Applied Corporate Finance - Final Questions

1573 words 7 pages
Solutions to Practice Problems by Kyung Hwan Shim University of New South Wales Australian School of Business School of Banking & Finance for FINS 3625 S1 2010 May 23, 2010



These notes are preliminary and under development. They are made available for FINS 3625 S1 2010 students only and may not be distributed or used without the author’s written consent.



1

Solution for Question 1

Summary Table of Cash Flows t=0 I II CF from Machinery ignoring depreciation Working Capital Level in Working Capital CFs from Working Capital III Revenues Variable Costs Fixed Costs Pre Tax Profit Taxes at 34% After Tax Operating CF’s ignoring Deprec. -245,000 160,000 160,000 -160,000 0 0 0 0 0 0 t=1 0 180,000 20,000 -20,000 800,000 450,000
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To earn arbitrage profits, buy low (i.e., buy into L-firm) and sell high (i.e., sell out of U-firm). Strategy: Sell .00125% of equity of Unlevered Buy .00125% of equity of Levered Lend an amount equal to .00125% of Levered firms debt at the same rate, 8%, that levered pays. Strategy Sell .00125% EU Buy .00125% EL Lend 3,437.5 at 8% Total CFs Now +$10,000 -$5,625 -$3,437.5 +$937.5 6 CFs in the Future -$1,200 +$925 +$275 $0

Solutions for Question 6 (a) Since 10 rights are needed for each new share and there are 1 million shares outstanding, the number of new shares is
1,000,000 10

or 100,000. Each new share will provide $20 to the company so

the total funds raised will be 100, 000 × $20 = $2, 000, 000. (b) Ex-rights price: Ex-Rights Price = 1 (N × Cum-Rights Price+Subscription Price) N +1 1 [(10 × $25) + 20] = 10 + 1 = $24.55 (c) Value of one right = Rights on price ex-rights price = $25 - $24.55 = $0.45 Solutions for Question 7 In order to raise $2 million at $16 per share, 125,000 new shares must be sold. The number of rights needed to purchase a new share is:

# of rights per share =

total shares outstanding new shares issued 1M = 125, 000 = 8 rights per share

Ex-Rights Price =

1 (N × Cum-Rights Price+Subscription Price) N +1 1 = [(8 × $25) + 16] 8+1 = $24

To show that shareholders are as well off as before, consider a shareholder who owned 100 shares. Initially, the shares are worth $2, 500(100 × $25). The rights

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