TFIN603 Corporate Finance

Answers:

Question 1

Dividend at t = 1 = $1*1.08 = $1.08

Dividend at t =2 = $1.08*1.08 = $1.17

Dividend at t=3  = $1.17*1.08 = $1.26

Dividend at t=4 = $1.26*1.08 = $1.36

EPS at t = 4 = ($1.36/0.4) = $3.40

Price at t=4 = 20*3.40 = $68

Share price at t=0 = ($1.08/1.12) + ($1.17/1.12²) + ($1.26/1.12³) + ($1.36/1.12⁴) + ($68/1.12⁴) = $46.89

Question 3

Depreciation for machine at t=1 = $100,000

Depreciation for machine at t=2 = $75,000

Depreciation for machine at t=3 = $56,250

Depreciation for machine at t= 4 = $42,188

BV at t =4 = $126,562

After tax salvage value = $27,031

OCF at t =1 = $133,000

OCF at t =2 = $125,300

OCF at t =3 = $119,575

OCF at t =4 = $166,188

NPV at t = 0 = $12,810 

Question 4

Let us assume that the weight of C in portfolio is X%.

It is noteworthy that risk free asset would have beta of 0 and thus, would not contribute anything to the portfolio beta. Also, the portfolio beta would be the same as market beta of 1.

Then, 0.7*(90,000/500,000) + 1.2*(150,000/500,000) + 1.5*X = 1

Simplifying the above, X comes out as 0.3427 or 34.27%

Let the amount of investment in stock C be $ Y

Thus, (Y/$500,000) = 0.3427

Simplifying the above, Y comes out as $171,333

The total portfolio size is $500,000.

Hence, amount invested in risk free asset = $500,000 – (Investment in stock A + Investment in stock B + investment in stock C) = $500,000 – ($90,000 + $150,000 + $171,333) = $88,667

Beta for risk free asset is zero as the amount of risk associated is nil.

Question 5

Market price of each bond = $1,000*108% = $1,080

MV of debt = $1,080 * 20,000 = $21.6 million

MV of Ordinary Shares = $80 * 550,000 = $44 million

MV of preferred shares = $90 * 20,000 = $1.8 million

Cost of equity = R_f + β*MRP

Here, R_f = 3%, β =1.2 , MRP = 7%

Hence, cost of equity = 3% + 1.2*7% = 11.4% p.a.

Cost of preferred shares = (4/90)*100 = 4.44% p.a.

Weight of debt = (21.6/(21.6+44+1.8)) = 0.3205

Weight of ordinary shares = (44/(21.6+44+1.8))) = 0.6528

Weight of preference shares = (1.8/(21.6+44+1.8))) = 0.0267

WACC = 0.3205*5.6%*(1-0.3) + 0.6528*11.4% + 0.0267*4.44% = 8.82% p.a.

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