The questions are in the attached document
4402 '21 #10 HW Corrected (Un)lvrg betas, Valuatn First, (Nickname), Last ___________________________________ UNI ___________ mobile __________________ IEOR 4402 #10 HW Additional readings: Brealey & Myers, Ch 24-3 “Bank Loans” p647-650, 24-4 “CP, MTNs” p.650-52 Write the Honor Pledge, (“I pledge that I have neither given nor received any unauthorized aid on this homework.”) in the box below and provide your signature: Signature _________________________________________ Instructions: Providing just the correct number or answer will give you only partial credit. Explain why / demonstrate you understand the concept underlying the calculation or answer to receive full credit. If you provide an answer that is wrong, but you state your assumptions, and the answer makes sense given your assumptions, then you will receive partial credit. Notice: Total of 150 points A company is financed by both debt and common equity, and the market value of debt is 25% and equity is 75% of the total enterprise value. The corporate tax rate is 21%. Assume that the current long- term risk free interest rate is 2.5%, and the company’s debt yields 100bps over the long-term risk free rate. The historical bond risk premium has been 1.5%, and the historical equity risk premium has been 7.7%. Using the Brealey & Myers technique to determine the risk-free rate for the purposes of calculating equity beta, the beta of the company’s stock is 1.6. The company’s after-tax WACC is 10.68125% 1. (10pts) For the company above, assuming the dollar amount of the debt is kept constant through time, what is the stock’s unlevered beta? 2. (10pts) If the company above changed its financing so that the target ratio of the market value of Debt to the market value of Equity ratio were 15%/85%, what would the stock’s beta be? 3. (10pts) And based on the 15%/85% Debt/Equity ratio, what would the after-tax WACC be? First, (Nickname), Last ___________________________________ UNI ___________ mobile __________________ 4. (40pts) The B/S and I/S for Company ABC are below. At the beginning of year 1, all B/S items are zero except for a Factory, that begins year 1 at 200,000. All inventory is sold by the end of each year (EOY), but some sales and some expenses are “on account”. EBT for tax purposes is the same as the EBT on the Income Statement. Corporate taxes are 21%, and are paid in cash at EOY. All cash the company has at EOY is paid as cash dividends to shareholders. Calculate the dividends issued by the company each of the four years. End Of Yr1 EOY 2 EOY 3 EOY 4 Balance Sheet (B/S) Accounts Receivable 5,000 15,000 15,000 10,000 Accounts Payable 4,000 6,000 8,000 10,000 Cash 0 0 0 0 Factory 175,000 150,000 125,000 100,000 Income Statement (I/S) Revenues 190,000 200,000 200,000 200,000 COGS + SG&A (110,000) (90,000) (70,000) (50,000) Depreciation (25,000) (25,000) (25,000) (25,000) EBT 55,000 85,000 105,000 125,000 Taxes (11,550) (17,850) (22,050) (26,250) Net Income 43,450 67,150 82,950 98,750 Dividends issued by ABC: ________ ________ ________ ________ First, (Nickname), Last ___________________________________ UNI ___________ mobile __________________ 5. (10pts) At the end of year 4, the Terminal Value of Company ABC will be calculated using an EBITDA multiple. Under column 4 below, enter the EBITDA value at EOY 4, the multiple you think is appropriate, and the Terminal Value. To help you choose a multiple, here is additional information: a. Company ABC makes internal computer hard disks b. Company B makes computer operating system software and has an EBITDA multiple of 11 c. Company C makes external computer hard disks; EBITDA multiple of 9 d. Company D makes internal and external computer hard disks; EBITDA 50% from internal; 50% from external; EBITDA multiple of 8 EOY1 EOY2 EOY3 EOY4 EBITDA TV/EBITDA multiple Explain why this multiple makes sense. Terminal Value 6. (30pts) Investor A is thinking about buying Company ABC today and selling it at the end of the fourth year immediately after receiving the 4th dividend. Assuming: - After-taxes, Investor A present values the dividends (Q16) paid by Company ABC as $230,000 - A expects to sell the company (Terminal Value) at EOY 4 for $1,500,000 - A pays tax of 20% on capital gains (the difference between the TV and the purchase price) - Investor A uses an after-tax discount rate of 9%. What is the highest price investor A would be willing to pay for Company ABC today? First, (Nickname), Last ___________________________________ UNI ___________ mobile __________________ 7. (10 pts) You have built a Free Cash Flow model for a company, and calculate that the FCF for the fifth year from today is $1,000 (i.e. an investor who owns the enterprise would receive FCF of $1,000 exactly five years from today). Assuming FCF grows at 3% each year forever from that point onwards, and that the WACC is 8%, calculate the PV today of the Terminal Value that is based on this perpetuity. (For the purposes of this question, only value FCF after the fifth year.) 8. (10 pts) Assume a Modigliani & Miller world where there are no taxes, no bankruptcy costs. A company is 25% financed by debt and 75% by equity. This ratio does not change through time. The stock’s beta is 1.4 and the debt’s beta is 0.2. What is the stock’s unlevered beta? 9. (10 pts) Still assume M&M, but that the company changed its financing from 25% debt / 75% equity to 10% debt / 90% equity, and that the debt’s beta did not change. What would the stock’s beta be? 10. (10 pts) The Federal corporate tax rate currently is 21%. If a company with an enterprise value of $3billion has $1billion of debt paying 6%, and plans to have this debt forever, and if the tax rate is increased to 26%, according to Miller & Modigliani, how does this change impact the enterprise value of this company? Provide a % change.