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Hi Please answer the following questions: 1. Describe the role that the \"winner's curse\" may play in the underpricing of IPOs. 2. a. Does a rights offer cause a share price decrease? Why or why not? b. How are existing shareholders affected by a rights offer? Illustrate your answer with an example. 3. TUV Guy Inc. is proposing a rights offering. There are currently 240,000 shares outstanding at $80 each. There will be 60,000 new shares offered at $60 each. a. What is the new market value of the company? b. How many rights are associated with one of the new shares? c. What is the value of a right? d. What is the ex-rights price per share? e. Why might a company have a rights offering rather than a general cash offer? 4. WXYZ Co. has concluded that additional equity financing will be needed to expand operations, and that the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $50 to $45 ($50 is the rights-on price; $45 is the ex-rights price). The company is seeking $12.5 million in additional funds with a per share subscription price of $25. How many shares are there currently, before the offering? (Assume that the increment to the market value of the equity equals the gross proceeds from the offering.) 5. a. In five sentences or less, briefly explain the M&M Proposition I with taxes. Ensure that you include the appropriate formula in your explanation. b. What are the two implications of M&M Proposition I with taxes? c. In five sentences or less, briefly explain the M&M Proposition II with taxes. Ensure that you include the appropriate formula in your explanation. d. What are the two implications of M&M Proposition II with taxes? 6. Under what conditions of personal and corporate taxation will there be no gain from financial leverage? Explain using the formula VL = VU + [1 - (1-TC) x (1-TS)/(1-Tb)] x D 1 7. VWX Corporation has an EBIT of $166,666.67, a corporate tax rate of 40%, debt of $500,000, and unlevered cost of capital of 20%. The cost of debt capital is 10%. a. What is the value of VWX's equity? b. What is the cost of equity capital for VWX? c. What is the WACC? d. Compare the WACC of VWX to the WACC of an unlevered firm. What is your conclusion? What principle have you proven in this case? 8. STU's Disco Factory Inc. is financed solely by equity and it is considering issuing debt and using the proceeds to repurchase some of the outstanding shares at the current market price of $30. There are currently 200,000 shares outstanding. EBIT is expected to remain at $1.5 million, with all earnings paid out as dividends. The firm can issue debt at a rate of 8%, and the firm's tax rate is 40%. Three alternative amounts of debt are being considered: Amount of debt Required return on equity 0 15% $1,000,000 15.5% $2,000,000 16% Assume that all stock repurchases will be made at $30 per share. a. Using the M&M Proposition I with taxes, calculate the value of the firm at each debt level. b. What is the optimum amount of debt? c. Show that, at the optimum capital structure, the firm also minimizes the WACC. d. Show that, at the optimum capital structure, the firm also maximizes the price of the outstanding shares. 9. Explain homemade leverage and why it matters. 10. Positive NPV projects enhance shareholder wealth. However, in some cases the payment of dividends limits the number of positive NPV projects a firm can take. Why, then, shouldn't shareholders prefer a residual dividend policy? 11. You own 1,000 shares of stock in ABC Corporation. You will receive a 60 cent per share dividend in one year. In two years, ABC will pay a liquidating dividend of $30 per share. The required return on ABC stock is 15%. What is the current share price of your stock (ignoring taxes)? If you would rather have equal dividends in each of the next two years, show how you can accomplish this by creating homemade dividends. (Hint: Dividends will be in the form of an annuity.) 2 Suppose you want only $200 total in dividends the first year. What will your homemade dividend be in two years? 