You are on page 1of 30

Sheet1

Spring 1998
Problem 1
Bond Rating = BBB
Interest Rate = 9.00%
After-tax Cost of Debt = 5.40%
Unlevered Beta = 1.06/(1+(1-0.4)(.1111)) = 0.993756211
Beta at 25% D/E Ratio = 0.99(1+0.6(.25)) = 1.1428196426
Cost of Equity = 7% + 1.14 (5.5%) = 13.27%
Cost of Capital = 5.40% (.2) + 13.27% (.8) = 11.70%

Problem 2
Change in Firm Value = (250 + 50) (.11-.10)/(.10-.05) = 60
Change in stock price = 60/10 = $ 6.00 ($10.00 if you assume buyback at current price)

Problem 3
(100/250) (2) + (150/250) (X) = 5
Solve for X, X = 7 years

Spring 1999
Problem 1
Value of Bank Loan = 4 (PVA,7%,5) + 50/(1.07)^5 = $52.05 Alternatively, you can assume that the bank debt is at market value
Value of Bonds Outstanding = $50.00
PV of Operating Leases = 10 (PVA,7%,7) = $53.89
Market Value of Outstanding Debt= $155.94 Market Value of Debt = 153.94

Market Value of Equity = 15* 10 = $150.00 If you do this, the cost of debt will be a weighted average of 7% and
Debt Ratio = 155.94/(150+155.94) = 50.97% 8%, the cost of debt will be around 7.5%.

Cost of Equity = 6% + 1.2 (5.5%) = 12.60%


Cost of Capital = 12.60%(.49) + 7% (1-.4)(.51) = 8.32%
31.5
Adjusted EBIT = 40 + 53.89*0.7 = $43.77
Adjusted BV of Capital = 50 + (50 + 50 + 53.89) = 203.89
Adjusted Return on Capital = 43.77 (1-.4)/203.89 = 12.88%

Problem 2
Change in Firm Value = 3 * 10 = $30.00
Firm Value (Chg in WACC)/(WACC(after)-.05) = 250 (Chg in WACC)/(.10 -.05)= 30
Chg in WACC = 0.60%
WACC before = 10.600%
Ke (.8) + 8%(1-.4) (.2) = 10.57%
Cost of Equity before transaction = (.106-.0096)/.8 = 12.05%

Problem 3
Value of firm before expansion = 300 + 70*10 = 1000
Duration of assets after expansion = 7.5 (1000/1250) + 1 (250/1250) = 6.2
Weighted Duration of Assets has to be equal to 6.2years
(200/550)(1) + (100/550)(4) + (250/550) (X) = 6.2
Solve for X
X = 11.24 years

Page 1
Sheet1

Spring 1999 (A)


Problem 1
PV of operating leases = $ 1,408
Straight Debt portion of convertible debt = $ 1,798
Total Debt = $ 3,206

Equity
Value of stock = $ 3,000
Value of conversion option = 2500-1798= $ 702
Value of Equity = $ 3,702

Cost of Equity = 5.5% + 1.25(6.3%) = 13.375%


Cost of Debt (after-tax) = 7.5%(1-.4)= 4.50%
Cost of Capital = 13.375% (3702/6908) + 4.50% (3206/6908) = 9.26%

Problem 2
Change in Firm Value = 500
5000 (.10 - WACC after)/WACC after = 500
Solve for WACC after,
WACC after = 500/5500 = 9.09%
Cost of Equity after = 5.5% + 1 (6.3%) = 0.118
11.8(X) + 5% (1-X) = 9.09%
Solve for X,
X = (9.09-5)/6.8 = 60%
Debt to Capital ratio = 40%

Problem 3
Cody's should have long term debt: Negative coefficient suggests duration of 7.5 years
BAM should have floating rate debt: Oper income tends to move with inflation

Spring 2000
Problem 1
a. False. It has to be weighed off against the increase in both costs
b. True. It will reduce the marginal tax advantage of debt
c. True. The net operating loss carry forward will reduce the tax benefit of the debt. (No matter how the
the argument is structured, the firm without net operating losses will be able to borrow more money and get
a larger tax savings. The NOL will reduce the income available from which interest expenses can be deducted.
d. False. If you are more uncertain about future investment needs, you will value flexibility more and borrow less.

