ISBM GDM ISBM CASE STUDY ANSWER SHEETS – Does it matter in this case that the entire amount is being raised from debt
ISBM GDM ISBM CASE STUDY ANSWER SHEETS – Does it matter in this case that the entire amount is being raised from debt
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Corporate Finance Management
Case Studies
CASE STUDY (20 Marks)
Suppose your company needs $ 15 million to build a new assembly line. Your target debt equity ratio is 0.90. The flotation cost for new equity is 8 percent, but the flotation cost for debt is only 5%. Your boss has decided to fund the project by borrowing money because the flotation costs are lower and the needed funds are relatively small.
Answers the following question.
Q1. What do you think about the rationale behind borrowing the entire amount?
Q2. What is your company’s weighted average flotation cost, assuming all equity is raised externally?
Q3. What is the true cost of building the new assembly line after taking flotation costs into account?
Q4. Does it matter in this case that the entire amount is being raised from debt?
CASE STUDY (20 Marks)
Suppose Stock in Wills Corporation has a beta of ·80. The market risk premium is 6 per cent and the risk free rate is 6 percent. Wills Corporation last dividend was $ 1.20 per share, and the dividend is expected to grow at 8 per cent indefinitely. The stock currently sells for $ 45 per share.
Answer the following question.
Q1. What is Wills Corporation cost of equity capital?
Q2.In addition to the information given in the above case, suppose Wills Corporation has a target debt equity ratio of 50 per cent. Its cost of debt is 9 percent before taxes. If the tax rate is 35 percent, what is weighted Average Cost of Capital?
Q3. What will be the new WACC if the debt equity ratio changes to 60 per cent in the above question No 2?
Q4. What are your suggestions to the Company on the basis of the above calculations of cost of equity capital?
CASE STUDY (20 Marks)
ABC Co. & XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $ 800,000 in stock XYZ uses both stocks and perpetual debt, its stock is worth $ 400,000 and the interest rate on its debt is 10 per cent. Both
firms expect EBIT to be $ 90000. Ignore taxes.
Answer the following question.
Q1. Rico owns $ 30,000 worth of XYZ’s stock. What rate of return is he expecting?
Q2. Show how Rico could generate exactly the same cash flows and rate of return by investing in ABC and using homemade leverage?
Q3. What is the cost of equity for ABC? What is it for XYZ?
Q4. What is the WACC for ABC? For XYZ? What principle have you illustrated?
CASE STUDY (20 Marks)
The day long corporation is considering a change in credit policy. The current policy is cash only, and sales per period are 2000 units at a price of $ 110. If credit is offered the new price will be $ 120 per unit, and the credit will be extended for one period. Unit sales are not expected to change, and all customers are expected to take the credit. Day long anticipates that 4 percent of its customers will default.
Answer the following question.
Q1. If the required return is 2% per period, is the change a good idea?
Q2. What if only half the customer take the offered credit?
Q3. Do you think the change of policy is going to be beneficial?
Q4. What better policy will you recommend?
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