Corporate Finance

Workshop 1

2 April 2014

Jan Wallner

Introduction
10 Workshops
2 TAs with 5 workshops each
Usually from 9:00 to 10:45 on a Wednesday (but not always, check
your timetable!)
Please practice beforehand!

End-of-chapter exercises covered are listed in the course manual

Ask questions!
During the Workshop
Before or after the workshop or during the break

Discussion Board
Questions regarding exercises
But also conceptual questions if necessary
(Email: 357599jw@student.eur.nl) discussion board preferred!

Some Advice
Try to really get an understanding of the concepts

Practice on Connect

Focus on assigned exercises

Exam discrimates well between students who studied and
those who did not

Todays Plan
Exercise 12.32: WACC

Exercise 12.35: Finding the WACC

Exercise 14.17: Equity Accounts

Exercise 15.13: Break-even EBIT

Exercise 15.22: Calculating WACC

Exercise 15.30: Cost of Capital



Exercise 12.32 WACC
We are given the following for Kose SA:
Debt-equity ratio: 0.80
WACC: 10.5 %
Tax rate: 35 %
a) If Koses cost of equity is 15 %, what is ist pre-tax cost of
debt?
Formula for WACC: =

First need to determine debt and equity weights:

= 0.80

=
0.80
1
D +E = V = 1.80,

+
=
1
1.8
;

+
=
0.8
1.8











Exercise 12.32 WACC
Now, we can plug into our formula
=

0.105 =
1
1.8
0.15 +
0.8
1.8

1 0.35
Rearranging:

= 0.075 = 7.5 %

b) If the after-tax cost of debt is 6.4 %, what is the Cost of
Equity?
0.105 =
1
1.8

+
0.8
1.8
0.064
Rearranging:

= 0.1378 = 13.78 %










Exercise 12.35 Finding the WACC
We are given the following for Titan Mining Corp:
9 million shares of equity
1,200,000 8.5 % semi-annual bonds outstanding with a par
value of 100
Share price: 34
Equity beta: 1.20
Bonds have 15 years to maturity and sell for 93 % of par
The market risk premium is 10 %, T-bills are yielding 5 %
Tax rate is 28 %

If you are given so much information, a useful first step is to
sort it.












Exercise 12.35 Finding the WACC
Equity
9 million shares
Share price: 34
Equity beta: 1.20
Market risk premium: 10 %
T-bill rate: 5 %
Debt
1,200,000 bonds
8.5 % coupon with semiannual payments
Maturity: 15 years
Par value: 100
Sell for 93 % of par
Tax rate: 28 %

a) What is the firms market value capital structure?


















If you read market risk premium and T-
bill rate, always think CAPM
}

Exercise 12.35 Finding the WACC
a) What is the firms market value capital structure?
MV
EQUITY
= Shares * Share Price:

= 34 9,000,000 = 306,000,000

MV
DEBT
= Bonds * Bond Price:

= 100 0.93 1,200,00 = 111,600,000

MV
FIRM
=

= 111,600,000 + 306,000,000 = 417,600,000

Weights of debt & equity:

=
306,000,000
417,600,000
= 0.7328

=
111,600,000
417,600,000
= 0.2672
Exercise 12.35 Finding the WACC
a) If Titan Mining is eveluating a new investment project that
has the same risk as the firms typical project what rate
should the firm use to discount the projects cash flows?
, : =

Finding the cost of debt:


























Debt: 1,200,000 8.5 % coupon bonds outstanding, par value 100, selling for
93% of par, bonds make semi-annual payments
The pre-tax cost of debt is the YTM of the bonds

Using a financial calculator we find:

In Excel the function to calculate YTM is "=rate()"
Bond yields 0.0469 every six months,
hence bonds YTM (quoted per year)
is :

= 2 0.0469 = 9.38%

Exercise 12.35 Finding the WACC
Finding the cost of equity:

























Market: 10 % market risk premium, 5 % risk-free rate, equity beta is 1.20
We apply the CAPM to find the expected return on equity:

= 0.05 +1.2 0.1 = 0.17 = 17%

Exercise 12.35 Finding the WACC
Finding the WACC:






Plugging into the formula:
=

= 0.7328 0.17 + 0.2672 0.0938 1 0.28 = 0.1426
= 14.26 %

=
306,000,000
417,600,000
= 0.7328

=
111,600,000
417,600,000
= 0.2672
=

= 0.0938 = 9.38%

= 0.05 + 1.2 0.1 = 0.17 = 17%

Exercise 14.9 Par Values
International Energy plc was formed in 1912 with 100,000 shares
of equity with a 1 par value. Today, the companys share price is
9 and retained earnings are 213,000. International Energy has
just decided that it wishes to issue 25,000 new shares.