Problem 2
Current cost of capital = Cost of equity (because firm has no debt) = 9.20%
Change in firm value = .1375 = (Cost of capital before - Cost of capital after)/Cost of capital after Common errors
0.1375 = (0.092 - Cost of capital after)/Cost of Capital after 1. Reversed the cost of capital before and after in
Solving, firm value change calculation.
Cost of capital after = 0.092/(1+.1375) = 8.09% 2. Computed change in firm value incorrectly
Cost of equity after = 10.48% 3. Did not use after-tax cost of debt
Cost of debt after = 4.5% 4. Other math errors.
10.48% (1-X) + 4.5% (X) = 8.09%
Solving for X,
X = 40%

Page 2
Sheet1

Problem 3
Duration of assets = 7 Common errors
Existing Debt = 1 (duration of this debt = 4 years) 1. Misread the problem to read change by instead of
New Debt = 3 change to.
(1/(1+3)) (4) + (3/(1+3)) X = 7 ! Since the asset mix does not change, the duration remains 72. Tried to change asset duration (why?)
Solving 3. Set up new debt incorrectly (had two unknowns with
Duration of new debt = 8 one equation)
Proportion on new debt that has to be 2 year debt = 25% (.25(2) + .75(10) = 8) 4. Other errors.

Spring 2001
Problem 1
a. Current Cost of Equity = 10.72% ! 5% + 1.04*5.5% ! If you decide to use the effective tax rate, the rationale
Current cost of debt = 3.90% has to be that you do not have enough operating income to c
Current cost of capital = 8.47% ! 10.72% (.67) + 3.9% (.33) However, this will mean that the effective tax rate should be
If you did this, I gave you full credit.
b. New debt to capital ratio = 50%
New debt to equity ratio = 100.00% ! I gave full credit if you read the increase as 0.25%
Unlevered Beta = 0.8 of the existing interest rate (I did take off half a point
New Beta = 1.28 if you read it as 25%
New cost of equity = 12.0400% ! You lost a point if you did not unlever and relever betas
New after-tax cost of debt = 4.05%
New Cost of capital= 8.05%

c. Number of shares bought back = 21.7391304 ! Since the price at which you were buying back the stock wa
c. Change in annual financing cost = $6.30 cannot divide by the total number of shares outstanding.
Change in firm value = $78.26
Change per share = $0.58 ! Transfer of wealth to stockholders selling back stock = (11.

Problem 2
Market value of the firm = 2000 ! 1000/.5
Dollar debt at optimal of 25% = 500 ! Don't increase the size of th
Duration of debt at optimal
Let X be the proportion of the debt that is 5-year debt at optimal
X (4) + (1-X) (8) = 7
X = .25
The firm has to have $ 125 million in 5-year debt and $ 375 million in 10-year debt
It needs to pay off $ 275 million of 5-year debt and $ 225 million of 10 year debt.

Spring 2002
Problem 1
Part a: Current cost of capital
Beta = 1.15 Math error: -0.5
Cost of equity = 9.85% forgot to after-tax cost of debt: -0.5
Cost of capital = 9.23% ! Debt ratio = 10%

Part b: New cost of capital


Unlevered beta = 1.078125 ! Forgot to adjust cost of equity : -1
New levered beta = 1.35535714 ! Don't forget to unlever and relever ! Math errors: -0.5
New cost of equity = 10.67%
New cost of capital = 8.73%

Part c

Page 3
Sheet1

Borrow money over next 5 years and pay dividends ! Closely held, outperformed: Not target of a takeover - No immediacy
Its stockholders like dividends, because it has paid large dividends in the past ! ROC < Cost of capital : Don't invest
Its projects earn less than its cost of capital ! History of paying dividends: Pay more dividends

Problem 2
Cost of capital before = 9.00%
Cost of capital after 8.00%
Change in firm value = 800 ! Forgot to consider the effect of growth : -1 point
Increase in dollar debt to get to 25% = 1000
Number of shares bought back = 12.5
Number of shares left = 37.5 ! Did not adjust the number of shares for buyback : -1
Increase in value per share = 21.3333333 ( Remember that you cannot divide by 50 if you are buying back at the current price)

