Questions 1-5 relate to the same “mega” problem. For all questions that follow assume that changes in working capital are negligible and capex and depreciation are of the same magnitude and therefore cancel each other.
1. Suppose Talmart is an all-equity firm with an EBIT of $75,000 per year that is expected to stay the same for the foreseeable future. Your research shows that the beta equity of Talmart is 2.00 and it has 20,000 shares outstanding. Suppose the expected return on the market is 10% and the risk free rate is 5%. For this question, assume taxes are zero.
What are the market value and price per share of Talmart?
a) $400,000; $200
b) $600,000; $30
c) $500,000; $25
d) $250,000; $12.50
2. (Follow on to Q1 above)
Talmart has however recently issued a bond yielding 7.50% with a market value of $250,000 and will use these funds to buy back shares (a fairly common practice). Talmart also plans to retain $250,000 of debt financing in perpetuity. How many shares will Talmart buy back?
3. What will Talmart’s new return on equity be?
4. What will Talmart’s new beta of equity be?
5. What will Talmart’s new share price be?