Reference no: EM131313923
Directions: Answer completely and fully with every step lined out, I need this done in excel and in word.
1. Snake Farm Inc. (SFI) has been offered to submit a competitive bid for building 31 and 22, 18, and 11offshore pits per year for Athletic Inc. over the next four years. If the bid is accepted, SFI will be also construct 49, 51, 27, and 13 offshore pits per year for the next four year for other clients at a guaranteed price of $153 million per pit. SFI will be spending $2,400M in new capital spending in order to build these pits. Each pit costs $72 million in materials. To run the facilities in which the pits are going to be built, SFI has to spend $1,100M annually in fixed costs. SFI needs to increase its net working capital initially by $701M and every year after with 15% of the next year's change in sales. SFI can sell the facilities and equipment for $700M in four years. SFI uses an accelerated depreciation method which has the following schedule: Year 1, 16%Year 2, 44%; Year 3, 26%; Year 4, 9%; Year 5, 6%. SFI's cost of capital is 20%. SFI has a hurdle IRR rate of 30% to accept any new projects. SFI's tax rate is 45%. SFI's WACC is 20%. SFI would set up a separate corporate entity to do this project and thus there are no subsidizations across divisions. Income tax is treated differently from the capital gain/loss taxes.
A. What is the lowest bid that SFI can make without violating the capital budgeting criterion for accepting new projects, if there are no tax-loss-carry provisions?
B. Determine what would be lowest bid that SFI can make without violating the capital budgeting criterion for accepting new projects, IF (1) the depreciation method is changed to straight-line (for 4 years with zero accounting salvage value) and (2) there exist a carry forward (indefinitely in future) tax loss provision?
2. Butthole Industries is buying out Avengers, Inc. Butthole and Avengers both have market capitalizations equal to their fair value or the present value of their net cash flows. Butthole generates $45M per year in net cash flows but has no growth. Avengers is expected to generate $25M in net cash flows next year. Also, grow at 15% per year after. The return on capital of both companies over the past years:
|
Return on Capital
|
Butthole
|
Avengers
|
|
Year 1
|
-20.5%
|
45.8%
|
|
Year 2
|
41.1%
|
-5.8%
|
|
Year 3
|
10.5%
|
20.9%
|
Note that the relevant discount rate for each firm is the "average" return on capital.
A. If past history is a good indicator of future performance, what are the expected return on capital and standard deviation of return on capital for the merged entity?
B. In which of the two major dimensions this merger could possibly help Butthole: boosting the return or reducing the risk? Prove your point quantitatively.
3. Typical start-up businesses' estimated profit are forecasted as following:
|
State
|
Bad
|
Good
|
|
Probability
|
81%
|
21%
|
|
Profit
|
-3.5M
|
16M
|
A. Quantitatively prove that even with obvious likelihood of failure, a person could rationally justify chasing such a risky entrepreneurial proposition.
B. Consider the case of two economies-one with two start-ups and another with four start-ups whose fortunes are completely separate of each other. Quantitatively prove that the distribution of the wealth for the economy becomes much more normally distributed than each start-up's especially as the number of start-ups rises.
C. Argue factually what the results imply for the macro policy towards angel/venture capital investing.
4. Cowboy Corporation is estimating its WACC. The firm's debt structure contains: (1) 30,100 long-term bonds with an 8.1% coupon, paid semiannually, a 10 years-to-maturity, and a $1000 face-value which sells for $1200; (2) 20,200 callable long-term bonds with an 4.6% coupon, paid semiannually, a 15 years-to-maturity, an 8-year call protection, an 8.1% call premium, and a $1000 face-value which sells for $850; and (3) 2000, 20-years-to-maturity, zero-coupon bonds that sell for 40% of par with a par of $25,000. The firm also has 500,000 shares of preferred stock which sells at $120 per share, and pays a 10 percent (of $100 par) annual dividend. Cowboy's common stock, which will be paid a dividend of $4.00 next year, sells for $80.00 per share. Common dividends are expected to grow at a rate of 7 percent per year. Cowboy has 2,000,000 common shares outstanding. The firm's marginal tax rate is 35 percent.
A. What are costs of debt, preferred stock, and equity components of capital?
B. What is Cowboy's WACC
5. Angel Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent financed Percent financed Debt-to-equity Bond Before-tax
With debt (wd) with equity (wE) ratio (D/E) rating Credit Spread
0.10 0.90 0.10/0.90 = 0.11 AAA 0.7%
0.20 0.80 0.20/0.80 = 0.25 AA 1.0%
0.30 0.70 0.30/0.70 = 0.43 A 1.4%
0.40 0.60 0.40/0.60 = 0.67 BBB 2.2%
0.50 0.50 0.50/0.50 = 1.00 BB+ 3.4%
0.70 0.30 0.70/0.30 = 2.33 BB- 6.6%
0.90 0.20 0.90/0.10 = 9.00 B 10.8%
The company's tax rate, τ, is 50 percent. The company uses the CAPM to estimate its cost of common equity, re. The risk-free rate is 4% and the market risk premium is 6%. Angel estimates that if it had no debt its beta would be 1.0. (Its "unlevered beta," βU, equals 1.0.) The levered beta, β, relates to the unlevered beta, βU, via β = [1 + (1 - τ)*D/E] βU.
A. On the basis of this information, whereby WACC is minimized?
B. If the tax rate is reduced to 10.1%, whereby WACC is minimized?
Based on your findings, then, argue what are the macro consequences of a reduction of corporate tax rate from 50.01% to 10.01%?