Microsoft Word - Ps6.doc

Here is a simplified balance sheet for Upjohn Company at the end of 2012 (dollars in millions):

Current assets $1,418 Current liabilities $653

Net property, plant, Long-term debt 457

Net property, plant, Deferred taxes 199

and equipment 1,240 Shareholders equity 1,821

Other assets 472 Total 3,130

Total 3,130

Other information: There are 75 million shares of equity outstanding with a per share price of $20 at end of year. The equity has a beta of 1.25. Historical average risk premium is 8.0% per year and the risk-free rate is 2%. Newly issued Upjohn long-term debt carries a spread of 1.5% to the risk-free rate. The companys marginal tax rate is 35%.

1. (a) Calculate Upjohns WACC. (hint: Use the CAPM and the data above and only use Long-term debt as debt)
2. (b) What would Upjohns WACC be if it moved to and maintained a debt to market value ratio of 30%? As a result, the spread on debt increase to 2%. Assume the only taxes are corporate taxes.
3. (c) Now assume that the bondholders and the equityholders have effective tax rates of 30% and 10%, respectively, and the current market price of $20 reflects this capital structure. What would be the total equity value and the per share price if Upjohn were 100% equity finance?