Q 1 Gladstone Corporation is about to launch a new product. Depending on the success of the new? product, Gladstone may have one of four values next? year: $ 153$153 ?million, $ 136$136 ?million, $ 92$92 ?million, and $ 75$75 million. These outcomes are all equally? likely, and this risk is diversifiable. Gladstone will not make any payouts to investors during the year. Suppose the? risk-free interest rate is 5 %5% and assume perfect capital markets.
a. What is the initial value of? Gladstone's equity without? leverage? Now suppose Gladstone has? zero-coupon debt with a $ 100$100 million face value due next year. b. What is the initial value of? Gladstone's debt? c. What is the? yield-to-maturity of the? debt? What is its expected? return? d. What is the initial value of? Gladstone's equity? What is? Gladstone's total value with? leverage?
Q 2 Suppose Tefco Corp. has a value of $ 133$133 million if it continues to? operate, but has outstanding debt of $ 135$135 million that is now due. If the firm declares? bankruptcy, bankruptcy costs will equal $ 26$26 ?million, and the remaining $ 107$107 million will go to creditors. Instead of declaring? bankruptcy, management proposes to exchange the? firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the? firm's equity that management would need to offer to creditors for the workout to be? successful?
Q 3 Kohwe Corporation plans to issue equity to raise $ 45$45 million to finance a new investment. After making the? investment, Kohwe expects to earn free cash flows of $ 11$11 million each year. Kohwe currently has 5 million shares? outstanding, and has no other assets or opportunities. Suppose the appropriate discount rate for? Kohwe's future free cash flows is 6 %6%?, and the only capital market imperfections are corporate taxes and financial distress costs. a. What is the NPV of? Kohwe's investment? b. What is? Kohwe's share price? today? Suppose Kohwe borrows the $ 45$45 million instead. The firm will pay interest only on this loan each? year, and maintain an outstanding balance of $ 45$45 million on the loan. Suppose that? Kohwe's corporate tax rate is 30 %30%?, and expected free cash flows are still $ 11$11 million each year. c. What is? Kohwe's share price today if the investment is financed with? debt? Now suppose that with? leverage, Kohwe's expected free cash flows will decline to $ 10$10 million per year due to reduced sales and other financial distress costs. Assume that the appropriate discount rate for? Kohwe's future free cash flows is still 6 %6%. d. What is? Kohwe's share price today given the financial distress costs of? leverage?
Q 4 Marpor Industries has no debt and expects to generate free cash flows of $ 15$15 million each year. Marpor believes that if it permanently increases its level of debt to $ 30$30 ?million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers. As a? result, Marpor's expected free cash flows with debt will be only $ 14$14 million per year. Suppose? Marpor's tax rate is 40 %40%?, the risk free rate is 6 %6%?, the expected return of the market is 14 %?, and the beta of? Marpor's free cash flows is 1.31.3 ?(with or without? leverage). a. Estimate? Marpor's value without leverage. b. Estimate? Marpor's value with the new leverage.