BUS 330a: CORPORATE FINANCE I

FALL 2012, AUBG

Quiz 4(b)
S!u"i# Gui$%
P&b!%' 1 (( )i#"*)
A firm has 10 million shares outstanding with a market price of $20 per share. The firm
has $25 million in extra cash (short-term inestment! that it plans to use in a stock
repurchase. The firm has no other financial inestment or an" de#t. $hat is the firm
alue of operations and how man" shares will remain after the repurchase%
S!u"i#:
&
op
' (n
0
()! * +xtra cash ' (10,000,000 x $20! * $25,000,000 ' $1-5,000,000.
.o,
n ' &
op
/ ) ' $1-5,000,000 / $20 ' 0,-50,000.
P&b!%' 2 (10 )i#"*)
)ettit )rinting 1ompan" ())1! is considering a change in its capital structure. ))1
currentl" has $20 million de#t carr"ing a rate of 02, and its stock price is $30 per share
with 2 million shares outstanding. ))1 is a 4ero-growth firm and pa"s out all of its
earnings as diidends. The firm5s +67T is $13.899 million, and it faces a 302 federal-
plus-state tax rate. The market risk premium is 32, and the risk-free rate is :2. ))1 is
considering increasing its de#t leel to a capital structure with 302 de#t, #ased on market
alues, and repurchasing shares with the extra mone" that it #orrows. ))1 will hae to
retire the old de#t in order to issue new de#t, and the rate on the new de#t will #e 82.
))1 has a #eta of 1.0
a. $hat is ))15s unleered #eta% ;se market alue </. and =amada formula.
#. $hat are ))15s new #eta and cost of e>uit" if it has 302 de#t%
c. $hat are ))15s $A11 and total alue of the firm with 302 de#t%
S!u"i#:
a. 6+A5s unleered #eta is #
;
' #
?
/@1 A (1-T!(</.!B '1.0/(1 A (1-0.30!(20/00!! '
0.0-0.
#. #
?
' #
;
(1 A (1-T!(</.!!.
At 30 percent de#tC #
?
' 0.0-@1 A 0.:(302/:02!B ' 1.210.
Then, r
.
' :2 A 1.210(32! ' 10.0-22
c. $A11 ' w
d
r
d
(1-T! A w
ce
r
s
1
' (0.3!(82!(1-0.3! A (0.:!(10.0-22! ' 0.:092.
& '
00:09 . 0
! 3 . 0 1 !( 899 . 13 ($
$A11
! T 1 !( +67T (
$A11
D1D
=

= ' $109.100 million.

P&b!%' 3 (( )i#"*)
.hortl" explain the essence of EE theor". =ow does the alue of the compan" and the
weighted aerage cost of capital change in the presence of corporate taxes% ;se
appropriate chart to show the effect of financial leerage on compan" alue if #ankruptc"
costs are taken into account. (FoteC there is a limit of 5 sentences.!
S!u"i#:
++ P&)&"i# 1 , *-&" %.)!a#a"i#
++ P&)&"i# 2 , *-&" %.)!a#a"i#
Value of Firm, V
0
Debt
V
L
V
U
Tax Shield
Distress
Costs
2