Latest NMIMS solutions April 2022 Keystone Energy Infrastr

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Corporate Finance I

1. You are helping a manufacturing firm decide whether it should invest in a new plant. The initial investment is expected to be Rs. 100 crores, and the plant is expected to generate after-tax cash flows of Rs. 8 crores for the next 20 years. An additional incremental investment of Rs. 10 crores will be needed to upgrade the plant in 10 years. If the discount rate is 10%, estimate the net present value of the project. (10 Marks)

2. Keystone Energy Infrastructure Company currently has 2.5 million common shares of stock outstanding and the stock has a beta of 1.1. It also has $ 10 million face value of bonds that have six years remaining to maturity and 9% coupon with annual payments and are priced to yield 8%. If the company issues up to $ 5 million of new bonds, the bonds will be priced at par and have a yield of 8%; if it issues bonds beyond $ 5 million, the expected yield on the entire issue will be 8.8%. The company management has learnt that it can issue new common stock at $ 10 a share. The current risk-free rate of interest is 3% and the expected market return is 10%. The company s marginal tax rate is 25%. If the company raises $ 20 million of new capital while maintaining the same debt-to-equity ratio, what would be its weighted average cost of capital? (10 Marks)

3. Blue Origin Exploration Company is expected to generate $ 5,000,000 in revenues and $ 1,500,000 in operating earnings next year. Currently, the company does not use debt financing and has assets of $ 10,000,000. Suppose the company were to change its capital structure, buying back $ 4,000,000 of stock and issuing $ 4,000,000 in debt. If we assume that interest on debt is 10% and income is taxed at 25%, what is the effect of debt financing on the company s net income and return on equity if operating earnings may vary as much as 40% from expected earning operating earnings in following circumstances?

a. When the company has no debt, and (5 Marks)

b. When the company has debt to total assets = 50%. (5 Marks)

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