Individual Assignment – MGMT3048, Semester 1, 2023

ISSUE DATE: September 11, 2023 at midnight

DUE DATE: October 10, 2023, 11.59 p.m. ECT

INSTRUCTIONS TO CANDIDATES:
1. There are FIVE questions in this assignment. All questions are
compulsory.
2. Candidates are required to work individually on this assignment.
3. The first page of the assignment must have the candidate’s name and
ID number written legibly.
4. All computations must be done and shown in detail.
5. Completed assignment must be submitted to the designated Dropbox on
the Learning Exchange. No email submissions are allowed.
6. Late submissions attract late submission penalty as per guidelines
specified in the course guide. Plan your work in advance so as to
prevent such an eventuality.
7. Plagiarism in any form is a serious offense and applicable penalty
will be applied as per UWI plagiarism policy if any part of your work
is plagiarized.
8. This graded activity is worth 35% of the total course assessment.

PREPARED BY CHANDRA S BHATNAGAR, CI, MGMT3048 1

Question 1
Tireless Wheels Limited has no debt financing and has a value of $60 million
and EBIT of $25 million. The firm is planning to change its capital structure
by issuing $30 million in debt, and repurchasing requisite number of shares.
The firm is estimated to pay 8 percent on interest expense. Its income is
taxed at a per annum rate of 30%.

a) What is the firm’s unlevered cost of equity?

b) What is the firm’s levered cost of equity?
c) What will be the firm’s WACC after the recapitalization?
d) What change do you observe in the firm’s WACC before and after
recapitalization? Why?

(1 + 2 + 1 + 1 = 5 marks)
Question 2
Firm U is an all equity firm and has a market value of $100,000 and EBIT of
$300,000. Firm L has identical EBIT but it uses 40% debt in its capital
structure. Firm L pays total annual interest of $3000 on its debt. Both
firms satisfy the MM assumptions. Taxes are absent.
a) Ryan is the holder of $9,000 worth of L’s stock. What rate of return
can he expect, assuming a dividend pay-out of 100%?
b) Using homemade leverage, show how Ryan could generate exactly the same
cash flows and rate of return by investing in Firm U.

(5 + 10 = 15 marks)

Question 3
Nelco Inc. has decided in favour of a capital structuring that involves
increasing its existing $80 million in debt to $125 million. The interest
rate on debt is 9% and is not expected to change. The firm currently has 10
million shares outstanding and the price per share is $45. If the
restructuring is expected to increase the ROE, what is the minimum level of
EBIT that Nelco’s management must be expecting. Ignore taxes in your answer.
(5 marks)
Question 4
Brightland Inc. has a market value equal to its book value. Currently, the
firm has excess cash of $1,500, other assets of $5,800, and equity valued
at $5,000. The firm has 250 shares of stock outstanding and net income of
$500. What will the new earnings per share be if the firm uses 30 percent
of its excess cash to complete a stock repurchase?
(5 marks)

PREPARED BY CHANDRA S BHATNAGAR, CI, MGMT3048 2

Question 5
In the absence of market imperfections and taxes, stock repurchases are same
as cash dividends. How does this change in real world circumstances and what
effect does a stock repurchase announcement have on stock price?
(150 Words max.)
(5 marks)
END OF ASSIGNMENT

PREPARED BY CHANDRA S BHATNAGAR, CI, MGMT3048 3