Answered: Firm CCC has no debt. Existing assets… | bartleby

Firm CCC has no debt. Existing assets generate earnings of $20mil. per year forever. Discount rate=10%. Firm has n shares (5 mil.) currently selling at P=$40 per share. Now firm plans to invest I=$40mil. in new project. Project will generate $5 mil. in new earnings per year forever. Firm will issue new shares to fund this new project. a. In an efficient capital market, what is the price that new shareholders are willing to pay for each share of Firm CCC’stock? What is the gain by existing shareholders? b. Suppose market is inefficient and new shares can be sold for $45, what is the gain/loss by new shareholders from purchasing these new shares?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter12: The Cost Of Capital

Section: Chapter Questions

Problem 7P

See similar textbooks

Related questions

Question

13.

Firm CCC has no debt. Existing assets generate earnings of $20mil. per year forever. Discount rate=10%. Firm has n shares (5 mil.) currently selling at P=$40 per share. Now firm plans to invest I=$40mil. in new project. Project will generate $5 mil. in new earnings per year forever. Firm will issue new shares to fund this new project.

a. In an efficient capital market, what is the price that new shareholders are willing to pay for each share of Firm CCC’stock? What is the gain by existing shareholders?

b. Suppose market is inefficient and new shares can be sold for $45, what is the gain/loss by new shareholders from purchasing these new shares?

Definition Definition Degree to which financial markets incorporate all available information into the prices of assets. In a more efficient market, the prices reflect the available information more than that in a weak efficient market. It is difficult for investors to outperform the market in a strong efficient market. This is because all the available information is already discounted in the asset's price. However, in a weak-form efficiency, the market does not reflect all information in the asset's price. As a result, it becomes easier to generate better returns in a weak form or an inefficient market.

Expert Solution

Trending now

This is a popular solution!

Step by step

Solved in 3 steps with 2 images

SEE SOLUTION Check out a sample Q&A here

Blurred answer

Knowledge Booster

Dividends

Learn more about

Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.

Similar questions

Optimal Capital Structure with Hamada Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a zero-growth firm and pays out all of its earnings as dividends. The firm’s EBIT is $14,933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0. What is BEA’s unlevered beta? Use market value D/S (which is the same as wd/ws when unlevering. What are BEA’s new beta and cost of equity if it has 40% debt? What are BEA’s WACC and total value of the firm with 40% debt?
WACC Estimation On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm’s present market value capital structure, shown here, is considered to be optimal. There is no short-term debt. New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 = 4%.) The marginal tax rate is 40%. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC? Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question.
Hasting Corporation is interested in acquiring Vandell Corporation. Vandell has 1 million shares outstanding and a target capital structure consisting of 30% debt; its beta is 1.4 (given its target capital structure). Vandell has $10.82 million in debt that trades at par and pays an 8% interest rate. Vandell’s free cash flow (FCFJ is $2 million per year and is expected to grow at a constant rate of 5% a year. Vandell pays a 40% combined federal and state tax rate. The risk-free rate of interest is 5%, and the market risk premium is 6%. Hasting’s First step is to estimate the current intrinsic value of Vandell. What are Vandell’s cost of equity and weighted average cost of capital? What is Vandell’s intrinsic value of operations? [Hint: Use the free cash flow corporate valuation model from Chapter 8.) What is the current intrinsic value of Vandell’s stock?

Recommended textbooks for you

EBK CONTEMPORARY FINANCIAL MANAGEMENT

EBK CONTEMPORARY FINANCIAL MANAGEMENT

Finance

ISBN:

9781337514835

Author:

MOYER

Publisher:

CENGAGE LEARNING - CONSIGNMENT

Corporate Fin Focused Approach

Corporate Fin Focused Approach

Finance

ISBN:

9781285660516

Author:

EHRHARDT

Publisher:

Cengage

Intermediate Financial Management (MindTap Course…

Intermediate Financial Management (MindTap Course…

Finance

ISBN:

9781337395083

Author:

Eugene F. Brigham, Phillip R. Daves

Publisher:

Cengage Learning

EBK CONTEMPORARY FINANCIAL MANAGEMENT

EBK CONTEMPORARY FINANCIAL MANAGEMENT

Finance

ISBN:

9781337514835

Author:

MOYER

Publisher:

CENGAGE LEARNING - CONSIGNMENT

Corporate Fin Focused Approach

Corporate Fin Focused Approach

Finance

ISBN:

9781285660516

Author:

EHRHARDT

Publisher:

Cengage

Intermediate Financial Management (MindTap Course…

Intermediate Financial Management (MindTap Course…

Finance

ISBN:

9781337395083

Author:

Eugene F. Brigham, Phillip R. Daves

Publisher:

Cengage Learning

EBK CFIN

Finance

ISBN:

9781337671743

Author:

BESLEY

Publisher:

CENGAGE LEARNING - CONSIGNMENT

SEE MORE TEXTBOOKS