Author Question: In November of 1988, KKR, an investment firm, won a bidding war to buy all of the shares (250 ... (Read 39 times)

tnt_battle · **on:** Apr 25, 2021

Question 1

If you are a CFO who wants to maximize the market value of your company, what is the optimal D/V ratio according to M&M Proposition I (with taxes).
◦ It doesn't matter
◦ D/V = 0
◦ D/V = 1
◦ D/V = ∞

Question 2

In November of 1988, KKR, an investment firm, won a bidding war to buy all of the shares (250 million) of RJR Nabisco for $108 per share. RJR shares had been trading for $55 prior to the buyout. The purchase was debt financed ($27 billion). The new debt was added to the $4.5 billion of debt that predated the buyout. KKR intended to hold the debt of RJR constant at that level (in dollar terms) in perpetuity. Analysts expected RJR to generate free cash flow of $1.41 billion in the year after the buyout. Assume that cash flows occur on Dec 31 and today is January 1. Analysts expected RJR's cash flow to grow at 5% in perpetuity. RJR's cost of debt was 10% and its cost of unlevered equity was 12%. The tax rate was 40%. What was the value of KKR's equity in the company after the buyout?
◦ $343 million
◦ $543 million
◦ $943 million
◦ $1,243 million

ashely1112 · **Reply #1 on:** Apr 25, 2021

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