12. Suppose we have two equally risky firms, Firm A and B. Firm B's shares are currently worth $100, and they are expected to be worth $120 in one year. Personal dividend tax rate is 30%, and capital gains are exempt from taxes. a. What is the after-tax return on Firm B? b. If Firm A opts to pay a dividend of $20 per share in one year, what is the after-tax return on Firm A? c. Given that dividends will reduce firm value proportionally, what is the share price of Firm A's stock if it pays a dividend of $20 in one year? 3 1) Describe the role that the \"winner's curse\" may play in the underpricing of IPOs. Answer: Winerscurse was the termintroduced byRock in the year 1986. In like manner, at whatever point the in for the IPOshares are high, informedinvestors will attempt to buy theseshares just when they are unde Then again, the uinformed financial specialists won't have anyopinion or thought regarding both unde or overrated IPO, this thus will actuate theseinvestors in assigning an extent of sum at all deasirable IP well. Due the unfriendly determination design these ignorant financial specialists will simply present IPO buy arranges just when they are underpriced to stay away from hazard and this will be to such an that it will repay from predisposition in theallocation of new IPO. erpricing of IPOs. like manner, at whatever point the interest theseshares just when they are underpriced.. nion or thought regarding both underpriced g an extent of sum at all deasirable IPO as ncial specialists will simply present their m hazard and this will be to such an extent 2) a. Does a rights offer cause a share price decrease? Why or why not? Answer: Right issue will reduce theprice of share.Issuing rights to the present shareholders will give them the privilege to purchase additional shares as per the proportion, number of shares held. For the most part, right issues permit the shareholders to buy offers at rebate and this offer abatements the share cost as number of shares outstanding increased. When number of shares outstanding increases it will naturally pull down the stock price. b. How are existing shareholders affected by a rights offer? Illustrate your answer with an example. Answer: For example number of shares owned 1000 of X co and purchase price is 100 per share. It is currently trading at 200/share. Currently company have 1,000,000 shares in circulation and desired to raise $375,000 and using the issuance of 250,000 new shares. Existing share holders are offered 1:4 rights offer, to encourage it shares are available at $150. Then initial value 2,000,000. After the rights offer = (1,000,000*200) + (250,000 * 150) = 2,375,000 Ex rights per share 2,375,000 / 1,250,000 = 190, the share price was decreased. But the extent of decrease using rights issue will be lesser than ordinary issue. 3) TUV Guy Inc. is proposing a rights offering. There are currently 240,000 shares outstanding at $80 each. There will be 60,000 new shares offered at $60 each. Current Share Outstanding Share price New Shares New Shares price a. What is the new market value of the company? Answer: New Market Value = b. How many rights are associated with one of the new shares? Answer: Rights associated with one share = c. What is the value of a right? Answer: Value of a right = Current Market Price - Ex Right Price Value of a right = d. What is the ex-rights price per share? Answer: Ex rights of shares = (Ex Price - Subscription Price) / (Rights on price - Ex price) 4 = (Ex Price - $60) / ($80 - Ex Price) $320 - 4Ex Price = Ex Price - $60 $380 = 5 Ex Price Ex Price = e. Why might a company have a rights offering rather than a general cash offer? Answer: Right issues will enable the existing shareholders to purchase the outstanding shares at discounted price and it actually protects the proportion of shares held by the respective shareholders. This also protects from the underpricing. 00 shares outstanding at 240,000 $80 60,000 $60 $22,800,000 4 $4 $76 h offer? ding shares at discounted ve shareholders. This also 4) WXYZ Co. has concluded that additional equity financing will be needed to expand operations, and t the needed funds will be best obtained through a rights offering. It has correctly determined that as a result of the rights offering, the share price will fall from $50 to $45 ($50 is the rights-on price; $45 i the ex-rights price). The company is seeking $12.5 million in additional funds with a per share subscription price of $25. How many shares are there currently, before the offering? (Assume that th increment to the market value of the equity equals the gross proceeds from the offering.) Answer: Pex = 45 = (25+$50N)/(N+1) $45N+$45 = $25+$50N $45-$25 = $50N-$45N 20 = $5N $5N = 20 N = 4 Number of new shares = Number of old shares = 500,000 Shares 2,000,000 Shares o expand operations, and that rectly determined that as a s the rights-on price; $45 is nds with a per share e offering? (Assume that the m the offering.) 