Problem Set 1
Valuing Cash Flows
Exercise 1 (Ex. 11.2 - 11.6 GT): Assume that Marriott’s restaurant division has the following joint distribution with the market return: Market Scenario Bad Good Great .25 .50 .25 Probability Market Return (%) -15 5 25 YR 1. Cash Flow Forecast $40 million $50 million $60 million

Assume also that the CAPM holds. 11.2 Compute the expected year 1 restaurant cash ﬂow for Marriott. 11.3 Find the covariance of the cash ﬂow with the market return and its cash ﬂow beta. 11.4 Assuming that historical data suggests that the market risk premium is 8.4 percent per year and the market standard deviation is 40 percent per year, ﬁnd the certainty equivalent of the year 1 cash ﬂow. What are the advantages and disadvantages of using such historical data for market inputs as opposed to inputs from a set of scenarios, like those given in the table above exercise 11.2? 11.5 Discount your answer in exercise 11.4 at a risk-free rate of 4 percent per year to obtain the present value. 11.6 Explain why the answer to exercise 11.5 diﬀers from the answer in Example 11.2.

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Advanced Corporate Finance I SS 2012

Problem Set 1 Valuing Cash Flows

Exercise 2 (Ex. 13.1 - 13.7 GT):) Exercises 13.1 - 13.7 make use of the following data: In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC for discounting the projected cash ﬂows for Hughes was diﬀerent from General Motors’ WACC, GM assumed that Hughes was of approximately the same risk as Lockheed or Northrop, which had low-risk defense contracts and products that were similar to those of Hughes. Speciﬁcally, assume the Hamada model of debt interest tax shields and the inputs in the table at right. Comparision ﬁrm GM Lockheed Northrop βE 1.20 0.90 0.85 D/E 0.40 0.90 0.70

Target D/E for acquisition of Hughes = 1 Hughes’s expected unlevered cash...

...CorporateFinance Exam with Answers
Posted on May 10, 2012 by Sam
CorporateFinance, Chapters 8, 9 & 10. Exam Questions:
1. A project’s opportunity cost of capital is: A. The forgone return from investing in the project.
2. Which of the following statements is correct for a project with a positive NPV? A. The IRR must be greater than 1.
3. What is the NPV of a project that costs $100,000 and returns $50,000 annually for 3 years if the opportunity cost of capital is 14%? C. $16,085
4. The decision rule for net present value is to: C. Accept all projects with positive net present values
5. What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years, and the cost of capital is 9%? C. $126,565
6. What is the NPV for the following project cash flows at a discount rate of 15%? [C0= ($1,000), C1= $700, C3= $700.] C. $138
7. Which mutually exclusive project would you select, if both are priced at $1,000 and your discount rate is 15%: Project A with three annual cash flows of $1,000; or project B, with 3 years of zero cash flow followed by 3 years of $1,500 annually? A. Project A
8. What is the approximate IRR for a project that costs $100,000 and provides cash inflows of $30,000 for 6 years? A. 19.9%
9. What is the IRR of a project that costs $100,000 and provides cash inflows of $17,000 annually for 6 years? A. 0.57%...

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CORPORATEFINANCE CASE STUDY
SUPERMAR VALUATION
Question 1 - Find SUPERMAR’S current firm and equity values under the following capital structure scenarios:
In order to calculate the cash flows the first step is to calculate the necessary inputs for the WACC. The case indicates that the current capital structure is 14% debt. We have all of the other inputs needed to calculate the cost of equity, cost of debt and WACC. The inputs are the following:
Before, calculating the actual firm value, it is important to mention some calculations made for the discounted cash flows. For the net change in working capital we included all of the current assets and liabilities. Cash is included because we saw a direct relationship between the increases in sales each year with the increase in cash, assuming that cash has been used for operational purposes. This increase over years is exactly 3.2%. On the other hand, we identified an odd behavior in the increase of CAPEX. According to accounting principles and using the correct formula of Fixed Assets to calculate the purchases, we identified a CAPEX of €3,125 per year. The formula used to calculate these values is the following:
Ending PPE- Beginning PPE+ Depreciation = CAPEX
However, we took into consideration no net increase (difference between the gross depreciation, which is “0”). This is mainly because as stated in the case, SUPERMAR is not able to invest more cash as the market is...

