Q3

Question 3 Leverit Inc. is a firm that produces mechanical equipment. Leverit will operate for one period and its only cash-flow will be received in one year (at t=1 ). This cash-flow will be $80 million with probability 1/6,$160 million with probability 1/3,$280 million with probability 1/3, and $360 million with probability 1/6. Leverit is currently all-equity financed and currently has 100 million shares outstanding. The risk-free interest rate is 5%, the market risk-premium is 6%, and Leverit's beta is 1.2. Assume perfect capital markets. i. Determine Leverit's share price, expected return on equity, and expected cashflow per share. ( 3 marks) ii. Leverit now (at,t=0) issues zero coupon debt, with a face value of $20million, and a maturity of 1 year. What is the current market value of Leverit's debt? Briefly explain your reasoning for your choice of discount rate in this part of the question. (3 marks) iii. Leverit immediately employs the proceeds from the debt issue to buy back shares at the current share price (i.e., the share price you calculated in (i.)). How many shares can Leverit buy back? ( 3 marks) iv. What is the new market value of Leverit's equity after the debt issue? What is Leverit's leverage (D/E) ratio? (4 marks) 7 v. Calculate Leverit's new expected return on equity and expected cash-flows per share. (4 marks) Vi. Using the information from (v), calculate Leverit's new share price after the share repurchase. ( 4 points) Yii. Briefly discuss the effects of a leveraged recapitalization on share price, expected return on equity, and earnings per share in a perfect capital market ( 23 sentences). (4marks) Question 3 Leverit Inc. is a firm that produces mechanical equipment. Leverit will operate for one period and its only cash-flow will be received in one year (at t=1 ). This cash-flow will be $80 million with probability 1/6,$160 million with probability 1/3,$280 million with probability 1/3, and $360 million with probability 1/6. Leverit is currently all-equity financed and currently has 100 million shares outstanding. The risk-free interest rate is 5%, the market risk-premium is 6%, and Leverit's beta is 1.2. Assume perfect capital markets. i. Determine Leverit's share price, expected return on equity, and expected cashflow per share. ( 3 marks) ii. Leverit now (at,t=0) issues zero coupon debt, with a face value of $20million, and a maturity of 1 year. What is the current market value of Leverit's debt? Briefly explain your reasoning for your choice of discount rate in this part of the question. (3 marks) iii. Leverit immediately employs the proceeds from the debt issue to buy back shares at the current share price (i.e., the share price you calculated in (i.)). How many shares can Leverit buy back? ( 3 marks) iv. What is the new market value of Leverit's equity after the debt issue? What is Leverit's leverage (D/E) ratio? (4 marks) 7 v. Calculate Leverit's new expected return on equity and expected cash-flows per share. (4 marks) Vi. Using the information from (v), calculate Leverit's new share price after the share repurchase. ( 4 points) Yii. Briefly discuss the effects of a leveraged recapitalization on share price, expected return on equity, and earnings per share in a perfect capital market ( 23 sentences). (4marks)