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Assignment Task :

Question 1 

This question consists of six multiple choice questions. For each question pick the most reasonable response based only on the information provided. 

a) NXX Ltd is currently trading at $35.00. The call and put options issued for this share all have the same expiration date. Which one of the following options is most likely to trade at the highest price (or premium)? 

A. A call option with an exercise price of $20. B. A call option with an exercise price of $55. C. A put option with an exercise price of $15. D. A put option with an exercise price of $55. 

b) Which of the following statement(s) is (are) most likely to be true? 

I. The total value of a firm is defined as the market value of its equity plus the net present value of all its investment projects. II. In the context of a firm’s capital structure decision, Modigliani and Miller’s proposition 1 states that the value of the firm’s equity does not change regardless of the level of debt in its capital structure. 

 

c) A firm currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the debt outstanding each year. The firm’s marginal corporate tax rate is 40% and that the interest tax shields have the same risk as the loan. The present value of the interest tax shield from this debt is closest to: 

 

Question 2

The finance manager of Megacorp Ltd has approached you for assistance with the firm’s capital budgeting process. At your request, she has provided you with the following information in relation to the firm’s finances. Some years ago, the firm issued 100,000 bonds (each with a $100 face value) bearing a coupon rate of 7% paid annually. These bonds are currently trading on the market at their face value. A coupon payment relating to the bonds was made yesterday and the bonds will mature three years from today. The firm has 20 million ordinary shares on issue and they are currently trading at $1.50 per share. The beta of the ordinary shares has been estimated at 1.2, the rate of return on 10-year Commonwealth bonds is currently at 5% and the market risk premium has been estimated at 8%. 

a) Calculate Megacorp Ltd’s before-tax weighted average cost of capital. Show all calculations. 

b) The following investment projects are being considered by Megacorp. All projects are independent and are in Megacorp’s usual line of business. Assume that the NPVs of the projects were calculated using the weighted average cost of capital obtained in part (a).

 

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