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2* Cabernet and Chardonnay are two bio-tech companies in the same business risk class. Cabernet is quoted on the Paris Bourse and has a debt-equity
2* Cabernet and Chardonnay are two bio-tech companies in the same business risk class. Cabernet is quoted on the Paris Bourse and has a debt-equity ratio of 1:3. The company's equity has a beta of 1.6 and the debt capital can be assumed to be riskless. Chardonnay is an unquoted, private company which is all-equity financed. The expected return on the CAC stock market index is 16%. The return on government bonds (and also the return on Cabernet's debt) is 10%. Assume that both Cabernet and Chardonnay pay out constant annual dividends. Cabernet's debt is irredeem- able. Ignore taxation Required: (a) Explain precisely what is meant by the term 'same business risk class'. Estimate the beta value of Chardon- nay's equity. (b) Estimate the WACC of each company and comment briefly on the significance of your figures in respect of the M and M (no-tax) capital structure hypothesis. (c) Jean Davide is a small shareholder in Chardonnay. He has just received his regular dividend of 1 500. Jean has now been offered 10 000 for his shareholding. However, he does not know whether or not to sell his shares as he relies heavily on his annual dividend from the company. (d) Explain how Jean Davide can make himself better off, with no change in risk, by selling his shares in Char- donnay and investing in Cabernet. What would be his resulting gain? (e) Assuming Cabernet's debt and equity capital are at their equilibrium value, estimate the equilibrium value of Jean's shareholding in Chardonnay. 2* Cabernet and Chardonnay are two bio-tech companies in the same business risk class. Cabernet is quoted on the Paris Bourse and has a debt-equity ratio of 1:3. The company's equity has a beta of 1.6 and the debt capital can be assumed to be riskless. Chardonnay is an unquoted, private company which is all-equity financed. The expected return on the CAC stock market index is 16%. The return on government bonds (and also the return on Cabernet's debt) is 10%. Assume that both Cabernet and Chardonnay pay out constant annual dividends. Cabernet's debt is irredeem- able. Ignore taxation Required: (a) Explain precisely what is meant by the term 'same business risk class'. Estimate the beta value of Chardon- nay's equity. (b) Estimate the WACC of each company and comment briefly on the significance of your figures in respect of the M and M (no-tax) capital structure hypothesis. (c) Jean Davide is a small shareholder in Chardonnay. He has just received his regular dividend of 1 500. Jean has now been offered 10 000 for his shareholding. However, he does not know whether or not to sell his shares as he relies heavily on his annual dividend from the company. (d) Explain how Jean Davide can make himself better off, with no change in risk, by selling his shares in Char- donnay and investing in Cabernet. What would be his resulting gain? (e) Assuming Cabernet's debt and equity capital are at their equilibrium value, estimate the equilibrium value of Jean's shareholding in Chardonnay
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