Problem 3
a. Long term, Dollar, Fixed Rate, Straight ! Heavy infrastructure: Long term 0.25 points off for each mistake
! U.S. operations: Dollar
! No pricing power: Fixed
! Low growth: Straight
b. Long term, Mixed Currency, Floating Rate, Straight ! Brand Name: Long term
! Worldwide operations: Mixed Currency
! Pricing power: You can pass inflation through Hence, floating rate debt
! High margins and cashflows : Straight
c. Short term, Dollar, Fixed Rate, Convertible ! Speedy Obsolescence: Short term
! U.S. operations: Dollar
! High Uncertainty: Floating (but Competitive Industry: Fixed - So, I gave credit for both)
! High growth: Convertible

Spring 2003
Problem 1
Current cost of capital = 9%
Current debt ratio = 0.25
Current after-tax cost of debt = 0.036
Current cost of equity = 0.108
Current beta = 1.45

Unlevered beta = 1.21


New levered beta = 2.30 ! Debt = 3000; Equity = 2000; Stock buyback reduces the value of equity

Cost of equity = 14.18%

New cost of capital = 8.19%

Change in firm value $393.82 ! (.09 - .0819) (4000)/.0819 ! If you had the NPV of the new investment, you can add that on.

Number of shares = 100


Price at which bought back = $33.00
Number bought back = 30.3030303 ! 1000/33
Number remaining = 69.6969697

Change in value per share = $4.35 ! (393.82 - (33-30) (30.30))/69.70


Price per share after transaction = $34.35

Page 4
Sheet1

Problem 2
Duration of existing debt = 2.00

Duration of new debt = 6.50

Currency break down


Dollar debt = 50%
Euro debt = 50% ! $1 billion of Euro debt needed to get to $ 1 billion (1/3 of total debt)

Spring 2004
Problem 1
New beta = 1.12
Cost of equity = 0.093984

Interest coverage ratio = 3.75


Rating = BB+
Cost of debt = 0.06
After-tax cost of debt = 0.036

Cost of capital = 7.08%

Problem 2
a. Value of firm = 1050 ! 80*10+250
Cost of capital = 10%
Cashflow last year = 50 1050 = 50 (1+g)/ (Cost of capital -g)
Expected growth rate= 0.05 1050 = 50 (1+g)/(.10-g)

b. Increase in value from recapitalization


Annual cost at current cost of capital = 105
Annual cost at new cost of capital = 94.5
Annual savings = 10.5
PV at expected growth rate = 262.5

c. If investors are rational, savings will accrue to all stockholders


Increase in value per share = 3.28125
New stock price = 13.28125
Number of shares bought back = 18.8235294
Number of shares left = 61.1764706

Problem 3
6 (150/500) + 8 (100/500) + X (250/500) = 10
Solving for X,
Duration of new bond = 13.2

Since the firm has little pricing power, you would go with fixed rate debt
Since half of its revenues come from the EU region, half of its total debt of $ 500 million should be in Euros
Hence the firm should use 100% Fixed rate, Euro debt

Spring 2005
Problem 1
Value of unlevered firm = 1000 !100 *10 !This firm has no debt. This is the unlevered firm value.

Page 5
Sheet1

With $250 million in debt, used to buy back stock


Value of levered firm = 1025 ! 100 *10.25 !Note that the stock price increases on the announcement to reflect what the firm will be worth after the
Tax benefit from additional debt = 100 ! Tax rate * Dollar Debt 1. Tried to force cost of capital approach through: -2 to -3
2. Wrong bankrupcty cost: -0.5 to -1
Value of levered firm = Value of unlevered firm + Tax benefit - (Probability of bankruptcy * Cost of bankruptcy) 3. Other errors: -0.5 to -1
1025 = 1000 + 100 - (X* .30*1000)
Probability of bankruptcy = 25%

Problem 2
Current market value of equity = 4000 1. Error in estimating current cost of equity: -0.5
Market value of debt = 1000 2. Did not unlever beta: -0.5
Value of firm = 5000 3. Estimated new cost of equity wrong: -0.5
4. Used old cost of equity instead of capital in computing firm value change: -0.5
Cost of capital = 10.44% = Cost of equity (.80) + 4.2% (.20) 5. Did not compute PV of annual savings: -0.5
Cost of equity = 0.12 6. Did not compute increase in firm value at all: -1
Current beta = 1.75

