Question

Assume all future cash flows (FCFF, FCFE, and Dividends) will grow at a constant sustainable growth rate (gur=ROE*b) in perpetuity. Use the following information in the table below to help answer problems 8-10: Cost of Debt 12.5% Cost Equity 22.5% Tax Rate 35.0% all figures below in millions Shares Outstanding 35.0 FCFF (T-0) $ 600 FCFE (T-0) $ 560 Net Incorre $ 100 Dividends $ 60 Total Assets $ 1,200 Total Debt $ 800

Answer 1

Que 10 Total assets 1200 Total debt Total equity 800 400 WACC = Cost of debt* weight of debt*(1-Tax rate) + cost of equity * weight of equity Cost of debt weight of debt Tax rate 12.5% 66.67% 35% Cost of equity weight of equity 22.50% 33.33% WACC 12.5*0.6667*(1-0.35) + 22.5*0.3333 12.92 % FCFF growth rate WACC 600 7.50% 12.92% We will be suing FCFF and WACC because the private equity group wants to acuire the enitre firm. Value of a growing perpetuity = FCFF* (1+ Growth rate )/(WACC-growth rate) 600*1.075/(0.1292-0.075) 11900.37 The answer would be 11,908 Million approximately

11) The correct answer is (a) Modigliani & Miller Proposition I (MMI) MM Proposition I state that the market value of the firm is independent of its capital structure. MM II states that the cost of equity is directly related and incremental to the percentage of debt in the capital structure while static theory says that firm capital structure is a trade off tax benefit and bankruptcy cost. 12) The correct answer is (C) Static theory. Static theory addresses states that higher debt level in capital structure implies higher risk of bankruptcy and capital structure is a trade off between the tax benefit and financial distress cost. MM I state that market value of firm is independent of its capital structure. MM II state that the cost of equity is directly related to the increase in percentage debt in the capital structure.