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Problem 16-19 Sarvon Systems has a debt-equity ratio of 1.2, an equity beta of 2.0, and a debt beta of 0.30. It is currently evaluating
| Problem 16-19 | ||||||||||
| Sarvon Systems has a debt-equity ratio of 1.2, an equity beta of 2.0, and a debt beta of 0.30. It is currently evaluating the following projects, none of which would change the firms volatility: | ||||||||||
| Project | A | B | C | D | E | |||||
| Investment (million) | $100 | $50 | $85 | $30 | $75 | |||||
| NPV (million) | $20 | $6 | $10 | $15 | $18 | |||||
| a. | Which project will equity holders agree to fund? | |||||||||
| b. | What is the cost to the firm of the debt overhang? | |||||||||
| D/E Ratio | 1.20 | |||||||||
| bEquity | 2.00 | |||||||||
| bDebt | 0.30 | |||||||||
| a. | Which project will equity holders agree to fund? | |||||||||
| Cutoff | ||||||||||
| Project | A | B | C | D | E | |||||
| Profitability index | ||||||||||
| Equity funded? | ||||||||||
| b. | What is the cost to the firm of the debt overhang? | |||||||||
| Opportunity cost (million) | ||||||||||
| Requirements | ||||||||||
| 1. | In cell D19, by using cell references, find the ratio between the debt beta and equity beta and multiply it by the debt-to-equity ratio (1 pt.). | |||||||||
| 2. | In cell D22, by using cell references, calculate the profitability index of project A (1 pt.). Copy cell D22 and paste it onto cells E22:H22 (1 pt.). | |||||||||
| 3. | To decide which project would be eligible for equity funding, you need to compare the profitability index of each project to the cutoff measure by using the function IF. In cell D23, by using the function IF and absolute and relative cell references, compare the profitability index of project A to the cutoff measure; if true, type "Yes"; if false, type "No" (1 pt.). Copy cell D23 and paste it onto cells E23:H23 (1 pt.). | |||||||||
| 4. | In cell E27, by using cell references, calculate the cost to the firm of the debt overhang (1 pt.). | |||||||||
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Intermediate Financial Management
Authors: Eugene F. Brigham, Phillip R. Daves
7th Edition
0030333288, 9780030333286
