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The Obama Corporation has 120,000 shares outstanding with a current market price of $8.10 per share. The company needs to raise additional $36,000 to finance new expenditures, and has decided on a rights issue. The issue will allow current shareholders to purchase one additional share for 20 rights at a subscription price of $6 per share.

If the Ex-Rights price were set at $7.90, would you, as a potential new shareholder, chose to buy shares ex-rights or buy shares at the old price ad exercise your rights?

a) Buysharesex-rights

use the following information to answer Questions 2 and 3

Your company will produce a pre-tax cash flow of $20 next year, $22 the year after that, $24 .20 the year after that… that is, cash flows will grow at 10% each year forever. The corporate tax rate is 30% nd there are no personal taxes. The all-equity cost of capital is 15%.

2. What is the value of your firm if it is all equity financed

a) $280.00

Year Cash flow PVIF at 15% PV

1 14 0.869565217 12.17391

2 15.4 0.756143667 11.64461

3 16.94 0.657516232 11.13832

3 372.68 0.657516232 245.0431

280

3. You decide to issue $20 worth of perpetual debt. What is the value of your firm? a) $246.00

Use the following information to answer Questions 4 to 5

Blackberry is currently all equity financed. Its earnings are $10M per year and will stay that way in perpetuity. The current value of the firm is $120M. The firm is considering issuing risk-free debt worth $50M, maturing 10 years at an interest rate of 6% and using it to repurchase $50M of equity. Assume there are no taxes.

4. Calculate the new value of Blackberry after the restructuring. c) $120M

5. What would be return on equity after the refinancing

b) 10.00%

6. Now assume that the corporate tax rate is 40% and that the interest expense is tax deductible. Calculate the new cost of equity after the refinancing. Assume that the value of the unlevered firm at the all-equity cost of capital remain the same as in the absence of taxes.

Use the following information to answer questions 7 and 8.

Aqua Marine Corporation (AMC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6 percent. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero-growth company. AMC’s current cost of equity is 10 percent, and its tax rate is 40 percent. The firm has 10,000 shares of common stock outstanding.

7. What is AMC’s current total market value?

9. According to M&M (Proposition II), as a firm’s debt-to-equity ratio decreases:

I. Its operating risk increases

II. Its financial risk increases

III. The required rate of return on equity decreases

IV. The required rate of return on equity increases

b) III only

10.An all-equity firm is subject to a 30-percent corporate tax rate. Its equity holders require a 20-percent return. The firm’s initial market value is $3,500,000, and there are 175,000 shares outstanding. The firm issues $1 million of bonds at 10 percent and uses the proceeds to repurchase common stock. Assume there is no change in the cost of financial distress for the firm. According to Modigliani & Miller, what is the new market value of the equity of the firm?

a) $3,800,000