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UNIVERSITY OF TORONTO at Scarborough MANAGEMENT MGTMidterm Examdiate Finance) Date: June 25, 2011 ASSIGNMENT 1 DUE DATE: October 24, 2011 By 3:05 pm Prof. Syed W. Ahmed STUDENT’S NAME:________________________________________________ Last First Middle STUDENT’S I.D. NO.:_______________________________________________ QUESTION NO. MAX. MARKS MARKS OBTAINED 1 20 __________________ 2 25 __________________ 3 25 __________________ 4 15 __________________ 5 15 __________________ TOTAL MARKS 100 __________________ -2- QUESTION 1: AllEquity Limited (AE) and SomeDebt Inc (SD) are identical firms in all respects except for their capital structure. AllEquity is all equity financed with $10,000,000 in stock. SomeDebt uses both stock and perpetual debt. Its stock is worth $8,000,000 and the interest rate on its debt is 6%. Both firms expect EBIT to be $1,000,000. Ignore taxes. a. Jessica MoneySmart owns $100,000 worth of SomeDebt’s stock. What rate of return is she expecting? b. Show how she could generate exactly the same cash flows and the rate of return by investing in AllEquity and using homemade leverage. c. What is the cost of equity for AllEquity? for SomeDebt? d. What is the WACC for AllEquity? For SomeDebt? What is your conclusion? QUESTION 2: Fonex Enterprises (FON) has three divisions – Rog Communications (ROG), Lob Supermarkets (LOB), and Rouge Canyons Restaurants (RC). Data on the firm and the divisions are as follows: Fon Rog Lob RC BetaEquity 1.1 1.7 0.7 1.9 Debt 40% 50% 30% 35% Equity 60% 50% 70% 65% Assume debt is perpetual; coupon rate is 8% and is trading at 125% of the face value. Risk free rate of return is 3% and the market risk premium is 7%. Corporate tax rate is 40%. Fon is considering the following projects: Proposed Investment Projects (in millions) IRR Communications – 1 $20 7% Communications – 2 30 9 Communications – 3 60 11 Supermarkets - 1 70 9 Supermarkets – 2 50
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