F1 Q6-Q10

Please show all workings/give explanations

Note: Questions 6 10 are based on the same mega problem. For convenience

we have included the entire set of information in every question. For purposes

of the questions that follow, assume that changes in working capital are

negligible and capex and depreciation are of the same magnitude and therefore

cancel each other. This is the assumption we made in most of the videos to

focus on valuation effects of borrowing and taxes and to figure out the key differences between alternative valuation methods.

XYZ, Inc.s revenues have been $500,000 and total costs have been $250,000;

both costs and revenues are expected to remain the same in perpetuity. XYZ,

Inc. is an all equity firm (i.e., it has no debt) and has 125,000 shares outstanding.

The market knows that the company has no other investment (or growth)

opportunities. XYZ, Inc. currently pays out all its earnings as dividends (100%

payout) and is expected to do so forever. The dividends on the basis of last

years earnings have just been paid out. If the appropriate discount rate for XYZ,

Inc. is 7.50%, For this question, assume taxes are zero. (Enter the number with up to two decimals but without any $ or comma sign.)

Q6 What is the price per share of XYZ, Inc.?

Q7 What is the price-to-earnings ratio?

XYZ, Inc.s revenues have been $500,000 and total costs have been $250,000;

both costs and revenues are expected to remain the same in perpetuity. XYZ,

Inc. is an all equity firm (i.e., it has no debt) and has 125,000 shares outstanding.

The market knows that the company has no other investment (or growth)

opportunities. XYZ, Inc. currently pays out all its earnings as dividends (100%

payout) and is expected to do so forever. The dividends on the basis of last

years earnings have just been paid out. The appropriate discount rate for XYZ,

Inc. is 7.50%. The CEO of XYZ, Inc. has a very exciting plan to make her company

look more attractive to investors. She suggests to her CFO that if the firm issues

$2.50M debt in perpetuity with a return of 5%, and uses this debt to repurchase

some of the shares of the company, it will make the firm more attractive to

acquirers. The CFO is skeptical of the CEOs plan and argues with her about the

logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally

simply states: I do not have to convince you, Gautam, especially since my plan

is fool proof. My debt-based strategy will make our company attractive to any

acquirer because it will lower our price-earnings ratio and, consequently, make

them offer us a lot more money for our assets than they would otherwise. Is

the CEO correct in believing that the price-earnings ratio of XYZ, Inc. will drop?

For this question, assume taxes are zero.

Q8 Is the CEO correct in believing that the price-earnings ratio of XYZ, Inc. will drop?

Yes

No

It depends

Q9 What will be the new price-earnings ratio of XYZ?

Q10 What will the value of the firm be?

3,000,000

2,333,333

3,333,333

None of the above