5) a. In five sentences or less, briefly explain the M&M Proposition I with taxes. Ensure that you include the appropriate formula in your explanation. Answer: M&M theories proides the basis for modern understanding and analysing about the capital structure. Value of firm wilth debt is nothing but the total of value of unlevered firm and debt tax shield. There is a positive but linear relationship exist between the value of firm and its leverage. This is based on the simple concept that value of the company will increase when the proportion of debt becasue of the tax shield provided by its interest. VL = VU + TCD Where, VL = The value of the levered firm VU = Value of un-levered firm TCD = The tax rate * The value of debt, it assumes that the debt is perpetual. b. What are the two implications of M&M Proposition I with taxes? Answer: First and foremost that the proportin of debt capital should be 100% as debt financing is more advantageous. In this case the cost of capital that is WACC will decrease because of higher dependence debt. c. In five sentences or less, briefly explain the M&M Proposition II with taxes. Ensure that you include the appropriate formula in your explanation. Answer: Any increase in risk and return of equity will be offset by the interest tax shield. There is a positive relationship between the leverage and the expected return on equity. According to this the cost of equity will decrease with increase in debt equity ratio. rE = r0+(D/E)(r0-rD)(1-TC) Where, rE = the required rate or return on equity r0 = cost of capital without leverage rD = required rate or return on borrowings D/E = debt to equity ratio Tc = tax rate d. What are the two implications of M&M Proposition II with taxes? Answer: 1. WACC will generally lie between the cost of equity and cost of debt adjusted with tax effects. 2. Generally, value of a levered firm will be greater than unlevered firm. xes. Ensure that you about the capital vered firm and debt ue of firm and its ill increase when the bt financing is more because of higher dependence on axes. Ensure that you include shield. There is a positive rding to this the cost of equity 6) Even in some special cases (1-Tc).(1-Ts)=(1-Tb) like the above given condition, all taxes are identical t zero and therefore there will be no advantage of expanding obligationofextent. As such, estimationtaxation of both will levered and Under whatthe conditions personal and corporate there be no unlevered firm will be equivalent. The principle purpose behind this occasion is gain from financial leverage? Explain using the formula that tax )benefit the corporate VL =the V loan + [1 cost - (1-T x (1-TSon )/(1-T )] x D assessments will be precisely the C b same toU counterbalance the higher charges on the personal income from these Answer: stocks and securities. 7) VWX Corporation has an EBIT of $166,666.67, a corporate tax rate of 40%, debt of $500,000, and u 20%. The cost of debt capital is 10%. EBIT $166,666.67 Corporate Tax 40% Debt $500,000 Unlevered Cost of capital 20% Cost of debt 10% a. What is the value of VWX's equity? Answer: Value of Unlevered Firm = EBIT/Cost of capital unlevered Value of Unlevered Firm = $833,333.35 Value of Unlevered Firm after tax = $500,000 Value of the Firms Levered = Value of Unlevered Firm after tax+Debt Value * tax Value of the Firms Levered = $700,000 Equity Value = $200,000 Hence the Value of the Equity is = $200,000 b. What is the cost of equity capital for VWX? Answer: Cost of Equity capital = c. d. What is the WACC? Answer: WACC = 35% 14.29% Compare the WACC of VWX to the WACC of an unlevered firm. What is your conclusion? What principle have you proven in this case? Answer: When the unlevered WACC is exceeding 20%,but the levered WACC remains at 14.29% and it is far below the unlevered WACC. It is considered to be better because it cost less to the company when compared to unlevered cost of capital. By opting levereage both equity and debt combination reduces the WACC to 14.29% which will be more beneficial. 40%, debt of $500,000, and unlevered cost of capital of alue * tax is your conclusion? mains at 14.29% ause it cost less to reage both equity beneficial. 