BUSS384 - Corporate Finance - Problem Set #1
Due by Wednesday, 15 October 2014
1. [10 points] Sydney Industries, Inc., is considering a new project that costs $30 million. The project will generate after-tax (year-end) cash flows of $8 million for five years. The firm has a debt-to-equity ratio of 0.25. The cost of equity is 12 percent and the cost of debt is 7 percent. The corporate tax rate is 40 percent. It appears that the project has the same risk of the overall firm. Should Sydney undertake the project?
2. [10 points] Here is some data for three firms in the restaurant industry: Firm #1: $100 million in debt, $200 million in equity, current estimated equity beta of 3.0 Firm #2: $200 million in debt, $200 million in equity, current estimated equity beta of 3.0 Firm #3: $300 million in debt, $100 million in equity, current estimated equity beta of 4.0 There are no corporate or personal taxes
(a) For each firm, calculate unlevered.
(b) Using your answer in part (a), what would you predict the equity beta to be for a firm in the restaurant industry with $300 million in debt and $600 million in equity? (Hint: Adopt the method we used in the Marriott case.)
3. [10 points] We want to determine cost of equity for Firm A. We know that Firm A’s target debt-toequity ratio is 1.50. We also know that there is a comparable firm which has exactly same lines of business and therefore is expected to have the same level of business risk as Frim A. The equity beta of the comparable firm is known to be 1.80. The market value of equity and the market value of debt of the comparable firm are $400 million and $200 million, respectively. The corporate tax rate is 20%. Based on the information given, answer following questions.
(a) What would be your estimate of equity beta for Frim A?
(b) If you find that equity beta is different between Frim A and its comparable firm in (a), how would you explain the difference? If you expect no difference explain why they are not...
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