Question 3 (total of 12 marks): For each of the following events, state the effect on the market value of the firm's levered assets (), cost of debt, cast of equity, weighted average cost of capital after tax, weighted average cast of capital before tax, and market value of levered equity 0. Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfalio, all events happen in isolation and are a surprise, and all transactions are done at a fair price. Assume a corporate tax rate of 20%, but there are no transaction costs, no asymmetric information (so ignore signalling effects), and no change in the credit risk of the firm's debt. Weighted Market Value of Firm value Cost of debt Weighted average cost of Firm's Equity (E) average cost of V capital before capital (after tax) tax) fo issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments + Issues fixed-coupon bonds and uses the proceeds ta repurchase shares The corporate tax rate suddenly increases by a material amount Conducts a 3-for-1 rights issue at a significant 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 3 (total of 12 marks): For each of the following events, state the effect on the market value of the firm's levered assets (), cost of debt, cast of equity, weighted average cost of capital after tax, weighted average cast of capital before tax, and market value of levered equity 0. Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfalio, all events happen in isolation and are a surprise, and all transactions are done at a fair price. Assume a corporate tax rate of 20%, but there are no transaction costs, no asymmetric information (so ignore signalling effects), and no change in the credit risk of the firm's debt. Weighted Market Value of Firm value Cost of debt Weighted average cost of Firm's Equity (E) average cost of V capital before capital (after tax) tax) fo issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firm's usual investments + Issues fixed-coupon bonds and uses the proceeds ta repurchase shares The corporate tax rate suddenly increases by a material amount Conducts a 3-for-1 rights issue at a significant 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
