BUSS384 - Corporate Finance - Problem Set #1

Due by Wednesday, 15 October 2014

1. [10 points] Sydney Industries, Inc., is considering a new project that costs $30 million. The project will generate after-tax (year-end) cash flows of $8 million for five years. The firm has a debt-to-equity ratio of 0.25. The cost of equity is 12 percent and the cost of debt is 7 percent. The corporate tax rate is

40 percent. It appears that the project has the same risk of the overall firm. Should Sydney undertake the project? 2. [10 points] Here is some data for three firms in the restaurant industry:

Firm #1: $100 million in debt, $200 million in equity, current estimated equity beta of 3.0

Firm #2: $200 million in debt, $200 million in equity,
*…show more content…*

There are 2 million shares outstanding. How many shares would you need to hold to be certain that you can elect at least one director assuming that

(a) [5 points] Spartan has straight voting

(b) [10 points] Spartan has cumulative voting

5. [15 points] Consider two firms A and B that are identical in all respects except capital structure. Firm

A has $160 million in equity outstanding and $40 million in bonds outstanding. Firm B has $200 million in equity outstanding and $0 million in bonds outstanding.

(a) Suppose an investor has an $8 million investment in the stock of firm A. What alternative $8 million investment that includes firm B’s stock will give the investor the same cash flow payoff in future years as his current investment in firm A’s stock? (Hint: I am looking for the amount of cash you would invest in firm B's stock and the amount of cash you would either invest in other securities or borrow from other sources so that $8 million comes out of your pocket today and you get the exact same cash payoff down the road as the current $8 million investment in firm A’s stock.)

(b) Suppose an investor has a $16 million investment in the stock of firm B. What alternative $16 million investment that includes firm A’s stock will give the investor the same cash flow payoff in future years as his current investment in firm B’s stock? (Hint: I am looking for the amount of cash you would invest in firm A's stock and the amount of

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