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Question3:

Step 1:

Rate of return = Rf + (Rm-Rf)Beta

= 8% + (4%)x1.25

= 8% + 5%

= 13%

Step2:

Dividend ratio = dividend paid/net income where, Retain Earning = a – (a x 30%)

= 600,000 / 2,000,000 a = net income

= 30%RE = a – 0.3a

1,400,000 = 0.7a

a = 2,000,000

therefore, dividend paid = 2,000,000-1,400,000

= 600,000

Step3:

D0 = Dividend paid / Number of share outstanding

= 600,000 / 1,000,000

= 0.60

D1 = D0 (1+g)

= 0.60 (1+0.04)

= 0.624

Step 4:

If the market is equilibrium, we assume that rate of return = cost of common stock = 13%

(D1/Pricenett) + g = 13%

0.624/ Pricenett ) + 4% = 13%

0.624 / P ) = 9%

0.09P = 0.624

Price = RM6.93

Therefore, market value of the firm’s common equity is RM6.93

QUESTION 6

Pit Row Auto, a national autoparts chain, is considering purchasing a smaller chain, Southern Auto. Pit Row’s analysts project that the merger will result in incremental net cash flows of $2 million in Year 1, $4 million in Year 2, $5 million in Year 3, and $117 million in Year 4. The Year 4 cash flow includes a terminal value of $107 million. Assume all cash flows occur at the end of the year. The acquisition would be made immediately, if it were undertaken. Southern post-merger beta is estimated to be 2.0, and its post-merger tax rate would be 30 percent. The risk-free rate is 8 percent, and the market risk premium is 4 percent.

a. What is the value of Southern Auto to Pit Row Auto?

Buyer: Pit Row Auto
Target firm: Southern auto

After acquired
beta=2.0
tax = 30%
risk-free rate = 8%
market risk premium = 4%

step1:
r = Rf + (Rm-Rf)Beta
= 8% + (4%)2.0
= 16%

step 2:
V= NCF1 + NCF2...
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