ASB.com is currently an all-equity firm. The firm's equity is worth £8 million. There are 500,000shares outstanding. The cost of capital on unlevered assets is 12% p.a. ASB.com pays no taxes.ASB.com plans to raise £800,000 by issuing risk-free debt to be repaid in perpetuity. ASB.com willuse the funds raised to repurchase the stocks. The cost of risk-free debt is 5% p.a.a) Calculate the annual unlevered cash flows in perpetuity that are compatible with a marketvaluation of £8 million. Calculate the ASB.com stock price.b) Calculate the annual interest expense if ASB.com goes ahead with the debt issue. What amountof cash flows will be left for equity holders?c) Since ASB.com pays no taxes, calculate the firm's value after the share repurchase and the debtissue.d) Calculate the equity value after the repurchase. Calculate the rate of return on equity after therepurchase. Explain why the rate of return on equity has or has not changed.

Answered: ASB.com is currently an all-equity…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Xtel Inc. with a total market value of $630 million has $30 million in excess cash and no debt. Xtel has 1 million shares outstanding. Xtelʹs board is meeng to decide whether to pay out its $30 million in excess cash as a special dividend or to use it to repurchase shares of the firm’s stock. You own 1,000 shares of Xtel stock. Assume that Xtel uses the entire $30 million to repurchase shares. You are unhappy with Xtelʹs decision and would prefer that Xtel used the excess cash to pay a special dividend. As a result, you decide to create a “homemade” dividend. What is the number of shares that you would have to sell in order to receive the same amount of cash as if Xtel paid the special dividend? B
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Rally inc, is an all equity firm with assets worth $25B and 10B shares outstanding. Rally plans to borrow $10B and use funds to repurchase shares. Rally’s corporate tax rate is 35% and Rally plans to keep its outstanding debt equal to $10B permanently. Suppose Rally offers $3 per share, and shareholders tender their shares at this price. What will be Rally’s share price after the repurchase?
Farmington Company can borrow at 7.05 percent. The company currently has no debt and the cost of equity is 11.45 percent. The current value of the firm is $660,000. The corporate tax rate is 23 percent. What will the value be if the company borrows $375,000 and uses the proceeds to repurchase shares?
Kennedy Limited is an all-equity publicly listed firm with 600,000 shares currently on issue trading at $20 per share and is expected to generate $1,800,000 in EBIT p.a. in perpetuity. They are considering immediately repurchasing one third their equity at the current market price and replacing this with debt with an interest cost of 4% per annum. Assume that Kennedy Limited operate in a perfect capital market with no taxes, information costs, transaction costs etc. a) Demonstrate the impact of the change in capital structure on the (i) Net Income, (ii) ROE and (iii) ROA for Kennedy Limited. b) For what value of EBIT will ROE be unaffected by Kennedy Ltd’s decision to repurchase shares?
Sunnyfax Publishing pays out all its earnings and has a share price of $37.00. In order to expand, Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds. Once the funds are reinvested, they are expected to grow at a rate of 14%. If the reinvestment does not affect Sunnyfax's equity cost of capital, what is the expected share price as a consequence of this decision? O $45.87 $40.14 $68.81 $57.34 Suppose a ten-year, $1,000 bond with an 8.6% coupon rate and semiannual coupons is trading for $1,035.39. What is the bond's yield to maturity (expressed as an APR with semiannual compounding)? 8.08% O4.04% O 5.36% O 10.72%
Tatum can borrow at 6.85 percent. The company currently has no debtand the cost of equity is 11.25 percent. The current value of the firm is $640,000. The corporate tax rate is 24 percent. What will the value be if the company borrows $355,000 and uses the proceeds to repurchase shares?
Special Engineering Plastics carries no debt on its books. It has $100 million long term financing consisting entirely of equity. The firm wishes to raise another $50 million for expansion through one of the two choices, (a), it can raise all additional funds by selling ordinary shares at $50 per share, and, (b) it can raise additional funds by selling debt at 12% pa interest. The firm has earnings before interest and taxes of $15 million that are expected to rise to $27 million with expansion. The firm’s tax rate is 40% and 2,000,000 ordinary shares are presently outstanding. Find out EPS under each option. The firm has made further calculations. It finds that with equity financing, EPS falls to zero at EBIT = 0 and that for debt financing, EPS falls to zero with EBIT = $6,000,000. Draw an EBIT-EPS chart and interpret it.
There are two firms: Firm U and Firm L. Both firms have $30,000 total assets and $5,000 EBIT (earnings before interest and taxes). Firm U is an unlevered firm without debt, and its number of outstanding shares is 1,000. Firm L is a levered firm financed with 50% debt and 50% common equity. The firm plans to use the debt to repurchase 50% of the outstanding shares (Note: reduce the outstanding shares). The pre-tax cost of debt for Firm L is 10%. Both firms have a 20% corporate tax rate. Calculate the earnings per share (EPS) for the unlevered firm U. A)$3.5 per share B)$5.0 per share C)$4.0 per share D)$5.6 per share

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