# Study Session 7: Corporate Finance

## Textbook Question on cost of capital

Your firm has a debt-equity ratio of .60. Your cost of equity is 11% and your after-tax cost of debt is 7%. What will your cost of equity be if the target capital structure becomes a 50/50 mix of debt and equity?

Solutions given: WACC = [(1.0 / 1.6) x .11] + [(.6 / 1.6) x .07] = .095; .095 = .5Re + (.5 x .07); Re = 12%

Isn’t the above solution totally wrong? Since WACC is always going to change with a change in capital structure, in the presence of taxes.

## MM Proposition 1: No taxes

Hi guys, i have a question over the application of MM..

Assuming perfect capital markets; Company A is an all-equity company, with share price at \$10. It announces to issue debt of \$100m to repurchase shares.

By MM, the share price of Company A after announcement of this debt issuance should remain at \$10. And the reason behind this is Value(levered firm) = Value(unlevered firm).

## Real Options - Capital Budgeting

From the 2020 CFAI curriculum, volume 3, page 54 the example for the Abandonment Option.

So I understand real options, and determining NPV without the option then calculating if the real option is valuable enough to overcome a negative NPV, but the final answer in this example confuses me.

From page 53, the project NPV = NPV (only using DCF) - Cost of the Option + the Value of the option.

The example on page 54 indicates the project NPV is -9.808, therefore unviable without the option.

## Cost of debt with multiple bonds/borrowings?

Hi all, if there’s a company that happen to have both a loan from bank (say 5% p.a) + bonds issuance (say YTM 7%), how do we compute the cost of debt?

I was thinking to take a weighted average of the two?

## 100% independent audit and compensation committee?

Reading CFAI it is a little unclear -

Do audit and compensation committee have to be comprised by 100% independent directors?

## Barbara Carlyle Case Scenario Mock A Morning Session

The most recent bond issue includes a covenant that limits the company’s D/E ratio to 35%. She asks Lee to prepare an analysis for Avignon, using the information in Exhibit 3, to see if the debt covenant will be violated if the company repurchases shares. Info provided:

Book value of equity C\$3,600 million

Shares outstanding 200 million

Expected share repurchase price (at market) C\$32.00

Cash available for repurchase C\$155 million

Debt- to- equity ratio 30.0%

After- tax cost of debt 5.0%

## Stock repurchase

Stock repurchase is similar to stock dividends?

I remember it reading somewhere but I’m not sure if it’s stock dividend or stock split

Thank you so much!

## Staggered board elections

Corporate governance best practice is to hold annual board elections (not staggered), yet staggered elections make for a pre-offer takeover defense mechanism.  How should I view this contradiction?

## Audit committee

Is it mandatory for ALL audit committee members to have previous audit experience?

## Employee stock options

Assuming for example:

• Grant of options 1 January 2010
• Vesting of options 1 January 2015

I understand the expense will be recognised between the two above dates, on a straight line basis

However what happens in the option price (and value) increases in between these two dates? Is the amount to be expensed determined at grant date and does not change even if value of the options change?