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Question	Possible marks	Comments/hints
Ch 16 Q&P 5	10 pts
Ch 16 Q&P 9	30	9a) assume Clifford is not selling the stock. 9c) assume the D/E for St. R = 1
Ch 16 Q&P 13	18
Ch 16 Q&P 17	6
CH 16 Q&P 24 (my version)	10	Please see below
TOTAL	74

Ch 16 Q&P 24 [my version is based on Q&P24 but slightly modified. The company details are the same. I labeled the questions you are to answer as (A) – (C). (C ) is new and (D) is to be omitted(it is posed in the text but we will ignore it)].

The Odanak corporation (OC) has filed for bankruptcy. All of OC’s assets would fetch $43m on the open market today if put up for sale. The other alternative is to reorganize the business. If this occurs, the company would generate $3.97m cash flows in perpetuity. Since there are no competitors making products similar to OC, there is no company that can offer a comparable discount rate. Analysts estimate that the discount rate can be between 10 and 25%.

A) If the company’s discount rate is 10%, should the company be liquidated or reorganized?

B) Is the answer the same for the 20% discount rate?

(new)C) What is the break-even discount rate at which they would be indifferent between reorganization and liquidation?

(ignore)(D)What other factors may play a role in deciding whether to liquidate the company or reorganize it?

Ch 16 Q&P 5

4. Break-Even EBIT (LO2) Vanier Corporation is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 195,000 shares of stock outstanding. Under Plan II, there would be 140,000 shares of stock outstanding and $1,787,500 in debt outstanding. The interest rate on the debt is 8%, and there are no taxes.

a. If EBIT is $400,000, which plan will result in the higher EPS?

b. If EBIT is $600,000, which plan will result in the higher EPS?

c. What is the break-even EBIT? (This is only for Question 5, DO NOT do question 4)

5. M&M and Stock Value (LO2) In Problem 4, use M&M Proposition I to find the price per share of equity under each of the two proposed plans. What is the value of the firm?

Ch 16 Q&P 9

9. Homemade Leverage and WACC (LO2) St. Louis Co. and St. Romuald Co. are identical firms in all respects except for their capital structure. St. Louis is all-equity financed with $780,000 in stock. St. Romuald uses both stock and perpetual debt; its stock is worth $390,000 and the interest rate on its debt is 8%. Both firms expect EBIT to be $87,000. Ignore taxes.

a. Clifford owns $48,750 worth of St. Romuald’s stock. What rate of return is he expecting?

b. Show how Clifford could generate exactly the same cash flows and rate of return by investing in St. Louis and using homemade leverage.

c. What is the cost of equity for St. Louis? What is it for St. Romuald?

d. What is the WACC for St. Louis? For St. Romuald? What principle have you illustrated?

Ch 16 Q&P 13

13. Calculating WACC (LO2) Laurier Corp. has no debt but can borrow at 6.4%. The firm’s WACC is currently 9.5%, and the tax rate is 35%.

a. What is the company’s cost of equity?

b. If the firm converts to 25% debt, what will its cost of equity be?

c. If the firm converts to 50% debt, what will its cost of equity be?

d. What is the company’s WACC in part (b)? In part (c)

Ch 16 Q&P 17

17. Firm Value (LO3) Lazare Corporation expects an EBIT of $19,750 every year forever. Lazare currently has no debt, and its cost of equity is 15%. The firm can borrow at 10%. If the corporate tax rate is 35%, what is the value of the firm? What will the value be if the company converts to 50% debt? To 100% debt?