Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part I)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
1
Module Summary
6.1
6.2
6.3
6.4
6.5
6.6
6.7
6.8
Adjusted Present Value Method (Level 1)
The Weighted Avg. Cost of Capital Method
(Level 1)
The Equity Residual Method (Level 1)
Comparison of Methods (Level 1)
Types of Leases (Level 1)
Lease vrs. Buy Decision (Level 1)
Mergers and Acquisitions (Level 1)
Leveraged Buyouts (Level 2)
2
6.1 Adjusted Present Value Method
● It is useful when an investment project has financial
effects or special financing arrangements.
● By taking into account financing benefits, APV includes
tax shields, such as those provided by deductible
interest.
It is calculated as the “Base-case NPV” +/- benefits
(costs) arising from financing
3
1
6.1 Adjusted Present Value Method
“Base Case NPV”
- Calculate the cash flows obtained from the project
assuming the project will be financed with all equity
(unlevered project)
- Determine the cost of capital assuming an all-equity
firm
- Discount the unlevered cash flows by the unlevered
cost of equity
4
6.1 Adjusted Present Value Method
Adjusted Present value:
[Equation 6-1]
- Calculate the base-case NPV (all equity)
+ PV of interest tax shield
+ PV of subsidized loans
+ PV of government grants
- floatation costs of new securities, etc.
All financing adjustments are discounted using the after-tax
cost of debt.
5
6.1 Adjusted Present Value Method
Other formulas:
Present value of interest tax shields
Equation 6-2
Present value of tax shields on
floatation costs
Equation 6-3
Present value of the after-tax
bankruptcy costs
Equation 6-4
6
2
6.1 Adjusted Present Value Method
e.g. A company is purchasing new equipment. Rather than
financing the $230,000 purchase with a bank loan of 5%
per annum, the company is eligible for a subsidized
provincial loan at a rate of just 3% per annum.
The subsidized loan would be for a 3 year term and would
be fully amortized with equal end-of-year payments.
The corporate tax rate is 40%. What is the present value of
tax shields on the interest payments for the subsidized
loan?
7
6.1 Adjusted Present Value Method
You must first determine the payments, then the interest,
and then the tax shield on those interest payments.
PV = 230,000
i=3% n=3
FV=0
PMT = 81,312
Loan amortization shows that interest costs for Years 1-3
as follows:
Year 1
$6,900
Year 2
$4,668
Year 3
$2,368
8
6.1 Adjusted Present Value Method
PV of interest tax shield
Appropriate discount rate = 5(1-.40) = 3%
Yr 1
Yr 2
Yr 3
6,900 x 40% = 2,760
4,668 x 40% = 1,867
2,368 x 40% = 947
Total PV of interest tax shield
PV
$2,680
1,760
867
$5,307
9
3
6.1 Adjusted Present Value Method
Present value of the after-tax bankruptcy costs
PV (BC) = Probability of financial distress x (1-T) x BC
e.g. A company is assessing an investment project that will
involve a higher proportion of debt financing than is usual for
the firm.
The probability of the firm experiencing financial distress is
currently estimated to be 5%, but will rise to 10% of the
project is accepted. The costs of bankruptcy will also rise,
from $600,000 without the project, to $750,000 with the
project.
10
6.1 Adjusted Present Value Method
The tax rate is 50%. When the adjusted present value for
this project is calculated, by what amount will present
value be adjusted for this change in the probability of
bankruptcy?
Solution:
[(750,000 x 10%) – (600,000 x 5%)] (1-.50)
= 22,500
11
6.1 Adjusted Present Value Method
Hint re: Assignment 3, Question 2
Financing related adjustments are required in Parts (d),(e)
and (h)
Remember to use the after-tax cost of debt. In this
question, QWC’s debt rate is 8% and the tax rate is 40%
(d) ITC of $1 million at end of Yr 1
(e) Operating subsidies of $20,000/yr for the first 3 yrs
12
4
6.1 Adjusted Present Value Method
(h) Floatation costs
Total purchase price = $18 million. Financing is 50% debt
and 50% equity.
Floatation costs are 3% of equity funds. Costs are
deductible over 5 years for tax purposes.
Floatation costs on an after tax basis =
Gross cost - tax shield
13
6.2 Weighted Avg Cost of Capital
Method
• Used when the risk of the project is identical to the firm’s
overall risk
• The WACC method assumes that the debt to equity ratio
will be constant over time.
