Applied Corporate Finance - Final Questions

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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

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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.

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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 …show more content…

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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