Assignment Questions:
1. For models 2, 2a, and 2b:
What is the best way to minimize the weighted average cost of capital?
What is the effect of the weighted average cost of capital on the market value?
2. For models 3, 3a, and 3b:
What is the relationship between book value of equity and time t-1 and the market value of the equity?
3. Discuss model 4 and expand on the importance and the meaning of the market risk premium.
4. In your own words, what are the main conclusions for this article, and what could be improved upon in its analysis?
Assignment Questions:
1. For models 2, 2a, and 2b:
What is the best way to minimize the weighted average cost of capital?
What is the effect of the weighted average cost of capital on the market value?
2. For models 3, 3a, and 3b:
What is the relationship between book value of equity and time t-1 and the market value of the equity?
3. Discuss model 4 and expand on the importance and the meaning of the market risk premium.
4. In your own words, what are the main conclusions for this article, and what could be improved upon in its analysis?
Related questions
MNA is a retail store that operates through its stores across the USA. The following table (MNA Data as of end of 2016) shows data as of end 2016. BOD is a group considering LBO (leveraged buyout option) of MNA at the beginning of 2017. BOD is considering 25% equity and 75% debt. Group made the projections for 10 years (2017 through 2026) as shown below.
MNA Data as of end 2016
Debt on balance sheet $4,658 millions
Shareholders' equity at book value $3,524 millions
Market value of equity $6,300 millions
Market equity beta 0.88
Income tax rate 35%
BOD Assumptions
Debt 75%
Equity 25%
___________________________________________
Risk free rate 4.2%
Market risk premium 5%
Interest Rate 10%
Free cash flows to equity and debt holders (millions)
| Year 2017 | $778 |
| Year 2018 | $821 |
| Year 2019 | $864 |
| Year 2020 | $790 |
| Year 2021 | $754 |
| Year 2022 | $864 |
| Year 2023 | $859 |
| Year 2024 | $887 |
| Year 2025 | $945 |
| Year 2026 | $1,014 |
Questions:
a. Compute the unlevered market equity beta (asset beta) of MNA. Assume that the market value of debt is same as the book value.
b. Compute the cost of equity for BOD group with new capital structure. Risk free rate and market risk premium are provided in table BOD assumptions above.
c. Using the cost of equity calculated in question b, compute the weighted average cost of capital for BOD. Interest rate is provided in the table BOD assumptions.
d. Compute the present value of free cash flows to all debt and equity capital stakeholders at the weighted average cost of capital. Ignore the midyear adjustment. Assume that the free cash flows grow at 3% after 2026 for computing the continuing value.
e. Assume that BOD acquired MNA for the value calculated in d. Will BOD have the cash flows sufficient to pay the interest? Explain.