• It assumes that the financial structure of the project is
the same as the firm
Weighted average cost of capital
Beta of a levered firm
[Equation 6-9]
[Equation 6-10]
14
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part II)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
15
5
6.3 Equity Residual Method
It is a valuation method that determines the cash flows
distributed to shareholders after paying operating costs,
financing costs, and debt repayments.
It uses the “LEVERED COST OF EQUITY” CAPITAL as the
discount rate.
Refer to Equation 6-11
16
6.3 Equity Residual Method
How does the ER method differ from the APV
method?
17
6.3 Equity Residual Method
How does the ER method differ from the APV
method?
The ER method involves calculating the present value of
cash flows available for distribution to shareholders after
paying operating costs, financing costs and debt
repayment.
Both the cash flows and the discount rate differ from those
used in the APV method.
18
6
6.3 Equity Residual Method
How do you calculate the cash flows using the
ER method?
19
6.3 Equity Residual Method
How do you calculate the cash flows using the
ER method?
Cash flows, after tax per year, are estimated after
deducting interest payments to debtholders
Cash flows = earnings after interest and taxes
+ CCA
- principal payments on debt
20
6.3 Equity Residual Method
How do you calculate the discount rate to apply
to the cash flows under the ER method?
21
7
6.3 Equity Residual Method
How do you calculate the discount rate to apply
to the cash flows under the ER method?
The discount rate is the cost of equity capital for the
levered firm (or for the leverage applicable to the project
being analyzed).
22
6.3 Equity Residual Method
Under what circumstances is the ER method
particularly useful?
23
6.3 Equity Residual Method
Under what circumstances is the ER method
particularly useful?
The ER method is particularly useful when the required rate
of return on equity changes over time.
For example, there could be an expected change in the
debt ratio during the life of a project.
24
8
6.4 Comparison of Methods
(APV Method)
Advantages
Disadvantages
Adjusts for differences in Cash flows are
capital structures between discounted at rate
projects
required for unlevered
equity (high rate)
Evaluates projects with a Only financing side effects
changing capital structure are discounted at after-tax
borrowing rate
Preferred when tax
breaks on debt financing
are spread over a finite #
of years
25
6.4 Comparison of Methods
(WACC Method)
Advantages
Disadvantages
Easiest to implement
Not useful for projects
with different capital
structures than the firm
Useful when capital
structure of firm is not
likely to change over time
Not effective if projects
have special financing
arrangements
Method assumes that
debt and equity are
constant
26
6.4 Comparison of Methods
(ER Method)
Advantages
Disadvantages
Avoids need to estimate
WACC
More difficult to use since
cash flows must be
estimated for each period
Corrects for changes in
required return on equity
over time
It assumes that projects
stand alone
More accurate than APV,
since it discounts at a
high rate cash flow
distributions to S/H’s
27
9
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part III)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
28
6.5 Types of Leases
• 4 primary types of leases:
–
–
–
–
Operating leases
Capital (financial) leases
Direct leases
Leveraged leases
29
6.5 Types of Leases
• “Operating lease”
– A lease contract that allows the use of an asset, but
does not convey rights similar to ownership of the
asset.
– An operating lease is not capitalized; it is accounted
for as a rental expense.
– Usually short term and easily cancellable
– Leases that require the lessor to handle maintenance
and servicing are often referred to as “service leases”.
30
10
6.5 Types of Leases
• “Capital lease”
– A lease considered to have the economic
characteristic of asset ownership.
– cannot be easily cancelled
– insurance and taxes are often paid by the lessee
– various ownership/purchase options normally
included
31
6.5 Types of Leases
• “Direct lease”
– A contractual financing arrangement in which the
lessor, typically a bank, purchases the property
directly from the manufacturer and leases that
property to the lessee. (100% financing)
– Lessee decides on the type and options of leased
asset
– Lessee negotiates warranties, terms of delivery, etc.
32
6.5 Types of Leases
• “Leveraged lease”
– A lease agreement wherein the lessor, by borrowing
funds from a lending institution, finances the purchase
of the asset being leased.
– The lessor pays the lending institution back by way of
the lease payments received from the lessee.
