Problem 1 (23 marks) wwwww The Teenie Tiny Company is currently an un-levered firm with a beta of 1.3925. Since this is a start-up company with significant impact on the social well-being of the country, the firm was given a tax- exempt status for the first five years of operation. In the market, you observe that the latest Government of Canada T-bill issue is yielding 3% and the market risk premium is 8%. This is the last year for the company's tax-exempt status. Assuming that the tax rate will be 40% and that there is no cost for the risk of default. Use the following table to answer these questions: Value of Debt RD Beta EBIT Tax Rate 800,000 0 5.0% 1.392500 40% 250,000 5.0% 1.483015 T-bill Rate 3.0% 500,000 5.0% 1.542274 TSX 11.0% 750,000 5.0% 1.607016 1,000,000 5.0% 1.678038 1,250,000 5.0% 1.756303 1,500,000 5.0% 1.842075 1,750,000 5.0% 1.939488 2,000,000 5.0% 2.047619 c) Calculate the required rate of return for the un-levered firm. (2 marks) Calculate the market value of the un-levered firm in proposition 1. (2 marks) Calculate the WACC for an un-levered firm in proposition II. No calculation required (1 mark) d) Using the information from the table, calculate the value of the firm (proposition I), cost of equity, and the WACC (proposition II) of the firm for each level of debt. (16 marks) e) Debt Un-levered TD 250,000.00 500,000.00 750,000.00 1,000,000.00 1,250,000.00 Levered 1,500,000.00 1,750,000.00 2,000,000.00 WACC Wd r* (1-T) We re Equity Using the information from your calculations draw the graphs for proposition I and proposition II. (4 marks) Problem 2 (31 marks) Your best friend is in a senior position of the finance department of Teenie Tiny and you are having lunch together after a round at the golf course. The discussion gets around to the fact that Teenie Tiny will lose their tax-exempt status and your friend mentions that all the debt that the company needs will be financed using bonds with a 5 percent coupon. However, you remember that during a lecture at SMU, it was mentioned that as a company issues more and more debt, the risk for the bondholders will increase and bondholders will require coupon interest rates to increase as the amount of debt increases. You have prepared the following table to assist in answering these questions: Value of Debt RD Beta EBIT Tax Rate 800,000 0 5.0% 1.392500 40% 250,000 5.5% 1.483015 T-bill Rate 3.0% 500,000 6.0% 1.542274 TSX 11.0% 750,000 6.5% 1.607016 1,000,000 7.0% 1.678038 1,250,000 9.0% 1.756303 1,500,000 11.0% 1.842075 1,750,000 13.0% 1.939488 2,000,000 15.0% 2.047619 a) Calculate the required rate of return for the un-levered firm. (2 marks) b) Calculate the market value of the un-levered firm in proposition 1. (2 marks) c) Calculate the WACC for an un-levered firm in proposition II. (1 mark) d. Using the information from the table, calculate the value of the firm (proposition I), cost of equity, and the WACC (proposition II) each level of debt. (16 marks) d. Using the information from the table, calculate the value of the firm (proposition I), cost of equity, and the WACC (proposition II) each level of debt. (16 marks) Value of Debt Value of Cost of rp Beta the Firm Equity (re) WACC 0 250,000 500,000 750,000 1,000,000 1,250,000 1,500,000 1,750,000 2,000,000 e) Calculate the present value of distress. (4 marks) Value of Debt 0 250,000 500,000 750,000 1,000,000 1,250,000 1,500,000 1,750,000 2,000,000 PV of Distress f) Graph (on 2 separate graphs) the information for proposition I and proposition II. (4 marks) g) Briefly explain the amount of debt the company should use as a levered company. (2 marks) Problem 4 (7 marks) The Tooth Fairy Company's stock currently sells on the Toronto Stock Exchange at $90 per share. Below is their partial balance sheet: Common Stock (1,500,000 shares outstanding) Retained Earnings Total 30,000,000 15,000,000 45,000,000 a) The company is considering a 3 for 2 stock split. What will be the company's stock price following the stock split? How many shares will be outstanding? Show any changes to the Balance sheet. b) If instead, the company does a 7.5% stock dividend. What will be the company's stock price following the stock dividend? How many shares will be outstanding? Show any changes to the 4