8) STU's Disco Factory Inc. is financed solely by equity and it is considering issuing debt and using the proceeds to repurchase some of the outstanding shares at the current market price of $30. There are currently 200,000 shares outstanding. EBIT is expected to remain at $1.5 million, with all earnings p as dividends. The firm can issue debt at a rate of 8%, and the firm's tax rate is 40%. Three alternativ amounts of debt are being considered: Amount of debt Required return on equity $0 15% $1,000,000 15.50% $2,000,000 16% Assume that all stock repurchases will be made at $30 per share. a. Using the M&M Proposition I with taxes, calculate the value of the firm at each debt level. Answer: Amount of debt Rate of return Value of Equity Value of firm $0 0.15 $40,000,000 $40,000,000 $1,000,000 0.155 $38,709,677.42 $39,709,677.42 $2,000,000 0.16 $37,500,000 $39,500,000 b. What is the optimum amount of debt? Answer: Zero debt is optimum. c. Show that, at the optimum capital structure, the firm also minimizes the WACC. Answer: WACC = (100% * 15%) + (0% * 8% *(1 - 40%)) WACC = 15% d. Show that, at the optimum capital structure, the firm also maximizes the price of the outstanding sha Answer: Price of share = $40,000,000 / 200000 Price of share = $200 ring issuing debt and using the market price of $30. There are $1.5 million, with all earnings paid out ax rate is 40%. Three alternative rm at each debt level. he WACC. the price of the outstanding shares. 9) Explain homemade leverage and why it matters. Answer: Custom made leverageis a substitution for the investors hazard. This will enable in moving from overpriced shares of an exceedingly leveraged firm to underpriced shares of unlevered firm by getting cash on the individual record. As indicated by this a suspicion is that the terms and cost of borrowing continues as before between the corporate and individual which will enable them to derive the benefit of leverage. It is only the capacity of the speculator in changing their influence keeping in mind the end goal to get the sought capital structure regardless of organization's capital structure. On the off chance that on the off chance that the addition influence utilization by the financial specialist or to undo the current levereage of the firm at the fancied level then capital structure choice of the organization is unessential to the investor. 10) Positive NPV projects enhance shareholder wealth. However, in some cases the payment of dividends limits the number of positive NPV projects a firm can take. Why, then, shouldn't shareholders prefer a residual dividend policy? Answer: As indicated by residual dividend arrangement, dividends are paid just from the residual income. Shareholders are making direct interest in the organization they are the proprietors, therefore it is vital to give a proportion of the profit created by the organization to their respective shareholders in fitting extent as per their ownership. For this situation, the organization will initially meet its obligations and investment requirements, then the rest of the salary will be distributed to the shareholders as profit. This really makes more unpredictability in the profit installments on the grounds that consistently prerequisites changes and this is undesirable from a shareholders' perspective. Extend with positive NPV will enhance the abundance of shareholders yet there are few cases, the installment of profit will turn into an impediment to the positive NPVprojects. Subsequently, residual dividend strategy will be desirables this will empower the organization in upgrading their total value. 11) You own 1,000 shares of stock in ABC Corporation. You will receive a 60 cent per share dividend in o two years, ABC will pay a liquidating dividend of $30 per share. The required return on ABC stock i What is the current share price of your stock (ignoring taxes)? If you would rather have equal divide of the next two years, show how you can accomplish this by creating homemade dividends. (Hint: Di be in the form of an annuity.) Suppose you want only $200 total in dividends the first year. What will your homemade dividend be in Answer: Dividend received in year 1 = $600 Price of stock in one year = $26.09 Number of shares purchased = 15.33 Shares Dividend in year two = $30,460.00 cent per share dividend in one year. In uired return on ABC stock is 15%. uld rather have equal dividends in each emade dividends. (Hint: Dividends will ur homemade dividend be in two years? 12) Suppose we have two equally risky firms, Firm A and B. Firm B's shares are currently worth $100, a $120 in one year. Personal dividend tax rate is 30%, and capital gains are exempt from taxes. a. What is the after-tax return on Firm B? Answer: After-tax retrurn 20% b. If Firm A opts to pay a dividend of $20 per share in one year, what is the after-tax return on Firm A? Answer: After-tax return $ 14.00 c. Given that dividends will reduce firm value proportionally, what is the share price of Firm A's stock year? Answer: Share price $ 80.00 currently worth $100, and they are expected to be worth mpt from taxes. -tax return on Firm A? price of Firm A's stock if it pays a dividend of $20 in one