Question 1
Bob's Farm Rental and Party Supply posted an EBIT of $45,000 and has no investments in working capital or assets. Shareholders are requiring a return of 22%. Calculate the value of the company. Assume a tax rate of 15%.
◦ $204,545
◦ $173,864
◦ $300,000
◦ $234,000
◦ $217,865
Question 2
Café Americain Coffee Inc. is all equity financed and generates perpetual annual EBIT of $600. Assume that the EBIT, and all other cash flows, occur at year end and that we are currently at the beginning of a year. Assume that Café Americain has a 100% payout rate, 1,000 shares outstanding, and that shareholders require a return of 6%. Assume that the tax rate is 0%.
Café Americain is considering an open market stock repurchase. It plans to buy 20% of its outstanding shares at the price of $10.00 per share. The repurchased shares will be cancelled. It will finance the repurchase by issuing perpetual bonds worth a total sum of $2,000 and a coupon rate (and yield) of 4%. Assume that the tax rate is 0%.
If Café Americain goes ahead with the repurchase, then what is the required return of stock holders after the repurchase is complete?
◦ 6.1%
◦ 6.2%
◦ 6.3%
◦ 6.4%
◦ 6.5%
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