Reference no: EM133065102

Question 1: M&M Proposition 1: A company financed completely with equity currently has a cost of capital equal to 15 per cent. If Modigliani and Miller's Proposition 1 holds and the company is thinking about changing its capital structure to 50 per cent debt and 50 per cent equity, what will be the cost of equity after the change if the cost of debt is 10 per cent?

Question 2: Interest tax shield benefit: Sterling Ltd has $350 million of debt outstanding at an interest rate of 9 per cent. What is the amount of the tax shield on that debt, just for this year, if Sterling is subject to a 30 per cent company tax rate?

M&M Proposition 1: The weighted average cost of capital for a company (assuming all three Modigliani and Miller assumptions) is 15 per cent. What is the current cost of equity capital for the company if its cost of debt is 10 per cent and the proportion of debt to total company value for the company is 0.5?

M&M Proposition 2: Mikos Processed Foods is currently valued at $500 million. Mikos will be repurchasing $100 million of its equity by issuing a nonmaturing debt issue at a 10 per cent annual interest rate. Mikos is subject to a 30 per cent company tax rate. Given all of the Modigliani and Miller assumptions, except the assumption that there is no tax, what value will Mikos have after the recapitalisation?

Question 3: Ruttabul Ltd has $250 million of debt outstanding at an interest rate of 11 per cent. What is the present value of the debt tax shield if the debt will mature in 5 years (and no new debt will replace the old debt), assuming that Ruttabul is subject to a 30 per cent company tax rate?

Question 4: According to the pecking order theory,
a. new debt is preferable to new equity.
b. new equity is preferable to internally generated funds.
c. new debt is preferable to internally generated funds.
d. new equity is always preferable to other sources of capital.

Question 5: The price of a share is $15.00 on 16 February 2014. The record date for a $0.50 dividend is 10 February 2014. If there are no taxes on dividends, what would you expect the price of a share to be on 9 through 16 February? Assume that no other information that could change the price of a share arises.

Question 6: Dividend policy and company value: Explain how a share buy-back, although it places cash in the hands of its shareholders, is different from a dividend payment.

Dividends: Undecided Ltd has additional cash on hand right now, although management is not sure about the level of cash flows going forward. If the company would like to put cash in its shareholders' hands, what kind of dividend should it pay, and why?

Dividend policy and company value: A company can deliver a negative signal to shareholders by increasing the level of dividends or by reducing the level of dividends. Explain.

Question 7: Cholla Ltd currently has 30,000 shares outstanding. Each share has a market price of $20. If the company buys back $150,000 worth of shares at market price, what will be the value of each share after the repurchase? Ignore tax.