– usually used for expensive items
– 3 parties involved: lessee, lessor and lender
33
11
6.5 Types of Leases
Advantages of leasing
Disadvantages of leasing
Save on initial outlay
It can be more expensive
than borrowing to buy
Protection against
obsolescence
Lessee loses depreciation
tax savings
Easier to obtain if the firm
has a weak credit rating
Lessee has no salvage value
benefit
Usually simpler, faster and
less costly to obtain
34
6.5 Types of Leases
• Similarities between leasing and debt financing
include:
– leasing uses up the firm’s debt capacity in the same
manner as debt
– lease payments magnify the variability of the net
cash flows to shareholders
– leasing requires periodic cash outflows similar to
those required to service debt
35
6.6 Lease vrs. Buy Decision
• Factors to be considered in Lease vrs. Buy Decision
analysis:
identify the costs and benefits of leasing, as opposed
to those of borrowing to buy
– discount the incremental costs and benefits of
leasing at the after-tax cost of debt, OR A HIGHER
RATE, DEPENDING ON RISK.
– A positive net present value of leasing means the
firm should lease rather than borrow to buy
–
36
12
6.6 Lease vrs. Buy Decision
(Sample format)
Leasing
Borrowing to Buy
Cost avoided
+XX Cost of asset
-XX
PV of CCA
tax shield
-X
PV of CCA
tax shield
+X
PV of salvage
-X
PV of salvage
+X
PV of lost TS
on salvage
+X
PV of lost TS
on salvage
-X
PV after tax
lease pyts
-X
NPV
+/- X
NPV
+/- X
37
6.6 Lease vrs. Buy Decision
• “Equivalent loan”
– a loan amount that commits the firm to the same
cash outflows that the lease does.
Borrowing to purchase is preferable if the amount that
could be borrowed under the loan > the initial
investment outlay.
Leasing is preferable if the amount that could be
borrowed under the loan < the initial investment
outlay.
38
6.6 Lease vrs. Buy Decision
• “ Net value to leasing”
– equals the initial outlay minus the equivalent loan
amount
– if the amount is negative, borrowing to purchase is
preferable
– if the amount is positive, leasing is preferable
39
13
6.6 Lease vrs. Buy Decision
Leasing is
preferable
Borrowing is
preferable
Outlay
xx
Outlay
xx
Equivalent
loan
amount
(xx)
Equivalent
loan
amount
(xx)
Net value
to leasing
+xx
Net value
to leasing
(xx)
40
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part IV)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
41
6.6 Lease vrs. Buy Decision
e.g. Hippo Inc. has decided to acquire new equipment at a
cost of $125,000. Hippo Inc. can either lease or borrow
to purchase.
If purchased, Hippo can deduct CCA at 20%. The
purchase could be funded with a $125,000 bank loan at
7% over 4 years. After 4 years, the equipment is
expected to be sold for $30,000. At the end of each
year, Hippo would incur pre-tax maintenance costs of
$1,500 per year.
42
14
6.6 Lease vrs. Buy Decision
If leased, payments of $35,000 per year for 4 years are
required. Operating cash flows and the tax shield due to
the lease payment would occur at the end of each year.
Maintenance costs would be paid by the lessor.
Hippo’s tax rate is 35%, and it’s WACC for the asset
purchase is 12%.
Calculate (i) the net value to leasing; (ii) the equivalent loan
amount. Should Hippo lease or purchase the
equipment?
43
6.6 Lease vrs. Buy Decision
The discount rate for most of the calculations will be the
after-tax borrowing rate = 7(1-.35) = 4.55%.
Cost avoided
125,000
PV of CCA tax shield
125,000 x .2 x .35(2.0455)
2(.20+.0455) (1.0455)
(34,866)
44
6.6 Lease vrs. Buy Decision
PV of salvage
30,000/(1.12)4
PV of tax shield on salvage
30,000 x .2 x .35
(1.12)4 (2+.0455)
(19,066)
5,436
NOTE THAT FOR THE PV OF SALVAGE, AND THE PV
OF TAX SHIELD ON SALVAGE, THE WACC RATE IS
USED AS THE DISCOUNT RATE! [Equation 6-17]
45
15
6.6 Lease vrs. Buy Decision
PV of lease payments
PMT=35,000 n=4 i=4.55%
(131,123)
PV of tax savings on lease payments
PMT = (35,000 x .35) n=4 i=4.55%
43,896
PV of maintenance cost savings
PMT = (1,500 x .35) n=4 i=4.55%
NPV of leasing
3,494
(7,229)
46
6.6 Lease vrs. Buy Decision
Since the NPV of leasing is negative, Hippo should borrow
to purchase instead of leasing.
