Question 1

You have been hired to estimate the beta for HP and have broken the company down into 4 broad business groups. The market values and equity betas for each group are shown on the table below:

Divisions equityMarket Value

Business GroupMarket ValueAsset BetaDivision Debt

(in $billions)(in $billions)

Mainframes$2.01.10$0.75

Personal Computers$2.01.50$0.50

Software$1.02.00$1.00

Printers$3.01.00$1.25

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Estimate the equity beta for HP as a company.

If the market risk premium is 5% and the T-Bond rate is 2%, determine how much of the return HPs shareholders earn is due to business (asset) risk, and how much is due to financial risk.

Assume you are HPs CEO. Outside investors would like to know what WACC (s) you use to evaluate each divisions projects. Would you use one for each division, or one for the entire firm. Why? Please explain.

Question 2 Use the following financial statements to answer question 2

2015 Income Statement

Sales836,100

Costs of Goods Sold650,700

Other Expenses17,100

Earnings Before Interest and Tax168,300

Interest Expense12,600

Taxable Income155,700

Taxes54,495

Net Income101,205

Dividends30,300

Addition to Retained Earnings70,905

2015 Balance Sheet

AssetsLiabilities and Owners Equity

Current AssetsCurrent Liabilities

Cash24,035Accts Payable64,600

Accts Receivable38,665Notes Payable16,150

Inventory82,555Total80,750

Total145,555Long-term debt150,000

Owners Equity

Fixed AssetsCommon Stock and Paid-in Surplus130,000

Net Plant & Equip.392,350Retained Earnings176,855

Total Assets537,605Total Liabilities and Owners Equity537,605

The company would like to grow at 20%. Assume that the dividend payout rate will remain constant, what, if any, is the companys external financing need? The company plans to meet any external financing needs with debt; the interest rate on debt is 5%.

Forecast the pro-forma financial statements for 2016.

Compute at least 5 financial ratios and discuss the firms financial status.

Question 3

Plastico, a manufacturer of consumer plastic products is evaluating its capital structure. The book value balance sheet of the company follows:(all numbers in millions)

AssetsLiabilities

Current Assets$1000Debt $2500

Net Fixed Assets$4000Equity $2500

Total$5000$5000

In addition, you are provided the following information

The companys debt is long-term bonds, the coupon rate is 10%. Bonds are currently rated AA with a Yield to Maturity of 12%. The bonds market value is 80% of par.

The firm currently has 50 million shares outstanding, the current market price per share is $80. The firm pays a dividend of $4 per share, and has a P/E ratio of 10.

The stock currently has a of 1.2. The T-Bond rate is 8%.

The firms tax rate is .40

Plastico is considering a major change in its capital structure. The firm plans to issue $3 billion in new debt and buy back stock. This will cause the firms debt rating to drop to CCC. (CCC debt yields 18% in the market).

Find the cost of equity after this change takes place.

Find the firms WACC.

Assuming there is no cost of financial distress imposed on the firm, what is the new share price?

Discuss how financial distress might affect this firm. Include in your discussion the impact on its stock price, and the impact on current bondholders.