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    Lebanese International University: School of Business Masters of Business Administration

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    Taghrid A. H
    This document provides solutions to 7 exercises related to financial strategy concepts such as stock splits, capital budgeting, stock repurchases, break-even analysis, and weighted average cost of capital calculations. The exercises calculate stock prices and shares outstanding after a stock split, the percentage of a capital budget that must be debt financed, the number of shares repurchased and post-repurchase value, variable costs, break-even points, levered and unlevered betas, and changes in the cost of equity from changes in capital structure.

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    Lebanese International University: School of Business Masters of Business Administration

    Uploaded by

    Taghrid A. H
    35 views8 pages
    This document provides solutions to 7 exercises related to financial strategy concepts such as stock splits, capital budgeting, stock repurchases, break-even analysis, and weighted average cost of capital calculations. The exercises calculate stock prices and shares outstanding after a stock split, the percentage of a capital budget that must be debt financed, the number of shares repurchased and post-repurchase value, variable costs, break-even points, levered and unlevered betas, and changes in the cost of equity from changes in capital structure.

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    This document provides solutions to 7 exercises related to financial strategy concepts such as stock splits, capital budgeting, stock repurchases, break-even analysis, and weighted average cost of capital calculations. The exercises calculate stock prices and shares outstanding after a stock split, the percentage of a capital budget that must be debt financed, the number of shares repurchased and post-repurchase value, variable costs, break-even points, levered and unlevered betas, and changes in the cost of equity from changes in capital structure.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    35 views8 pages

    Lebanese International University: School of Business Masters of Business Administration

    Uploaded by

    Taghrid A. H
    This document provides solutions to 7 exercises related to financial strategy concepts such as stock splits, capital budgeting, stock repurchases, break-even analysis, and weighted average cost of capital calculations. The exercises calculate stock prices and shares outstanding after a stock split, the percentage of a capital budget that must be debt financed, the number of shares repurchased and post-repurchase value, variable costs, break-even points, levered and unlevered betas, and changes in the cost of equity from changes in capital structure.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 8

    Lebanese International University

    School of Business
    Masters of Business Administration
    BFIN650 – Financial Strategy

    Revision Sheet Chapters 14 & 15- Answer Key

    Exercise 1:
    Alpha Medical has 1 million shares outstanding trading at 90$ a share. The company is
    contemplating a 3-for-2 stock split. Assume that the stock split will have no effect on the market
    value of its equity.

    Required:
    a. What will be the company’s stock price following the split?
    b. What will be the number of shares following the split?

    Solution:
    90
    a. Ppost= Pprior / split = = $60/share
    3/2

    b. Npost= Nprior * split = 1 million * 3/2 = 1.5 million shares


    Exercise 2:
    Warren Supply Inc. is evaluating its capital budget. The company finances with debt and
    common equity, but because of market conditions, wants to avoid issuing any new common
    stock during the coming year. It is forecasting an EPS of $3.00 for the coming year on its
    500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is
    committed to maintaining a $2.00 dividend per share.

    Required:
    Given these constraints, what percentage of the capital budget must be financed with debt?

    Solution:
    Determine NI:

     EPS= NI/Number of shares  NI= 3*500,000= $1.5 million

    Determine Dividends:

     DPS= Dividends/ Number of shares  Dividends = 2*500,000= $1 million

    Determine the % of Equity:

     Dividends = NI – (capital budget * % Equity)  %Equity = 62.5%

    Determine the % of debt:

     100%=%Equity + %Debt  %Debt = 37.5%


    Exercise 3:
    The following data apply to Diesel Industries, Inc. (DII):

    Free Cash Flow (FCF) $10,000


    Extra cash $1,000
    Number of shares 500
    Intrinsic stock price $25

    DII plans on distributing the extra cash to common stockholders via stock repurchase.

    Required:
    a. What is DII’s value of operations?
    b. How many shares will remain after the repurchase?
    Solution:
    a. Vop = (N0*P) – Extra Cash = 500*25 – 100 = $11,500

    b. N (repurchased) = Extra cash / P = 1,000 / 25 = 40 shares

    N(post rep) = N(prior) – N(rep) = 500 – 40 = 460 shares


    Exercise 4:
    Dallas Company has 30 million shares of common stocks outstanding, and $40 million in short
    term investments, which it plans to liquidate and distribute to common shareholders via stock
    repurchase; the firm has no other non-operating assets.

