Valero Oil Finance Assingment Help With Solution

Question1
Briefly answer the following questions in the space provided.

A) What are the conditions under which it is appropriate to use a firm’s overall weighted average cost of capital as a discount rate when computing the NPV for a project?

B) Under what conditions will the value of a firm increase when it increases leverage?When will it decrease, if ever? Why or why not?

C) Stockholders prefer less risky projects than debt holders. Is this true or false and why? How do the risk preferences of stockholders differ between firms that have and that do not havedebt? (5 points)

Question 1 continued

D) If two companies, with equal business risk and similar capital structures but from different industries, merge, and there are no synergistic gains (i.e., the value of the merged company is just the sum of the values of the separate companies), then what are the likely effects of the merger on the values of the debt and equity in the two companies? Why?

Question 2
You are analyzing Valero Oil, a Venezuelan oil company that is expected to generate $120 million in free cash flow to equity next year; the cost of equity is 10% and theexpected growth rate in perpetuity is 4%. The company has 100 million shares outstanding, and these shares are currently selling for$15. Venezuela is very unstable and there is some concern that Valero will be nationalized and the stockholders will receive nothing. Assuming that your estimates of the cash flows, the cost of equity, and the growth rate, as well as the market price areright, what is the probability that Valero Oil will be nationalized?

Question3
Wolf, Inc. is considering launching a hostile takeover of Lamb, Inc. Lamb is currently unlevered, with a cost of equity of 15%. In the event of a takeover, Lamb’s pre-tax cash flows from operations (EBIT)will be $10 million in the first year and will grow at an expected annual rate of 7% forever. Capital expenditures and additions to working capital are expected to exceed depreciation and amortization by an amount that equals 10% of EBIT each year. Wolf would lever up Lamb so that it would have an interest expense of $2 million in the first year, and this amount wouldalso be expected to grow at a rate of 7% forever. Assuming a before-tax cost of debt of 9% and a tax rate of 40%, what is the maximum Wolf should pay for all the equity in Lamb?

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Question 4
You own a small brewing company in Austin, Texas and want to determine when it will make sense to replace an old bottling line. Assume that the old bottling line and a new line that you are considering purchasing are equivalent in terms of capacity and unit production costs. The new linewould require an investment of $300,000, would last for nine years, and would cost $12,000 per year to maintain. Your current line will last for three more years. The cost to maintain it will by $65,000 in the first year, $85,000 in the second year, and $0 in the third year. Assume the appropriate discount rate is 8%. When should you replace the old line?

Question 5
The common stock of Spiffy Company is selling for $90. A 26-week call option written on Spiffy’s stock is selling for $8. The call option’s exercise price is $100. The annual risk-free rate is 3.97%.

A) Suppose that put options on Spiffy’s stock are not traded, but that you want to buy one. How would you do it?

B) Suppose that put options are traded on Spiffy’s stock. What would a 26-week put with an exercise price of $100 sell for?

C) Suppose that, two months later,it is possible to buy three-month call options and three month put options on stock. If the risk free rate is still 3.97 and both options have an exercise price of $95 and are worth $5, what is the stock price?

Question 6
A project requires an investment of $1 million. It is expected to generate after tax cash flows of $250,000 per year forever. The asset beta is 1.5. Half of the investment amount is obtained through a debt issue at par that yields an expected return of 6%. The firm’s marginal tax rate is 35%.

A) If the risk free rate is 3.97%, and the risk premium on the market is 5.17%, what is the APV of the project?(4 points)

B) What is the WACC?

Question 7
You have been asked to value Trendy Corporation as a potential acquisition target that would be merged into your firm. Your company has an average tax rate of 25% and a marginal tax rate of 35%.The risk free rate is 3.97%, and the market risk premium is5.17%. Your company has a target debt to total capital (debt plus equity) ratio of 0.3 while Trendy has a target of 0.4.Your company and Trendy currently have debt of $300 million and $500 million, respectively, and both companies are paying 5.5% on their debt.
While the equity of neither firm is publically-traded, there are comparable public firms. The comparable firm for your company has equity worth $5 billion with an equity beta of 1.4 and debt worth $3 billion outstanding with a cost of debt equal to 6%. Trendy’s comparable firm has equity worth $2 billion with an equity beta of 1.1 and debt worth $1 billion outstanding with a cost of debt of 5.5%.

Trendy currently has annual net sales of $995 million, cash cost of goods sold of $600 million, depreciation of $100 million, and interest expense of $40 million. Annual investment to replace depreciated machinery is $150 million. This state of affairs is expected to continue for the foreseeable future. Trendy also has $200 million in excess cash, currently invested at the risk free rate. The interest on the excess cash is included in the net sales projections. Also, the comparable firms have no excess cash.
What is the value of Trendy’s equity using the FCFF (WACC) valuation approach?

Question 8
What determines the volatility of the cash flows to equity holders from a business?

Question 9
Pied Piper is a firm with a proprietary compression algorithm for data storage. In one year, its stock price will be worth either $20 or $40. It has call options trading that expire in one year and have an exercise price of $32. The current price of these call options is $5.40. They also have one-year put options trading that have an exercise price of $24. These puts have a current market price of $1.00. Assume that the markets are in equilibrium (i.e., that no arbitrage opportunities exist).

A) What is the current one-year risk-free rate?

B) What is Pied Piper’s current stock price?

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