Reference no: EM132027578
Thorndike Oil (TO) is a diversified company with two operating divisions: Oil and Telecom which represent 70% and 30% of the firm's value, respectively. TO has no debt on its balance sheet.
To estimate the cost of capital for each division, TO has identified one principal competitor for each of its two divisions. The competitors are pure-plays, i.e., they are not diversified and operate in only one industry each. They maintain a constant Debt-Equity ratio at all times.
Assume that the debt of the two competitors is risk-free, the risk-free interest rate is 1%, the expected return on the market portfolio is 6% and that the CAPM holds. Competitor VP-Oil Equity Beta: 0.8 D/E: 2/6 AB&B-Telecom Equity beta: 1.5 D/E:1/4
a. Estimate the expected return on TO's equity.
Now assume that TO is considering a change in its capital structure that will increase its leverage. Two plans are considered:
1. Issue $55 million immediately in debt and maintain its level in perpetuity.
2. Issue $90 million immediately in debt, repay $20 million of its principal in one year, $20 million in two years and maintaining the remaining $50 million in perpetuity.
Assume that in both plans TO will be able to borrow at the risk-free interest rate; that all proceeds are paid out to equity holders and that in Plan 2 the reduction in debt is financed by issuing equity. Corporate tax rate is 35% and there are no other markets imperfections.
b. Which of these two plans would you recommend? Explain.
|
Which one retirement plans should you choose
: You have three choices of retirement plans: a) $1 million at the end of 20 years,
|
|
What is the present value of the maintenance costs
: You are thinking of making an investment in a new factory. The factory will generate revenues of $1,110,000 per year for as long as you maintain it.
|
|
What is your internal rate of return on the investment
: You are thinking about letting a friend borrow $10,000 today given that she will repay you $15,000 in 5 years.
|
|
How much is in savings at the end of this time
: A $10,000 deposit is made in a Savings account. For the first 4 years the interest rate is 3% per year. At the end of the fourth year a $5,000 withdrawal.
|
|
Which of these two plans would you recommend
: Issue $90 million immediately in debt, repay $20 million of its principal in one year, $20 million in two years and maintaining the remaining $50 million.
|
|
What is the internal rate of return on the incremental
: If you drive 14,000 miles per year and gasoline costs $4.00 per gallon, what is the internal rate of return on the incremental investment in the hybrid automobi
|
|
What would be the effect of selling the van on 3rd year
: The tax rate is 40% What would be the effect of selling the van on the third year cash flow.
|
|
The amount you would be willing to pay for this bond
: If you would like to make 8% return on your investment, what is the amount you would be willing to pay for this bond?
|
|
How much would you save if you choose the 15-year over
: Calculate the total amount of interest paid throughout the life of the loan. How much would you save if you choose the 15-year over the 30-year mortgage?
|