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a.
With a par value of $1,000 and a coupon rate of 8%, the bondholder receives
$80 per year.
b.
PV $80
c.
1
1
$1,000
$1,065.15
9
(1.07) 9
0.07 0.07 (1.07)
1
1
$1,000
$1,136.03
9
(1.06) 9
0.06 0.06 (1.06)
PV $80
18.
a.
The coupon rate must be 7% because the bonds were issued at face value with
a yield to maturity of 7%. Now the price is:
1
1
$1,000
$641.01
8
1.158
0.15 0.15(1.15)
PV $70
b.
The investors pay $641.01 for the bond. They expect to receive the promised
coupons plus $800 at maturity. We calculate the yield to maturity based on these
expectations by solving the following equation for r:
1
1
$800
8
8 r = 12.87%
r r (1 r ) (1 r )
$641.01 $70
Chapter 8
19.
a.
NPV for each of the two projects, at various discount rates, is tabulated below.
NPVA = $20,000 + [$8,000 annuity factor (r%, 3 years)]
1
3
r r (1 r )
= $20,000 + $8,000
NPVB = $20,000
Discount Rate
0%
NPVA
$4,000
$25,000
(1 r )3
NPVB
$5,000
6-1
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
3,071
2,201
1,384
617
105
785
1,427
2,033
2,606
3,148
3,558
2,225
990
154
1,217
2,205
3,126
3,984
4,784
5,532
From the NPV profile, it can be seen that Project A is preferred over Project B if the
discount rate is above 4%. At 4% and below, Project B has the higher NPV.
b.
IRRA = discount rate (r), which is the solution to the following equation:
1
$8,000
IRRB = discount rate (r), which is the solution to the following equation:
$20,000
$25,000
= 0 IRRB = 7.72%
(1 r )3
6-2
Chapter 11
9.
a.
Year
Stock
Market
Return
2006
2007
2008
2009
2010
b.
15.77
5.61
37.23
28.30
17.16
Total
Average
T-Bill
Return
4.80
4.66
1.60
0.10
0.12
Risk
Premium
Deviation
from Mean
10.97
0.95
38.83
28.20
17.04
18.33
3.67
7.30
2.72
42.50
24.53
13.37
Squared
Deviation
53.35
7.38
1,805.91
601.92
178.86
2,647.42
529.48
c.
The variance (the average squared deviation from the mean) was 529.48.
Therefore: Standard deviation = 529.48 23.01%
16.
Escapist Films:
Boom:
$0 ($18 $25)
28%
$25
Normal:
$1 ($26 $25)
8%
$25
Recession:
r
$3 ($34 $25)
48%
$25
( 28) 8 48
9.33%
3
Variance =
1
1
1
(28 9.33) 2 (8 9.33) 2 ( 48 9.33) 2 963.56
3
3
3
6-3
1
1
1
(91 26) 2 (13 26) 2 (26 26) 2 2,366
3
3
3
a.
The expected cash flows from the firm are in the form of a perpetuity. The discount
rate is:
rf + (rm rf) = 4% + 0.4 (11% 4%) = 6.8%
Therefore, the value of the firm would be:
P0
b.
$147,058.82
r
0.068
If the true beta is actually 0.6, the discount rate should be:
rf + (rm rf) = 4% + [0.6 (11% 4%)] = 8.2%
Therefore, the value of the firm is:
P0
$121,951.22
r
0.082
6-4
Beta
0.75
1.75
11%
7% = market risk
premium
4%
beta
0
Cost of
Capital
11.0%
4.0%
18.0%
6.8%
15.2%
Beta
1.0
0.0
2.0
0.4
1.6
1.0
IRR
NPV
14%
6%
18%
7%
20%
+
+
0
+
+
$25.29
= $100 + $15
10
0.152 0.152 (1.152)
Beta
1.22
Cost of Capital
13.54%
6-5
Apple
Hershey
Coca-Cola
1.44
.39
.59
15.08%
7.73%
9.13%
a.
b.
The rate on Buildwells debt is 5%. The cost of equity capital is the required rate of
return on equity, which can be calculated from the CAPM as follows:
4% + (0.90 8%) = 11.2%
The weighted-average cost of capital, with a tax rate of 40%, is:
D
WACC
rdebt (1 TC )
requity
V
15.
a.
1
1
$1,000
$938.55
10
1.1010
0.10 0.10(1.10)
PV $90
1
$1,000
15
15 r = 10.83%
r r (1 r ) (1 r )
$940 $100
6-6
18.77
23.50
b.
Chapter 16
21.
