Part A :

Karren Corporation is currently an unlevered firm with 500 million shares outstanding, $250 million of excess cash, and a current stock price of $15 per share. The companys board intends to distribute the cash as a dividend.

Required:

1. Calculate the ex-dividend share price of Karren stock (Assume that stock is trading in a perfect capital market).
2. Assume that instead of paying the dividend, the firm decides to use the cash for the share repurchase, then what is the effect of this decision on the stock price of the firm? (Assume that stock is trading in a perfect capital market).
3. Assuming the perfect capital market assumption, which policy (dividend payout or share repurchase) makes investors better off?

Part B:

The current value of the GIGA corporation is $400 million. The existing capital structure of the company shows that the company is unlevered and has 10 million shares outstanding. Moreover, the balance sheet shows that the company has excess cash of $100 million. The company has used this excess cash for the shares repurchase. The announcement of share repurchase may have a positive or negative effect on the current value of the firm. It is expected that it may increase or decrease the current value of the firm by $200 million.

Required:

Calculate the price of GIGAs stock before the repurchase decision.

What is the effect of an increase and decrease in the firm value on stock price after share repurchase?

Question No 2

Part A:

Dazin corporation is an unlevered firm. Recently, the company decided to expand its business. For this purpose, it would require a capital of $30 million. The company may raise the capital through equity financing, and for this reason, it must sell 2/3^rd of the equity stakes. However, this decision would dilute the firms ownership control. The firm does not want to lose control and, therefore, intends to keep fifty percent ownership.

Required:

1. Assume that the firm finances $20 million through borrowing; what percentage of equity would Dazin corporation need to sell to finance $10 million? (Assume that the firm operates in a perfect capital market)
2. Calculate the smallest amount Dazin corporation can borrow to finance $30 million without losing ownership control (Assume that the firm operates in a perfect capital market).

Part B:

King corporation is an unlevered firm with a market worth of $20 million. Given the tax benefit of debt, the company is considering changing its existing capital structure by adding debt. For this purpose, it plans to issue a permanent debt of $ 2 million and use the proceeds to buy back the shares. The debt would be issued at an interest rate of 7 percent. The corporate tax rate is 40%.

Required:

1. What is the effect of the new capital structure on the value of the firm?
2. What is the effect of the new capital structure on the remaining value of equity?

Part C:

Given its current leverage level, Ring Inc. is expected to have a net income of $9.5 million next year. If the company has a cost of debt of 8 Percent and has a 30 percent corporate tax rate, then how much additional debt can Ring Inc issue this year and still get the interest tax shield benefit next year? (3 Marks)

Question No. 3

Part A

ABC company has bond outstanding of 100,000 selling at par. Similar bonds in the market have a yield rate of 7.5%. In its capital structure, the company also has 5 million common shares outstanding and one million preference shares outstanding of 10.5%. The systematic risk of the firm is 1.2 and has a stock price of $38. Preferred shares are trading in the market at a price of $56 per share. The market return is 12 percent, and the risk-free rate is 3 percent.

Required

Calculate the WACC of ABC company.

Part B:

Refreshment inn is a small refreshment business. It currently rents the bottling machine for its operations and pays a yearly rent of $54000. The rent is inclusive of all the maintenance expenses. The owner of the business is now planning to buy his machine instead of renting it. For this purpose, he is considering two choices.

• The first choice is to buy the existing machine that the business is renting. The machine will cost the business $16500. Moreover, the business has to incur an annual maintenance expense of $22000 on this machine.
• The second choice is to buy a new machine for $255000. This machine is an improved version of the existing machine and uses the latest technology. The new machine has a maintenance cost of $18000 per year and will decrease the annual bottling cost of the business by $15000. Furthermore, the business must incur an upfront cost of $38000 for the training of the new operators.

Lets consider that the business uses the discount rate of 7 percent of ad machines are bought today. Assume that business uses straight-line depreciation method and machines have a useful life of 10 years. The tax rate is 38 percent.

Required:

Should the business buy a new machine, an existing machine, or continue renting? Evaluate.

Question 4

Part A

River Inc. is considering buying a new ship at the cost of $497 million. The firm wants to operate it for a period of 20 years. It is expected that the ship will earn an annual cash flow of $71.1 million and has a cost of capital of 12.5 percent.

Required:

1. Prepare the NPV profile of the investment.
2. Calculate the IRR and identify it on the graph.
3. Should the firm invest?
4. How far could the estimated cost of capital be before the investment decision of the firm would change?

Part B

Nisocom Industries is planning to distribute a dividend of $3 per share this year. It has an equity cost of capital of 10 percent. Moreover, its earnings are expected to grow at an annual rate of 4 percent.

Required:

1. What is the share price of Nisocom industries if it is assumed that the company has a constant expected growth rate and dividend payout rate and that it does not repurchase or issue shares?
2. If we assume that it pays $1 as a dividend this year and utilize the remaining $2 per share for the share buyback, then what is the share price of the company keeping the total payout rate constant?

3. Next, calculate the expected growth rates of earnings and dividends per share if the company maintains the total payout and dividend rate calculated in part b. (2 Marks)