PROBLEM 2 I want solutions with steps for PROBLEM 2. You are the sole owner of T
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PROBLEM 2
I want solutions with steps for PROBLEM 2.
You are the sole owner of Titanic Inc. Titanic currently has no assets but it has a project that requires an investment of $75 today that is equally likely to yield pre-tax earnings of $130 or $50 at the beginning of year 1. At that date, with 100% chance, Titanic will have a second follow-up project that costs $40 and will yield an additional $60 by the end of year 1. Assume the following. All risk is unsystematic and the risk-free rate is zero (i.e., ignore discounting). Capital markets are eFFIcient. The corporate tax rate is 20%. All debt payments (interest plus principal) can be deducted for tax purposes. There are no direct costs of bankruptcy. In the event of default no taxes are paid by anyone, debt holders take possession of assets and equity holders get nothing. As the current sole equity holder of Titanic you are considering the relative merits of the following two Financing & investment plans: Plan I Raise the $75 today via a zero coupon debt issue with face value F1 = 5100 secured against the cash FLows of your First project. Raise cash for the second project by using internally generated cash, but only if cash FLows from First project cash FLows are high (equal to $130). If First project cash FLows are low (equal to $50), declare bankruptcy and do not invest in the second project, letting creditor take possession of existing assets that are worth $50. Plan II Raise $70 today via zero-coupon debt with face value F1 = $70. Raise the remaining amount by issuing equity. Use the proceeds to invest in the First project. Raise cash for the second project by using internally generated cash, regardless of what the First project cash FLows are. Which Financing and investing plan is better for you? Show me the numbers, i.e., perform an APV calculation for both plans. Make sure that each plan is feasible, i.e., investors will be willing to supply the necessary capital for each plan under the other assumptions. Problem 2 Consider the same information as the previous problem but with just one diFFerence: the second project (with cash FLows $60 and cost $40) is available only with 5% chance at the beginning of year 1, regardless of what the actual values of the First cash FLows are. With 95% chance there is no follow up project. In all other respects, the problem is identical to problem 1. Re-evaluate plan I and plan II. Which plan is better for you? Show me the numbers, i.e., perform an APV calculation for both plans. What do the two problems taken together tell you about the debt capacity of Firms with intangible assets in the form of growth opportunities? No calculations necessary.Explanation / Answer
Answer :- evaluation of Plan 1
Issue Zero coupon debt having FV $ 100 and raise Capital $ 75
If Earning at the begining of year 1 = $ 130 then go for second project having Investment of $ 40 and additional earning $ 60
With earning of $ 130 pay $ 100 Interest and principal for zero coupon bond remaining left is the profit liable for tax @ 20% which is equal to 130-100 = 30 - 30 *20% = $ 24.
The internal generation is $ 24 and raise $ 16 from Investor and go ahead with Second Project with Investment of $ 40 and additional earning $ 60
Therefore , earning = $ 60 - $ 16 ( payment made to the investor of second project) = $ 44 - tax @ 20% = $ 35.20 = = net earning with adjest investment of $ 24 . APV of Plan 1 = 35.20 - 24 = $ 11.20
If Earning at the begining of year 1 = $ 50 , then avoid second project and go for bankruptcy and let creditor took over the assets worth $ 50 . earning = $ 0
evaluation of Plan 2
Raise $ 70 via zero coupon debt and $5 from equity and make Investment of $ 75 in frist project
IF earning is $ 130 then pay for $ 70 for zero coupon debt + $ 5 equity Investment = 130 -70-5 = $ 55 - 55*20% (tax) = $44 = NET EARNING
with this earning go ahead with second project with investment of $ 40 and have addtional earning $ 60
= earning $ 60- $ 40 (investment ) = $ 20 - (20 * 20%) = $ 16
Resulting in total earning of $ 44+ $ 16 = $ 60
If the earning from Frist project is $ 50 then arrange further $ 25 for repayment of debt and equity = - $ 25 earning
Further arrange $ 40 from Investor and go for second project having earning of $ 60
therefore , 60-40= 20 - (20*20%) = $ 16
therefore net earning = -$ 25+$ 16 = -$ 9
The owner of titanic Inc should for Plan 1 as there is not chance of any loss to Inc the earning will be either $ 11.20 or $ 0 as the case may be .
With 5% chance of second project then also the INC should go for plan 1 as there is positive expected cash flow or zero . in plan 2 there may be chance of loss of $ 24.2.
The problem state that the Inc enjoys the good market reputation which in turn help them to raise money as they required . The firm had good credit worthiness which help them to get money from the market . The debt capacity of the firm is said good as firm enjoys its intangible assets in the form of growth oppurtunities .
plan 1 earning is $ 130 Earning Pro Expected 24 0.95 22.8 11.2 0.05 0.56 23.36 plan 1 earning is $ 50 then earning will be $ 0 Plan 2 earning is $ 130 Earning Pro Expected 44 0.95 41.8 60 0.05 3 44.8 Plan 2 earning is $ 50 Earning Pro Expected -25 0.95 -23.75 -9 0.05 -0.45 -24.2Related Questions
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