After debt is repaid


New beta = 1.52173913
New cost of equity = 11.09% ! Equal to cost of capital

New firm value = $4,708.24 ! Change in firm value = (.1044-.1109) 5000/.1109

Problem 3
a. Current asset duration = 0.75(10) + 0.25 (5) = 8.75 Current Balance Sheet
Transporation 0.75 Debt 0.5
b. Expected asset duration if tourism business doubles = (0.75/1.25)(10) + (0.5/1.25) (5) = Tourism 0.25 Equity 0.5
To solve for duration of new debt
(.5/.75)*6+(.25/.75)*X = 8 ! New debt issue = 0.25 New Balance Sheet
Transporation 0.75 Debt 0.75
Duration of new debt = 12 Tourism 0.5 Equity 0.5

Fall 2006
Problem 1
a. Cost of equity = 4.5% + 1.00*4% = 8.50% ! Mechanical errors: -0.5
Cost of capital = 8.5% (.9) + 5% (.1) = 8.15% ! Tax effect: -0.5

b. With change in tax status and leverage


Unlevered beta = 0.9 ! 1/ (1+(1-0)(1/9)) ! Unlevered with tax rate: -0.5
New levered beta = 1.44 ! 0.9 (1+(1-.4)(50/50)) ! Relevered with wrong debt to equity: -0.5
Cost of equity = 10.26% ! Forgot to tax effect cost of debt: -0.5
Cost of capital = 6.93% ! 10.26% (.5)+6%(1-.4)(.5) ! Wrong debt ratio: -0.5

c. Change in firm value, assuming 3% growth rate


Savings in costs each year = $12.20 ! 1000 (.0815-.0693) ! Okay if you used (1+g) in numerator
Increase in firm value = $310.43 ! 12.20/(.0693-.03) ! Change in firm value incorrect: -1 to -1.5
Firm value after transaction = $1,310.43
Price paid on transaction ! Gan/Loss on Sale: -1 to -1.5
For equity = 11.5*90= $1,035.00
For debt = $100.00
Total price paid = $1,135.00

Page 6
Sheet1

Value gained in transaction = $175.43

Prtoblem 2
Duration of assets after divestiture = 8.25 ! Duration for assets computed incorrectly: -1.5 to -2

Duration of debt after transactiion


Let the proportion of 10-year bonds after the repayment be X
X(10) + (1-X) (2) = 8.25
Solving for X,
X= 0.78125
Dollar debt after repayment = 8 -4 = 4 ! Repaid $ 4 billion of debt ! Dolalr debt after restructuring incorrect: -1
10-year bonds after the repayment = 3.125 ! Breakdown of debt after restructuring: -1 to -1.5
2-year bonds after the repayment = 0.875
Repaid amounts
10-year bonds = 2.875
2-year bonds = 1.125

Spring 2007
Problem 1
a. Cost of capital at existing debt r 8.44% ! 13%(.4)+9%(1-.4)(.6)
b.
Beta at current cost of equity = 2 ! (13-5)/4
Unlevered beta = 1.0526
New Debt to Equity Ratio = 42.86% ! (600-300)/(400+300)
Levered Beta = 1.32330827
New cost of equity 10.29%
New cost of capital 8.29%

Problem 2
a. Change in firm value = $11.11 ! (80+20)(.10-.09)/.09
b. Number of shares bought back = 6
Share of firm value to buy back $6.00 ! 6* $1/share
Share of firm value to remaining $5.11
Number of shares remaining 14 ! 20-6
Value increase per remaining sha $0.37

Problem 3
Duration of existing assets = 8 ! 2(5/20)+10(15/20)
Duration of existing debt = 8

Duration after transaction 6.8 ! 2(5/12.5)+10(7.5/12.5)


To estimate the duration of the new debt
8(5/10) + X(5/10) = 6.8
Duration of new debt = 5.6

Spring 2008
Problem 1 Grading Guidelines
Old debt to equity = 0% 1. Did not adjust the cost of equity at all: -1.5 points
Current beta = 1.00 ! Cost of equity is 9%; Rf =5% and Risk premium =4% 2. Error in beta estimation: -0.5 to -1 point
New debt to equity = 42.86% ! 600/1400; Debt used to buy back stock 3. Weights incorrect: -0.5 point
New beta = 1.2571 4. Forgot to after-tax cost of debt: -0.5 point
New cost of equity = 10.03%

