1. FINA Corp. is considering two potential projects. One is to further develop its current auto parts. The other project is to enter a new industry of kitchen appliances. FINA Corps beta without the new project is 1.2. The market risk premium is 7%. The risk free rate is 3%. The total shares outstanding of FINA is 20 million. The stock price now is $5 per share. Tax rate is 35%. Following three firms are in the new industry that FINA wants to enter. Firm A is a competitor of FINA in auto parts. Firm A also has a division in kitchen appliances. Firm B is producing kitchen appliances and all kinds of furniture. Firm C is in kitchen appliances business only.

Firm WACC D/E Cost of Debt Tax Rate

A 10% 0.8 3% 30%

B 11% 1.0 3% 30%

C 10% 0.5 3% 35%

a. What is the current required rate of return on the equity of FINA Corp.?

b. FINA issued 30-year bond 5 years ago. The current market value of the debt is $50M. The face value of the bond is $44.5M. The coupon rate is 6%. The bond pays coupon semiannually. What is the current cost of debt?

c. What is the WACC of the project to further develop the auto parts?

d. Which one should be used as a reference to calculate the WACC of the new business project? e. What is the WACC of the project to enter kitchen appliances market?

e. What is the WACC of the project to enter kitchen appliances market?

2. As mentioned earlier, Gladstone Corporation is about to launch a new product. Depending on the success of the new product, Gladstone may have one of four values next year: $150 million, $135 million, $95 million, and $80 million. These outcomes are all equally likely, and this risk is diversifiable. Suppose the risk-free interest rate is 5% and that, in the event of default, 25% of the value of Gladstones assets will be lost to bankruptcy costs. (Ignore all other market imperfections, such as taxes.)

a. What is the initial value of Gladstones equity without leverage? Now suppose Gladstone has zero-coupon debt with a $100 million face value due next year.

b. What is the initial value of Gladstones debt?

c. What is the initial value of Gladstones equity? What is Gladstones total value with leverage? Suppose Gladstone has 10 million shares outstanding and no debt at the start of the year.

d. If Gladstone does not issue debt, what is its share price?

e. If Gladstone issues debt of $100 million due next year and uses the proceeds to repurchase shares, what will its share price be? Why does your answer differ from that in part (d)?