Problem I:
Assume that Home Grown Company (HGC) wishes to create a sponsored ADR program worth $75 million to trade on the NASDAQ stock market. Assume that HGC is currently selling on the SWX Swiss Exchange for SF25.00 per share, and the current dollar/Swiss franc exchange rate is $0.8000/SF. American Bank and Trust (ABT) is handling the ADR issue for HGC and has advised the company that the ideal trading price for high-technology shares on the NASDAQ is about $60 per share (or per ADR).
(a). Describe the precise steps ABT must take to create an ADR issue meeting HGC's preferences.
(b). Assume that HGC's stock price declines from SF25.00 to SF22.50 per share. If the exchange rate does not also change, what will happen to HGC's ADR price?
(c). If the Swiss franc depreciates from $0.8000/SF to $0.7500/SF, but the price of HGC's shares remains unchanged in Swiss francs, how will HGC's ADR price change?
Problem II:
(1). Rosa purchases shares of a company that recently executed an IPO at the post-offering market price of $35 per share, and she holds the shares for one year. She then sells her shares for $40 per share. The company does not pay dividends, and she is not subject to capital gains taxation. During this year, the return on the overall stock market was 13 percent. What net return did she earn on her share investment? Assess this return in light of the overall market return.
(2). Griswold Company needs to raise $50 million of new equity capital. Its common stock is currently selling for $50 per share. The investment bankers require an underwriting spread of 3 percent of the offering price. The company's legal, accounting, and printing expenses, associated with the secondary offering, are estimated to be $750,000. How many new shares must the company sell to net $50 million.
Problem III:
A firm has EBIT of 10 million; the firm has $60 million of debt outstanding with a required rate of return of 6.5 percent. The required rate of return on the industry is 10 percent. The corporate tax rate is 30 percent. Assume corporate taxes but no personal taxes.
(a). Determine the present value of the interest tax shield of the firm, as well as the total value of the firm.
(b). Determine the gain from leverage, if personal taxes of 10 percent on stock income and 35 percent on debt income exist.
Problem IV:
(Ignore income taxes in this problem.) Big Blue Co. is considering three investment opportunities having cash flows as described below:
- Project I would require an immediate cash outlay of $10,000 and would result in cash savings of $3,000 each year for 8 years.
- Project II would require cash outlay of $3,000 per year and would provide a cash inflow of $30,000 at the end of 8 years.
- Project III would require a cash outlay of $10,000 now and would provide a cash inflow of $30,000 eight years from now.
Required:
If Big Blue has a required rate of return of 14%, determine which, if any, of the three projects is acceptable. Use the NPV method.