Question
Question 3 (total of 14 marks): For each of the following events, state the effect on the firm's market value of levered equity (E), market
Question 3 (total of 14 marks): For each of the following events, state the effect on the firm's market value of levered equity (E), market value of fixed-coupon debt (D), market value of the firms levered assets (V), systematic risk of the firm's levered assets measured using beta (BV) and existing shareholder wealth.
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.
Firm value Cost of debt Weighted average cost of capital (after tax) Weighted Market Value of average cost of Firm's Equity (ED capital (before tax) V ro 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 to 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 splitStep by Step Solution
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