Equivalent loan amount = Initial investment – NPV of
leasing
= 125,000 – (7,229)
= 132,229
The ELA > the initial outlay
borrow to purchase.
47
6.6 Lease vrs. Buy Decision
Note that you could have also calculated the equivalent
loan amount directly, as follows:
PV of lease payments
- PV of tax on lease payments
- PV of after tax maintenance costs
+PV CCA tax shield (net)
+PV of salvage
131,123
(43,896)
( 3,494)
29,430
19,066
Equivalent loan amount
132,229
48
16
6.7 Mergers and Acquisitions
• “Merger”
– The combining of two or more companies, generally
by offering the stockholders of one company
securities in the acquiring company in exchange for
the surrender of their stock.
– Two previously existing companies become one.
49
6.7 Mergers and Acquisitions
• Global mergers and acquisition volume climbed 39% to
$1.98 trillion US in the first nine months of 2005
compared to 2004
• “Private-equity deals” accounted for 14% of total merger
and acquisition activity worldwide in the first nine months
of 2005
• The reverse of merger activity also occurs – “spinoffs”
and “carve-outs”
Source: The Canadian Press
50
6.7 Mergers and Acquisitions
• Various studies have confirmed that current M&As are
more successful than those completed in the past:
– More disciplined
– More comprehensive due diligence
– Concentrating on not only financial due diligence, but also
integration, cost volatility, workforce evolution, and culture
compatibility
– Corporate governance has also become more disciplined,
in part as a result of the introduction of Sarbanes – Oxley
Source: CA Magazine, August 2006
51
17
6.7 Mergers and Acquisitions
• “Merger” generally refers to the combination of two
“equal” companies. e.g. Daimler-Benz and Chrysler
ceased to exist when the two firms merged, and a new
company, DaimlerChrysler, was created
• In an “acquisition”, one company takes over another and
clearly becomes the new owner
• In a “reverse merger” a private company reverse merges
into a public shell company, and together they become
an entirely new publicly traded company.
52
6.7 Mergers and Acquisitions
• Types of mergers:
– horizontal – two firms usually in the same line of
business. Get a larger market share.
– vertical – combines a company and it’s direct
customer, or a company and it’s direct supplier.
– conglomerate – combines unrelated businesses.
– congeneric – combines companies selling different
but related products.
53
6.7 Mergers and Acquisitions
• What are some of the motives for mergers?
– “synergy” which is defined as “the effect created by
economies of scale; the realization of increased
earnings (as a result of the combination of two or
more business operations over and above the
aggregate earnings of the two businesses viewed
separately) or reduced risk.”
(Source: CVS, Deboo)
54
18
6.7 Mergers and Acquisitions
•
Other possible motives for M&A include:
– diversification (e.g. stabilize earnings)
– good investment (e.g. buying assets below
replacement cost)
• Two strategies of mergers:
– “friendly”
– “hostile” – target company may execute a “poison
pill” defense, and/or seek a “white knight” (friendlier
potential suitor)
55
6.7 Mergers and Acquisitions
• Typical evaluation techniques use the tools that we
have already covered.
• WACC method
– estimate merger costs, incremental cash flows of the
new firm over the acquired assets life, terminal value
of acquired assets, and adopt a discount rate
– calculate the NPV of acquisition and NPV per share
56
6.7 Mergers and Acquisitions
•
APV Method
– calculate base-case NPV +/- merger related
effects
– merger related effects can include changes in
financial structure, changes in operating
structure, competitive position, synergies, etc.
• Comparative Method
– Analyze past mergers for guidance to determine
a reasonable offer price
– calculate a minimum and maximum offer price
based on various items/ratios
57
19
6.7 Mergers and Acquisitions
• Popular ratios include:
– EPS
– cash flow per share
– book value per share
– current share price
– replacement cost of net assets
• Then calculate an overall range:
– e.g. from the maximum of the “minimum prices” to
the minimum of the “maximum prices”
58
6.8 Leveraged Buyouts
• Buyers commit very little capital and borrow the balance
• The target company’s assets serve as security for the
loans taken out by the acquiring firm
• Buyers hope to achieve quick improvement in
operations and higher residual cash flows
• High leverage enables the owners, if successful, to gain
substantial wealth from improving the operating
performance of their firms.
