Blog

Cobalt Corp. has an unlevered value of $40 million and their debt has a market value $15 million. Their tax rate is 25 percent. Ignoring agency costs, what is value of the firm’s bankruptcy costs at this level of debt if the actual market value of the company is $39.375 million? (Hint: start with the M&M Propositions)

Monetta, Inc, has no debt, but is considering borrowing for the first time to finance a three-year project. The company currently has an unlevered cost of capital of 18 percent and  a 30 percent tax rate. The project requires an initial investment of $1.8 million, which will be straight-line depreciated over the three-year project life. The project, which is as risky as the firm’s current projects, is expected to generate earnings before depreciation of $900,000 per year for the three years. The capital for the initial investment will be raised with a loan for the full amount. The loan’s interest rate is 7 percent (which is also the current risk-free rate) and the principal will be repaid in one balloon payment at the end of the third year. What is the APV of the loan?

The 10-year loan for a project we are evaluating requires $200,000 in flotation costs. These costs can be straight-line amortized over the life of the loan. If our cost of debt is 5 percent and our tax rate is 25 percent, what is the NPV of the flotation costs?

Southern Wind is an all-equity firm with 25,700 shares of stock outstanding and a total market value of $374,000. Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $37,000 if the economy is normal, $22,800 if the economy is in a recession, and $51,200 if the economy booms. Ignore taxes. Management is considering issuing $94,600 of debt with an interest rate of 8 percent. If the firm issues the debt, the proceeds will be used to repurchase stock. What will the earnings per share be if the debt is issued and the economy booms?  

Management at an unlevered firm is evaluating a new project. The project is expected to generate earnings before depreciation of $[EBIT] million per year for the next two years. The project will require an initial investment in equipment that will be straight-line depreciated to zero over the two years of the project. The firm’s tax rate is 21 percent and their cost of capital is currently [R0] percent. If they were to borrow funds, they’d pay the risk-free interest rate of [RB] percent. The firm is currently negotiating the price of the equipment with the equipment’s manufacture. What is the maximum price management should be willing to pay for the equipment? (Enter your answer in dollars, not millions of dollars. For example, for $2.5 million, enter 2500000, not 2.5)

Cobalt Corp. has an unlevered value of $30 million and their debt has a market value $25 million. Their tax rate is 25 percent. Ignoring agency costs, what is value of the firm’s bankruptcy costs at this level of debt if the actual market value of the company is $29 million? (Hint: start with the M&M Propositions)

ABC Co. has a debt-equity ratio of 4, which will stay the same forever. Their cost of debt is 10 percent per year, which means their annual interest payment is $1.4 million each year forever. The firm’s unlevered cost of capital is 15 percent and their tax rate is 20 percent. The firm’s assets will generate an annual EBIT of $2.75625 million in perpetuity. Depreciation, agency costs, and bankruptcy costs are all zero in perpetuity. What is the value of the company’s equity? (Hint: use the Flow-to-Equity approach)

Monetta, Inc, has no debt, but is considering borrowing for the first time to finance a three-year project. The company currently has an unlevered cost of capital of 13 percent and a 30 percent tax rate. The project requires an initial investment of $1.2 million, which will be straight-line depreciated over the three-year project life. The project, which is as risky as the firm’s current projects, is expected to generate earnings before depreciation of $600,000 per year for the three years. The capital for the initial investment will be raised with a loan for the full amount. The loan’s interest rate is 8 percent (which is also the current risk-free rate) and the principal will be repaid in one balloon payment at the end of the third year. What is the APV of the loan?

Cobalt Corp. has an unlevered value of $40 million and their debt has a market value $5 million. Their tax rate is 25 percent. Ignoring agency costs, what is value of the firm’s bankruptcy costs at this level of debt if the actual market value of the company is $37.125 million? (Hint: start with the M&M Propositions)

Janice purchased 400 shares of a company whose capital structure is 40 percent debt. The company announced that it will sell new shares of stock to pay off all of its debt (that is, become unlevered). The value of the shares is $60 per share before and after the restructuring. How can Janice use homemade leverage to replicate the company’s old capital structure? Ignore taxes in your analysis.