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Question 1.  This question should be a good gauge of your ability to apply your tools and analytic skills acquired thus far on the topic of valuation. **Important to note the firm goes into financial distress in this case and defaults on its payment.

 1.      (a) (i) You have the following information about BreadfruitHead Ltd.(BH):

Free Cash Flow projections ($m) of the unleveraged firm are as follows:

2006    2007     2008      2009 

 

 80         95         110       120

 

The cost of equity is 15% and the tax rate is 30%, both per annum. Values for 2010  onwards are estimated to be the same as for 2009. BH is considering adding  permanent debt of $125 at a 10% annual rate of interest. It was also estimated the probability of default was 16%  and if there was default it would affect the entire debt of the firm. What are the unleveraged and the leveraged value of the firm?

(b) (ii) If the tax rate was 20% per annum, and if  after 2009 there is growth in all values of 2% per annum what would be the unleveraged and leveraged value of the firm? Why is it different from (i) above?  

This question should be a good gauge of your ability to apply your tools and analytic skills acquired thus far on the topic of Capital Structures.

Question 2)   (a) The Board  of  SIENA Inc. have hired you to review the capital structure policy of the company. You have collected the following information:

PV of the Free Cash Flows (FCFs) for the next 5 years = $55m.

The FCF in year 5 = $21m    Expected growth for Year 6 onwards = 2.5%

The unleveraged cost of equity = 17%          Corporate tax rate = 35%

Value of Debt (constant) = $60m

What is the Value of SIENA? (4%)

(b)  While you are completing the valuation above you are interviewing a number of Board members. Some complain that the capital structure is sub optimal because management has been setting capital structure by using a Pecking Order approach. Others complain that there is not enough debt in the capital structure and management is wasting the excess cash on frivolous projects. You decide to do a short memo to the Board on the implications of the Tradeoff, Pecking Order & Agency Models. Describe each and indicate the implications of each to Capital Structure policy. (5%)

Reference no: EM1379976

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