Page 7
Sheet1

New after-tax cost of debt = 3.60%


Debt Ratio = 30.00% ! 600/ (600 +1400)
Cost of capital = 8.100%

Problem 2
Current cost of capital = 12% 1. Cost savings per year incorrect: -0.5 point
New cost of capital = 10.00% 2. PV of savings incorrect: -1 point
Market value of firm = 1000 ! 200 + 800 3. Math errors: -0.5 point each
Annual cost savings = 20
PV of savings (with g=4%) = 333.333333 ! 20/ (.1-.04): Okay if you used (1+g)
New firm value = 1333.33333

b. Value of firm = 1333.33333 1. Divided by existing number of shares: -1 point


- Debt = 500 ! Paid off $ 300 million out of $ 800 million 2. Error in computing per share value: -.5 to -1 point
Value of equity = 833.333333
Number of shares = 30
Value per share = $27.78

Here is anyother way to get to the same solution


Increase in firm value = $333.33
Discount on stock offered = $100.00 ! The discount on the private placement
Remaining value savings = $233.33
/ Number of shares= $30.00
Increase in value per share= $7.78
Added tos hare price = $27.78

Problem 3 Existing asset New Business


Value of business 100 50 1. Asset duration incorrect: -0.5 to -1.5 points (depending)
Duration of assets 7.5 3 2. Debt duration incorrect: -0.5 to -1 point
Weighted duration = 6 ! 7.5(100/150)+3 (50/150) 3. Math error: -0.5 point
Existing debt New debt
Value 25 50
Duration 5 X
Solving for duration of new debt
5 * (25/75) + X (50/75) = 6
Duration of new debt = 6.50

Spring 2009
Problem 1
a. Existing cost of capital
Estimated val Weoight Cost Risk measure
Debt 600 0.6 6.00% BB ! Wrong cost of debt : -.5
Equity 400 0.4 17.68% 2.28 ! Math error: -.5
Capital 1000 10.67%

b. New cost of capital


New debt ratio = 30.00% ! Wrong debt ratio: -0.5 to -1
New D/E ratio = 0.42857143 ! Forgot to unlever and relever beta: -1
Unlevered beta = 1.2 ! Used Debt to capital ratio to lever beta: -0.5
New levered beta = 1.50857143 ! Wrong cost of cebt : -.5

Weight Cost Risk Measure

Page 8
Sheet1

Debt 30.00% 3.90% A


Equity 70.00% 0.13051429 1.50857143
10.31%

Problem 2
Current cost of equity = Current cost of capital = 10.00% ! Firm value computed incorrectly: -1
If investors are rationa, all shares get an equal portion of increase in firm value ! Did not lever beta: -1
Increase in firm value = 100 ! Since investors are rational, ! Error in setting up new WACC: -.5 to -1
all shares gain $1.00.
Solving for cost of capital after,
(Cost of capital before - Cost of capital after)*Existing firm value/ Cost of capital after =100
(.10-Cost of Capital after)*1000/ cost of capital after = 100
Cost of capital after = 9.09%

Beta after = 1.4 ! Lever the beta, using new debt/equity ratio
Cost of equity after= 12.400%
12.4% (.6) + X(1-.4) (.4) = .0909
Pre-tax cost of debt = 6.88%

I kept the firm value constant at 1000 in the example above. If you use 1100 as firm value, the answers will be different.
D/E ratio after = 0.57142857
Beta after = 1.34285714
Cost of equity after = 12.06%
12.06% (700/1100) + X (1-.4) (400/1100)= .0909
Pre-tax cost of debt = 6.49%

Problem 3
Weighted duration of assets after cash is used = 8.4 ! Weighted average of just operating asse! Computed beta of assets including cash: -1
Duration of the debt has to be equal to this after the debt is paid off: (since cash is being used for retiring de (Cash is used up after the transaction)
X (10) + (1-X) (0) = 8.4 Did not comptue the new debt level right: -1
84% of the debt has to be 10-year zero coupon debt. Other math errors: -.5 point
Total debt outstanding after debt retirement = 1300 ! Debt outstnading before - Debt repaid
!0-year zero coupon debt = 1092 ! 84% of outstanding debt
10-year coupon debt to be paid off = 108 ! Long term debt repaid
Short trm debt to be paid off = 92 ! Short term debt repaid

