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FINC 607: ADVANCED CORPORATE FINANCE

HOMEWORK 3
a) Consider the following balance sheet of market values of ABC Co. ABC has
fallen on hard times, and the market is currently valuing its GHC 300 million debt
at GHC 250
Net working capital GHC 200 Bonds outstanding GHC 250
Fixed assets 100 Common stock 50
Total assets GHC 300 Total GHC 300
Between shareholders, creditors, and any other third party (you determine who) who
gains and who losses from the following maneuvers?
i. ABC pays out GHC 50 in cash dividend;
ii. ABC halts operations, sells its fixed assets, and converts net working
capital into GHC 200 cash. Unfortunately the fixed assets fetch only
GHC 60 on the second-hand market. The GHC 260 cash is invested in
Treasury bills;
iii. Suppose that a new project has NPV = +GHC 50 and is financed by an
issue of ordinary shares by ABC;
iv. Suppose that a new project has NPV = +GHC 50 and is financed by
funds taken out of the ABC’s working capital;
v. The lenders agree to extend the maturity of their loan from 1 year to 2 in
order to give Circular a chance to recover.
b) Modigliani & Miller (1958) Proposition
The required return on the assets of your firm is 32%. Its cost of debt is 24%, and the
debt-to-equity ratio is 45%. It has not issued preference shares. The firm’s marginal tax
rate is 25%.
i. What is firm’s cost of equity?
ii. What would 50% cost of equity imply about debt-to-equity ratio of a competitor
which is similar to you in all other respects?

c) State Modigliani & Miller (1958) Propositions I and II. Explain the conditions
under which these hold.
d) Suppose a company borrows GHS 1 million at an interest rate of 24 percent and
the corporate tax rate is 25 percent. What is the annual interest tax shield? If the
debt is permanent, what is the value of these tax shields?
e) Why might the existence of personal taxes partly offset the benefit of the
corporate tax shield on interest payments?
Mergers & Acquisitions
i) Company A acquires the shares of B by issuing its own shares (really of the
merged company) to shareholders of B. Suppose 1,000 shares are issued to
them. If after the announcement the price of A’s shares (really of the merged
company) rise to ¢2,250 from ¢2,000 each, and the pre-takeover market value
of company B was ¢1,750,000 what was the cost of this transaction to B’s
shareholders?

ii) If the market value of the merged company is ¢6,750,000 and the pre-merger
market value of A was ¢4,000,000, what was the NPV to A’s shareholders if A
paid for B by an issue of stock?

Merger NPV.
Harrods PLC has a market value of £500 million and 30 million shares outstanding.
Selfridge Department Store has a market value of £180 million and 20 million shares
outstanding. Harrods is contemplating acquiring Selfridge. Harrods’s CFO concludes
that the combined firm with synergy will be worth £720 million, and Selfridge can be
acquired at a premium of £25 million.

i. If Harrods offers 12 million shares of its stock in exchange for the 20 million
shares of Selfridge, what will the stock price of Harrods be after the
acquisition?
ii. What exchange ratio between the two stocks would make the value of the stock
offer equivalent to a cash offer of £205 million?

Q. Ghana Stock Exchange Trading Reports


Attached is information on companies listed on the Ghana Stock Exchange. You
believe that the PRICE-to-BOOK ratios closely approximate the given
PRICE/EARNINGS (P/E) ratios.
a) What are the book values of the shares of the following companies: Standard
Total; Ecobank Ghana Ltd; Cocoa Processing Buying Company, and CAL
Bank?
b) List the top 4 companies that the market appears to be most enamored with
c) List the top 4 companies that the market appears to be least enamored with
d) If you are a pensioner living only on your SSNIT pension which 2 stocks will
you buy, all things equal? Why?
e) Alternatively, if you are just starting life at 25 and wish to buy the shares of 2
companies, which ones will you buy, all things equal? Why?
f) What value will you place on a share of Despite Inc. which is privately held, is
similar to Unilever in most respect including size, but has issued only 10 million
shares?
g) On January 1, 2015 you owned 100 shares of SCB which you intended to sell in
the course of the year. If you had perfect foresight how much would you have
realized from the sale?
h) Your friend did not have the gift of perfect foresight and sold their 100
shareholding in SCB when the price was least favourable. How much did your
friend realize?
i) Is it true that on May 19, 2015 somebody wanted to sell UTB but could not
agree with a buyer?