QRS N-Queries Company has an exciting new project that will cost $10,000,000. The company proposes to finance this project by issuing new shares with a rights offering. Currently, the company has 2,000,000 shares outstanding, each valued in the financial market at $30. With the rights offering, shareholders will be able to purchase one new share for a subscription price of $10.

a.What is the rights-on price for each share, M₀?

b.How many new shares will be issued?

c.How many rights will be required to buy one new share, N?

d.What is the value of a right before the ex-rights date, R₀?

e.What is the ex-rights price for each share, M_e?

f. What is the value of a right after the ex-rights date, R_e?

DEF Company is comparing three different capital structures. Plan A is an all-equity plan and would result in 1000 shares of stock. Plan B would result in 700 shares of stock and $13,500 in debt. Plan C would result in 800 shares of stock and $9000 in debt. The firm's EBIT will be $10,000 per year until infinity. The interest rate on the debt is 12%.

a.Ignoring taxes, compute the EPS for each of the three plans. Which of the three plans has the highest EPS? Which has the lowest?

b.Compute the break-even EBIT that will cause the EPS on Plan B to be equal to the all-equity EPS (Plan A).

c.Compute the break-even EBIT that will cause the EPS on Plan C to be equal to the all-equity EPS (Plan A).

d.Compare your results from parts (b) and (c) above. Is one higher than the other? Why?

e.Ignoring taxes, what is the break-even EBIT that will cause the EPS on Plan B to be equal to the EPS on Plan C? What conclusions do we reach when we compare the results from parts (b), (c), and (e) above?

Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%.

a.What is Q Corporation's firm value?

b.What is R Inc.'s firm value?

c.What is R Inc.'s equity value?

d.What is Q Corporation's cost of equity capital?

e.What is R Inc.'s cost of equity capital?

f.What is Q Corporation's WACC?

g.What is R Inc.'s WACC?

h.Compare the WACC of the two companies. What is your conclusion?

i.What principle have you proven in this case?

j.Both companies are now evaluating a project that requires an initial investment of $1.15 million, that will yield after tax cash inflows of $500,000 per year for the next three years. Assume that this project has the same risk level as each individual firm's assets. Should Q Corporation invest in this project? Should R Inc. invest in this project?

k.Based on your results in part (j), discuss the effects of leverage and its tax shields on the future value of the two firms.