Hi there,

Please kindly find my question as attached.

Many thanks for your kind help.

Corporate Finance / Financial Resources Part 2 Assignment #3 Please explain concisely but clearly all of your answers. We are obviously not expecting perfection as long as your train of thought is sound. Problem 1 (Modigliani-Miller I and II) Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000 and the project's cost of capital is 15%. The risk-free interest rate is 5%. (a) The NPV for this project is closest to: (1) (2) (3) (4) $6,250 $14,100 $10,000 $18,600 (b) Suppose that to raise the funds for the initial investment, the project is sold to investors as an all-equity firm. The equity holders will receive the cash flow of the project in one year. The market value of the unlevered equity for this project is closest to: (1) (2) (3) (4) $94,100 $90,000 $86,250 $98,600 (c) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the cash flow that equity holders will receive in one year in a weak economy is closest to: (1) (2) (3) (4) $6,000 $10,000 $0 $33,000 (d) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the value of the firm's levered equity from the project is closest to: (1) (2) (3) (4) $0 $10,000 $6,000 $8,600 (e) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk-free rate, then the cost of capital for the firm's levered equity is closest to? (1) (2) (3) (4) 45% 25% 15% 95% Problem 2 (Share repurchase) Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors, and has already announced the stock repurchase plan. Currently, Luther is an all-equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share (a) The market value of Luther's non-cash assets is closest to: (1) (2) (3) (4) $20 billion $19 billion $25 billion $24 billion (b) After the repurchase, how many shares will Luther have outstanding? (1) (2) (3) (4) 0.75 billion 1.0 billion 1.1 billion 1.2 billion (c) With perfect capital markets, what is the market value of Luther's equity after the share repurchase? (1) (2) (3) (4) $15 billion $10 billion $25 billion $20 billion (d) With perfect capital markets, what is the market price per share of Luther's stock after the share repurchase? (1) (2) (3) (4) $25 $24 $15 $20 Problem 3 (MM fallacies: Leverage and share prices) Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all-equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently, RC has 5 million shares outstanding and its stock is trading for a price of $12 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12. (a) Prior to any borrowing and share repurchase, RC's EPS (i.e., earnings per share) is closest to: (1) (2) (3) (4) $0.60 $1.00 $1.20 $0.50 (b) Prior to any borrowing and share repurchase, the equity cost of capital for RC is closest to: (1) (2) (3) (4) 8% 10% 12% 9% (c) Following the borrowing of $12million and subsequent share repurchase, the number of shares that RC will have outstanding is closest to: (1) (2) (3) (4) 4.0 million 6.0 million 4.9 million 4.5 million (d) Following the borrowing of $12 and subsequent share repurchase, the equity cost of capital for RC is closest to: (1) (2) (3) (4) 12% 9% 11% 10% (e) Following the borrowing of $12 and subsequent share repurchase, the expected earnings per share for RC is closest to: (1) (2) (3) (4) $1.32 $1.44 $1.40 $1.20 (f) Following the borrowing of $12million and subsequent share repurchase, the value of a share of RC is closest to: (1) (2) (3) (4) $14.00 $13.20 $12.00 $10.80 Problem 4 (MM fallacies: Capital structure and share prices) Rockwood Enterprises is currently an all equity firm and has just announced plans to expand its current business. In order to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares outstanding and following the expansion announcement these shares are trading at $25 per share (hence, any positive NPV is already reflected into Rockwood's current stock price). Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per share. (a) If Rockwood finances their expansion by issuing new stock, what will Rockwood's cost of equity capital be? (1) (2) (3) (4) 12% 15% 8% 10% (b) If Rockwood finances their expansion by issuing $100 million in debt at 5%, what will Rockwood's cost of equity capital be? (1) (2) (3) (4) 11.25% 10.70% 12.50% 12.00% (c) Show mathematically that the stock price of Rockwood does not depend on whether they issue new stock or borrow to fund their expansion