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28 Apr 2018

Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. There is no tax.

Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage, how much do you need to borrow in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock?

$10,000

$5000

$2,500

$0

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Trinidad Tremblay
Trinidad TremblayLv2
28 Apr 2018

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1，

Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. There is no corporate tax.

Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as with. You have $5000 of your own money to invest and you plan on buying Without stock. Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in with stock. The number of shares of Without stock you purchased is closest to:

A425 B1650 C2000 D825

2，

Galt Industries has no debt, total equity capitalization of $600 million, and an equity beta of 1.2. Included in Galt's assets is $90 million in cash and risk-free securities. Assume the risk-free rate is 4% and the market risk premium is 6%. There is no tax.

Galt's asset beta (ie the beta of its operating assets) is closest to:

A1.1 B1.2 C1.3 D1.4

3，

Taggart Transcontinental has a value of $500 million if it continues to operate, but has outstanding debt of $600 million. If Taggart declares bankruptcy, bankruptcy costs will equal $50 million, and the remaining $450 million will go to creditors. Instead of declaring bankruptcy, Taggart proposes to exchange the firm's debt for a fraction of its equity in a workout. The minimum fraction of the firm's equity that Taggart would need to offer to its creditors for the workout to be successful is closest to:

A50% B75% C83% D90%

(homemade leverage) You have 100 shares of XYZ, Inc. The firm’s current capital structure is 30% equity and 70% debt. The stock price is $25 per share and there are 600,000 shares outstanding. You desire lower financial leverage which is 50% debt and 50% equity. The interest rate on the firm’s debt is 10% per year. There are three possible scenarios for next year. If recession, EBIT will be $3 million. If normal, EBIT will be $5.5 million. If boom, EBIT will be $8 million.

(10 pints) What is the break-even EBIT?

(15 points) How would you homemade your own desired leverage? (Borrow/lend how much money? Buy/sell how many shares?) Verify your answer by showing that the cashflows you receive (after homemade leverage) will be exactly the same as if you buy shares from a company with the desired capital structure.

Please TYPE your answer clearly and concisely. You do not have to write a lot in your answers but clarity is important for me to understand your answer.

(homemade leverage) You have 100 shares of XYZ, Inc. The firm’s current capital structure is 30% equity and 70% debt. The stock price is $25 per share and there are 600,000 shares outstanding. You desire lower financial leverage which is 50% debt and 50% equity. The interest rate on the firm’s debt is 10% per year. There are three possible scenarios for next year. If recession, EBIT will be $3 million. If normal, EBIT will be $5.5 million. If boom, EBIT will be $8 million. Normal Economy

A. What is the break-even EBIT?

B. How would you homemade your own desired leverage? (Borrow/lend how much money? Buy/sell how many shares?) Verify your answer by showing that the cashflows you receive (after homemade leverage) will be exactly the same as if you buy shares from a company with the desired capital structure.

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