Heavy Duty, a manufacturer of hydraulic tipper trailers for the mining business and its competitor Bullmaster...
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Heavy Duty, a manufacturer of hydraulic tipper trailers for the mining business and its competitor Bullmaster are located in Folfanga. Folfanga does not charge corporate taxes. In the local stock market, Heavy Duty's shares trade at €40.00 and 2.5 million shares are outstanding. Heavy Duty's next (annual) dividend payment will amount to €10 million and its growth rate (g) is expected to be 3% (the last dividend has just been paid). The company's WACC is 11.00% and the firm is financed by 20% debt in terms of market value (perpetuity assumed). a) Assume that the EPS will be €8 and that Heavy Duty is able to invest the retained (i.e., plowed back) earnings at its book ROE. What is the firm's book ROE? (4 points) b) Heavy Duty's competitor Bullmaster is unlevered and has 2.5 million shares outstanding, but is otherwise identical to Heavy Duty. Assuming that Miller&Modigliani's propositions hold, what is the fair price of Bullmaster's stock? (3 points) c) To gain a competitive advantage over Bullmaster, Heavy Duty's executives decide to raise additional debt to fund future investment opportunities. What is the return that bondholders demand, assuming that the firm's (business) risk is not affected by the increase in leverage? (3 points) d) Due to a recession, Folfanga has decided to levy corporate taxes. Regarding the corresponding changes in market value of the two competitors, who will suffer more from this decision? Provide a rationale for your response. (3 points) Heavy Duty, a manufacturer of hydraulic tipper trailers for the mining business and its competitor Bullmaster are located in Folfanga. Folfanga does not charge corporate taxes. In the local stock market, Heavy Duty's shares trade at €40.00 and 2.5 million shares are outstanding. Heavy Duty's next (annual) dividend payment will amount to €10 million and its growth rate (g) is expected to be 3% (the last dividend has just been paid). The company's WACC is 11.00% and the firm is financed by 20% debt in terms of market value (perpetuity assumed). a) Assume that the EPS will be €8 and that Heavy Duty is able to invest the retained (i.e., plowed back) earnings at its book ROE. What is the firm's book ROE? (4 points) b) Heavy Duty's competitor Bullmaster is unlevered and has 2.5 million shares outstanding, but is otherwise identical to Heavy Duty. Assuming that Miller&Modigliani's propositions hold, what is the fair price of Bullmaster's stock? (3 points) c) To gain a competitive advantage over Bullmaster, Heavy Duty's executives decide to raise additional debt to fund future investment opportunities. What is the return that bondholders demand, assuming that the firm's (business) risk is not affected by the increase in leverage? (3 points) d) Due to a recession, Folfanga has decided to levy corporate taxes. Regarding the corresponding changes in market value of the two competitors, who will suffer more from this decision? Provide a rationale for your response. (3 points)
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