Last year hot shots exterminators, inc. conducted an IPO
Subject: Business   / Finance
Question
1. Last year hot shots exterminators, inc. conducted an IPO, issuing 1 million common shares with a par vale of $1 to investors at a price of $10 per share. During its first year of operation, hot shots earned a net income of $0.20 per share and paid a dividend of $0.05 per share. At the end of the year, the company’s stock was selling for $15 per share. Construct the equity accounts for hot shots at the end of its first year in business, and calculate the firm’s market capitalization.
2. Couglin Inc. has net operating income of $120,000 per year. Couglin uses no debt in its capital structure and the required rate of return to equity holders is 12 percent.
a.   Calculate the value of the unlevered firm if the firm has a marginal tax rate of 0%.
b.   Calculate the value of the unlevered firm if the firm has a marginal tax rate of 30%.
c.   Interpret the difference in your findings to parts a. and b.
d.   If your answer to part a. is less than your answer to part b, can we increase firm value by taking on debt? If so, will these benefits always continue as we add more and more debt?
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3. If a firm operates in a perfect capital market, has a required return on its outstanding debt of 8%, a required return on its common stock of 16%, and a WACC of 13%, what is the firm’s debt-to-equity ratio?
4. An unlevered corporation has net income of $50,000 and a required rate of return of 14%. What would the value of this firm be if it borrowed $125,000 to buy back some of its stock? Assume a corporate tax rate of 35%.
4. Given the following information.
Equity Corporation Debt Corporation
Cost of equity 12% 18%
Debt ——– $2,500,000
Pretax cost of debt ——– 8%
EBIT $500,000 $ 500,000
Calculate the market value of Equity Corporation, Debt Corporation, and the present value of the tax shield to Debt Corporation if both companies have a tax rate of 40%. Assume there are no financial distress or agency costs and that expected growth of EBIT is zero.
