Exercice 1: Capital Structure and Valuation I (20 pts, 5 by question) F has 200,000 shares outstanding with a market value of $30 each and no debt. F is subject to a corporate tax rate Tc = 30% and the beta of unlevered equity Bo is 0.8. Risk- free rate is 3% and expected return of the market portfolio is 8%. We ignore bankruptcy costs in this exercise. F considers the following alternative operations 1. Operation 1: F pays $2,000,000 in dividends to stockholders. This divi- dend is financed by issuing debt for the same amount. If you hold one F stock, how much value is created/destroyed for you in this operation? 2. Operation 2: F invests $1,000,000 in a project that generates $150,000 per year after tax. This project has the same systematic risk as F's existing assets. The investment cost is financed by issuing risk-free debt for the same amount ($1,000,000). If you hold one F stock, how much value is created/destroyed for you in this operation? 3. The beta of debt BB is 0.1 after operation 1. Compute the Bg of levered equity after operation 1 and after operation 2. 4. Operation 3: F buys portfolio of stocks worth $1,000,000 (at market value). This purchase is financed by issuing risk-free debt for the same amount. Following the operation, F's beta of levered equity increases to 1. Compute the systematic risk Bpf of the portfolio bought by F. Hint: What is the beta of a portfolio of assets ? 4 Exercice 1: Capital Structure and Valuation I (20 pts, 5 by question) F has 200,000 shares outstanding with a market value of $30 each and no debt. F is subject to a corporate tax rate Tc = 30% and the beta of unlevered equity Bo is 0.8. Risk- free rate is 3% and expected return of the market portfolio is 8%. We ignore bankruptcy costs in this exercise. F considers the following alternative operations 1. Operation 1: F pays $2,000,000 in dividends to stockholders. This divi- dend is financed by issuing debt for the same amount. If you hold one F stock, how much value is created/destroyed for you in this operation? 2. Operation 2: F invests $1,000,000 in a project that generates $150,000 per year after tax. This project has the same systematic risk as F's existing assets. The investment cost is financed by issuing risk-free debt for the same amount ($1,000,000). If you hold one F stock, how much value is created/destroyed for you in this operation? 3. The beta of debt BB is 0.1 after operation 1. Compute the Bg of levered equity after operation 1 and after operation 2. 4. Operation 3: F buys portfolio of stocks worth $1,000,000 (at market value). This purchase is financed by issuing risk-free debt for the same amount. Following the operation, F's beta of levered equity increases to 1. Compute the systematic risk Bpf of the portfolio bought by F. Hint: What is the beta of a portfolio of assets ? 4
