Question

The MoMi Corporation’s cash flow from operations before interest and taxes was $1.5 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 15% of pretax cash flow each year. The tax rate is 21%. Depreciation was $210,000 in the year just ended and is expected to grow at the same rate as the operating cash flow. The appropriate market capitalization rate for the unleveraged cash flow is 12% per year, and the firm currently has debt of $3 million outstanding. Use the free cash flow approach to calculate the value of the firm and the firm’s equity. (Enter your answer in dollars not in millions.)

A 12-year bond of a firm in severe financial distress has a coupon rate of 10% and sells for $920. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to reduce coupon payments on the bond to one-half the originally contracted amount. The firm can handle these lower payments. What are the stated and expected yields to maturity of the bonds? The bond makes its coupon payments annually. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

A newly issued 20-year maturity, zero-coupon bond is issued with a yield to maturity of 8.5% and face value $1,000. Find the imputed interest income in the first, second, and last year of the bond's life. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Suppose that today’s date is April 15. A bond with a 9% coupon paid semiannually every January 15 and July 15 is quoted as selling at an ask price of 1,015.000. If you buy the bond from a dealer today, what price will you pay for it? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

1).

Pre-interest & tax cash flow from ops (Last CF)	1,500,000
Depreciation (D)	210,000
Perpetual growth rate (g)	5%
Discount rate (k)	12%
Current debt	3,000,000
Tax rate (T)	21%

Formula
CF1 = Last CF*(1+g)	Pre-interest & tax cash flow from ops	1,575,000
D1 = D*(1+g)	Depreciation	220,500
TI = CF1 - D1	Taxable income	1,795,500
21%*TI	Tax @ 21%	377,055
NI = TI - Tax	Unlevered net income (NI)	1,418,445
	Add: depreciation (D1)	220,500
NI + D	OCF	1,638,945
15%*CF1	Less: Investment (I)	(236,250)
OCF - I	FCF	1,402,695
FCF/(k - g)	Firm value (FV)	20,038,500
	Less: Debt	(3,000,000)
FV - Debt	Equity value	17,038,500

Firm value = 20,038,500; Equity value = 17,038,500

2). Stated YTM = 11.25%: expected YTM = 5.95%

	N	12		12
	FV (or par value)	1,000		1,000
	PV	920		920
	Coupon rate ('r)	10%	Reduced rate	5%
r*par value	PMT	100	r*par value	50
	YTM	11.25%		5.95%