Question 18 Natytas Marked out of 12.00 Fqwa Question 3 (total of 12 marks): For each of the following events, state the effect on the firm's market value of debt), market value of levered equity 0. market value of the firm's levered assets (0), systematic risk of the firm's levered assets measured using beta ). cost of equity, and weighted average cost of capital before tax. Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfolio, all events happen in isolation and are a surprise, all transactions are done at a fair price, that there are no transaction costs, no asymmetric information (so ignore signalling effects), no change in the credit risk of the firm's debt and no interest tax shields or depreciation tax shields due to the absence of corporate and personal taxes. Market Value of Market Value of Market value of Systematic risk Weighted Firm's Debt (D) Firm's Equity) the Firm's Assets pf the firm's D ) average cost of A firme V assets capital (before tax) issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments Increase Issues fixed-coupon bands and uses the Decrease proceeds to repurchase shares Unchanged Takes out a bank loan to expand an unprofitable and risky division which the market widely believes to be a negative NPV investment Conducts a 3-far-1 rights issue at a discount to the current market share price + Invests in a lower than average risk project with a positive NPV funded half with a bank loan and half with a share issue Unexpectedly generates larger than usual cash flows, and uses those cash flows to repay debt Conducts a 2 for 1 share split Question 18 Natytas Marked out of 12.00 Fqwa Question 3 (total of 12 marks): For each of the following events, state the effect on the firm's market value of debt), market value of levered equity 0. market value of the firm's levered assets (0), systematic risk of the firm's levered assets measured using beta ). cost of equity, and weighted average cost of capital before tax. Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfolio, all events happen in isolation and are a surprise, all transactions are done at a fair price, that there are no transaction costs, no asymmetric information (so ignore signalling effects), no change in the credit risk of the firm's debt and no interest tax shields or depreciation tax shields due to the absence of corporate and personal taxes. Market Value of Market Value of Market value of Systematic risk Weighted Firm's Debt (D) Firm's Equity) the Firm's Assets pf the firm's D ) average cost of A firme V assets capital (before tax) issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments Increase Issues fixed-coupon bands and uses the Decrease proceeds to repurchase shares Unchanged Takes out a bank loan to expand an unprofitable and risky division which the market widely believes to be a negative NPV investment Conducts a 3-far-1 rights issue at a discount to the current market share price + Invests in a lower than average risk project with a positive NPV funded half with a bank loan and half with a share issue Unexpectedly generates larger than usual cash flows, and uses those cash flows to repay debt Conducts a 2 for 1 share split
