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Under which scenario(s) of base-case, best-case or worst-case would you recommend Samupgrade the railroad company?s station equipment on the basis of NPV?Find the IRR for the base-case. Use 27% (NPVBase =$ ?7,760) or 7% (NPVBase =$ 181,137) asthe second rate depending if you need to increase or decrease the rate. Show all working stepsclearly.

AP/ADMS4540

Assignment #2

Winter 2016

Instructions:

(1) This assignment is to be done individually. You must sign and submit the standard

cover page supplied as the last page of this assignment; otherwise you will be deducted 5

marks.

(2) Before you start, please note the necessary working steps to be shown as explained in

the first lecture.

(3) This assignment is due in the ADMS office (Atk 282) or at the final exam review class on

April 4, 2016.

(4) This assignment must be handwritten. Any work that is not original handwritten (e.g.,

printed or photocopied) will receive zero credit. Work that is too difficult to read due to

messiness and poor handwriting will also receive zero credit. You must show all the

necessary working steps to receive full credit.

(5) This assignment carries a total of 100 marks.

(6) Under no circumstances would a late assignment be accepted after the answer key to

the assignment has been posted on the course website.

(7) Decimal places: please keep at least 4 in your calculations and round to the nearest

penny or basis point in your final answers.

Question

Topic

Full Marks

1

Leasing

20

2

Financial Ratios

20

3

M&A

20

4

MM Arbitrage Exercise

20

5

Scenario Analysis

20

Total

100

Marks Obtained

Question 1

Leasing (20 marks)

Your firm needs to either buy or lease $230,000 worth of vehicles. These vehicles have a life of

4 years after which time they are worthless. The vehicles belong in CCA class 10 (a 30% class)

and can be leased at a cost of $68,000 a year for the 4 years. The corporate tax rate is 34% and

the cost of debt is 10%. There are many more assets in this asset class. The lease payments are

made at the beginning of the period. The half year rule is applicable.

a)

b)

c)

d)

e)

f)

g)

h)

i)

What is the after-tax cost of debt? (1 mark)

What is the amount of the after-tax lease payment? (1 mark)

What is the present value of the depreciation tax shield? (1 mark)

What is the net advantage to leasing? (2 marks)

The lessor in this case has a tax rate of 35%. What is the net advantage of leasing to the lessor?

(4 marks)

What is the amount of the break-even lease payment to the lessee? How would you solve for it

on Excel? (4 marks)

What is the amount of the breakeven to the lessor? (3 marks)

Is a lease feasible? (2 marks)

What should be the tax rate of the lessor so that a lease is feasible? (2 marks)

Question 2

Financial Ratios (20 marks)

a)

b)

c)

d)

e)

f)

g)

What is the current ratio for 2009? (2 marks)

What is the equity multiplier for 2009? (2 marks)

What is the days' sales in receivables for 2009? (2 marks)

What is the change in net working capital? (3 marks)

What is the net working capital turnover rate for 2009? (2 marks)

What is the cash coverage ratio for 2009? (2 marks)

What is the market-to-book ratio if the Smith Co. has 2,603 shares of common stock outstanding

with a current market price of $22 per share? (2 marks)

h) On a common size statement of comprehensive income for 2009, earnings before interest and

taxes would be assigned a common value of? (2 marks)

i) Suppose interest expense is $2,000, times interest earned is 5, and cash coverage ratio is

5.5. Calculate the depreciation expense. (3 marks)

Question 3

Mergers and Acquisitions (20 marks)

Blenheim PLC is considering making an offer to purchase Howard Department Store. The vice

president of finance has collected the following information:

P/E ratio

Number of shares

outstanding (million)

Earnings per share

Dividends per share ($)

Blenheim

14.5

1.30

3.000

0.73

Howard

9.2

0.175

3.657

1.77

Blenheim also knows that securities analysts expect the earnings and dividends of Howard to

grow at a constant rate of 5 percent each year. Blenheim management believes that the

acquisition of Trafford will provide the firm with some economies of scale that will increase this

growth rate to 6 percent per year.

a) What is the value of Howard to Blenheim?

