CASE 1 (20 points)
You work for a medical research laboratory that is contemplating leasing a diagnostic scanner (leasing is a common practice with expensive, high-tech
equipment). The scanner costs €4,500,000, and it would be depreciated straight-line to zero over five years. Because of radiation contamination, the scanner
will be worthless in five years. You can lease the scanner for €1,000,000 per year for five years. You can borrow at 7 percent before taxes. Assume that the tax
rate is 25 percent.
Instructions:
a. Create a lease-versus-buy analysis. Calculate the NPV of leasing. Should you lease or buy? (10 points)
b. What are the differences between an operating lease and a financial lease? Compare their features. (5 points)
c. Explain the impact of operating lease and a financial lease on the balance sheet. (5 points)
CASE 2 (35 points)
Suppose stock in Wesley Corporation has a beta of 0.90. The market return is 11 percent, and the Treasury Bill rate is 5 percent. Wesley’s last dividend was
€1.40 per share, and the dividend is expected to grow at 6 percent indefinitely. The stock currently sells for €47 per share. Wesley’s target capital structure is
1/3 debt and 2/3 equity. Its cost of debt is 10 percent before taxes. Its tax rate is 25 percent.
Instructions:
a. What is Wesley’s cost of equity capital? Assume that you equally believe in the CAPM approach and the dividend growth model. (10 points)
b. What is Wesley’s WACC? (5 points)
c. Wesley is seeking €20 million for a new project. The necessary funds will have to be raised externally. Wesley’s flotation costs for selling debt and
equity are 3 percent and 14 percent, respectively. If flotation costs are considered, what is the true cost of the new project? (10 points)
d. Under what circumstances would it be appropriate for Wesley Corporation to use different costs of capital for its different operating divisions? What are
two techniques you could use to develop a rough estimate for each division’s cost of capital? (10 points)
CASE 3 (25 points)
Firm Alpha is analysing the possible acquisition of Firm Beta. Both firms have no debt.
There are two alternatives for Firm Alpha: to use cash or stock as payment.
You have the following premerger information:
Firm Alpha Firm Beta
Price per share €80 €40
Number of shares 100 40
Total market value €8,000 €1,600
You estimate that the incremental value of the acquisition is €500.
The board of Firm Beta has indicated that it will agree to a sale if the price is €1,800, payable in cash or stock.
Instructions:
a. What is the cost of each alternative? (5 points)
b. What is the NPV of each alternative? (5 points)
c. Which alternative should Firm Alpha choose? (5 points)
d. What are some important factors in deciding whether to use stock or cash in an acquisition? (5 points)
e. Explain what defensive tactics the managers of Firm Beta could use to resist acquisition. (5 points)
CASE 4 (20 points)
Northland Corporation is suffering from financial distress as it can be seen from its balance sheet:
Two scenarios are possible for Northland in Year 3:
In scenario 1, Year 3 for Northland is expected to result in an additional $150,000 operating loss.
In scenario 2, Year 3 is expected to be a “breakout” year for Northland when higher sales and lower costs owing to economies of scale are forecasted to
produce operating profits of $250,000 in Year 3.
Total assets are expected to remain at $200,000 under either scenario. Total debt will be increased to finance additional operating losses. Operating profits
will be used to reduce total debt.
Instructions:
a. Construct Northland’s balance sheets under both scenarios. (10 points)
b. Based on your analysis, will Northland Corporation still be balance sheet insolvent in Year 3 under scenario 1? If this trend continues, would you
describe Northland’s financial distress as a temporary or a permanent problem? (3 points)
c. Based on your analysis, will Northland Corporation still be balance sheet insolvent in Year 3 under scenario 2? If this trend continues, would you
describe Northland’s financial distress as a temporary or a permanent problem? (3 points)
d. There are two basic options in the situation of financial distress. Name and explain them. (4 points)
