FNCE 370v8 Assignment 5 Assignment 5 is worth 5% of your final mark. Complete and submit Assignment 5 after you complete Lesson 15.

FNCE 370v8: Assignment 5


Assignment 5 is worth 5% of your final mark. Complete and submit Assignment 5 after you complete Lesson 15.


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There are 12 questions in this assignment. The break-down of marks for each question is presented in the table below. Please show all your work as this will help the marker give you part marks as well as serve as a good study aid as you prepare for the Final Examination.


Question Marks Available Reference
1 5 Lesson 13
2 5 Lesson 13
3 10 Lesson 13
4 10 Lesson 13
5 10 Lesson 14
6 5 Lesson 14
7 10 Lesson 14
8 15 Lesson 14
9 5 Lesson 14
10 5 Lesson 15
11 10 Lesson 15
12 10 Lesson 15
Total 100  




Describe how the “winner’s curse” could contribute to the undervaluation of IPOs.
(5 markings)




(5 markings)
Does a rights offer result in a drop in the share price? If not, why not?


How does a rights offer affect current shareholders? Describe your response using an example.




A rights offering is being proposed by TUV Guy, Inc. At the time of writing, 240,000 shares are still in circulation. 60,000 new shares will be made available at a price of $60 each.
(10 marks)


What is the company’s current market value?


What number of rights are attached to each new share?


What does a right have to offer?


What is the share price after ex-rights?


Why wouldn’t a business make a broad cash offer instead of a rights offer?




WXYZ Co. has decided that a rights issue will be the most effective way to raise the necessary funds to expand operations since it will be necessary to raise further equity funding. It has been properly predicted that the share price will decrease as a result of the rights offering from $50 to $45 ($50 is the rights-on price; $45 is the ex-rights price). The startup is looking to raise $12.5 million more, with a $25 subscription price per share.
Prior to the offering, how many shares are there currently? (Assume that the increase in the equity’s market value is equal to the offering’s gross revenues.)
(10 marks)




(10 marks)
Give a quick explanation of M&M Proposition I with taxes in no more than five sentences. Make sure you use the proper formula in your justification.


What are the two tax repercussions of M&M Proposition I?


Give a succinct explanation of M&M Proposition II with taxes in no more than five sentences. Make sure you use the proper formula in your justification.


What are the two tax effects of M&M Proposition II?




What tax regulations for individuals and corporations will prevent financial leverage gains? Describe utilizing the formula.

VL is equal to VU plus [1 – (1-TC) x (1-TS)/(1-Tb)]. x D

(5 markings)




The EBIT for VWX Corporation is $166,666.67, the corporate tax rate is 40%, the company owes $500,000 in debt, and the unlevered cost of capital is 20%. Debt capital has a 10% cost.
(10 marks)


What is the equity value of VWX?


How much does VWX’s equity capital cost?


The WACC is what?


Contrast VWX’s WACC with an unlevered firm’s WACC. What is your judgment? What tenet have you demonstrated in this instance?







The only source of funding for STU’s Disco Factory Inc. is stock, and the company is thinking of issuing debt and utilizing the money to repurchase some of the outstanding shares at the current market price of $30. Presently, 200,000 shares are in circulation. EBIT is anticipated to stay at $1.5 million, and all profits will be distributed as dividends. The company’s tax rate is 40%, and it is permitted to issue debt at a rate of 8%. There are three other debt amounts under consideration:


Debt amount 0: $1,000,000
15% 15.5% 16% is the minimum return on equity.


Assume that $30 per share will be used for all stock repurchases. (15 marks)


Determine the firm’s value at each debt level using M&M Proposition I with taxes.


What is the ideal level of debt?


Show that the firm minimizes the WACC at the ideal capital structure.


Show that the company maximizes the price of the outstanding shares at the optimal capital structure.




Why is handmade leverage important? Please explain. (5 markings)




Projects with a positive NPV increase shareholder wealth. The number of positive NPV projects a company can undertake is occasionally, nonetheless, constrained by the payment of dividends. So why wouldn’t investors like a residual dividend policy? (5 markings)




You are the owner of 1,000 shares of ABC Corporation stock. In a year, you’ll get a dividend of 60 cents per share. ABC will distribute a $30 liquidation dividend per share in two years. 15% of a return is necessary on ABC stock. What is the price per share of your stock right now, excluding taxes? Show how you can create homemade dividends to achieve equal dividends in each of the following two years, if you like.
The dividends will be paid as an annuity (hint:


Suppose you only desire $200 in dividends overall for the first year. In two years, what will your own dividend be? (10 marks)

Assume that firms A and B are two equally hazardous businesses. Shares of Firm B are currently valued at $100 and are predicted to be worth $120 in a year. Capital gains are not taxed, while the personal dividend tax rate is 30%. (10 marks)


What is Firm B’s post-tax return?


What is Firm A’s after-tax return if it chooses to pay a $20 dividend per share over the course of a year?


What is the share price of company A’s stock if it pays a dividend of $20 over the course of a year, keeping in mind that dividends erode company value proportionally?

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