Chapter 16 and 17 Questions In Tutorial Library

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TITLE: Chapter 16 and 17 Questions

UNIVERSITY / INSTITUTE: Strayer University



Chapter 16

2. Baruk Industries has no cash and a debt obligation of $36 million that is now due. The market value of Baruk’s assets is $81 million, and the firm has no other liabilities. Assume perfect capital markets.

a. Suppose Baruk has 10 million shares outstanding. What is Baruk’s current share price?

b. How many new shares must Baruk issue to raise the capital needed to pay its debt obligation?

c. After repaying the debt, what will Baruk’s share price be?


7. You have received two job offers. Firm A offers to pay you $85,000 per year for two years. Firm B offers to pay you $90,000 for two years. Both jobs are equivalent. Suppose that firm A’s contract is certain, but that firm B has a 50% chance of going bankrupt at the end of the year. In that event, it will cancel your contract and pay you the lowest amount possible for you to not quit. If you did quit, you expect you could find a new job paying $85,000 per year, but you would be unemployed for 3 months while you search for it.

a. Say you took the job at firm B, what is the least firm B can pay you next year in order match what you would earn if you quit?

b. Given your answer to part (b), and assuming your cost of capital is 5%, which offer pays you a higher present value of your expected wage?

c. Based on this example, discuss one reason why firms with a higher risk of bankruptcy may need to offer higher wages to attract employees.


14. Marpor Industries has no debt and expects to generate free cash flows of $16 million each year. Marpor believes that if it permanently increases its level of debt to $40 million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers. As a result, Marpor’s expected free cash flows with debt will be only $15 million per year. Suppose Marpor’s tax rate is 35%, the risk-free rate is 5%, the expected return of the market is 15%, and the beta of Marpor’s free cash flows is 1.10 (with or without leverage).

a. Estimate Marpor’s value without leverage

b. Estimate Marpor’s value with the new leverage


21. You own your own firm, and you want to raise $30 million to fund an expansion. Currently, you own 100% of the firm’s equity, and the firm has no debt. To raise the $30 million solely through equity, you will need to sell two-thirds of the firm. However, you would prefer to maintain at least a 50% equity stake in the firm to retain control.

a. If you borrow $20 million, what fraction of the equity will you need to sell to raise the remaining $10 million? (Assume perfect capital markets).

b. What is the smallest amount you can borrow to raise the $30 million without giving up control? (Assume perfect capital markets.)


Chapter 17

7. Natsam Corporation has $250 million of excess cash. The firm has no debt and 500 million shares outstanding with a current market price of $15 per share. Natsam’s board has decided to pay out this cash as a one-time dividend.

a. What is the ex-dividend price of a share in a perfect capital market?

b. If the board instead decided no use the cash to do a one-time share repurchase, in a perfect capital market what is the price of the shares once the repurchase is complete?

c. In a perfect capital market, which policy, in part (a) or (b), makes investors in the firm better off?


25. Raviv Industries has $100 million in cash that it can use for a share repurchase. Suppose instead Raviv invests the funds in an account paying 10% interest for one year.

a. If the corporate tax rate is 40%, how much additional cash will Raviv have at the end of the year net of corporate taxes?

b. If investors pay a 20% tax rate on capital gains, by how much will the value of their shares have increased, net of capital gains taxes?

c. If investors pay 30% tax rate on interest income, how much would they have had if they invested the $100 million on their own?

d. Suppose Raviv retained the cash so that it would not need to raise new funds from outside investors for an expansion it has planned for next year. If it did raise new funds, it would have to pay issuance fees. How much does Raviv need to save in issuance fees to make retaining the cash beneficial for its investors? (Assume fees can be expensed for corporate tax purposes).

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