Problem #1 Optimal Capital Structure Inc., an all-equity firm, currently has 15,000 shares outstanding and a perpetual EBIT of $27,000 per year. Optimal Capital Structure Inc. is considering issuing...

Problem #1

Optimal Capital Structure Inc., an all-equity firm, currently has 15,000 shares outstanding and a perpetual EBIT of $27,000 per year. Optimal Capital Structure Inc. is considering issuing $22,500 in new par bonds to add financial leverage to the firm. The proceeds of the debt issue will be used to repurchase equity. The pre-tax cost of debt is 7.00%. Optimal Capital Structure Inc.'s asset beta is equal to 1.25, the unlevered cost of equity is 12.00% and the tax rate is 35%.

a. What is the value of Optimal Capital Structure Inc. before restructuring?

b. What will be the value of Optimal Capital Structure Inc. after restructuring?

c. What will be Optimal Capital Structure Inc.’s equity beta after restructuring?

d. What will be Optimal Capital Structure Inc.’s cost of equity after restructuring?

e. What will be Optimal Capital Structure Inc.’s cost of capital after restructuring?

f. The share repurchase will be conducted at $12.50 per share. What is the EPS under the unlevered capital structure? The EPS under the levered capital structure?

Problem #2

Active Innovation Incorporated has estimated sales (in millions) for the four quarters of 2019 as follows:

· Accounts receivable at the beginning of the year were $325 million.

· Active Innovation Incorporated has a 30-day collection period.

· Active Innovation Incorporated’s purchases from suppliers in a quarter are equal to 55 percent of the next quarter's forecast sales, and suppliers are normally paid in 45 days.

· Wages, taxes, and other expenses run about 30 percent of sales.

· Interest and dividends are $65 million per quarter.

· Active Innovation Incorporated plans a major capital outlay in the second quarter of $422.5 million.

· Finally, the company started the year with a $130 million cash balance and wishes to maintain a $65 million minimum balance.

Prepare a cash budget that shows details and calculations of collections, disbursements and the surplus/deficit cash position for Active Innovation Incorporated for Q1, Q2, Q3 and Q4 of 2019.

Problem #3

Explain 1) the concept of house money, 2) why the house money concept is such a common behavior for so many individuals and 3) why house money is an irrational behavior.

Problem #4

a) Consider the following financial statement information for Inverness Corporation. Assume 365 days in a year.

i. Calculate the operating cycle and cash cycle.

ii. How do you interpret the cash cycle you calculated above?

b) Okanagan International’s stock currently sells for $80.75 per share. Earnings for the year are expected to be $157,500 Suppose Okanagan International follows a strict residual dividend policy. Calculate the dividend per share they will pay if planned investments for this year are $285,000. Okanagan International has a target D/E ratio of 1.5.

Problem #5

You work for a nuclear research laboratory that is considering leasing a diagnostic scanner. The scanner costs $7.65 million, qualifies for a 20 percent CCA rate and can be sold for $625,000 in 4 years. The scanner can also be leased for $1.875 million per year for 4 years. The lease payments will be made at the beginning of the year. Assume the tax rate is 35 percent and that the asset pool remains open after 4 years. The before tax cost of debt is 8.14%. The scanner will induce annual savings of $1,250,000 over the next 4 years.

a. What is the net advantage to leasing? Should the managers of the nuclear research laboratory lease or buy the scanner?

b. What is the after-tax break-even lease payment?

c. Assume the nuclear research laboratory becomes exempt from taxes. What will be the new net advantage to leasing?

Problem #6

Firm X and Firm Y are both 100% equity-financed. Firm X wants to acquire Firm Y for $165,000 in the form of either cash or stock. The synergy value of the deal is $25,000. You are given the following additional information:

a. What is the merger premium expressed as a percent of Firm Y's stock price? What is the NPV of the acquisition if cash is used? (3 marks)

b. What is the price per share of the post-merger firm following a cash acquisition?

c. What is the price per share of the post-merger firm if payment is made in stock?

d. What is the NPV of acquiring Firm Y when stock financing is used?