Spring 2010
Problem 1
a. Current cost of capital
Cost of equity= 10%
After-tax Cost of debt = 3.60% ! Wrong weights: -0.5 pt
Debt/Capital ratio = 20.00% ! Did not after-tax debt: -.5
Cost of capital = 8.72%

b. New after-tax cost of debt


Operating Income 120 ! Used 40% as tax rate: -1 point
New dollar debt = 1500 ! Used 0% as tax rate: -0.5 point
New interest rate= 10% ! Math errors on tax rate: -0.5 point
New interest expenses = 150
Adjusted tax rate = 32.00%
New after-tax cost of debt = 6.80%

Page 9
Sheet1

c. New cost of capital


Current beta = 1.2 ! Did not unlever beta: -0.5 point
Unlevered beta = 1.0435 ! Used old tax rate to unlever ! Left cost of equity untouched at 10%: -1 point
New Equity value = 1000 ! Weights wrong: -0.5 to -1 point
New D/E ratio = 1.5 ! Wrong after-tax cost of debt: -0.5 (only if inconsistent
New levered beta = 2.11 ! Used new tax rate to relever but no penalty if you use 40% with your answer to part b
New cost of equity = 14.54%
New after-tax cost of debt = 6.80%
New debt to capital ratio = 0.6
New cost of capital = 9.90%

Problem 2
Current firm value = 1000 ! Did not set up firm value change : -2 to -3 point
Current cost of capital = 9% ! Used wrong firm value: -0.5 point
! Computed change in firm value wrong: -1 point
Since the shares were bought back at $10.50 and investors are rational
Increase in firm value = 50 ! Everyone has to receive $0.50 more ! No penalty for using (1+g)

Increase in firm value = (Old cost of capital - New cost of capital) Firm value/
(New cost of capital - growth rate)
50 = (.09-X) (1000)/(X-.03)
Solving for X,
New cost of capital = 8.71%

Problem 3
Duration of debt currently = 8 !Duration of debt incorrect: -1 point
Duration of all assets = 8 ! Weigths for assets incorrect: -1 point

Value of all assets = 5


Value of Manufacturing = 4
Value of Financial Services = 1
Since the duration of assets = duration of debt
9 (4/5) + X (1/5) = 8
X= 4

Spring 2011
Problem 1
Current D/(D+E) = 40.00% Error in computing current cost of equity/beta: -1 point
Current after-tax cost of debt = 4.80% Used wrong debt to equity ratio in unlevering beta: -0.5 point
Cost of capital = Cost of equity (.60) + 4.80% (.40) = .0972 Did not unlever beta: -1 point
Current cost of equity = 13% Did not compute new cost of capital correctly: -1 point
Current beta (levered) = 2
Unlevered beta = 1.42857143
New cost of equity (capital) = 10.14%

Problem 2
Current value of equity = 400 Used equity value instead of firm value in computation: -1 point
Current value of debt = 200 Used old cost of capital to discount savings: -1 point
Current firm value = 600 Math errors: -0.5 point
Current cost of capital = 10.50% Did not compute new stock price correctly: -1 point
New cost of capital = 10%
Annual savings = 3 (Okay if you used (1+g) in numerator)

Page 10
Sheet1

Change in value = 37.5


New price per share = 43.75
Number of shares bought back 4.57142857

Problem 3
Value of acquirer = 400 Errors on weights for duration of assets: -1 point
Value of target = 400 Errors on weights for duration of debt: -1 point
Duration of combined firm's assets 5.5 Math errors: -0.5 point each
Total debt of combined firm = 600
Duration of debt = (200/600)*4+(100/600)*6+(300/600)*X = 5.50
Duration of new debt = 6.33333333

Spring 2012
Problem 1
a. Current Beta = 2.72 ! Did not after-tax cost of debt: -1/2 point
Cost of Equity 19.32% ! Error on weights: -1/2 point
After-tax Cost of Debt 5.40% ! Math errors: -1/2 point each
Market value of equity = $20.00
Market value of debt = $80.00
Debt to capital ratio 80.00%
Cost of capital 8.18%

b. New debt ratio = 30%


New pre-tax cost of debt 6% ! Default spread goes from 6% to 3%
New after-tax cost of debt= 3.60%
Unlevered beta = 0.8 ! 2.72/ (1+ (1-.40)(80/20))
New debt to equity ratio = 0.42857143 ! Errors on unlever or relevering beta: -1 point
New levered beta 1.01 ! Did not unlever and relever beta: -1.5 points
New cost of equity = 9.0343% ! Wrong cost of debt: -1/2 to -1 point
New cost of capital = 7.40% ! Math errors: -1/2 point each

