Question
Bright City is a publicly traded all-equity company that was set up to release a rock album. The album will be finished in exactly one
Bright City is a publicly traded all-equity company that was set up to release a rock album. The album will be finished in exactly one year's time, when the company will be dissolved and the funds distributed to shareholders. The EBIT that the company will generate in one year will be 100 million. At this time the company will no longer need the 7 million of working capital that it has invested.
The beta of the company is 1, and it has 100 million shares outstanding. The risk-free rate is 5%, and the market risk premium is 5%. The corporate tax rate is 30%.
- (6 points) Calculate the price per share of Bright City today.
- (10 points) The chief financial officer of the company decided to apply what she had learned in her MFA, and decided to increase leverage. She borrowed 42 million pounds for one year, at an interest rate of 5%, with a single coupon payment in one year's time. She used the 42 million raised to pay a cash dividend to shareholders. Calculate the share price of Bright City after this change in capital structure, and the dividend payment. Are shareholders better off or worse off? By how much?
- (10 points) Immediately after the change in capital structure, and unexpectedly, the local council where Bright City is carrying out the project decided to file a lawsuit against the firm, on the basis that the project carried out had a negative environmental impact (noise pollution). The outcome of the lawsuit will be known in one year's time. Analysts expect that if the lawsuit is successful, which will happen with probability of 60%, the firm will have to pay the council 17.5 million before it is allowed to pay any funds to its investors. The outcome of the lawsuit is uncorrelated with the market return. Calculate the share price after the news came out. What is the cash dividend that shareholders will receive per share in one year's time if the lawsuit is successful?
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