MGFC10H3S (Intermediate Finance)

L01, L02 & L03

ASSIGNMENT 1 Due Date: Friday February 26, 2021
Professor: Syed Ahmed by 11:59pm Toronto local time

Always leave 4 decimals in the ($) numbers in your calculations (e.g. PMT = $10.8924) and, particularly, 6 decimals for
interest rates (e.g. r = 0.078643 or 7.8643%).

STUDENT’S NAME: ________________________________________________

Last First Middle
STUDENT’S I.D. NO.:_______________________________________________

QUESTION NO. MAX. MARKS MARKS OBTAINED

1 25 __________________

2 25 __________________

3 25 __________________

4 25 __________________

TOTAL MARKS 100 __________________

GOOD LUCK
Management, 1265 Military Trail, Toronto, ON, M1C 1A4, Canada
www.utsc.utoronto.ca/mgmt

The University of Toronto's Code of Behaviour on Academic Matters applies to all University of Toronto
Scarborough students. The Code prohibits all forms of academic dishonesty including, but not limited to,
cheating, plagiarism, and the use of unauthorized aids. Students violating the Code may be subject to
penalties up to and including suspension or expulsion from the University.
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QUESTION 1:
Ellesmere Technologies is considering building a new factory to manufacture electric cars on the land it
bought 15 years ago for $5,000,000. The land is currently appraised at $30,000,000. The construction cost
of the factory will be $100,000,000. The following is the current market data on Ellesmere’s securities:
Common Stock: 10,000,000 shares, selling for $50 per share; the beta is 1.7.
Debt: 500,000 bonds with a coupon rate of 6% per year and 20 years to maturity,
selling for $894.06 each.
Preferred Stock: 1,000,000 shares of 5% preferred stock outstanding, selling
for $90 per share. Par value is $100 each.
Market: 5% expected market risk premium; 2% risk free rate.

An initial investment of $20,000,000 in net working capital is required. CorporateTax rate is 40%.

a. Determine the weighted average cost of capital.

b. The plant will have 25 year useful life. It will be depreciated straight line, and after 25 years will be
scrapped for $10,000,000. Land is expected to be sold for $70,000,000. Ellesmere will make 4,000
electric cars per year, and sell them at an average price of $25,000 each. The variable cost will be
$15,000 per car. The fixed cost will be $20,000,000 per year. Determine NPV.
Hint: Use risk free rate to determine PV of CCATS.

QUESTION 2:
Oasis Limited an all equity firm has 1,000,000 shares outstanding. Investors currently require 12.5%
return on Oasis common stock. The company pays out all earnings as dividends. The company expects to
have EBIT of $5,000,000 per year forever. Assume no personal or corporate taxes.
a. What is the value of the firm?
Oasis would like to replace some of the equity with $25,000,000 of debt at an interest rate of 6%.
1. What will the new value of the firm be?
2. What will the new value of the debt be?
3. What will the new value of equity be?
4. What will the new required rate of return on equity be?
5. What will the new weighted average cost of capital be?
b. Suppose the corporate tax rate is 40%.
1. Using M&M determine the value of the firm, value of the debt, and the value of the
equity?
2. Does the presence of the taxes increase or decrease the value of the firm? Why?
c. Suppose personal tax rate on debt income is 30% while on the equity income is 20%.
1. What happens to the value of the firm in an MM world with personal taxes?
2. What will happen to the value of the firm as the personal tax rate on debt income
increases?
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QUESTION 3:
UCF Limited and LCF Inc are identical firms in all respects except for their capital structure. UCF is all
equity financed with $10,000,000 in equity. LCF uses both stock and perpetual debt. Its Debt/Equity ratio
is 3/5 and cost of debt is 5%. Both firms expect EBIT to be $1,000,000. Ignore taxes.
a. Elizabeth Kwan owns $20,000 worth of UCFs equity. What cash flow and the rate of return is she
expecting?
b. Show how she could generate exactly the same cash flows and the rate of return by investing in LCF
and using homemade unleverage.
c. What is the cost of equity for UCF? for LCF?
d. What is the rWACC for UCF? for LCF? What is your conclusion?

QUESTION 4:
Pickering Manufacturing Limited (PML) is considering purchasing a widget maker. The widget maker
will result in before tax cost savings of $400,000 per year for 15 years. Assume CCA rate of 25%. After
15 years of use salvage value of the widget maker will be 0. Asset pool will remain open. The widget
maker will not add/reduce the risk of the firm. Cost of unlevered equity is 10%, corporate tax rate is 40%,
and risk free rate of return is 3%. Hint: Use risk free rate to discount CCATS.
a. What is the maximum price PML should pay for the machine?
b. Suppose due to economic conditions Ontario government is willing to lend PML $2,000,000 at 2%.
This loan will be amortized over 4 years in 4 equal installments (principal repayment + interest).
Using APV approach, what is the maximum price PML would be willing to pay for the widget maker
if PML’s cost of debt is 8%?