Q1. Compaq Computers has seen its stock price decline from $45 to $24. The firm

Question

Q1.

Compaq Computers has seen its stock price decline from $45 to $24. The firm expects to reinvest 50% of its $2 billion after-tax operating income in new investments and to earn a return on capital of 10.69%. The firm is currently all equity financed and has a cost of equity of 11.50%. Compaq has decided to move to its optimal debt ratio of 20%, at which its cost of equity will be 12.50% and its after-tax cost of debt will be 4.50%. What is the value of the firm expected to be at this optimal capital structure?

Select one:

A. $16.78 billion

B. $17.36 billion

C. $18.98 billion

D. $20.34 billion

E. None of the above

Q2.

Accurate Information, Inc. has announced it will attempt to acquire Timely Services Corp. Accurate Information has seen its stock price decline on the announcement from $33/share to $31/share. On the other hand, the stock price of Timely Services has risen from $12/share to $15/share. Accurate Information has 10 million shares outstanding and Timely Services has 6 million shares outstanding. What value is expected from this acquistion?

Select one:

A. A net loss of $15 million

B. A net gain of $10 million

C. A net loss of $5 million

D. A net loss of $2 million

E. None of the above

Explanation / Answer

1)

growth rate = retention ratio * ROIC = 50%*10.69% = 5.35%

WACC = 80%*12.5% + 20%*4.5% = 10.9%

Value = 50%*2*(1+5.35%) / (10.9% - 5.35%) = 18.964 billion (Option C)

2)

Value = 10*(31-33) + 6*(15-12) = -2 million loss (Option D)

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