1) Omega Industries has 30mm shares outstanding trading for $15 per share and $90mm in outstanding debt. Omega's equity cost of capital is 12%, its debt cost of capital is 6% and ts corporate tax rate is 30%.
a. What is Omega's unlevered cost of capital?
b. What is Omega's after-tax debt cost of capital?
c. What is Omega's weighted average cost of capital?
2) Consider two bonds A and B with the following characteristics that have the same price.
Annual Coupon Annual Yield Maturity
A Zero 5% 4yrs
B ? 6% 5yrs
a. What is the common price (as a percentage of notional amount) of the two bonds?
b. If you spent $10mm to purchase bond B, how much principal would you receive on its maturity date?
c. If you spent $10mm to purchase bond B, what coupon payment (in $) will you receive each year?
3) Castle Rock Inc. will have one of three values at the end of next year: $200mm with 30% probability, $130mm with 50% probability or $70mm with 20% probability. The risk of these outcomes is diversifiable. The risk free rate is 10%. In the event of default, the 30% of Castle rock's assets will be lost to bankruptcy costs. Castle Rock has 1,000,000 shares outstanding. (Ignore taxes.)
a. What is the initial value of Castle Rock's equity without leverage?
b. What is the price per share of Castle Rock's equity without leverage?
Assume that Castle Rock issues $90mm face value of zero coupon debt due in one year.
c. What is the initial value of Castle Rock's debt?
d. What is the yield of Castle Rock's debt?
e. What is the value of Castle Rock's equity and it price per share with leverage?
f. What is Castle Rock's total firm value with leverage?
4) Acme Co. is assessing it current capital structure. Acme is currently financed entirely with common stock with 1,000,000 shares outstanding. Investors currently require a 20% return on Acme stock. Acme pays out all earnings as dividends to common shareholders. Expected earnings (EBIT) generated by the firm's assets are $3,000,000 per year and expected to continue into perpetuity. Assume agency and bankruptcy costs are zero.
a. Assuming that the corporate tax rate is zero, calculate:
i. The value of the firm
ii. The market value per share
iii. The firm's cost of capital
b. Acme's CEO has decided to issue debt so that the firms balance sheet will be split evenly between debt and equity. He plans to issue $7,500,000 of perpetual debt with a 10% annual rate and use the proceeds to repurchase equity. Again assuming the corporate tax rate is zero, calculate
i. The value of the firm
ii. The market value per share
iii. The required rate of return on equity
iv. The firm's weighted average cost of capital
c. Now assume the corporate tax rate is 40%. Calculate
i. The value of the firm
ii. The market value per share
iii. The required rate of return on equity
iv. The firm's weighted average cost of capital.