Problem 2 ! Used wrong discount rate for change in firm value: -1 point
Pre-change cost of capital = 8.25% ! Used equity value instead of firm value: -1/2 point
Post-change cost of capital = 8.00% ! Error on increase in firm value: -1 point
Pre-change value of firm = $1,000.00 ! Market value of equity + Debt ! Did not compute change in value from buyback: -1.5 points
Change in cost of capital = 0.25% ! Did not subtract out premium paid in buyback: -1 point
Savings in financing costs = $2.50 ! Change in cost of capital * Firm value ! Divided change by total number of shares: -1.5 points
Increase in firm value = $31.25 ! Savings per year/ New cost of capital

New debt = $440.00


Price per share = $11.00
Number of shares bought back 40 ! New Debt/ Price per share
Premium/share $1.00 ! Buyback price - Old price
Total premium paid = $40.00 ! # Shares bought back * Premium/share

Remaining change in value = -$8.75 ! Increase in firm value - Premium paid in buyback
Remaining shares outstanding = 40.00 ! Original shares outstanding - Bought back shares
Change in value/share -$0.22 ! Remaining change in value/ Remaining shares outstanding
Price per share $9.78

Problem 3

Page 11
Sheet1

Duration of telecom business = 8 ! Duraton of assets incorrect: -1 point


Duration of the media business = 2 ! Duration of existing debt incorrect: -1 point
Value of Ulysses equity, pre-acquist 2000 ! Did not solve for new debt correctly: -1/2 to -1 point
Value of Ulysses debt, pre-acquisito 500
Value of Ulysses, pre-acquisiton = 2500 ! Value of equity + Value of debt
Value of Sylvan, pre-acquisition 1500
Duration post-acquisition 5.75 ! 8 (2500/4000) + 2 (1500/4000)

Existing debt
Duration of existing debt = 2 ! 0.5 (3) + 0.5 (1)
Value of new debt = 1500 ! Set equal to acquired company
(500/2000) (2) + (1500/2000)(X) = 5.75
Duration of new debt = 7

Spring 2013
Problem 1 Grading template
Current cost of capital = Current cost of equity = 10% 1. Did not back out beta: -1 point
Unlevered beta for the firm = 0.75 2. Did not adjust tax rate: -1 point
Current value of firm = 1000 3. Did not relever beta: -1 point
If it borrows $ 800 million 4. Did not after-tax cost of debt: -1/2 point
Interest expense = 60 5. Error on new debt ratio: -1 point
EBIT = 45 6. Math errors: -1/2 point each
Adjusted marginal tax rate = 30.0%
New Debt to equity ratio = 400% ( I gave full credit, if you relevered the beta using the 40% tax
New Debt to capital ratio = 80% rate instad of the adjusted marginal tax rate)
New levered beta = 2.85
New cost of equity = 20.100%
After-tax cost of debt = 5.25%
Cost of capital = 8.22%

Problem 2
The first step is to estimate the current value of the firm
Debt outstanding = 100 1. Did not compute change in value correctly: -1 point
Market value of equity = 400 2. Did not set up for new cost of capital: -1 point
Value of the firm = 500 3. Used new firm value in computation: -1/2 point
The next step is to compute the value gained by stockholders in the buyback 4. Math errors: -1/2 point each
Number of shares bought back = 5
Premium paid on buyback = 5
Value gained by buyback investors 25
Remaining shares = 11
Premium on remaining shares = 2
Value gained by remaining shares 22
Total value gained = 47
The third step is to set the value gain, relative to the original firm value
(.09 - New Cost of capital)* 500/ New cost of capital = 47
New cost of capital = 8.23%

You could also solve the problem this way


Number of shares outstanding after the buyback 11
Price per share after buyback = 27
Value of equity = 297

Page 12
Sheet1

Debt outstanding after buyback = 250


Value of firm after buyback = 547
Change in value = 47
Then, use the same third step as before to get the same answer