...increasing the firm’s market value just by substituting debt for equity. a) If RMO operated in perfect capital markets without any taxes (no corporate or personal taxes), how will RMO’s market value change if the firm decides to issue 50 million € of debt, buying back 50 million € of common stock in return? In this scenario RMO will pay interest only on this debt and plans to hold that amount of debt permanently without further adjustments in the future. (2 points) b) In contrast to a) above assume now that there is a corporate tax with statutory rate of 35% (but no personal taxes). What would be the effect of the same financial transactions on RMO’s value? (5 points) c) Personal taxes on investors’ income (from either interest payments on corporate debt, dividends or capital gains) might offset some of the tax benefits of leverage. Suppose the tax rate on interest income is 35% and the tax rate on dividends as well as capital gains is 10% for all investors. How high must the (marginal) corporate tax rate be for debt to still offer a tax advantage? (5 points) c) The CEO is skeptical about these valuation effects and seeks your advice. She asks whether there are also costs to debt financing not adequately accounted for in these calculations so far. What could these costs of leverage be? (3 points) d) Assume again that there is only a corporate tax with tax rate 35% (like in question b) above; no personal...

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NEW YORK UNIVERSITY
STERN SCHOOL OF BUSINESS
UB008.001 ADVANCEDCORPORATEFINANCE
Spring 2015
Monday Wednesday 9:30am-10:45pm
General Information
Professor Nikolay Halov
Office: KMC 9-151
E-mail: nhalov@stern.nyu.edu
Phone: 212-998-0836
Office Hours
• Tuesday 5-7pm
• Other times by Appointment
TA: Ryan Liu
E:mail: ryan.liu@stern.nyu.edu
Office hours: Friday 4-5pm
Room: E&Y Lounge, LL in Tisch
Course Objective
By the end of this course, I would like you to be able to
• Apply value public or private firms and projects using discounted cash flow analysis
-Estimate free cash flows to the firm and equity
-Estimate growth rates of operating income and net income
-Estimate cost of capital and cost of equity capital
• Understand and identify the costs and benefits associated with the different way to finance the firms operations.
-Costs of debt: bankruptcy costs, costs of financial distress, debt overhang and the conflicts of interest between its various stakeholders
-Benefits of debt: tax benefits, reduction in asymmetric information problems, reduction in agency problems between owners and managers of the firm.
• Design corporate financing strategies with respect to IPOs, recapitalizations, bankruptcy and restructuring
Required Material
Class notes
Self contained: will do a brief review of concepts from CorporateFinance
Handouts in class
To see...

...Final Exam CorporateFinance FINC 650 1. Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting? a. b. c. d. e. Long-term debt. Common stock. Short-term debt used to finance seasonal current assets. Preferred stock. All of the above are considered capital components for WACC and capital budgeting purposes.
2. A company has a capital structure which consists of 50 percent debt and 50 percent equity. Which of the following statements is most correct? a. b. c. d. The cost of equity financing is greater than the cost of debt financing. The WACC exceeds the cost of equity financing. The WACC is calculated on a before-tax basis. The WACC represents the cost of capital based on historical averages. In that sense, it does not represent the marginal cost of capital. e. The cost of retained earnings exceeds the cost of issuing new common stock.
3. Which of the following statements is most correct? a. Preferred stock does not involve any adjustment for flotation cost since the dividend and price are fixed. b. The cost of debt used in calculating the WACC is an average of the after-tax cost of new debt and of outstanding debt. c. The opportunity cost principle implies that if the firm cannot invest retained earnings and earn at least rs, it should pay these funds to its stockholders and let them invest directly in other assets...

