FINANCE 2 WINTER 2010

REVIEW PROBLEMS
WEEK 5
Question 1:

1.      Novack Enterprises is considering undertaking a new peoject.

The company is not publicly traded, and needs to determine the appropriate weighted average cost of capital
to discount the cash flows from its project. Novack Enterprises is engaged in the same business as its publicly traded rival,
Palmer Corporation. Palmer has an equity beta of 1.2 and a debt-to-value ratio of 40%. Novack is planning to target a
25% debt-to-value ratio for this project. What weighted average cost of capital (WACC) should Novack use?
In your analysis please assume the following: The beta of debt for Novack Enterprises is 0.5
and for Palmer Corp is 0.25, the risk free rate is 4%, the market risk premium is 5%, the corporate tax rate is 40%,
and interest expense is tax deductible.

beta debt Novack 0.5 WACC 6.65000% = (e/v) * r equity + (d/v) * (1 - tax rate)* r debt
beta debt Palmer 0.25
Eq beta Palmer 1.2 r equity Novack 7.567% = risk free + Beta equity * MRP
d/ v Palmer 40%
risk free 4% Beta equity Novack 0.713333333 = beta assets - (D/E) *(beta assets - b d
MRP 5%
tax rate 40% r debt novack 6.50%

Beta assets Palmer 0.82

= Beta assets Novack

Question 2:

Zinger Corporation issued convertible bonds in 2000 due in 2012 with the face value of $1000. The bonds were set to
be convertible at the conversion ratio of 25. When Zinger issued its convertible bonds, its common stock was trading at
$30 per share. Calculate the conversion price and conversion premium:

Question 3:
Samuel Industries has $20 million in excess cash and no debt. Samuel has 10 million shares outstanding.
The firm expects to generate additional free cash flows of $48 million per year in subsequent years.
Samuel's unlevered cost of capital is 12%.

a. What is the total market value of Samuel Industries?

b.
Samuel's management is thinking about paying out all its cash to investors in the form of dividend.
The stock will go ex-dividend on December 12.
What is Samuel's price just before the stock goes ex-dividend?

c. What is Samuel's price after the stock goes ex-dividend?

a
b
c
d
E
F
G
E
F
G
E
F
G
E
F
G
E