Case 1: Aspeon Water In Tutorial Library

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TITLE: Case 1: Aspeon Water

CLASS / COURSE: Valuation and Capital Structure

QUESTION DESCRIPTION:

Case 1: Aspeon Water 

Instructions:

Submit your answer in memo form.  Your response should not exceed 2-3  pages.  There will be (4) parts to your memo.  Use headings to separate the sections in your report.

 

Executive Summary:  A brief (1-2 paragraphs) overview of the situation you are analyzing.  Practice addressing your audience in your writing, state what you have been asked to do and why, it can also be useful to summarize your recommendation here as well.  

 

Part I:         Valuation Analysis

 

a.       Estimate Aspeon’s stock price at the six levels of debt given in the case.  (Hint:  Use the spreadsheet as a model.  Assume that all debt issued by the firm is perpetual)

 

b.       How many shares will remain after each recapitalization under each debt scenario?

 

c.        Considering only the six levels of debt proposed in the case, what is Aspeon’s optimal capital structure?  Why?

 

d.       Calculate the EPS at each debt level, assuming that Aspeon begins with zero debt and raises new debt in a single issue.  Is EPS maximized at the same level that maximizes stock price? 

 

e.       Calculate the WACC at each debt level.

 

 

d.       What are the relationships between the amount of debt, stock price and WACC?

 

It would be very helpful to put your results in a well-organized, self-sufficient table (Do not simply cut and paste form Excel – it is not professional).  Briefly comment on the results.

 

Part II:Now consider two capital structure theories:  Modigliani and Miller with corporate taxes (MM63) and the Miller model.

 

a.       What would Aspeon’s value at $75 million debt, according to the MM63 model?

b.       What would be the value according to the Miller model?  (Assume that the personal tax rate on sock [TS] is 25% and that the personal tax rate on income from debt [TD]is 30%.  Also, use $120 million as the value of the unlevered firm [VU] in both the MM63 and the Miller models, even though they should be less in the Miller model.

c.        Why do the values differ when calculated by the equations in question 1, the MM63 model, and the Miller model?  (Hint:  consider the assumptions under each model.)

 

Hint:  It might be useful to summarize your numbers in a Table or Exhibit followed by your commentary. 

 

Part III:  Your recommendations to Aspeon Water.  Based on your abbreviated analysis what do you recommend?  A good answer would probably start with an initial recommendation, followed by recommendations for further analysis if necessary.

 

Other things to think about that we will cover in discussion – do not write up.

 

 

1.       What would happen if Aspeon’s business risk were significantly higher than previously estimated?  Using your Excel model, repeat question 1 using the following debt and equity cost estimates which reflect higher business risk:

 

 

Amount Borrowed

 

Cost of Debt

 

Cost of Equity

 

 

$   0.0

0.0%

17.0%

 

 

25.0

11.0

18.0

 

 

50.0

13.0

20.0

 

 

75.0

16.0

23.0

 

 

100.0

20.0

27.0

 

 

125.0

25.0

32.0

 

 

          What would be Aspeon’s optimal capital structure in this situation?

 

 

2.       What would happen if Aspeon’s business risk were significantly lower than previously estimated?  Using your Excel model, answer number 1 again using the following debt and equity cost estimates which reflect higher business risk:

 

 

Amount Borrowed

 

Cost of Debt

 

Cost of Equity

 

 

$   0.0

0.0%

14.0%

 

 

25.0

8.0

14.3

 

 

50.0

8.5

15.0

 

 

75.0

9.5

16.0

 

 

100.0

11.5

17.5

 

 

125.0

13.5

19.0

 

 

          What would be Aspeon’s optimal capital structure in this situation?

 

 

3.       Consider the usefulness of this analysis for most firms.

 

a.       What are the major weaknesses of the type of analysis called for in the case?

b.       What other approaches could managers use to help determine an appropriate target capital structure?

c.        Is target capital structure best thought of as a point estimate or a range?

d.       What other factors should managers consider when setting their firm’s target capital structure?

 

SOLUTION DESCRIPTION: Completed Solution is attached. Click on Buy button and then download file to get full solution.

SUBJECTS / CATEGORIES:
1. Finance
2. Financial Management
3. Corporate Finance
4. Investment and Portfolio Management

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