We are asked to find:
Total par value
Additional paid-in capital
Book value per share



















Exercise 14.9 Par Values
International Energy plc was formed in 1912 with 100,000 shares of equity with
a 1 par value. Today, the companys share price is 9 and retained earnings are
213,000. International Energy has just decided that it wishes to issue 25,000
new shares.
Equity before share issue:




Addition through issue

























Ordinary Shares (100,000 at 1 par value) 100,000
Additional Paid In Capital 0
Retained Earnings 213,000
Equity Value 313,000
Ordinary Shares (25,000 at 1 par value) 25,000
Additional Paid in Capital (25,000 x (9 - 1)) 200,000
Retained Earnings 0
Equity Value 225,000
Exercise 14.9 Par Values
Equity before share issue:




Addition through issue




Adding up:
Total par value = 100,000 +25,000 = 125,000
Additional paid-in capital = 200,000




















Ordinary Shares (100,000 at 1 par value) 100,000
Additonional Paid In Capital 0
Retained Earnings 213,000
Equity Value 313,000
Ordinary Shares (25,000 at 1 par value) 25,000
Additional Paid in Capital (25,000 x (9 - 1)) 200,000
Retained Earnings 0
Equity Value 225,000
Exercise 14.9 Par Values
Book value per share after the issue

Total equity = 313,000 + 225,000 = 538,000
Number of Shares: 100,000 + 25000 = 125,000

=


=
538,000
125,000
= 4.304




























Exercise 15.13 Break-even EBIT
Hammerson plc pays no taxes and compares two different capital
structures:
Plan 1
All-equity, 712 million shares
Plan 2
Leveraged, 475 million shares, 1 billion in debt outstanding with 5 %
interest
a) If EBIT is 459 million, which plan will result in higher EPS?
Plan 1: 459 million / 712 million = 0.647
Plan 2: (459 million 50 million) / 475 million = 0.861 (higher EPS)
b) If EBIT is 80 million, which plan will result in higher EPS?
Plan 1: 80 million / 712 million = 0.112 (higher EPS)
Plan 2: (80 million 50 million) / 475 million = 0.063





























Exercise 15.13 Break-even EBIT
c) What are the break-even EBIT?
(i.e. EBIT for which both capital structures yield the same EPS)

We just equate:

712
=
50
475


= 150




























Exercise 15.22 Calculating WACC
Shadow plc has no debt but can borrow at 8 per cent. The firms
WACC is currently 12 per cent, and the tax rate is 28 per cent.
a) What is Shadows cost of equity?
12%, why ? =

b) If the firm converts to 25 per cent debt, what will its cost of equity be?
:

=
0
+

= 0.12 +
0.25
0.75
0.12 0.08 1 0.28 = 0.1296 = 12.96 %
c) If the firm converts to 50 per cent debt, what will its cost of equity be?
:

=
0
+

= 0.12 +
0.5
0.5
0.12 0.08 1 0.28 = 0.1488 = 14.88 %






























Exercise 15.22 Calculating WACC
Shadow plc has no debt but can borrow at 8 per cent. The firms
WACC is currently 12 per cent, and the tax rate is 28 per cent.
d) What is Shadows WACC in requirement b? In requirement c?
Lets look at b first: =

= 0.75 0.1296 + 0.25 0.08 1 0.28 = 0.1116

And c: =

= 0.5 0.1488 + 0.5 0.08 1 0.28 = 0.1032

























Exercise 15.30 Cost of Capital
Acetate:
MV Equity = 20 million
MV Debt = 10 million
Treasury bills yield 8 % per year
Expected return on market portfolio is 18 %
The beta of Acetates equity is 0.9

a) What is Acetates debtequity ratio?
Debt-equity ratio =

=
10
20
= 0.5

























Exercise 15.30 Cost of Capital
Acetate:
MV Equity = 20 million; MV Debt = 10 million; Treasury bills yield 8 % per year;
expected return on market portfolio is 18 %; the beta of Acetates equity is 0.9
b) What is Acetates WACC?
Cost of Equity: Again, we use the CAPM

= 0.08 + 0.9 0.18 0.08 = 0.17 = 17%

Cost of Debt:
In this exercise we are in the Modigliani-Miller world and assume that debt is risk-
free, hence, we use the T-bill rate: 8 %

Calculating the WACC:
=

=
20
30
0.17 +
10
30
0.08 1 0 = 0.14 = 14%



























Exercise 15.30 Cost of Capital
Acetate:
MV Equity = 20 million; MV Debt = 10 million; Treasury bills yield 8 % per
year; expected return on market portfolio is 18 %; the beta of Acetates equity is
0.9
c) What is the cost of capital of an otherwise identical all-equity firm?
14 %, why?

We can also prove this mathematically with MMs formula:

:

=
0
+

0.17 =
0
+
10
20
(
0
0.08)


0
= 0.14 = 14 %




























Thank you very much for your attention

I will stick around for questions