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1) Ilumni Inc. is a U.S. energy company with operations in oil and gas exploration and development (E\&P) and refining and marketing (R\&M). The marginal tax rate (TC) is 35% and the market risk premium is 5%. The current 30 -year U.S. Treasury bond yield is 2.9%. The target consolidated debt-to-value ratio, set in consultation among division and corporate executives and the board, is 25% (this is the firm's target for the proportion of net debt to enterprise value). Use net debt in your calculations (instead of total debt) consistently throughout the entire problem. Use the following data in order to calculate the prevailing consolidated debt-to-value ratio in part (a) below: Current stock price: $32.50 Shares outstanding (millions): 3,150.2 Total debt (\$million) $110,699 Cash and equivalents (\$million): $24,843 Enterprise value* (\$\$million): $233,592 * Enterprise value = market-value equity + net debt A. What is the prevailing consolidated debt-to-value ratio based on the table above? Answer format: Please enter your response using at least four decimals: for example, if your answer is 12.34% then please enter it as 0.1234. Answer: B) What potential error (or errors) exist in our estimate of net debt? Pick all the correct answers. a. The table above does not break down cash and equivalents into excess cash and cash held as working capital. In order to accurately calculate net debt, only excess cash should be deducted from total debt. b. The table above does not break down cash and equivalents into excess cash and cash held as working capital. In order to accurately calculate net debt, only cash held as working capital should be deducted from total debt. c. Debt should be measured in terms of market value and it is not clear whether the $101,845 million is market or book value. d. Debt should be measured in terms of book value and it is not clear whether the $101,845 million is market or book value. C) How does the prevailing consolidated debt-to-value ratio compare to the target consolidated debt-to-value ratio? What are possible explanations for the difference? Pick all correct answers. a. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is a decrease in the share price. b. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is an increase in the share price. c. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is that the company reduced its target leverage to achieve a higher credit rating. d. The prevailing consolidated debt-to-value ratio is lower than the target consolidated debt-to-value ratio. One possible explanation is that the company increased its target leverage to reduce corporate income taxes paid by the company.. e. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is that the company borrowed to finance a major investment but plans to return to its target in the long run. D) Derive an estimate of r E based on the target consolidated debt-to-value ratio using the CAPM and the formulas below: U=[1+(1TC)(D/E)]EE=[1+(1TC)(D/E)]U Use the 30-year U.S. Treasury bond yield as rf. E=1.30 and it is based on the prevailing consolidated debt-to-value ratio. To determine an appropriate estimate of equity beta based on the target capital structure, unlever E=1.30 and then relever (reminder: use the formulas above). Answer format: Please enter your response using at least four decimals: for example, if your answer is 12.34% then please enter it as 0.1234. E. What assumption (or assumptions) does one need to make when using these specific formulas? Are these the best formulas to use in this case? Pick all correct answers. a. The formulas are our best choice given what we know about llumni Inc. b. The formulas assume that the company has a target debt-to-equity ratio (constant ratio of debt-to-equity). c. The formulas assume that the company's debt is permanent (constant amount of debt). d. The formulas assume that interest expenses are deductible for corporate income tax purposes. e. The formulas assume that the beta of the company's debt is equal to 1 (one). f. The formulas assume that the beta of the company's debt is zero. 1) Ilumni Inc. is a U.S. energy company with operations in oil and gas exploration and development (E\&P) and refining and marketing (R\&M). The marginal tax rate (TC) is 35% and the market risk premium is 5%. The current 30 -year U.S. Treasury bond yield is 2.9%. The target consolidated debt-to-value ratio, set in consultation among division and corporate executives and the board, is 25% (this is the firm's target for the proportion of net debt to enterprise value). Use net debt in your calculations (instead of total debt) consistently throughout the entire problem. Use the following data in order to calculate the prevailing consolidated debt-to-value ratio in part (a) below: Current stock price: $32.50 Shares outstanding (millions): 3,150.2 Total debt (\$million) $110,699 Cash and equivalents (\$million): $24,843 Enterprise value* (\$\$million): $233,592 * Enterprise value = market-value equity + net debt A. What is the prevailing consolidated debt-to-value ratio based on the table above? Answer format: Please enter your response using at least four decimals: for example, if your answer is 12.34% then please enter it as 0.1234. Answer: B) What potential error (or errors) exist in our estimate of net debt? Pick all the correct answers. a. The table above does not break down cash and equivalents into excess cash and cash held as working capital. In order to accurately calculate net debt, only excess cash should be deducted from total debt. b. The table above does not break down cash and equivalents into excess cash and cash held as working capital. In order to accurately calculate net debt, only cash held as working capital should be deducted from total debt. c. Debt should be measured in terms of market value and it is not clear whether the $101,845 million is market or book value. d. Debt should be measured in terms of book value and it is not clear whether the $101,845 million is market or book value. C) How does the prevailing consolidated debt-to-value ratio compare to the target consolidated debt-to-value ratio? What are possible explanations for the difference? Pick all correct answers. a. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is a decrease in the share price. b. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is an increase in the share price. c. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is that the company reduced its target leverage to achieve a higher credit rating. d. The prevailing consolidated debt-to-value ratio is lower than the target consolidated debt-to-value ratio. One possible explanation is that the company increased its target leverage to reduce corporate income taxes paid by the company.. e. The prevailing consolidated debt-to-value ratio is higher than the target consolidated debt-to-value ratio. One possible explanation is that the company borrowed to finance a major investment but plans to return to its target in the long run. D) Derive an estimate of r E based on the target consolidated debt-to-value ratio using the CAPM and the formulas below: U=[1+(1TC)(D/E)]EE=[1+(1TC)(D/E)]U Use the 30-year U.S. Treasury bond yield as rf. E=1.30 and it is based on the prevailing consolidated debt-to-value ratio. To determine an appropriate estimate of equity beta based on the target capital structure, unlever E=1.30 and then relever (reminder: use the formulas above). Answer format: Please enter your response using at least four decimals: for example, if your answer is 12.34% then please enter it as 0.1234. E. What assumption (or assumptions) does one need to make when using these specific formulas? Are these the best formulas to use in this case? Pick all correct answers. a. The formulas are our best choice given what we know about llumni Inc. b. The formulas assume that the company has a target debt-to-equity ratio (constant ratio of debt-to-equity). c. The formulas assume that the company's debt is permanent (constant amount of debt). d. The formulas assume that interest expenses are deductible for corporate income tax purposes. e. The formulas assume that the beta of the company's debt is equal to 1 (one). f. The formulas assume that the beta of the company's debt is zero
