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UB MGF 301 - MGF301 Assignment 5 - Spring 2010 (answers)

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ASSIGNMENT 5MGF 301Corporation FinanceSpring 2010DUE: Monday, April 26th at 12:30pm. You can turn in your assignment until 11am in Jacobs 365 or before 12:30 in Jacobs 106 before the final class starts.You may work in a group of up to 4 on this Assignment. Please indicate clearly on all submitted Assignments who the members of the group are. Please note, all assignments submitted with more than 4 group members will automatically receive a 0 grade. No late assignments will be accepted. You may hand in the assignment in person in as noted above or submit it by email to the Digital Dropbox on UBLearns before the time it is due. All email submissions must be to the Digital Dropbox (go to Control Panel, Digital Dropbox and hit “Send file”). Note: Do not use the “#” symbol in your file name!________________________________________________________________________________________________________Answer all of the following questions. For each answer, show your work to get full points (stating the answer alone is not sufficient).1. The total book value of WTC’s equity is $60 million and book value per share outstanding is $5. The stock of WTC is currently selling for a price of $25 per share and the beta of WTC is .85. The bonds of WTC have a face value of $36 million and sell at a price of 115 percent of face value. The yield to maturity on the bonds is 7.5 percent and the firm’s tax rate is 35 percent. If the E(Rm) = 9% and Rf = 1%, calculate the WACC of WTC. Number of shares outstanding = 60,000,000 book value/5 per share =12,000,000 shares outstandingMarket Value of WTC = 25 per share x 12,000,000 shares = 300,000,000Book Value of Debt = 36,000,000Market Value of Debt = 36,000,000 x 1.15 = 41,400,000Expected Return on Stock = .01 + .85(.09 - .01) = .078WACC using market values of debt and equity: Market WACC= (300M / 341.4M) x .078 + (41.4M / 341.4M)x(1-.35)x.075Market WACC = .0685 + .006 = .0745 or 7.45%For comparison purposes, you will note that difference from the WACC using book values of debt and equity (note - this is not a required calculation in the assignment): Book WACC = (60M / 96M) x .078 + (36M / 96M) x (1-.35) x .075 Book WACC = .04875 + .01828 = .0670 or 6.70%2. Using the data in #1, answer the following:(a) The company is considering an expansion to double the production of its current product. The company's CEO argues that the WACC of the firm is the appropriate discount rate to use in the NPV analysis of the plant expansion. Is thisthe appropriate rate? Explain without doing any calculations. The company should only use the WACC here if the firm is financing the newproject using the same mix of debt and equity as the overall firm. If this is not the case, the firm should find the risk of being in their particular business (i.e., find the assets for their business) and use CAPM to find the discount rate. (b) The company is considering adding a new handheld computer tablet that is similar to the Ipad offered by Apple and the Kindle offered by Amazon. Calculate an appropriate discount rate using competitor companies that are publicly traded. This is a new line of business entirely, so the company should find the assets of the new line of business and use CAPM to find the discount rate. They could do this by finding other companies in that line of business or they could use industry figures to estimate assets. Apple has a beta of 1.50 and Amazon has a beta of 1.17 (according to Yahoo Finance). Using the average of the betas, a beta of 1.34 is an estimate for the beta of the assets of being in the handheld computer tablet business (note: neither company is exclusively in this business, so this is a rough estimate).Using a beta of 1.34 and Rm=.09 and Rf=.01, the expected rate of return is found using CAPM: E(r) = .01 + 1.34 x (.09-.01) = .1172 or 11.72%3. One year ago, an American investor bought 1000 shares of London Bridges at a price of £42 (or 42 UK pounds) per share when the exchange rate was $1.75/1£ (or $1.75 dollars = 1 pound). The investor also invested 2,000,000 Japanese Yen in a money market fund in Japan last year when the exchange rate was 100 Yen = $ 1 US. (a) Using current exchange rates, what is today’s value of the investor’s portfolio in U.S. dollars if the UK investment decreased 10% (in local currency) and the Japan investment increased 2% (in local currency)?Initial investment = 1000x£42 x 1.75 = $73,500 & 2,000,000Yen/ 100 = $20,000 in the money fund or $93,500 in the portfolioIf the UK investments decreases by 10% in local currency, it is worth 1000x£42x.9 = £37,800. If we convert back to dollars at today's rates (1£ = $1.535), the value is £37,800x1.535 = $58,023If the Japanese investments increases by 2% in local currency, it is worth 2,000,000Yen x 1.02 = 2,040,000Yen. If we convert back to dollars at today's rates ($1 = 93.99Yen), the value is 2,040,000Yen / 93.99 = $21,704.44(b) What is the overall rate of return on the portfolio over the last year?The overall rate of return = (58,023+21,704.44) - 93,500) / 93,500 = = -.1473 or -14.73%4. An American firm is evaluating an investment in Mexico. The project is expected to produce a cash flow of 250 million pesos each year for 8 years. If the appropriate discount rate is 11%, how much in U.S. dollars is the maximum the firm is willing to pay as the initial cost of the project? (Note: use the current exchange rate for pesos and do your calculation using an annuity factor to find PV).The first step is to convert the cash flows of 250 million pesos to U.S. dollars. At today’s rate of 12.1865 pesos = $1, the conversion is as follows:250,000,000/12.1865 = $20,514,504 per yearUsing this cash flow per year for 8 years at 11% gives an annuity factor of 5.1461. This means the PV is $20,514,504 x 5.1461 = $105,569,688It would be a positive NPV project to pay any amount less than $105,569,688 as the initial cost of the


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UB MGF 301 - MGF301 Assignment 5 - Spring 2010 (answers)

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