Exam 17: Dynamic Capital Structures and Corporate Valuation

Epsilon Consultants has the following projected free cash flows to equity and other information. It has no non-operating assets. Calculate Epsilon's intrinsic value of equity using the FCFE model. Year 1 Year 2 Year 3 FCFE 1,000 1,200 1,260 Long-term FCFE growth 5\% Required return on equity 9\%

In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the unlevered cost of equity.

Raymond Supply, a national hardware chain, is considering purchasing a smaller chain, Strauss & Glazer Parts (SGP). Raymond's analysts project that the merger will result in the following incremental free cash flows, tax shields, and horizon values: Year 1 2 3 4 Free cash flow \ 1 \ 3 \3 \ 7 Unlevered harizan value 75 Tax sheld 1 1 2 3 Harizon value of tar shield 32 Assume that all cash flows occur at the end of the year. SGP is currently financed with 30% debt at a rate of 10%. The acquisition would be made immediately, and if it is undertaken, SGP would retain its current $15 million of debt and issue enough new debt to continue at the 30% target level. The interest rate would remain the same. SGP's pre-merger beta is 2.0, and its post-merger tax rate would be 34%. The risk-free rate is 8% and the market risk premium is 4%. Using the compressed adjusted present value approach, what is the value of SGP to Raymond?

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the total value (in millions)?

The rate used to discount projected merger cash flows should be the cost of capital of the new consolidated firm because it incorporates the actual capital structure of the new firm.

The appropriate discount rate to use when analyzing a refunding decision is the after-tax cost of new debt, in part because there is relatively little risk of not realizing the interest savings.

Refer to data for Kitto Electronics. Using the compressed adjusted present value model, what is the value of Kitto's tax shield?

Refer to data for Glassmaker Corporation. What is Glassmaker's WACC, based on its current capital structure?

NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW). What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Palmer Company has $5,000,000 of 15-year maturity bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerationsσassume that the firm's tax rate is zero.σσThe company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?

Theta Therapeutics has the following information and projections. Use the FCFE model to calculate the intrinsic value of Theta's equity. EBIT (operating profit) Operating assets Operating liabilities Total Debt Tax rate Interest rate on debt long-term growth rate Required return on equity Cunent Year Year 1 Year 2 Year 3 NA 1,000 1,100 1,200 1,200 1,300 1,500 1,600 300 300 400 500 1,000 900 1,100 1,200 NA 25\% 25\% 25\% NA 6\% 6\% 6\% 4\% 9\%  

Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

Using the data for Sallie's Sandwiches and the compressed adjusted present value model, what is the appropriate rate for use in discounting the free cash flows and the interest tax savings?

When a firm refunds a debt issue, the firm's stockholders gain and its bondholders lose. This points out the risk of a call provision to bondholders and explains why a non-callable bond will typically command a higher price than an otherwise similar callable bond.

In a world with no taxes, MM show that a firm's capital structure does not affect the firm's value. However, when taxes are considered, MM show a positive relationship between debt and value, i.e., its value rises as its debt is increased.

Which of the following statements concerning the compressed adjusted present value (APV) model is NOT CORRECT?

MM showed that in a world with taxes, a firm's optimal capital structure would be almost 100% debt.

NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon. NWW is now considering refunding these bonds. It has been amortizing $3 million of flotation costs on these bonds over their 30-year life. The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market. A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million. NWW's marginal tax rate is 40%. The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW). What is the NPV if NWW refunds its bonds today?

Stanovich Enterprises has 10-year, 12.0% semiannual coupon bonds outstanding. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today, i.e., what is the nominal annual "breakeven rate"?