Ex2.

A commodity bond links interest and principal payments to the price of a

commodity. Differentiate a commodity bond from a straight bond and then from
equity. How would you factor these differences into your analysis of the debt ratio of
a company that has issued exclusively commodity bonds?
→
a.Differentiation from straight bond:
1. Cash Flows: The cash flows of a straight bond are fixed at issuance and are not
influenced by commodity price
changes. In contrast, a commodity bond's cash flows are directly affected by the price
movements of the
commodity.
2. Risk Exposure: Commodity bonds expose bondholders to commodity price risk, as
their returns are tied to the
performance of the underlying commodity. Straight bonds do not carry this specific
risk factor.
b.Differentiation from equity:
1. Ownership and Returns: Equity represents ownership in a company and is subject
to the company's
performance and profitability. Returns to equity holders come from dividends and
capital appreciation, whereas
commodity bondholders receive returns based on the price movements of the
designated commodity.
2. Risk Profile: Equity investments carry company-specific risks, such as business
performance and
decisions, while commodity bonds are more exposed to the specific price movements
of the underlying
commodity.
c.Factors to Consider:
- Sensitivity to Commodity Prices: The debt ratio analysis should account for the
company's exposure to commodity price movements. If the commodity prices are
volatile, the company's cash flows and ability to service its debt may be impacted.
- Risk Profile: Commodity bonds may introduce a different risk profile compared to
traditional bonds. Investors and analysts need to assess the company's ability to
manage commodity price risk and whether it aligns with their risk tolerance.
- Cash Flow Variability: Due to the linkage with commodity prices, the cash flows
from commodity bonds may vary. Analysts should evaluate the predictability of these
cash flows and how it affects the company's ability to meet debt obligations.

Ex5: You have been asked to calculate the debt ratio for a firm that has the following
components to its financing mix:
• The firm has 1 million shares outstanding, trading at $50 per share.
• The firm has $25 million in straight debt, carrying a market interest rate of 8%
• The firm has 20,000 convertible bonds outstanding, with a face value of $1,000, a
market value of $1,100, and a coupon rate of 5%.
Estimate the debt ratio for this firm.
→ Market Value of Share = 1M x $50 = $50M
Market Value of Debt = $25 + 20,000 x $1100 = $25M + $22M = $47M
Debt Ratio =
Ex8: Office Helpers is a private firm that manufactures and sells office supplies. The
firm has limited capital and is estimated to have a value of $80 million with the
capital constraints. A venture capitalist is willing to contribute $20 million to the firm
in exchange for 30% of the value of the firm. With this additional capital, the firm
will be worth $120 million.
a. Should the firm accept the venture capital?
b. At what percentage of firm value would you (as the owner of the private firm)
break even on the venture capital financing?
→ a.The firm's value after the investment = $120M
The firm's value without the investment = $80M
Because $120M >$80M => Firm should accept the venture capital
$ 20 M
b. Break- even point = × 100 = 16.67%
$ 120 M

Ex10: You are a venture capitalist and have been approached by Cirrus Electronics, a
private firm. The firm has no debt outstanding and does not have earnings now but is
expected to be earning $15 million in four years, when you also expect it to go public.
The average price-earnings ratio of other firms in this business is 50.
a. Estimate the exit value of Cirrus Electronics.
b. If your target rate of return is 35%, estimate the value of Cirrus Electronics.
c. If you are contributing $75 million of venture capital to Cirrus Electronics, at a
minimum what percentage of the firm value would you demand in return?
→ a, The exit value Earnings in four years P/E ratio = $15M x 50 = $75M
b, The Value of Cirrus electronics: Value =
Earnings $ 15 M
n'
= 4
(1+Target Rate off Return) (1+35 %)
¿$7,763,975
Investment $ 75 M
c. Percentage = ×100= =0.966 %
Firm Value $ 7,763,975

Ex18: MVP, a manufacturing firm with no debt outstanding and a market value of
$100 million, is considering borrowing $40 million and buying back stock. Assuming
that the interest rate on the debt is 9% and that the firm faces a tax rate of 35%,
answer the following questions:
a. Estimate the annual interest tax savings each year from the debt.
b. Estimate the present value of interest tax savings, assuming that the debt change is
permanent.
c. Estimate the present value of interest tax savings, assuming that the debt will be
taken on for 10 years only.
d. What will happen to the present value of interest tax savings if interest rates drop
tomorrow to 7% but the debt itself is fixed rate debt?
→
a. Annual interest tax savings = Interest Expense x Tax rate
= (Debt x Interest Rate) x Tax rate
= ($40M x 9%) x 35% = $1.26M
b. Present value of interest tax savings
(−n)
1−[(1+ Interest Rate) ] 1
= Annual interest tax saving x = $1.26M x =$ 14 M
Interest Rate 9%
(−10)
[1−(1+ 9 %) ]
c. Present value of interest tax savings = $1.26M x = $8.086M
9%
(−10)
[1−(1+7 % ) ]
d. Present Value of interest tax savings = $1.26M x = $8.85M
7%
=> Present value of interest tax savings will increase when interest rate drop to 7%

Ex24: A firm that has no debt has a market value of $100 million and a cost of equity
of 11%. In the Miller–Modigliani world.
a. what happens to the value of the firm as the leverage is changed (assume no taxes)?
b. what happens to the cost of capital as the leverage is changed (assume no taxes)?
c. how would your answers to a and b change if there are taxes?
→ In the Miller-Modigliani world, Indexes aren't effected by the leverage, so
a. The firm's value will remain at $100M
b. The cost of equity will continue to be 11%
c. Effect of Taxes: If taxes are introduced, the value of the firm increases with
leverage due to the tax shield on interest payments. Consequently, the cost of capital
decreases as the tax shield reduces the overall cost of debt, making it a more
attractive source of financing. Therefore, with taxes, the value of the firm increases
and the cost of capital decreases as leverage is increased.