Advanced Corporate Finance || All Answers Are Correct
100%.
How do you find price per share? correct answers Div/(r-g) Where G= ROE*(1-Div/EPS)
How do you find the value per share of a company that does not grow? correct answers EPS/(r-0)
. It's EPS because if company is not reinvesting its EPS then it has to give them all out.
What payout dividend policy maximizes the shareholders of a company? correct answers When
the ROE>r the optimal strategy is 100% retention. This is because the company is outperforming
and returning more money than it's equivalent risk or a similar investment of that risk.
If ROE<r what is the optimal dividend payout policy for shareholders of a company? correct
answers 100% payout. Since investors could receive a better return by investing in another
company with similar risk. The company is underperforming compared to it's risk.
Lemur LLC will earn $18 per share forever, and it pays out 100% of its earnings. Its cost of
capital is 12%. The first dividend payment will arrive in one year.
Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
i) If the investment generates a 10% return in perpetuity,
(1) What is the value of the one share of the firm? correct answers 1) find value of firm without
project. Div/(r-g) Where G= ROE*(1-Div/EPS)= $150.
2) Write out payout table in year one -9. The next years 9*.10
Find the perpetuity of the return (9*.10) and discount.
Discount the investment in year one (-9).
Add together.
Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
i) If the investment generates a 10% return in perpetuity,
How will this investment affect the firm's earnings? correct answers Take the initial investment
and multiply by the return so (9*.10)=$90. Since it starts to pay out in year 2 then you say
"starting at year two earnings will increase $.90" They will alway increase even if the project
decreased the value per share.
, Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
Should it take the Project? correct answers First figure out the value of the project see below. If
it's negative then NO because negative NPV.
Write out payout table in year one -9. The next years 9*.10
Find the perpetuity of the return (9*.10) and discount.
Discount the investment in year one (-9).
Add together.
What return on investment would make shareholders indifferent between the firm paying out a
dividend and reinvesting? Why? correct answers ROE=r, since then any investment amount does
not change the value of the firm.
Do question 5 can't fit it here correct answers
Marmoset is a gold mining company. Its equity has a market value of $300mm, and its debt has a
market value of $200mm. You measure the covariance of Marmoset's stock premium with the
market premium and find that it is 0.0720. The standard deviation of market returns over the
same period 0.3000. Marmoset's cost of debt is 4.5%. The market risk premium is 5% and the
risk free rate is 3%.
a) What is Marmoset's cost of equity?
b) What is Marmoset's asset beta?
Marmoset decides to invest in a gold refinery. The average equity beta for metal processors is is
1.1, the average debt beta is 0.10, and the average debt to value ratio is 0.8. What is Marmoset's
required return on assets for its new project? correct answers Typically you would just do
Rf+B(market risk premium). But you aren't straight up given beta. So use First equation of
second formula sheet.
.0720/.3000^2=.80Beta equity. Then plug in to find Re=Rf+Be(Mrp)
Cost of Equity= .03+.80(.05) Which equals return on equity.
For asset beta you can't simply use the formula for asset beta since you don't have the beta of
debt. So first it helps to do the Return on Asset formula. Once you have the return on asset
formula you can find the Beta of assets.
ra= D/V(rd) + E/V(re) you got the Re from first question.
100%.
How do you find price per share? correct answers Div/(r-g) Where G= ROE*(1-Div/EPS)
How do you find the value per share of a company that does not grow? correct answers EPS/(r-0)
. It's EPS because if company is not reinvesting its EPS then it has to give them all out.
What payout dividend policy maximizes the shareholders of a company? correct answers When
the ROE>r the optimal strategy is 100% retention. This is because the company is outperforming
and returning more money than it's equivalent risk or a similar investment of that risk.
If ROE<r what is the optimal dividend payout policy for shareholders of a company? correct
answers 100% payout. Since investors could receive a better return by investing in another
company with similar risk. The company is underperforming compared to it's risk.
Lemur LLC will earn $18 per share forever, and it pays out 100% of its earnings. Its cost of
capital is 12%. The first dividend payment will arrive in one year.
Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
i) If the investment generates a 10% return in perpetuity,
(1) What is the value of the one share of the firm? correct answers 1) find value of firm without
project. Div/(r-g) Where G= ROE*(1-Div/EPS)= $150.
2) Write out payout table in year one -9. The next years 9*.10
Find the perpetuity of the return (9*.10) and discount.
Discount the investment in year one (-9).
Add together.
Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
i) If the investment generates a 10% return in perpetuity,
How will this investment affect the firm's earnings? correct answers Take the initial investment
and multiply by the return so (9*.10)=$90. Since it starts to pay out in year 2 then you say
"starting at year two earnings will increase $.90" They will alway increase even if the project
decreased the value per share.
, Alternatively, Lemur LLC can invest in a project that will increase its earnings. The project
requires an initial investment in year 1 of $9 per share. Cash flows from this investment will be
received from year 2 onwards.
Should it take the Project? correct answers First figure out the value of the project see below. If
it's negative then NO because negative NPV.
Write out payout table in year one -9. The next years 9*.10
Find the perpetuity of the return (9*.10) and discount.
Discount the investment in year one (-9).
Add together.
What return on investment would make shareholders indifferent between the firm paying out a
dividend and reinvesting? Why? correct answers ROE=r, since then any investment amount does
not change the value of the firm.
Do question 5 can't fit it here correct answers
Marmoset is a gold mining company. Its equity has a market value of $300mm, and its debt has a
market value of $200mm. You measure the covariance of Marmoset's stock premium with the
market premium and find that it is 0.0720. The standard deviation of market returns over the
same period 0.3000. Marmoset's cost of debt is 4.5%. The market risk premium is 5% and the
risk free rate is 3%.
a) What is Marmoset's cost of equity?
b) What is Marmoset's asset beta?
Marmoset decides to invest in a gold refinery. The average equity beta for metal processors is is
1.1, the average debt beta is 0.10, and the average debt to value ratio is 0.8. What is Marmoset's
required return on assets for its new project? correct answers Typically you would just do
Rf+B(market risk premium). But you aren't straight up given beta. So use First equation of
second formula sheet.
.0720/.3000^2=.80Beta equity. Then plug in to find Re=Rf+Be(Mrp)
Cost of Equity= .03+.80(.05) Which equals return on equity.
For asset beta you can't simply use the formula for asset beta since you don't have the beta of
debt. So first it helps to do the Return on Asset formula. Once you have the return on asset
formula you can find the Beta of assets.
ra= D/V(rd) + E/V(re) you got the Re from first question.
