University of California Walter A Haas School of Business UGBA 103 Introduction to Finance Prof Dmitry Livdan 10 December 2018 Solutions to the FINAL 35 points total Sirap Co pays 40 in corporate taxes and is financed entirely by common stock with a 1 000 shares outstanding trading at 75 per share Sirap has only assets in place and thus does not grow The risk free debt yields 5 and the market risk premium is equal to 8 Let EPS stand for earnings per share E for equity and D for debt 1 The CAPM beta of Sirap s equity E is twice the portfolio weight on the risk free asset of the efficient portfolio with a return equal to 6 6 Calculate i 3 points Sirap s beta E The return of the efficient portfolio is equal to 6 6 5 w 8 w 0 2 from where we can find that the portfolio weight on the risk free asset is equal to 1 0 2 0 8 which implies E 2 0 8 1 6 ii 1 point the required return on the Sirap s stock Using CAPM we obtain rE 5 1 6 8 17 8 rA iii 1 point Sirap s P EPS ratio keep 3 digits after the decimal point We have P EP S 1 1 5 618 rE 0 178 iv 1 point Sirap s EPS keep 2 digits after the decimal point We have 75 5 618 EP S 13 35 EP S 2 For this part of the solution all the primed variables like E 0 denote after refinancing variables Sirap now decides to switch to ED0 2 by using debt to repurchase common stock If the debt is risk free calculate i 3 points The amount of debt issued keep 2 digits after the decimal point UGBA 103 FINAL Solutions 2 After debt is issued we have that VL D E 0 1 5D VU D 1 000 75 D which we can solve for D 75 000 1 1 68 181 82 ii 1 point The new price per share keep 2 digits after the decimal point The new price is the old price plus the interest tax shield per share P 0 75 0 4 68 18 102 27 iii 2 points The number of repurchased shares please round the number to make it integer We can calculate the number of repurchased shares by dividing the debt by the share price 68 181 82 102 27 to get 667 or 2 3 of all shares iv 2 points The new earnings per share EPS0 keep 2 digits after the decimal point After the refinancing we need to pay after tax interest to the debtholders leading to the following value of the total earnings ERN ERN 0 13 350 1 rD D 13 350 0 6 0 05 68 181 82 11 310 Since we have only 1 3 of the shares remaining EP S 0 11 310 333 33 95 v 1 point The new price earnings ratio keep 2 digits after the decimal point We have the new price and new EPS P EP S 0 102 27 3 01 33 95 vi 3 points Beta of the common stock after the refinancing After the refinancing we have using MMTII with taxes and rE 0 rA 1 D E0 1 D rA rD 17 8 0 6 2 17 8 5 33 16 E0 which implies from the CAPM E 0 It is also correct to use rE 0 to find rE 0 33 16 5 3 52 8 33 95 100 33 2 102 27 UGBA 103 FINAL Solutions 3 3 Sirap has decided not to go with the recapitalization i e it is still all equity firm Instead Sirap considers the following 5 year growth plan it will reinvest 10 out of its earnings per share for 5 years starting from year 1 It will stop the reinvestment in year 6 and will continue on the no growth path paying all EPS as dividends The after tax return on equity ROE is 30 in year 1 25 in year 2 and 20 forever starting from year 3 Each investment pays forever Keep 2 digits after the decimal point for your answers throughout this question i 1 point What is the Sirap s EPS and dividend in year 2 EP S2 13 35 0 30 10 16 35 I2 10 and D2 6 35 ii 1 point What is the Sirap s EPS and dividend in year 3 EP S3 13 35 0 25 10 10 18 35 I3 10 and D3 8 35 iii 1 point What is the Sirap s EPS and dividend in year 4 EP S4 13 35 0 2 10 10 10 19 35 I4 10 and D3 9 35 iv 1 point What is the Sirap s EPS and dividend in year 5 EP S5 13 35 0 2 10 10 10 10 21 35 I5 10 and D5 11 35 v 3 points What is Sirap s EPS in year 6 and price P 0 with this reinvestment policy EP S6 13 35 0 2 10 10 10 10 10 23 35 We can now calculate the price using the discount rate of 16 from the first part P0 3 35 6 35 8 35 9 35 11 35 1 23 35 80 22 2 3 4 5 1 178 1 178 1 178 1 178 1 178 1 1785 0 178 vi 1 point What is PVGO from such investment policy P V GO P 0 75 80 22 75 5 22 UGBA 103 FINAL Solutions 4 4 Sirap decides to use debt instead of earnings to finance the investments from part 3 Specifically it will get a 5 year risk free loan with a face value per share equal to the PV All Investments and then will repay it in five equal installments of 10 per share Each installment consists of the principal and interest payments Keep 2 digits after the decimal point for your answers throughout this question i 1 point What is the face value of the loan total not per share D 10 000 1 1 43 294 77 0 05 1 055 You need to figure out the interest payment on the debt each year Table below will navigate you through this task The top raw of the Table shows the amount of principal that needs to be repaid and on which the interest is charged i e Interest Paid t rD Principal Outstanding t The total annual repayment of 10 000 consists of the Interest Paid t and Principal Paid t Fill in the table by answering questions below Principal outstanding Payments on the debt Interest paid Principal paid Interest tax shield 1 43 294 77 10 000 00 2 164 74 7 835 26 865 90 End of Year 2 3 4 35 459 51 27 232 49 18 594 11 10 000 00 10 000 00 10 000 00 1 772 98 1 361 62 929 71 8 227 02 8 638 38 9 070 29 709 19 544 65 …