59
6.8 Leveraged Buyouts
• LBO’s rose to popularity for large public companies in
the late 1980’s – often as a reaction to a possible hostile
takeover
• Deregulation of many industries also prompted
restructurings and mergers
• The development of the “junk” (high yield) bond fueled
the LBO transaction
60
20
6.8 Leveraged Buyouts
• An ideal candidate for a leveraged buyout is a firm with
low business risk that are able to take on high financial
risk.
• Undervalued assets, stable/mature industry, etc. are
desirable
•
Companies not typically targeted are those with capital
structures that already contain mostly debt obligations
61
6.8 Leveraged Buyouts
Are you a proponent or an opponent of leveraged buyouts?
• Proponent – LBO’s make companies more efficient
• Opponent – LBO’s destroy value and create economic
hardship and disruption.
62
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part V)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
63
21
Handout Question 1 Introduction
Barney’s Ltd. (Page 1 of Handout)
In this question we will consider the lease versus buy
decision, and also calculate the “equivalent loan
amount”.
64
Handout Question 1 Comments
Barney’s Ltd. (Page 1 of Handout)
Two different discount rates are required for various
portions of the calculation:
- after tax cost of debt
- required rate of return on assets
Please pause the audio, read and attempt the question in
the handout, then listen to the solution.
65
Handout Question 1 Solution
Barney’s Ltd. (Page 2 of Handout)
a) Refer to Page 2 of the Handout.
b)
Equivalent loan = PV after tax lease payments
- PV after tax maintenance costs
+ PV of CCA tax shield
- PV of CCA tax shield lost on salvage
+ PV of salvage
36,087
( 289)
25,691
( 1,178)
2,893
63,204
66
22
Handout Question 2 Introduction
ABC Corp. (Page 3 of Handout)
In this question we will consider the comparative
valuation method and calculate:
-
times earnings paid
times cash flow paid
times book value paid
premium paid
times replacement cost paid
67
Handout Question 2 Comments
ABC Corp. (Page 3 of Handout)
Remember that in an exam, the “Important” ratios won’t be
provided to you. ie. you will likely need to know which
ratios to compute.
Please pause the audio, read and attempt the question in
the handout, then listen to the solution.
68
Handout Question 2 Solution
ABC Corp. (Page 4 of Handout)
a)
Ratio
Prem
TE
TCF
TBV
TRC
Merger 1
28.57%
7.20
4.50
1.20
1.125
Merger 2
25%
-10
20
1.67
1.43
Merger 3
16.67%
16.15
9.55
1.31
1.24
Merger 4
33.33%
29.63
12.31
1.25
1.18
b) Refer to Page 4 of the Handout.
69
23
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part VI)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
70
Handout Question 3 Introduction
SYC Inc. (Page 5 of Handout)
In this question we will consider / calculate the following:
- WACC
- base-case NPV
- Adjusted present value (APV)
71
Handout Question 3 Comments
SYC Inc. (Page 5 of Handout)
Without expansion = unlevered
With expansion = levered
“Base-case” NPV is calculated using the unlevered cost of
equity.
Please pause the audio, read and attempt the question in
the handout, then listen to the solution.
72
24
Handout Question 3 Solution
SYC Inc. (Page 6 of Handout)
a. The cost of equity for SYC without the plant
expansion is calculated using the unlevered beta
and the capital asset pricing model:
= 6% + 1.1 (10% – 6%) = 10.4%
The plant expansion proposal involves a change in
capital structure, including debt financing.
73
Handout Question 3 Solution
SYC Inc. (Page 6 of Handout)
The levered beta will be:
βL = βU + (1 – T) (D/E)βU
= 1.1 + (1 – 0.35) (25 / 75) (1.1) = 1.1 + 0.24 = 1.34
So the cost of equity, if the plant expansion proposal
is accepted, will be:
= 6% + 1.34 (10% – 6%) = 11.4%
74
Handout Question 3 Solution
SYC Inc. (Page 6 of Handout)
b. Without the plant expansion, SYC is 100% equity
financed, so the weighted average cost of capital equals
the unlevered cost of equity, or 10.4%.
