1. ABC, which had a market value of equity of $2 bil. and a beta of1.50, announced that it was acquiring XYZ, which had a

market value of equity of $1 bil. and a beta of1.30. Neitherfirm had any debt in its capital structure at the time ofthe acquisition and

the corporate tax rate was 40%.

the corporate tax rate was 40%.

a. Estimate the beta for ABC following the acquisition, assuming it was entirely financed with equity.

b.

Now assume that ABC instead borrowed $1 bil. to acquire XYZ. Estimate the beta afterthe acquisition involving debt.

c. Assuming the

risk-free rate is 5% and the return on the market portfolio is 12%, what is the cost of equity for ABC before the acquisition and following

the acquisition without and with debt?

the acquisition without and with debt?

(5 marks)

2. The South Park Tennis Club must choose between two mechanical tennis ball throwers. The

initial costs and maintenance expenses ofthese two machines are as follows.

Machine Yearo Year1 Year2 Year3 Year4

A -$500 -$120

-$120 -$120

B -$600 -$100 -$100 -$100 -$100

Machine A costs $500 and lasts three years. The annual maintenance expenses of

$120 are paid at the end of each ofthe three years. Machine B costs $500 and lasts 4 years. The annual maintenance expenses of $100 are

paid at the end of each ofthe four years. Revenues per year are the same for both machines.

paid at the end of each ofthe four years. Revenues per year are the same for both machines.

Required:

Using the equivalent annuity/annual

cost approach, which machine should the club choose? Ignore taxes and depreciation

3. Johnson Spacecraft Limited has four independent

one-off projects from which to choose, and has decided to use the net present value (NP/), internal rate of return (IRR), payback (PB) and

profitability index (PI) approaches to decide howto invest. The company cost of capital/hurdle rate is 10% and the maximum payback period

is 2 years.

profitability index (PI) approaches to decide howto invest. The company cost of capital/hurdle rate is 10% and the maximum payback period

is 2 years.

Year Space Plane Mars Shuttle Venus Satellite Moon Plant

0 -1 ,000,000 -2,000,000 -3 ,000 ,000 -1 ,500,000

1 1,000,000

1 ,000 ,000 4,000,000 900,000

2 1,000,000 1,000,000 – 900,000

3 – 1 ,000,000 – 900,000

Required:

a) Calculate the net present value (NP/)

for each project, identify which projects are acceptable, and rank the projects according to their desirability of acceptance?

b) Calculate

the internal rate of return (IRR) for each project, identify which projects are acceptable, and rank the projects according to their

desirability of acceptance?

desirability of acceptance?

c) Calculate the payback period (PB) for each project, identify which projects are acceptable, and rank the

projects according to their desirability of acceptance?

d) Calculate the profitability index (PI) for each project, identify which projects

are acceptable, and rank the projects according to their desirability of acceptance?

e) How do you explain any differences in the

acceptability and rankings ofthese projects using these fourtechniques?