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QUESTION 2 [15 Marks]

 

The market value of the assets of a corporation is currently $290.0 million but the owners wish to only use as collateral a value that will result in an interest rate of about 10%. The firm has on issue a debt outstanding that has a par value of $35.0 million and a due date of exactly five years. No intermediate interest payments are required. The risk-free (continuous) rate is 3.25% and the standard deviation of returns of the firm’s assets is 60%.

 

What is the value of the assets required by the debt holders to permit a fair interest rate of approximately10% (your answer should ensure that the fair interest rate is in the range of >9% and <11%)?

 

State any simplifying assumptions made in your calculations.

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Question 1

In a world with no frictions (taxes, etc.), value is created by how you finance a project.

Your Answer

False. True.

Question 2

(5 points) The return on equity is equal to the return on assets of a project/firm.

Your Answer

Never true.

Always true.

Sometimes true.

Question 3

Suppose the expected returns on equity of two firms, Macrosoft and Microsoft, that operate in the same industry are 10.50% and 12.60%, respectively. What is the return on assets in this business if Macrosoft has no debt? (Enter the answer with no more nor less than two decimal places, and leave off the % sign. For example, if your answer is 13.97% you should enter it as 13.97 NOT 0.14 nor 14)

Answer: _____________________

Question 4

Suppose CAPM holds, and the beta of the equity of your company is 2.00. The expected market risk premium (the difference between the expected market return and the risk-free rate) is 4.5% and the risk-free rate is 3.00%. Suppose the debt-to-equity ratio of your company is 20% and the market believes that the beta of your debt is 0.20. What is return on assets of your business? (Enter the answer with no more nor less than two decimal places, and leave off the % sign. For example, if your answer is 13.97% you should enter it as 13.97 NOT 0.14 nor 14)

Answer: _____________________

Question 5

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Your Answer Score Explanation

Do not have enough information to calculate.

158730159.

130718954.

Question 6

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Your Answer

The statement is false.

The statement is true.

The statement is partly true/false.

Question 7

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Question 8

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Question 9

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Your Answer

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Question 10

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Answer: _____________________

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