With the plant expansion, SYC is financed 25% with debt
and 75% with equity. The WACC is:
= 0.25 (7.5%) (1 – 0.35) + 0.75 (11.4%) = 9.8%
The rate with the plant expansion is lower than the
unlevered cost of equity. This is a result of the after-tax
cost of debt financing.
75
25
Handout Question 3 Solution
SYC Inc. (Page 6 of Handout)
c. Reasons that APV is more appropriate than NPV in this
case are:
• The project qualifies for a subsidized loan.
• The project has a different capital structure than the firm
as a whole.
• The project has partial debt financing, which provides
SYC with interest tax shields.
d. Refer to Page 6 of the Handout.
76
Handout Question 3 Solution
SYC Inc. (Page 7 of Handout)
e. For APV, add the PV of the two side effects, using
the after-tax cost of debt at the market rate for
SYC as the discount rate [7.5% (1 – 0.35)] =
4.875%.
PV of subsidized loan after tax = 600,000( .075 - .05)
(1 - .35)a74.875% = 56,673
PV interest tax shield = 5% (600,000) (0.35) a74.875%
= 61,033
77
Handout Question 3 Solution
SYC Inc. (Page 7 of Handout)
Adjusted Present Value = base-case NPV + PV side
effects
= (93,563) + 56,673 + 61,033
= 24,143
The APV is positive so the project is acceptable.
78
26
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part VII)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
79
Handout Question 4 Introduction
(Page 8 of Handout)
In this question we will analyze an investment proposal
using the equity residual method, including the
calculation of:
- PV of debt principal repayments
- PV of after tax interest payments
80
Handout Question 4 Comments
(Page 8 of Handout)
Debt = .75 x 15,000,000 = 11,250,000
Principal payments = 11,250,000/4 = 2,812,500
Then calculate annual interest amounts.
Then calculate PV of after-tax interest payments.
Please pause the audio, read and attempt the question in
the handout, then listen to the solution.
81
27
Handout Question 4 Solution
(Page 9 of Handout)
Initial investment
(15,000,000)
Debt
11,250,000
+PV of revenues – expenses (after tax) 8,086,742
+PV of CCA tax shield (net)
4,103,736
+PV salvage
1,380,728
- PV of debt principal repayments
(7,869,883)
-PV of after tax interest payments
( 633,772)
Net Present Value
1,317,551
82
Handout Question 5 Introduction
(Page 10 of Handout)
In this question we will consider/calculate the following:
- whether leasing or buying should be chosen according to
the equivalent loan amount approach
- determine the pre-tax lease amount that will make the
company indifferent between leasing and buying
83
Handout Question 5 Comments
(Page 10 of Handout)
Note the “annuity due” calculations!
For part (b), the firm will be indifferent between leasing and
buying if NVL = 0. ie. Initial investment outlay =
Equivalent loan.
Please pause the audio, read and attempt the question in
the handout, then listen to the solution.
84
28
Handout Question 5 Solution
(Page 11 of Handout)
(a)
PV of lease payments, after-tax
PV of after-tax operating costs
PV of CCA tax shield
PV of the salvage value lost by leasing
136,014
( 4,416)
62,634
6,439
Equivalent loan
200,671
NVL = 200,000 – 200,671 = (671)
85
Handout Question 5 Solution
(Page 12 of Handout)
(b) The firm will be indifferent when NVL=0.
i.e.
The initial investment outlay = Equivalent loan
= 200,000 + 4,416 – 62,634 – 6439
= 135,343
Pre-tax annual lease payment = $27,862
>> Refer to Page 12 of Handout
86
Course Name: FN2 – Advanced Corporate Finance
Module 6 (Part VIII)
Module Title: Special Financing & Investment Decisions
Lectures and handouts by:
Ron Muller
87
29
Handout Question 6 Introduction
Multiple Choice Questions (Page 13-14 of
Handout)
In Question 6 we will discuss a variety of multiple
choice questions.
Please pause the audio, read and attempt the questions in
the handout, then listen to the solutions.
