Question

Zorba Corp. is planning to invest in a manufacturing plant with an initial cost of $105 million (which includes $5 million of initial net working capital). The useful life of the plant is 20 years. The project will be financed with $40 million debt and the rest equity.

Zorba has an unlevered cost of capital of 10%, a cost of debt of 5% and a tax rate of 25%. The 20-year Treasury bond rate is 4% (assume is riskless).

What is the present value of the recovery of the net working capital?

Select one:

a. $743,218.14

b. $0

c. $2,394,461.71

d. $2,281,934.73     

e. $1,884,447.41

Agency costs of debt occur when lenders take advantage of the indenture (debt contract) at the expense of the shareholders.

Select one:

True

False

Puma Inc. is an unlevered firm with 20 million of shares outstanding and market value of $300 million. The cost of equity is 10% and the corporate tax rates is 40%. Based on this information what is the price of the stock?

Select one:

a. $15

b. $10

c. $90

d. $9

Answer 1

1) Computation of present value of working capital.

Initial working capital= 5 million

cost of capital= 10%

present value factor = 100/672.74 = .14864

present value of working capital = 5 million multiplied by .14864 = 743218.14

so the answer for first question is option a

2) False, because the concept of agency cost of debt is differrent from what is said above.

The lenders are not taking advantage of the indenture but they are trying to protect themself.

If management and shareholders teamup they can easily cheat debt holders(lender), So to protect themself they charge high interest rate.

3) Computation of price of stock

Shares outstanding: 20 million

Market value: 300 million

price of stock = Market value/shares outstanding

= 300 million divided by 20 million = 15.

So the answer is option a.