Questions: 1) Pickering Heavy Equipment Limited (PHL) would like to determine the lease payment it quotes to the lessee. Assume that the asset costs $2,000,000, has a 5 year useful life and a CCA rate of 40%. The corporate tax rate is 30% and the before tax cost of debt is 7%. Cost of capital is 12% CCA tax shield will be claimed at the end of the year and the lease payment will be at the beginning of the year. Before tax operating cost will be $200,000 per year payable at the end of the year. Risk free rate is 3% a year. Please do not take out taxes from the risk free rate. Resale value of the asset after 5 years is uncertain. It is assumed that resale value would be either $400,000 or $500,000 or $700,000. Probability that the resale value will be $500,000 is 50% and $700,000 is 20%.
- Determine the annual lease payment if PHL would like to have an NPV of $50,000. Assume asset pool is open.
- Determine the lease payment if PHL would like to have NPV of $50,000. Any gain/loss on disposal will be taxable.
- Suppose Oshawa Enterprises (OE) would like to lease the above asset. OE corporate tax rate is 10%. It's before tax cost of debt is 9%, and cost of capital is 14%. Asset pool is closed. What is the maximum lease payment OE would be willing to make?
- Within what range of values PHL and OE can make a deal?
2) Ajax Limited an all equity financed firm has 100,000 shares outstanding. It is about to pay $2 per share dividend and its dividends are expected to decline at the rate of 2% per year in perpetuity. The required rate of return on Ajax stock is 12%.
a. What is the value of the firm before paying out the dividend?
b. What is the ex-dividend price of Ajax's stock, if the Board of Directors follows the current policy?
c. At the dividend declaration meeting, several board members claimed that the dividend is too meager and is probably depressing the Ajax's stock price. They proposed that Ajax sell enough shares to finance a $4 dividend per share now and the next year.
- Comment on the claim that the low dividend is depressing the stock price. Support your argument with calculations.
- If the proposal is adopted, at what price will the new shares sell and how many will be sold?
3) GoingDown Corporation (GDC)will remain in business for one more year. The estimated probability of a boom year is 60%, status quo is 10% , and the recession is 30%. It is projected that GDC will have total cash flow of $1000 million in a boom year, $800 million in status quo, and $400 million in recession. Its required debt payment is $700 million at the year end. Assume risk neutrality and the required rate of return of 8% per year for both the stock and the bond.
- What is the total value of the firm? What is the value of the equity?
- If the total market value of the bond outstanding of GDC is $550 million, what is the expected bankruptcy cost in case of a recession?
- Continuing with part b, what is the total value of the firm now?
- What is the promised return on the bond? What is the probability?