Sample questions: Question 1. Taggart Transcontinental offers to acquire Phoenix

Sample questions:
Question 1. Taggart Transcontinental offers to acquire Phoenix-Durango by
paying a 30% premium over Phoenix-Durango’s premerger price. Taggart Transcontinental
will pay by issuing new shares. Taggart’ s premerger price per share was $15 and PhoenixDurango’s was $30. Pre-merger, Taggart has 5 million shares outstanding and PhoenixDurango’s has 3 million shares outstanding. What will the total number of shares after the
merger? What will be total value after the merger? And what will the price per share of the
combined corporation post the merger.
Question 2. (10 marks)
A company is considering a project that requires an initial outlay of
$785,000 and is expected to deliver $93,000 in unlevered free cash flow at the end of the first
year, growing thereafter at 3% p.a. The company has a target debt-to-equity ratio (D/E) of
0.50 but the industry target D/E is 0.35. The industry average equity beta is 1.3. The market
risk premium is 5% and the risk-free rate is 4%p.a. The company plans to finance the project at the company’s own target D/E ratio. The yield on the company’s borrowings is 6% p.a.
which is equivalent to the average industry borrowing cost. The corporate tax rate is 30%.
a) Calculate the company’s levered cost of equity. (4 marks)
b) Calculate the company’s Weighted Average Cost of Capital. (4 marks)
c) Calculate the NPV of the project and indicate whether the company should accept the
project.
Question 3. (10 marks)
ABC company is considering a project that has an initial cost today
of $10,000. The project has a two-year life with cash inflows of $6,500 each year (i.e. t=1 and
t=2).
Should ABC company decide to wait one year to commence this project, the initial cost will
increase by 5%. Then:
If market conditions are favourable, the project cash inflows will increase to $7,500 each year
for the following two years (i.e. t=2 and t=3).
If market conditions become more subdued, cash inflows would be only $6,500 in the first
year (t=2) and $5,000 in the next year (t=3).
Assume that the project can only be commenced now or in exactly 1 year and that all positive
cash flows are at year-end. The appropriate risk-free rate of return is 5% p.a. Ignore taxes.
a) Draw a fully labelled decision tree showing the alternatives available to ABC company.
Indicate decision and information nodes, decisions, timings, and values. (3 marks)
b) Calculate the value of the project if ABC company commences the project today. (2
marks)
c) Should the ABC company wait one year to commence the project? Answer the
question using the risk-neutral two-state binomial model to calculate the value the
option to wait. (5 marks)