Log in
Finance
1
answer
0
watching
1,153
views

Petr.on corporation's management team is meeting to decide on anew corporate strategy. There are 4 options, each with a differentprobability of success and total firm value in the event ofsuccess, as shown here. Probability of success, A 90% B 76% C 62% D48%. Firm value if successful (in millions) A 54 B 63 C 72 D 81.Assume that for each strategy, firm value is zero in the event offailure. Also suppose Petron Corporation pay a 25% tax rate on theamount of the final payoff that is paid to equity holders.(A)Assume management pays no tax on payments to, or capital raisedfrom, debt holders(maximizes the value of equity, and in case ofties will choose the strategy. b. Given your answer to (a) showthat total combined value of Petron's equity and debts is maximizedwith a face value of 30 milllion in debt. C. show that if Petronhas a 30 million in debt outstanding, shareholders can gain byincreasing the face value of debt to 52 million, even though thiswill reduce the total value of the firm. D. Show that if Petron has52 million in debt outstanding shareholders will lose by buyingback debt to reduce the face value of debt to 30 million, eventhough that will decrease the total value of the firm.

Watch
1
answer
0
watching
1,153
views

For unlimited access to Homework Help, a Homework+ subscription is required.

Nelly Stracke
Nelly StrackeLv2
28 Sep 2019

Unlock all answers

Get 1 free homework help answer.
Already have an account? Log in
Share

Related questions

Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of this product, MI will have a value of $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy and the cost of capital is equal to the risk-free rate, which is currently 5%. Assume that capital markets are perfect.

(a) The initial value of MI’s equity without leverage is closest to:

(1) $133 million

(2) $147 million

(3) $140 million

(4) $150 million

(b) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s debt is closest to:

(1) $125 million

(2) $111 million

(3) $100 million

(4) $116 million

(c) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI’s equity is closest to:

(1) $30 million

(2) $15 million

(3) $29 million

(4) $24 million

(d) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:

(1) $133 million

(2) $140 million

(3) $147 million

(4) $125 million

(e) Assuming that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs, the initial value of MI’s equity without leverage is closest to:

(1) $150 million

(2) $147 million

(3) $140 million

(4) $133 million

(f) Assume that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:

(1) $140 million

(2) $100 million

(3) $125 million

(4) $134 million

(g) Assume that in the event of default, 20% of the value of MI’s assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year. The present value of MI’s financial distress cost is closest to:

(1) $20 million

(2) $6.6 million

(3) $6.3 million

(4) $19 million

SFE Inc. has 1 million shares of common stock outstanding at a book value of $40 per share. The stock trades for $50 per share. It also has $10 million in face value of debt (corporate bonds of 5 years with coupon rate 10.4%, paid semi-annually) that trades at 110% of face value. The company’s common stock has abeta of 1.2. Treasury bills yield 2% and the market return is 10%. The corporate tax rate is 35%.

a) What is the total market value of equity?

b) What is the total market value of debt?

c) What is its ratio of debt to total firm value in the market-value driven capital structure?

d) What is the (annualized) before-tax cost of debt?

e) What is the after-tax cost of debt?

f) What’s the cost of equity?

g) What’s the after-tax WACC?

h) SFE is considering a project that costs $500,000 today. The project returns$150,000 each year, for the next five years. What is the NPV of the project?

6.12 An all-equity business has 100 million shares outstanding selling for$20 a share. Management believes that interest rates are unreasonably low and decides to execute a leveraged recapitalization (a recap). It will raise $1 billion in debt and repurchase 50 million shares.

a. What is the market value of the firm prior to the recap? What is the market value of equity?

b. Assuming the Irrelevance Proposition holds, what is the market value of the firm after the recap? What is the market value of equity?

c. Do equity shareholders appear to have gained or lost as a result of the recap? Please explain.

d. Assume now that the recap increases total firm cash flows, which adds $100 million to the value of the firm. Now what is the market value of the firm? What is the market value of equity?

e. Do equity shareholders appear to have gained or lost as a result of the recap in this revised scenario?

Weekly leaderboard

Home
Homework Help 3,900,000
Finance 370,000
Start filling in the gaps now
Log in