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Exercise 1:
Restex maintains a debt-equity ratio of 0.4, and has an equity cost
of capital of 10% and a debt cost of capital of 7%. Restexs
corporate tax rate is 40%, and its market capitalization is $250
million.
a.
b.
Exercise 2:
Kurz Manufacturing is currently an all-equity firm with 10 million
shares outstanding and a stock price of $12 per share. Although
investors currently expect Kurz to remain an all-equity firm, Kurz
plans to announce that it will borrow $50 million and use the funds
to repurchase shares. Kurz will pay interest only on this debt, and it
has no further plans to increase or decrease the amount of debt.
Kurz is subject to a 40% corporate tax rate.
a.
b.
c.
d.
Exercise 3:
Gladstone Corporation is about to launch a new product. Depending
on the success of the new product, Gladstone may have one of four
values next year: $110 million, $80 million, $75 million, and $40
million. These outcomes are all equally likely, and this risk is
diversifiable. Suppose the risk-free interest rate is 2.5% and that, in
the event of default, 25% of the value of Gladstones assets will be
lost to bankruptcy costs. (Ignore all other market imperfections,
such as taxes.)
a.
What is the initial value of Gladstones equity without
leverage?
Now suppose Gladstone has zero-coupon debt with a
$75 million face value due next year.
b.
c.
d.
f.
Exercise 4:
Zymase is a biotechnology start-up firm. Researchers at Zymase
must choose one of three different research strategies. The payoffs
(after-tax) and their likelihood for each strategy are shown below.
The risk of each project is diversifiable.
Strategy
Probability
Payoff ($ million)
100%
110
50%
180
50%
20%
310
80%
20
a.
b.
c.
d.