Please show computations and walk through the process to get a solution.
Problem 1: A 10-year Corporate bond is issued with a face value of $100,000, paying interest of $2,500 semi-annually. If market yields decrease shortly after the T-bond is issued, what happens to the bond's:
a. price?
b. coupon rate?
c. yield to maturity?
Problem 2: McCoy, Inc., has equity with a market value of $30 million and debt with a market value of $20 million. The cost of the debt is 6 percent semi-annually. Treasury bills that mature in one year yield 10 percent per annum, and the expected return on the market portfolio over the next year is 15 percent.
The beta of McCoy's equity is 0.8 .The firm pays no taxes.
a. What is McCoy's debt-equity ratio?
b. What is the firm's weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?
Problem 3: Poulsbo Manufacturing, Inc., is currently an all-equity firm that pays no taxes. The market value of the firm's equity is $3 million. The cost of this unlevered equity is 15% per annum. Poulsbo plans to issue 600,000 in debt and use the proceeds to repurchase stock. The cost of debt is 4% semi annually.
a. After Poulsbo repurchases the stock,what will the firm'sweighted average cost of capital be?
b. After the repurchase, what will the cost of equity be? Explain.
c. Using MM-Proposition 2, what will be the weighted average cost of capital after the repurchase?
Problem 4:
a. Why do venture capital companies prefer to advance money in stages? If you were the management of Marvin Enterprises, would you have been happy with such an arrangement? With the benefit of hindsight did First Meriam gain or lose by advancing money in stages?
b. The price at which First Meriam would invest more money in Marvin was not fixed in advance. But Marvin could have given First Meriam an option to buy more shares at a preset price. Would this have been better?
c. At the second stage Marvin could have tried to raise money from another venture capital company in preference to First Meriam. To protect themselves against this, venture capital firms sometimes demand first refusal on new capital issues. Would you recommend this arrangement?
Problem 5: Here is recent financial data on Pisa Construction, Inc.
Stock price $40 Market value of firm $400,000
Number of shares 10,000 Earnings per share $4
Book net worth $500,000 Return on investment 2% quarterly.
Pisa has not performed spectacularly to date. However, it wishes to issue new shares to obtain $100,000 to finance expansion into a promising market. Pisa's financial advisers think a stock issue is a poor choice because, among other reasons, "sale of stock at a price below book value per share can only depress the stock price and decrease shareholders' wealth." To prove the point they construct the following example: "Suppose 2,500 new shares are issued at $40 and the proceeds are invested. (Neglect issue costs.)
Suppose return on investment does not change. Then
Book net worth = $600,000
Total earnings = .0824(600,000) = $49,440
Thus, EPS declines, book value per share declines, and share price will decline proportionately to $38.40."
Evaluate this argument with particular attention to the assumptions implicit in the numerical example.