Corporate Finance Insights: Cost of Capital & Share Repurchase
School
The University of Hong Kong**We aren't endorsed by this school
Course
STAT 3904
Subject
Statistics
Date
Dec 10, 2024
Pages
2
Uploaded by MateWrenPerson503
THEUNIVERSITYOFHONGKONGDEPARTMENTOFSTATISTICSANDACTUARIALSCIENCESTAT3904 Corporate Finance for Actuarial Science (Fall 2024)Assignment 4Due:December 3, 2024 (Tuesday)1. Given the following information:Market value of common stock$6 millionMarket value of debt$4 millionBeta of common stock1.5Market risk premium6%Risk-free rate4%Assume that the company’s debt is risk free, and that there is no tax.(a) Estimate the company cost of capital.(b) Explain the discount rate that should be used to evaluate an expansion of thecompany’s present business.(c) The company wants to venture into a consultancy business. It identifies anothercompany in that business that does not issue any debt, and that company has abeta of 1.2. Cash flows in the next four years (assumed earned at the end of eachyear) are projected to be: $50,000, $60,000, $100,000, $120,000. Calculatethe maximum cost of establishing the business now, above which the companyis better off not attempting it.2. A company is planning to repurchase $20 million’s worth of its own shares. As-suming that the Modigliani-Miller propositions and the relevant assumptions hold,explain whether each of the following is true:(a) There is no change to the company’s value after the repurchase.(b) This operation has an identical effect on the share price compared to distribut-ing $20 million as cash dividends to the shareholders.(c) The share price will increase following the repurchase because there are feweroutstanding shares.3. You are given the following information for a company:Earnings per share in 20X2$5.5Number of shares outstanding40 millionTarget payout ratio50%Planned dividend per share$2.75Stock price at end of 20X2$130Dividends are to be paid in early 20X3. Ignore tax in this question.(a) What is the theoretical stock price after the planned dividend payout?STAT3904 Assignment 41Fall 2024
(b) Suppose the company announces that it will not pay dividends but insteadrepurchase shares using the original dividend budget at the current stock price(at the end of 20X2). Assuming that there is no information content on theannouncement, what is the stock price right after the announcement, and howmany shares will the company buy back?(c) Suppose the company announces that the planned dividend is doubled to $5.5per share and that it will raise additional capital to recoup the cash paid asdividends above the original dividend budget.Assuming that there is noinformation content on the announcement,i. what are the with- and ex-dividend share prices?ii. how many shares will the company need to issue?4. You are an entrepreneur starting a biotechnology firm. If your research is successful,the technology can be sold for $35 million. If your research is unsuccessful, it willbe worth nothing. To fund your research, you need to raise $2.7 million. Investorsare willing to provide you with $2.7 million in initial capital in exchange for 25% ofthe unlevered equity in the firm.(a) What is the total market value of the firm without leverage?(b) Suppose you borrow $0.9 million. According to the Modigliani-Miller propo-sitions, what fraction of the firm’s equity will you need to sell to raise theadditional $1.8 million you need?(c) What is the value of your share of the firm’s equity in cases (a) and (b)?5. Refer to Example 2 of Chapter 13. Suppose Macbeth maintains its current status ofbeing unlevered.(a) Describe clearly what you should do in order to achieve the same risk profileas the case if Macbeth changes its capital structure to 75% equity and 25%debt. Use tables similar to those in slides 6 and 8 to illustrate your plan.(b) Explain why your plan will not work if your borrowing cost is 12% per annum(rather than the company’s 10%).STAT3904 Assignment 42Fall 2024