the risk-free rate. The corporate tax rate is 40%.

Erofeev Inc., a conglomerate owned by Nikita, has the following market value balance sheet:

Assets Liabilities

Plastic production assets = $300 million Oil drilling assets = $700 million

Debt = $400 million Equity = $600 million

We know a few other things about Erofeev Inc. Its equity beta is 1.2, the beta of oil drilling assets is 1, and the market value of the debt is priced at the risk-free rate of 6.0%. The market risk premium is 4%. Both firms maintain constant debt-to-value ratios over time.

a) What is the equity beta for Plastics R' Us?
b) What is the asset beta for Plastics R' Us?

If there is insufficient information to answer these questions, please explain what additional information you would need in order to answer these questions.

Question 9

You are helping Yuyu make projections for a 5-year project in the telecom industry. The manufacturing equipment needed for the project costs 1.4 million, and according to the tax authority, is depreciated using the straight line method over five years. The pre-tax salvage value of the equipment at the end of the five years is 500,000. The purchase of the equipment is made in year 0 (now).

The expected revenues each year from production are expected to be 800,000 in year 1, then 830,000 in year 2, then 860,000 in year 3, and so on (30,000 increments until year 5). The expected sales growth is an extrapolation from past data on average industry sector sales. The labor required to operate the equipment will cost 90,000 every year, starting in year 1. Wages are not expected to change over time due to strict employment regulations. The typical firm in the utilities industry faces a marginal tax rate of 27%.

Working capital each year is maintained at 20% of next year sales (and is fully recovered at the end; i.e. the level of working capital is 0 in year 5). Thus in year 0, the level of working capital will be 20% of sales in year 1 (assume there was no working capital prior to year 0).

The cost of financing for the project can be inferred from the following data. The projected beta of equity for the project is 1.2, and the firm is planning to maintain a constant debt-to- equity ratio (in market values) of 0.4. Using expert forecasts for stock market returns, you find that the annual expected return for the entire market is 7.5% for the next 5 years, and that the risk-free rate will be projected to remain at 4% over the entire life of the project.

The cost of debt is unknown, however, Yuming provides you with the following information concerning the current market interest rates for corporate bonds of various ratings (firms of a given credit rating can borrow at an associated cost of debt, as long as they achieve an interest coverage ratio that is above the minimum required threshold as per the table below):

Credit Rating	AAA	AA	A	BBB	BB	B
Rd (cost of debt)	5%	5.20%	6%	7%	8%	9%
Minimum     Interest    Coverage (EBIT / Interest Payments)	45	10	7	5	3	2
Probability of Default	0.50%	0.70%	1.00%	2.00%	3.00%	5.00%

Please calculate the NPV of this project.

Question 10

You are considering setting up a firm, called Maximilian Inc., to produce gadgets. The demand for gadgets can be high, medium, or low with equal probability. The corresponding cash flows associated with each type of demand are the following:

Demand	Annual Cash Flows
High	600
Medium	0
Low	-600

These cash flows will begin one year after the investment is made and continue forever. The cost of the project is $300 today. The discount rate is 50% (very high!).

a) What is the NPV of the project?

b) Suppose you can commission a study that tells you what the demand for gadgets will be. The study takes two years to complete. What is the NPV of the project if you commission the study?

c) Suppose that you can commission a different type of study that takes only one year to complete. The drawback of this type of study is that the information is less precise than in part b). The result of the study will be either "positive" or "negative" with equal probability. When the result is positive, demand will be high with probability 2/3 and medium with probability 1/3 (and thus low with probability zero). When the result is negative, demand will be low with probability 2/3 and medium with probability 1/3. What is the NPV of the project if you commission this type of study?

Attachment:- Summative Questions.rar