Corporate Finance Assignment: Section A and B Solutions

This document provides a comprehensive solution to a corporate finance assignment. Section A presents solutions to 15 multiple-choice questions covering topics such as cost of capital, project selection, and the Modigliani-Miller propositions. Section B delves into more complex problems, including equity valuation, the impact of leverage, bond valuation, and the lease-versus-buy decision. The solutions include detailed calculations and explanations, addressing concepts like the trade-off model, the impact of taxes, and the determination of present values. The assignment covers a wide range of corporate finance principles, offering valuable insights for students studying finance.

Running head: CORPORATE FINANCE
Finance
Name of the Student:
Name of the University:
Author’s Note:

Table of Contents
Section A.........................................................................................................................................3
Section B..........................................................................................................................................4
Question 1....................................................................................................................................4
Question 2........................................................................................................................................4
Question 3........................................................................................................................................5
Question 4........................................................................................................................................5
Question 5........................................................................................................................................6

Section A
1 a) 6.2%
2 a)
3) a)
4 b)
5 b)
6 a)
7 a)
8 a)
9 b)
10 a)
11 c)
12 c)
13 a)
14 b)
15 b)

Section B
Question 1
a) i) The personal tax rate if greater than 35% would make the investor make indifference.
ii) The answer to part I above is not reasonable as per the concept of double taxation, investors
would not be charged tax on the dividends as the corporation tax rate is already charged to the
amount of profitability that has been earned by the company.
b) Investors and shareholders of the company require a steady and a stable amount of cash flows
that should flow from the company. Investors do not want the management of company invest to
much of money in capital investment project as not all project would be creating value for the
shareholders and firm on an overall basis.
Question 2
a) Value of Equity in accordance with the M&M Proposition is around $2,626,786 which has
been well calculated by taking the EBIT multiplied by the taxation rate of 35% for the company
and which resulted in Earnings After Tax which came to around $633,750. In order to well
calculate the value of equity the amount derived was calculated by dividing the amount with the
required rate of return. In order to well calculate the value of firm the same was done by dividing
the amount $633,750 with 14% cost of equity giving the value of firm to be around $4,526,786.
b) The value of the company determined by the CFO is correct where he has applied the trade-
off model concept. The value of the company includes the value for both the debt and equity
investors where the firm has also used the same for financing purpose which is well in line with
the trade-off model.

Question 3
a) The value of firm X is calculated with the help of number of shares outstanding multiplied by
the current share price of the company which is 15,000*$30: $450,000.
b) Value of Firm Y is calculated by taking the EBIT of $75,000 which is to be earned in
perpetuity amount is well multiplied with the discount rate of 9% to get the present value of
future benefits showing the amount to be around $833,333 which is the equity value and the debt
value is around $65,000 making the total value of firm to be around $898,333.
c) The value of firm Y equity is around $768,333 which has been well calculated by deducting
the interest amount from the reported EBIT of $75,000 that the company has reported in the
financials of the company.
Question 4
a) The bonds would be non-callable when the market interest rate will be greater than 7% say
10% then the price of the bond would be around $981.82.
b) The price of the bond if callable at one year at $1,100 would be around $1,134.62
c) The compensation for bearing the call risk can be well calculated with the help of difference
between the market interest rate and coupon rate that is paid by the company. The amount
calculated for call risk was around $9.35.

Question 5
The difference between buying or leasing the asset can be well considered or analysed
with the help of present value that would be created from the asset if the company buys the aset
it has to pay a immediate cost of $540,000. On the other hand side, to determine the present
value of the cash flows that the company will be paying will be calculated with the help of
applicable discount rate of 9% interest rate multiplied by the tax rate of 35% making the
effective cost of debt or discount rate to be around 5.85%. The present value of the lease was
around $$613,295 which is comparatively greater than the purchase amount.