Only need answers for parts d) and e). Please include calculations. XYZ company has the following expected cash flows for three scenarios that could occur: Recession Expected Expansion (prob. = .2) (prob. = .5) (prob. =.3) EBIT $10,000 $20,000 $30,000 MV Assets ______ (a) Complete the table above if the company is 100% equity financed, it pays taxes at 30%, the non-levered return on equity is expected to be 12%, the constant growth rate (g) is 5%, and overall firm value is calculated based on the expected after-tax cash flows (b) If the company wants to recapitalize (debt for equity swap) to save on taxes, what is the most debt the company can add (at a 6% rate) so that it will never go bankrupt under the above scenarios? (Assume the company goes bankrupt if EBIT < Interest owed) (c) Calculate the WACC for the unlevered case and for the result in part (b). (d) What is the market value of the assets if the firm chooses the debt level in part (b)? [Note: calculate this using MM Prop I (with taxes)] (e) If $200,000 in bonds are issued, what is the probability of bankruptcy over a three year period? (Note: you can assume each year is an independent draw from the above distribution)
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Only need answers for parts d) and e). Please include calculations.
XYZ company has the following expected cash flows for three scenarios that could occur:
Recession Expected Expansion
(prob. = .2) (prob. = .5) (prob. =.3)
EBIT $10,000 $20,000 $30,000
MV Assets ______
(a) Complete the table above if the company is 100% equity financed, it pays taxes at 30%, the non-levered
(b) If the company wants to recapitalize (debt for equity swap) to save on taxes, what is the most debt the company can add (at a 6% rate) so that it will never go bankrupt under the above scenarios? (Assume the company goes bankrupt if EBIT < Interest owed)
(c) Calculate the WACC for the unlevered case and for the result in part (b).
(d) What is the market value of the assets if the firm chooses the debt level in part (b)? [Note: calculate this using MM Prop I (with taxes)]
(e) If $200,000 in bonds are issued, what is the probability of bankruptcy over a three year period? (Note: you can assume each year is an independent draw from the above distribution)
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