(5 marks)

b) What would Blenheim's gain be from this acquisition?

(2 marks)

c) If Blenheim were to offer $38 in cash for each share of Howard, what would the NPV of

the acquisition be?

(2 marks)

d) What's the most Blenheim should be willing to pay in cash per share for the stock of

Howard?

(2 marks)

e) If Blenheim were to offer one of its shares in exchange for 1.75 shares of Howard, what

would the NPV be?

(4 marks)

f) If shares are exchanged in proportion to the current market price, what would be the NPV

of the acquisition?

(3 marks)

g) Why NPV or gain of acquirer from all cash offer is greater than NPV or gain from a

proportional stock offer?

(2 marks)

Question 4

MM Arbitrage Exercise (20 marks)

Unique Corporation and Levon Corporation are identical in every way except for capital

structures. Unique Corporation, an all-equity firm, has 250,000 shares of common stock

outstanding, currently trading at $40 per share. Unique Corporation has an equity capitalization

rate of 20%. Levon Corporation uses leverage in its capital structure and has $2,500,000 of debt,

on which it pays 12 percent annually. Each firm is expected to have annual earnings before

interest of $2,000,000 in perpetuity. Assume that every investor can borrow at 12 percent

annually and that there are no corporate or personal taxes and no transactions costs.

(a)What is the value of Unique Corporation? (1 mark)

(b)What is the value of Levon Corporation? (1 mark)

(c) How much will it cost to purchase 5 percent of each firm?s equity? (3 marks)

(d)Assuming each firm meets its earnings estimates, what will be the dollar return to each

position in part (c) over the next year? (2 marks)

(e)Develop an investment strategy in which an investor purchases 5 percent of Unique?s equity

and replicates both the cost and dollar return of purchasing 5 percent of Levon?s equity. Show all

supporting calculations. (4 marks)

(f)Assume that the value of Unique is $10,000,000 and the value of Levon is $12,500,000.

According to M&M, do these values represent equilibrium? If not, explain the process by which

equilibrium will be achieved. Show all supporting calculations, assuming that you own 5 percent

of Levon?s shares. (9 marks)

Question 5

Scenario Analysis (20 marks)

George and The Man then visit Bloom Lake Railway. Their junior corporate analyst, Sam, is

considering upgrading their station equipment to meet increased demand and lower operating

costs as the new station equipment is more energy efficient. The old station equipment was

purchased four years ago at a capital cost of $240,000. When purchased, the old equipment was

expected to last ten years with a salvage value of $28,000. New station equipment will cost

$365,000, including installation costs. The new equipment is expected to last six years along

with a salvage value of $107,000. The old station equipment could be sold for $110,000 at

present. Both the old and new equipment fall into CCA asset class 8 and they follow the CRA

requirement of using the declining balance method at a CCA rate of 20 percent. For simplicity,

changes in net working capital will be ignored. The railroad?s weighted average cost of capital is

14 percent taking into account all opportunity costs. The corporate tax rate is 37 percent. The

projections for annual pre-tax revenues and annual pre-tax costs with the new station equipment

are:

Annual Pre-tax Revenues

Annual Pre-tax Cost

Base Case

$197,430

$ 87,430

Upper Bound

$216,723

$105,786

Lower Bound

$135,786

$46,723

Under which scenario(s) of base-case, best-case or worst-case would you recommend Sam

upgrade the railroad company?s station equipment on the basis of NPV?

Find the IRR for the base-case. Use 27% (NPVBase =$ ?7,760) or 7% (NPVBase =$ 181,137) as

the second rate depending if you need to increase or decrease the rate. Show all working steps

clearly.

Faculty of Liberal Arts and Professional Studies

School of Administrative Studies

YORK UNIVERSITY

Toronto, Ontario, Canada

ADMS 4540 Winter 2016

Assignment #1

Personal Work Statement

I, the undersigned:

?

?

?

Warrant that the work submitted herein is my work and not the work of others

Acknowledge that I have read and understood the Senate Policy on Academic

Honesty

Acknowledge that it is a breach of the University regulations to give and receive

unauthorized assistance on a graded piece of work

Name (typed or printed)

York Student #

Signature

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