Home Depots interest expense is given in Table 3-3 as $676 million. Its annual interest
tax shield is 0.35 $676 = $236.6 million.
If the company plans to maintain its current debt level indefinitely, then we can find the
present value of the stream of tax savings using the no-growth valuation model. (See
Chapter 6.) The discount rate for the tax shield is 8%. Therefore, the present value of
the perpetuity of tax savings is:
PV
23.
$2,957.5 million
r
0.08
a.
b.
40
120
WACC
8% (1 0.35)
15% 12.55%
160
160
c.
Annual tax shield = 0.35 interest expense = 0.35 (0.08 $40) = $1.12
PV tax shield = $1.12 annuity factor (8%, 5 years)
1
1
$4.47
5
0.08 0.08 (1.08)
$1.12
$162,500
r
0.10
a.
b.
The value of the firm increases by the present value of the interest tax shield:
0.35 $50,000 = $17,500
c.
6-7
Alpha Corp is more profitable and is therefore able to rely to a greater extent on
internal finance (retained earnings) as a source of capital. It will therefore have
less dependence on debt and have the lower debt ratio.
Chapter 17
13.
19.
The pension fund pays no taxes. The corporation pays taxes equal to 35% of
capital gains income and 35% (1 0.70) = 10.5% of dividend income.
The individual pays 15% taxes on dividends and 10% taxes on capital gains.
Therefore, the after-tax rate of return for each investor equals:
dividend (1 dividend tax) capital gains (1 capital gains rate)
price
We can use this formula to construct the following table of after-tax returns:
Stock
Pension
Investor
Corporation
A
B
C
10.00%
10.00%
10.00%
6.500%
7.725%
8.950%
b.
Individual
9.00%
8.75%
8.50%
6-8
Stock A: P0
Stock B: P0
Stock C: P0
The increase in stock prices reflects the positive information contained in the dividend
increase. The stock-price increase can be interpreted as a reflection of a new
assessment of the firms prospects, not as a reflection of investors preferences for
high dividend payout ratios.
Chapter 21
6-9
6.
Premerger data:
Acquiring: Value = 10,000,000 $40 = $400,000,000
Takeover Target: Value = 5,000,000 $20 = $100,000,000
Gain from merger = $25,000,000
The merger gain per share of Takeover Target is $25 million/5 million shares = $5.
Thus, Acquiring can pay up to $25 per share for Target, $5 above the current price. If
Acquiring pays this amount, the NPV of the merger to Acquiring will be zero.
Acquiring:
Target:
Merged:
a.
The present value of the $500,000 annual savings is $500,000/0.08 = $6.25 million.
This is the gain from the merger.
b.
c.
9.
a.
b.
The cost of the stock alternative is $8.125 million. This is the increase in the
value of the stock held by Pogo shareholders.
6-10
c.
NPV = $1.875 million. This equals the decrease in the value of the stock
held by Velcros original shareholders. It also equals gains from the merger,
$6.25 million, minus the cost of the stock purchase, $8.125 million.
a.
At a price of $25 per share, Immense will have to pay $25 million to Sleepy.
The current value of Sleepy is $20 million, and Immense believes it can
increase the value by $5 million. So Immense would have to pay the full value
of the target firm under the improved management; therefore, the deal would
be a zero-NPV proposition for Immense. The deal is just barely acceptable for
shareholders of Immense and clearly attractive for Sleepy's shareholders.
Therefore, it can be accomplished on a friendly basis.
b.
If Sleepy tries to get $28 a share, the deal will have negative NPV to Immense
shareholders. There could not be a friendly takeover on this basis.
P/E
10
8
Shares
2 million
1 million
Price
$40
$20
EPS*
$4.00
$2.50
Earnings
$8.0 million
$2.5 million
b.
6-11
c.
If the P/E of CS remains at 10, the merged firm will sell for $4.20 10 = $42.
The firm is thus worth $42 2.5 million = $105 million.
Notice that the combined market value of the old firms was only $100 million.
d.
Gain to CS:
Gain to FF:
The total gain is thus $5 million, which is the increase in the combined market
value of the firms.
Est Time: 06-10
12.
b.
SCC will sell for its original price plus the per-share NPV of the merger:
$50 + ($10,000/3,000) = $53.33, which represents a 6.66% gain
The price of SDP will increase from $17.50 to the tender price of $20, a
percentage gain of $2.50/$17.50 = 0.1429 = 14.29%.
c.
(SCC)
(SDP)
(Merger gain)
6-12
Because SDP shareholders receive stock in SCC, and the price of SCC shares
rises to reflect the NPV of the merger, SDP shareholders capture an extra part
of the merger gains from SCC shareholders.
6-13