Problem 3
a. Duration of assets = 6.8 1. All or nothing, unless egregious math error
b. Duration of debt = 6.4 1. All or nothing, unless egregious math error
c. After acquisition of new business 1. Did not compute new asset duration: -1 point
Duration of assets = 7.25 2. Did not set up for new debt duration: -1 point
To set the duration of the debt to 7.25 years after the debt issue 3. Math errors: -1/2 point each
Let the value of new bonds issued be X (Here is a test of the second part. If you plug in 7.25
Debt oustanding after = 5+X and don't get the right answer, the second part of
(3/(5+X)) *4+ (2+X)/ (5+X) *10 = 7.25 the problem is set up incorrectly)
Solving for X
X= $1.55
Check the answer 7.25

Spring 2014
Problem 1 Grading template
a. Current cost of capital
Current levered beta = 1.15 1. Wrong debt ratio: -1/2 point
Cost of equity = 8.7500% ! 3% + Beta *5% 2. Math errors: -1/2 point each
After-tax cost of debt = 3.00% ! Pre-tax cost of debt (1-.40)
Debt to capital ratio = 20%
Cost of capital = 7.600%

b. New cost of capital


New debt to capital ratio = 60% 1. Wrong debt ratio: -1/2 point
New debt to equity ratio = 1.5 2. Did not adjust tax rate: -1 point
Unlevered beta = 1.00 3. Did not relever beta: -1 point
4. Other math errors: -1/2 point each
Interest expense on debt = 48
Operating income = 36
Maximum tax benefit on debt 14.4
Tax benefit on debt = 30.00% !Max Tax Benefit/ Interest expense

Levered beta = 2.05


New cost of equity = 13.2500%
New cost of debt = 5.60%
New cost of capital = 8.6600%

Problem 2
Value of firm before buyback 2400
Cost of capital before buybac 10%
Growth rate in perpetuity = 2%

Approach 1: Value generated from buyback

Page 13
Sheet1

Number of shares bought bac 40 1. Change in firm value incorrect: -1 point


Premium per share = $5 2. Firm value incorrect: -1 point
Premium paid on buyback = $200 3. Did not factor in growth: -1/2 point
4. Used wrong cost of capital in discounting: -1/2 point
Remaining shares = 60
Premium per share = 10
Premium to remaining shareh 600

Total value added by buyback $800

Value added by buyback = 800 = 2400 *(.10-X)/(X -.02)


Solving for X
Cost of capital after buyback 8.00%

Approach 2: Firm valuation


Value before = 2400 = Cash flow next year / (.10-.02)
Expected cash flow next year 192

Value of equity after buyback 1680


Value of debt after buyback = 1520
Total value after buyback = 3200

Value after buyback = 3200 = 192/(X -.02)


Solve for X
Cost of capital after = 8.00%

Problem 3
a. Duration of assets today Duration Weight Value
Hotel business 20 60% 600 ! Value of business = Debt + Equity = 800 + 200 = 1000
Travel business 2 40% 400 1. Weights incorrect: -1/2 point
Company assets 12.8 2. Math errors: -1/2 point

b. Duration of debt today Duration Weight Value


Zero coupon bond 15 50% 100 1. Weights incorrect: -1/2 point
Bank loan 1 50% 100 2. Math errors: -1/2 point
Company debt 8

c. After expansion
Expansion investment = 200
Duration of assets Duration Weight Value
Hotel business 20 0.5 600 1. Used old asset duration: -1 point
Travel business 2 0.5 600 2. Weights wrong for new duration: -1 point
Company assets 11 3. Weights wrong for debt: -1 point
5. Math errors: -1/2 point
Duration of debt
Existing debt 8 0.5 200

Page 14
Sheet1

New debt X 0.5 200


Desired duration = 11

Duration of new debt = 14

Page 15
Sheet1

Page 16
Sheet1

32.6086956

Page 17
Sheet1

Page 18
Sheet1

Page 19
Sheet1

Page 20
Sheet1

what the firm will be worth after the transaction

Page 21
Sheet1

Page 22
Sheet1

Page 23
Sheet1

Page 24
Sheet1

Page 25
Sheet1

Page 26
Sheet1

Page 27
Sheet1

Page 28
Sheet1

Page 29
Sheet1

Page 30