    Dallas current value of operations is $398 million. It has $258 million in debt and has no
    preferred stocks outstanding.

    Required:
    a. Immediately before the repurchase, what is Dallas’ intrinsic value of equity?
    b. Immediately after the repurchase, what is Dallas’s intrinsic value of equity?

    Solution:
    a. Vop 398 million
    + V. of non-operating assets 40 million
    = Total intrinsic value of the firm 438 million
    - Debt (258 million)

    = Intrinsic value of equity (prior to rep) $180 million

    b. Vop 398 million


    + V. of non-operating assets 0
    = Total intrinsic value of the firm 398 million
    - Debt (258 million)

    = Intrinsic value of equity (post rep) $140 million


    Exercise 5:
    During next year, Lipstick Inc. is expecting to produce and sell 1,500,000 lipsticks at $20 each. It
    estimates its fixed costs at $1,450,000 and expects to realize $2,750,000 profit before tax.

    Required:
    a. Calculate the variable cost per unit of Lipstick Inc.
    b. Determine the Breakeven point QBE

    Solution:
    a. EBIT = P*Q – V*Q – F

    2,750,000 = 20*1,500,000 – V*1,500,000 – 1,450,000

    V=$17.2

    b. QBE= F/(P-V) = 1,450,000 / (20 – 17.2)= 517,857 units.


    Exercise 6:
    Dyson Inc. is considering changing its capital structure from 20% debt to 60% by issuing
    additional bonds and using the proceeds to repurchase and retire some common stock at book
    value. The CFO has gathered the following data:

    Risk free rate 6% Tax rate 35%


    Market risk premium 6% Current debt ratio 20%
    Current beta (Levered) 0.2 New debt ratio 60%

    Required:
    What would be the firm’s new cost of equity after recapitalization?

    Solution:
     Determine the unlevered beta:
    bU = bL current / [1 + (1 − T)(D/E)]
    bU= 0.2/[1+(1-0.35)(0.2/0.8)] = 0.172

     Determine the new beta levered:


    bL New = bU * [1 + (1 − T)(D/E)] = 0.172*[1+(1-0.35)(0.6/0.4)] = 0.3397

     Determine the new cost of equity:


    New cost of equity = rsNew = rRF + bLNew(RPM)= 6% + (6%*0.3397) = 8.038%
    Exercise 7:
    Domino’s Inc. is considering a change in its capital structure and increase its debt ratio. The
    below table shows both the current and the target capital structures.
    Capital Structure Percentage of debt Percentage of equity
    Current 55% 45%
    Target 65% 35%
    Assume that the return on risk free is R f=12%, the market risk premium RPm=14%, the current
    cost of equity rs= 18% and the tax rate = 35%.
    Required:
    Calculate the estimated change in the cost of equity (r s new – rs old) if Domino’s Inc. has modified
    its capital structure and comment the result.
    Solution:
     Calculate β L old
    r s old =Rf + β Lold ∗RPm
    18%= 12% + β L old * 14%  β L old =0.428

     Calculate β u
    β Lold
    β u=
    ( 1−T )∗(% debt old ) 0.428
    1+ = =0.238 ¿
    (% equity ¿¿ old) ( 1−0.35 )∗0.55
    1+
    0.45

     Calculate β L new
    (1−T )∗( % debt new )
    β L new =β u∗1+
    ( 1−0.35 )∗0.65
    (% equity ¿¿ new)=0.238∗1+ =0.5253 ¿
    0.35

     Calculate r s new
    r s new =Rf + β Lnew ∗RP m=12%+ (0.5253*14%)= 19.35%

     Calculate the change in the cost of equity


    change ∈the cost of equity=r s new −r s old =19.35 %−18 %=1.35 %
     Comment
    There is an increase in the cost of equity, so the company should be advised to keep its current
    capital structure

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