CORPORATE FINANCE

Helpful Tips: The text book is Corporate Finance, 8th Edition by

Ross, Westerfield, Jaffe

Part A:

McKenzie Corporation’s Capital Budgeting

Sam McKenzie is the founder and CEO of Mckenzie Restaurants Inc. ,

a regional company. Sam is considering opening several new

restaurants. Sally Thornton , the company’s CFO, has been put in

charge of the capital budgeting analysis. She has examined the

potential for the company’s expansion and determined that the

success of the new restaurants will depend critically on the state

of the economy over the next few years.

McKenzie currently has a bond issue outstanding with a face value

of $25 million that is due in one year. Covenants associated with

this bond issue prohibit the issuance of any additional debt. This

restriction means that the expansion will be entirely financed with

equity at a cost of $9 million. Sally has summarized her analysis

in the following table, which shows the value of the company in

each state of the economy next year, both with and without

expansion:

Economic Growth

Probability Without

Expansion With

Expansion

Low .30 $20,000,000

$24,000,000

Normal

.50 $34,000,000

$45,000,000

High

.20 $41,000,000

$53,000,000

Question#2:

What is the expected value of the company’s debt in one year, with

and without expansion?

Question#3:

One year from now, how much value creation is expected from the

expansion? How much value is expected for stockholders?

Bondholders?

Part B:

Submit answers, as an attachment, to the following

questions. All calculations must be shown. For problems that have

an Excel template, be sure to download the template from the

publisher’s web site, and save as an Excel file. Please use excel

for all work and show calculations as well.

Chapter 14: Problem 1 (NO template is available) – you must use

Excel for this problem

Equity Accounts – Following are the equity accounts for Kerch

Manufacturing:

Common stock, $0.50 par

value $

165,320

Capital

Surplus

2,876,145

Retained

earnings

2,370,025

Total $5,411,490

Chapter 15: Problem 12 (template is available)

Calculating WACC – Weston Industries has a debt-equity ratio of

1.5. Its WACC is 12 percent, and its cost of debt is 12 percent.

The corporate tax rate is 35 percent.

a. What is Weston’s cost of equity capital?

b. What is Weston’s unlevered cost of equity capital?

c. What would the cost of equity be if the debt-equity ratio were

2? What if it were 1.0? What if it were zero?

Chapter 16: Problems 1 and 3 (templates are available for both

problems)

Problem#1:

Firm Value – Janetta Corp. has an EBIT rate of $750,000 per year

that is expected to continue in perpetuity. The unlevered cost of

equity for the company is 15 percent, and the corporate tax rate is

35 percent. The company also has a perpetual bond issue outstanding

with a market value of $1.5 million.

a. What is the value of the company?

b. The CFO of the company informs the company president that the

value of the company is $3.2 million. Is the CFO correct?

Problem#3:

Capital Structure and Growth – Edwards Construction currently has

debt outstanding with a market value of $80,000 and a cost of 12

percent. The company has an EBIT rate of $9,600 that is expected to

continue in perpetuity. Assume there are no taxes.

a. What is the value of the company’s equity? What is the

debt-to-value ratio?

b. What are the equity value and debt-to-value ratio if the

company’s growth rate is 5 percent?

c. What are the equity value and debt-to-value ratio if the

company’s growth rate is 10 percent?

## Leave a Comment