Question 3 (total of 12 marks): For each of the following events, state the effect on the firm's market value of fixed-coupon debt (D), market value of levered equity (EL), share price (P), number of shares (n), and market value of the firm's assets (VLI. 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. The firm: Market Value of Market Value of Firm's Debt Firm's Equity Share price Num shares Market Value of the Firm's Assets (D) ) (EL) (P) (n) n (VL) ) Issue $1m of bonds and use the funds to pay a $1m higher CEO bonus this year, which the market believes is a total waste. + Buys a patent intangible asset) with a beta of 2 funded half with loans and half via a rights issue Conducts a 100% stock dividend a % lior 1-for-1 bonus issue). . . Undertakes a private placement at a 40% discount to the pre- announcement market price. . . . Cuts in high-risk R&D which leads to higher profits in the short term but the market believe are overall a negative NPV decision. . Unexpectedly generates larger + than usual cash flows, and uses those cash flows to repay debt. Question 3 (total of 12 marks): For each of the following events, state the effect on the firm's market value of fixed-coupon debt (D), market value of levered equity (EL), share price (P), number of shares (n), and market value of the firm's assets (VLI. 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. The firm: Market Value of Market Value of Firm's Debt Firm's Equity Share price Num shares Market Value of the Firm's Assets (D) ) (EL) (P) (n) n (VL) ) Issue $1m of bonds and use the funds to pay a $1m higher CEO bonus this year, which the market believes is a total waste. + Buys a patent intangible asset) with a beta of 2 funded half with loans and half via a rights issue Conducts a 100% stock dividend a % lior 1-for-1 bonus issue). . . Undertakes a private placement at a 40% discount to the pre- announcement market price. . . . Cuts in high-risk R&D which leads to higher profits in the short term but the market believe are overall a negative NPV decision. . Unexpectedly generates larger + than usual cash flows, and uses those cash flows to repay debt