88
Handout Question 6 Solution
Multiple Choice Questions (Page 13 of Handout)
Question
Answer
1
2
3
4
5
(3)
(4)
(3)
(2)
(1)
89
Handout Question 6 Solution
Multiple Choice Questions (Page 14 of Handout)
Question
Answer
6
7
8
9
10
(3)
(3)
(1)
(1)
(1)
90
30
Handout II
(Pages 1-4)
Future Buyouts May use Mold of GE Plastics
- Bonds are part of an $8.2 billion package of debt issuance
helping to pay for the $11.6 billion sale of business
- The purchaser is putting up only about 30% of the purchase
price
91
Handout II
(Pages 1-4)
Future Buyouts May use Mold of GE Plastics
- Bonds are part of an $8.2 billion package of debt issuance
helping to pay for the $11.6 billion sale of business
- The purchaser is putting up only about 30% of the purchase
price
Leveraged Buyout Remorse?
- Three private-equity firms recently sought a lower price for
their planned purchase of Home Depot Inc.’s construction
supply unit
- Worry about ability to resell
92
Handout II
(Pages 1-4)
Fundamentals? Who cares when takeovers rule
- Fundamental value v. takeover speculation
- Investors take valuations used in acquisitions and apply
them to other companies
93
31
Handout II
(Pages 1-4)
Fundamentals? Who cares when takeovers rule
- Fundamental value v. takeover speculation
- Investors take valuations used in acquisitions and apply
them to other companies
Restructuring experts suddenly find themselves in demand
- Hot money is moving away from buyout funds and towards
restructuring
- “Workouts” are suddenly on the horizon
94
Handout II
(Pages 1-4)
Burst of buyouts seen losing steam
- While buyout values are outpacing 2006 totals, fundraising
has plummeted from the peak levels seen in 2006
95
Handout II
(Pages 1-4)
Burst of buyouts seen losing steam
- While buyout values are outpacing 2006 totals, fundraising
has plummeted from the peak levels seen in 2006
Home Depot’s Supply Unit may sell at a lower price
- Volatile credit markets continue to make it difficult for a wave
of agreed buyouts to be completed
- A lower priced Home Depot set off speculation on other
pending deals
96
32
Handout II
(Pages 1-4)
Asian Firms Chasing Overseas Deals
- Asian companies have been steadily increasing their
international acquisitions
- Japanese firms also benefit from a relatively stronger yen
97
Handout II
(Pages 1-4)
Asian Firms Chasing Overseas Deals
- Asian companies have been steadily increasing their
international acquisitions
- Japanese firms also benefit from a relatively stronger yen
Did “Quants” Miss the Boat on the LBO Boom
- Sophisticated models may have missed some of the stock
market’s strongest performers
98
Handout II
(Pages 1-4)
Canadian M&A activity hits record
- Huge takeovers of BCE and Alcan boosted merger and
acquisition activity to record levels
- Credit market concerns have yet to impact the “real”
economy
99
33
Handout II
(Pages 1-4)
Canadian M&A activity hits record
- Huge takeovers of BCE and Alcan boosted merger and
acquisition activity to record levels
- Credit market concerns have yet to impact the “real”
economy
Golden era for buyouts is gone
- Available credit reduced
- Internal rate of return reduced
100
Assignment 3 Hints
Question 2
- Parts (a) to (i) all require you to determine various
components of an adjusted present value calculation
- In part (f), since the NPV is less than 0, QWC should not
invest in the project financed entirely by equity
- In part (l) you need to use minimum/maximum ratios –
eg. times earnings paid of 3.29x to 7.39x
101
Assignment 3 Hints
Question 3
- In part (a)(i), since the expansion project is in the same
line of business as CC, the required rate = 10%
- In part (a)(iii), use the following formula to find the
number of shares that Antonio must sell:
N x new share price = desired $ + (cap gain/s x N x TPC)
102
34
Assignment 3 Hints
Question 4
- In part (a), the expected DPS is $1.38 using the
AVERAGE function
- In part (c), consider which dividend policy results in the
lower coefficient of variation of DPS.
103
Module content summary
Part 1
Topic
Slide numbers
Sample Question
6.1
6.2
1 - 13
14
Question 3
Question 3
104
Module content summary
Part II
Topic
Slide numbers
Sample Question
6.3
6.4
15-24
25-27
Question 4
n/a
105
35
Module content summary
Part III
Topic
Slide numbers
Sample Question
6.5
6.6
28-35
36-40
n/a
Questions 1,5
106
Module content summary
Part IV
Topic
Slide numbers
Sample Question
6.6
6.7
6.8
41-48
49-58
59-62
Question 1
Question 2
n/a
107
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