Calculations must be presented in Excel (use Excel to calculate the answers; do not simply type in the answers), do not present Word or pdf files, and all assignments must be submitted in one file, preferably with each problem on a separate worksheet.
Problem 1
Suppose Alpha Industries and Omega Technology have identical assets that generate identical cash flows. Alpha Industries is an all equity firm with 10 million shares outstanding that trade for a price of $22 per share. Omega Technology has 20 million shares outstanding as well as debt of $60 million.
a. According to MM Proposition I, what is the stock price for Omega Technology?
b. Suppose Omega Technology stock currently trades for $11 per share. What arbitrage opportunity is available? What assumptions are necessary to exploit this opportunity?
Problem 2
Suppose the Washington Post Company (WPO) has no debt and an equity cost of capital of 9.2%. The average debt to value ratio for the publishing industry is 13%. What would its cost of equity be if it took on the average amount of debt for its industry at a cost of debt of 6%.
Problem 3
On May 14, 2008, general motors paid a dividend on $0.25 per share. During the same quarter GM lost a staggering $15.5 billion or $27.33 per share. Seven months later the company asked for billions of dollars of government aid and ultimately declared bankruptcy just over a year later on June 1, 2009. At that point a share of BM was worth only a little more than a dollar.
a. If you ignore the possibility of a government bailout the decision to pay a dividend given how close the company was to financial distress is an example of what kind of cost?
b. What would your answer be if GM executives anticipated that there was a possibility of a government bailout should the firm be forced to declare bankruptcy?
Problem 4
Covix Corporation has $50 million in cash 10 million shares outstanding and a current share price of $30. Clovix is deciding whether to use the $50 million to pay an immediate special dividend of $5 per share or to retain and invest it at the risk force rat of 10% and use the $5 million in interest earned to increase its regular annual dividend of $0.50 per share. Assume perfect capital markets.
a. Suppose Clovix pays the special dividend. How can a shareholder who would prefer an increase in the regular dividend create it on her own?
b. Suppose Clovix increase its regular dividend. How can a shareholder who would prefer the special dividend create it on her own?
Problem 5
Berkshire Hathaway's (A) shares are trading at $120,000. What split ratio world it need to bring its stock price down to $50?