Exercice 1: Capital Structure and Valuation I (20 pts, 5 by question) F has 200,000 shares outstanding with a market value of $30 each and no debt. F is subject to a corporate tax rate Te = 30% and the beta of unlevered equity Bo is 0.8. Risk- free rate is 3% and expected return of the market portfolio is 8%. We ignore bankruptcy costs in this exercise. F considers the following alternative operations 1. Operation 1: F pays $2,000,000 in dividends to stockholders. This divi- dend is financed by issuing debt for the same amount. If you hold one F stock, how much value is created/destroyed for you in this operation? 2. Operation 2: F invests $1,000,000 in a project that generates $150,000 per year after tax. This project has the same systematic risk as F's existing assets. The investment cost is financed by issuing risk-free debt for the same amount ($1,000,000). If you hold one F stock, how much value is created/destroyed for you in this operation? 3. The beta of debt Be is 0.1 after operation 1. Compute the Bs of levered equity after operation and after operation 2. 4. Operation 3: F buys portfolio of stocks worth $1,000,000 (at market value). This purchase is financed by issuing risk-free debt for the same amount. Following the operation, F's beta of levered equity increases to 1. Compute the systematic risk Spf of the portfolio bought by F. Hint: What is the beta of a portfolio of assets ? Exercice 1: Capital Structure and Valuation I (20 pts, 5 by question) F has 200,000 shares outstanding with a market value of $30 each and no debt. F is subject to a corporate tax rate Te = 30% and the beta of unlevered equity Bo is 0.8. Risk- free rate is 3% and expected return of the market portfolio is 8%. We ignore bankruptcy costs in this exercise. F considers the following alternative operations 1. Operation 1: F pays $2,000,000 in dividends to stockholders. This divi- dend is financed by issuing debt for the same amount. If you hold one F stock, how much value is created/destroyed for you in this operation? 2. Operation 2: F invests $1,000,000 in a project that generates $150,000 per year after tax. This project has the same systematic risk as F's existing assets. The investment cost is financed by issuing risk-free debt for the same amount ($1,000,000). If you hold one F stock, how much value is created/destroyed for you in this operation? 3. The beta of debt Be is 0.1 after operation 1. Compute the Bs of levered equity after operation and after operation 2. 4. Operation 3: F buys portfolio of stocks worth $1,000,000 (at market value). This purchase is financed by issuing risk-free debt for the same amount. Following the operation, F's beta of levered equity increases to 1. Compute the systematic risk Spf of the portfolio bought by F. Hint: What is the beta of a portfolio of assets
