50.1K

Verified Solution

Link Copied!

Question 3 (total of 12 marks): For each of the following events, state the effect on the market value of the firms levered assets (), cost of debt , cost of equity , weighted average cost of capital after tax, weighted average cost of capital before tax, and market value of levered equity ().

Important assumptions: The risky firm's levered assets currently have the same systematic risk as the market portfolio, all events happen in isolation and are a surprise, and all transactions are done at a fair price. Assume a corporate tax rate of 30%, but there are no transaction costs, no asymmetric information (so ignore signalling effects), and no change in the credit risk of the firm's debt.

	Firm value VL	Cost of debt rD	Weighted average cost of capital (after tax)	System-atic risk of the firm's assets (VL)	Num shares (n)
Issues shares and uses the proceeds to invest in a positive NPV project with a higher systematic risk than the firms usual investments	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
Issues bonds and uses the proceeds to repurchase shares.	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
The corporate tax rate suddenly decreases by a material amount.	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
Conducts a 3-for-1 rights issue at a significant discount to the current market share price	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
Invests in a lower than average risk project with a positive NPV, funded half with a bank loan and half with a share issue.	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
Unexpectedly generates larger than usual cash flows and uses those cash flows to repay debt.	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged
Conducts a 2 for 1 share split	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged	IncreaseDecreaseUnchanged

Answer & Explanation Solved by verified expert

See Answer