What is the value of a financial asset that pays cash flows every eight months f

Question

What is the value of a financial asset that pays cash flows every eight months forever that grow at
a rate of 2% every eight months, with the first cash flow of $2 million starting today (to 1 decimal
place)? Assume an annually compounded interest rate of 8%.
a) $36.0 million
b) $61.3 million
c) $62.5 million
d) $63.3 million
e) $64.5 million

In an M&M world with no taxes, when leverage increases:
I. WACC will decrease
II. The cost of debt will decrease
III. The equity beta will decrease
IV. The cost of equity will increase
a) I only
b) II only
c) III only
d) IV only
e) II and IV only

Explanation / Answer

Question 1:

Annual compunding converted to 8-month compounding = (1+8%/1.5) - 1

=5.33%

Value of the firm = $2 million * (1+2%) / (5.33% - 2%)

= $61.3 million which is option (b)

Question 2:

a) I only

WACC decreases with increase in leverage (increase in debt component).

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