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Corporate Finance: European Edition

Chapter Fifteen: Capital Structure: Basic Concepts

Case Study: ACB Group

ACB Group is a global power and automation technologies firm that is listed on the Stockholm Stock Exchange.  You have been hired to assist the new management in evaluating two funding options for a major expansion project that will cost €1.5 billion.  The company is considering whether to issue 100% equity, 100% debt with a 5% coupon or 50/50 debt/equity.  Assume no taxes.

You have been given the following data:

Expected Earnings next year: €3 billion

Dividends: No dividends are paid by the company

Number of Shares Outstanding: 10 billion.

Cost of Equity: 10%

Net Cash Flow from Major Expansion Project: A permanent €0.3 billion per annum

Q1. What is the net present value of the project to ACB Group's shareholders?

Q2. Show the market value balance sheet of ACB Group upon completion of each of the three funding scenarios.

Q3. What is the expected return on equity for each scenario?

Q4. What is the share price of the firm under each scenario?

Q5. Are your results consistent with Modigliani and Miller's Proposition I and II?  Explain.

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