Question

Using the Profitability Index, which projects should you choose given the budget constraint? Which would you choose if there was no capital rationing? Show all work.

2. Construct a Market Value Balance Sheet for Trump-Toppers, Inc. (TT), a manufacturer of custom-made hairpieces, based on the following data (FYI: There are no other liabilities or equity issues other than those mentioned below.): (answer parts a through c)

a.) The company has issued $1,000 bonds that will mature in 5 years with a total face value of $45,000,000. The coupon rate on the bond is 7.0%, but the market interest rate on similar bonds is now 4.5%. What is the price of one bond and market value of the entire bond issue?

b.) The company also has 25,000,000 shares of common stock outstanding. The company’s earnings are expected to be $15 per share and it plans to pay out 40% of its earnings to its shareholders. With the growing popularity of fashionable cover-ups providing new expansion opportunities, the company expects that it can realize an estimated return on equity (ROE) of 22%, and, given the riskiness of the stock, the required rate of return is 20%. Calculate the price per share and the market value of the total equity position.

c.) The book value of assets in place (plant and equipment) is $640,000,000. Indicate the value of investment opportunities.

Answer 1

Problem 1:

A:

Number of bonds = 33,000

FV = $1000, N = 7 years, PMT = $60, RATE = 4%; Compute PV =?

Formula:

PV = PMT [N-year annuity factor] + FV [N-year discount factor]

PV = (PMT/RATE)*[1 – 1/(1 + RATE)^N] + FV/(1 + RATE)^N

PV = $1,120.04

Total market value of bond = 1120.04*33,000 = $36,961,320

B:

EPS = $12, POR = 0.35, ROE = 0.18

Dividend growth rate, g = ROE*(1 – POR) = 0.18*(1 – 0.35) = 0.117

POR = DPS/EPS

Dividend per share, DPS = 0.35*12

Return on stock = DPS / S + g

0.15 = 0.35*12 / S + 0.117

S = 0.35*12 / (0.15 – 0.117) = $127.27 which is stock price.

Total value of stock = 7,000,000*127.27 = $890,909,090.90 without truncation.

C:

Value of bond = $36,961,320.00

Value of stock = $890,909,090.90

Total = 927,870,410.91; PPE = 492,000,000

I guess value of investment opportunity is the amount left after PPE.