...of a new machine to produce this product
d. Salvage value of the new machine at the end of its useful life
e. Increase in net working capital at the beginning of the project’s life
f. Cost to develop a product prototype last year
11.2 A division of Blakewell Manufacturing is considering purchasing an auto insert machine to load computer components on mother boards for $1,500,000. The machine will have annual operating costs of $50,000 and save the company $370,000 in labor costs each year. The machine will have a useful life of 10 years. For tax purposes, straight-line depreciation will be used with an estimated salvage value of $300,000 (which will be the market value at that time). The discount rate is 12% and the corporate tax rate is 32%. What is the NPV of this proposal?
11.3 After examining a potential project’s NPV analysis, the manager advises that the initial fixed capital outlay be increased by $480,000. The initial fixed capital outlay is fully depreciated straight-line over a twelve year life. The tax rate is 35 percent and the required rate of return is 10 percent. No other changes are made to the analysis. What is the effect on the project NPV?
11.4 Central Embroidery needs to purchase a new monogram machine and is considering two options. The first machine costs $100,000 and is expected to last 5 years, and the second machine costs $160,000 and is expected to last 8 years. Assume that the opportunity cost of capital is 8...

...probability will increase the expected bankruptcy costs
Case 1: no taxes or bankruptcy costs. No optimal capital structure
Case 2: corporate taxes but no bankruptcy costs. Each additional dollar of debt increases the cash flow of the firm. Optimal capital structure is 100% debt
Case 3: corporate taxes and bankruptcy costs. There is a trade-off between the benefit from an additional dollar of debt and the increase in expected bankruptcy costs. Optimal capital structure is part debt and part equityThe tax benefit of debt is only important if the firm has a large tax liability that you may want to offset
Trade off theory. 1. Strong industry trends in capital structure
Lowest levels of debt- high cost of debt. Industries with great EBIT volatility and intangible assets: greater risk of financial distress. growth firms, firms with unique or specialized assets Drugs Computers
Highest levels of debt- Industries with steady EBIT and tangible assets: lower risk of financial distress. high benefits of debt financing tend to use more debt. industries with a strong union presence. firms with stable CF.
The prospect of bankruptcy may further diminish cash flows. Why?-Lawyers’ fees-Loss in consumer confidence-Managers may not take care of equipment
Covenants- clauses in debt contracts to avoid inefficient behavior.Problem with using equity finance- perquisite consumption, agency costs of equity? LBOs may help solve the agency cost of...

...(investment’s sensitivity to market). (0 = riskless, 1 = as risky as entire market)
* βA = D/(D+E) βD + E/(D+E) βE, where D & E are Market Values of Debt & Equity
* E = Price/Share * # Shares
* D = Market Value of outstanding Debt
* βE = βA + D/E (βA – βD)
* If firm is unlevered (D=0), βE = βA. If little chance of default then βD = 0 and βA = βE E/(D+E)
* Use the risk measure associated with the project you are investing in – not necessarily the risk measure for your firm
* VL = VU + PV (Tax Benefits) + Corporate Benefits (Debt) – Costs of Financial Distress
* VL is the value of the firm with leverage, VU is the value of the all-equity firm
* 2 methods used to incorporate tax benefits to previous valuation techniques: APV & WACC
* APV (Adjusted Present Value – adjusts for tax by increasing the cash flows due to the tax benefit
* Increase each annual CF by Debt capacity * Debt Rate * Corporate Tax Rate = ITS (Interest Tax Shield)
* Step: Plug into CAPM to get Discount Rate Ra = Treasury + 6*Asset Beta if current
* WACC (Weighted Average Cost of Capital) – adjusts for taxes by decreasing the discount rate
* WACC = r* = rd (1-tc) [D/(D+E)] + rE [E/(D+E)] done on a Market Value basis (D can be book value but not E)
* Steps: (1) Relever Asset Beta to Equity Beta: Asset Beta / Proposed Equity Ratio, (2) Plug into CAPM to get Equity Discount Rate, (3) WACC =...