In:

Submitted By paroski
Words 1019
Pages 5
14-3.
a. E[Value in one year].
b. D =. Therefore,
c. Without leverage, r =, with leverage, r =
d. Without leverage, r =, with leverage, r =
14-5.
a. | ABC | XYZ | FCF | Debt Payments | Equity Dividends | Debt Payments | Equity Dividends | \$800 | 0 | 800 | 500 | 300 | \$1,000 | 0 | 1000 | 500 | 500 |
b. Unlevered Equity = Debt + Levered Equity. Buy 10% of XYZ debt and 10% of XYZ Equity, get 50 + (30, 50) = (80,100)
c. Levered Equity = Unlevered Equity + Borrowing. Borrow \$500, buy 10% of ABC, receive (80,100) – 50 = (30, 50)
14-6.
a. V(Alpha) = 1022 = 220m = V(Omega) = D + E E = 220 – 60 = 160m p = \$8 per share.
b. Omega is overpriced. Sell 20 Omega, buy 10 Alpha, and borrow 60. Initial = 220 – 220 + 60 = 60. Assumes we can trade shares at current prices and that we can borrow at the same terms as Omega (or own Omega debt and can sell at same price).
14-11.
a. E = 1000 – 750 = 250. CF = (1400,900) – 500 (1.05) = (612.5,112.5)
b. Re = (145%, – 55%), E[Re] = 45%, Risk premium = 45% – 5% = 40%
c. Return sensitivity = 145% – (–55%) = 200%. This sensitivity is 4x the sensitivity of unlevered equity (50%). Its risk premium is also 4× that of unlevered equity (40% vs. 10%).
d.
e. 25%(45%) + 75%(5%) = 15%
14-12.
a. re = ru + d/e(ru – rd) = 12% + 0.50(12% – 6%) = 15%
b. re = 12% + 1.50(12% – 8%) = 18%
c. Returns are higher because risk is higher—the return fairly compensates for the risk. There is no free lunch.
14-13.
At a cost of debt of 6%:

14-14.
a. .
b. i. ii. if rd is higher, re is lower. The debt will share some of the risk.
14-17.
a. MM => no change, \$75
b. Initial enterprise value = 75 10 + 100 = 850 million
New debt = 350 million
E = 850 – 350 = 500
Share price = 500/10 = \$50
c. Ru = (750/850) 8.5% + (100/850) 4.25% = 8%
Re = 8% + 350/500(8% – 5%) = 10.1%

15-5.

Year | 0 | 1

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