Question ARE 171B Summer 2015

07 Jun Question ARE 171B Summer 2015

Question
ARE 171B Summer 2015

HOMEWORK 2 (complete)

Due Wednesday, Sept. 2nd, in class

1. (5) Kaytron’s dividend policy is based on the residual theory of dividends. The firm has 10 million shares of common stock outstanding, and has a target capital structure of 70% equity and 30% debt. It has identified several new investment projects for the upcoming year (2016). These projects’ combined ICO’s are $5 million.

a. Suppose the firm has earnings (EAT) of $4.5 million in 2015. How much internally generated capital will be needed to finance the new projects? What value of new stock will be issued, if any? How much new debt will be issued? What is the dividend paid per share? What is the dividend payout ratio?

b. Repeat question a, assuming instead the firm has earnings (EAT) of $1.5 million.

2. (10) Suppose a firm has EBIT that varies, with a mean of $20 million. The firm satisfies the Modigliani and Miller assumptions (for instance, all earnings are paid out as dividends). Investors’ required rate of return on the unlevered stock of this firm is Reu = 8%, and the required rate of return on bonds is Rd = 2%.

a. Imagine the firm is located in a country that has no corporate taxes. If the firm is unlevered, what is its value? If it instead chooses to sell $15 million in bonds, and use the proceeds to buy back shares, what will be the new firm value? What levered rate of return will investors require on the stock? What is the weighted average cost of capital?

b. Repeat part a, but assume the firm is located where there is a tax rate of T=.3

3.(8) Sefeguard Security Systems has EBIT of $10 million. The firm is currently all-equity financed, with 4 million shares of common stock. The firm’s P/E ratio is 18, and its tax rate is T=.4.

a. What is the firm’s EPS and stock price? What is the total market value of the firm?

b. Suppose the firm sells $20 million worth of convertible bonds, to finance an expansion project. The bonds sell for a par value of $1000, pay an interest rate of 5%, and each bond is convertible to 32 shares of common stock. What is the conversion value of these bonds when they are issued? What premium to conversion value are the bonds selling at?

c. Now suppose that, due to revenues generated by the new investment project, EBIT rises to $12.5 million. Given the bond sale as in part b, what is the firm’s new EPS? If the P/E ratio remains at 18, what is the new price of the common stock? Are the bonds likely to be converted at this time? Explain why or why not.

4. (8) Megamart Foods currently has 2,000,000 shares of common stock outstanding. The market price is $40/share. The firm is planning a major expansion, and would like to raise an additional $20 million through the issuance of new shares of common stock. To avoid diluting current shareholders’ proportional ownership of the firm, this will be accomplished through a rights offering.

a. Suppose the subscription price of the new shares is set at $20/share, and each existing share receives 1 right. How many rights per share will be needed for existing shareholders to purchase a new share at the subscription price? What will be the new market price of the shares, after the rights have been exercised? What is the value of each right?

b. Samantha owned 100 shares of Megamart before the rights offering was announced. Find the net value of her holdings, and her proportional ownership in the firm, in the following two cases: (i) she exercises her rights (after deducting any purchase costs for new shares); (ii) she does not want to purchase any more shares, thus she sells her rights.

5.(14) Office Mart’s balance sheet lists the following shareholder’s equity:

Common stock, par value $.50, 40,000,000 shares outstanding 20,000,000

Additional paid in capital 700,000,000

Retained earnings 1,490,000,000

The stock’s market price is $90.00

a. What is the current book value per share of this stock?

b. What price per share was originally paid for the stock? (Assume no previous small-percentage stock dividends have occurred.)

c. A 15% stock dividend is declared. What is the expected new market price per share?

What does the balance sheet look like?

d. A 100% stock dividend is declared. What is the expected new market price per share?

What does the balance sheet look like?

e. A 3-for-1 stock split is implemented. What is the expected market price per share?

What does the balance sheet look like?

f. A 2-for-1 reverse stock split is implemented. What is the expected market price per share?

What does the balance sheet look like?

6. (30) We will do a quick overview of the financial situation at two firms: Chevron (CVX) and Amazon (AMZN). First, look up the relevant info below, then answer the questions at the bottom of the page. You only need to turn in the answers to parts a, b, c, d, e.

From Edgar (official SEC site) Look up the most recent annual report (called a 10-K form)

https://www.sec.gov/edgar/searchedgar/companysearch.html

From the Balance Sheet, find:

# shares of common stock outstanding at the end of the most recent year, and its total book value

# shares preferred stock outstanding at the end of the most recent year, if any, and its total book value.

Book value of long-term debt, if any. If the firm has a significant amount of bonds, also look up

in the notes to the financial statements, a list of the various bonds with their coupon rates and maturities. What is the highest and lowest rate mentioned, and the longest maturity mentioned? Use the midpoint of these two rates as a quick estimate of Rd. (If we had more time, we would find the weighted average interest rate for these bonds, however there is too much to do in a short time!)

From the Income statement (sometimes called Statement of Operations)

Total sales, Total EBIT, and Total EPS (use diluted if there is a choice) in the last 2 years

EPS and Div per share, if any

Average tax rate in most recent year, if applicable (taxes/EBT)

From Yahoo finance: current market price of the shares

firm’s beta estimate, if any

also click on the stock’s chart, select Max for the time period, select events and add dividends and splits.

Now answer the following for each firm;