16. (5 points) Note: Questions 16 - 20 relate to the same "mega" problem.

For
convenience we have included the entire set of information in every question. For
purposes of the questions that follow, assume that changes in working capital are
negligible and capex and depreciation are of the same magnitude and therefore
cancel each other. This is the assumption we made in most of the videos to focus on
valuation effects of borrowing and taxes and to figure out the key differences
between alternative valuation methods.

Your company is considering acquiring ABC, Inc., a software company. ABC, Inc. has
expected annual EBIT of $840,000 in perpetuity, and the appropriate discount rate
for the risk associated with the cash flow is 12%. ABC is an all-equity firm and has
700,000 shares outstanding. The CEO of ABC, Inc. has a very exciting plan to make
her company look more attractive to your company. She suggests to her CFO that if
the firm issues $3.50M debt in perpetuity with a return of 8%, and uses this debt to
repurchase some of the shares of the company, it will make the firm more attractive
to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the
logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally
simply states: I do not have to convince you, Gautam, especially since my plan is
fool proof. My debt-based strategy will make our company attractive to any acquirer
because it will lower our price-earnings ratio and, consequently, make them offer us
a lot more money for our assets than they would otherwise. Assume that the
corporate tax rate is 25% and the interest payments on debt are tax deductible. Is
the CEO correct in believing that the price-earnings ratio of ABC, Inc. will drop?

No

Yes

May be
1
point
17.
17. (5 points) Note: Questions 16 - 20 relate to the same "mega" problem. For
convenience we have included the entire set of information in every question. For
purposes of the questions that follow, assume that changes in working capital are
negligible and capex and depreciation are of the same magnitude and therefore
cancel each other. This is the assumption we made in most of the videos to focus on
valuation effects of borrowing and taxes and to figure out the key differences
between alternative valuation methods.

Your company is considering acquiring ABC, Inc., a software company. ABC, Inc. has
expected annual EBIT of $840,000 in perpetuity, and the appropriate discount rate
for the risk associated with the cash flow is 12%. ABC is an all-equity firm and has
700,000 shares outstanding. The CEO of ABC, Inc. has a very exciting plan to make
her company look more attractive to your company. She suggests to her CFO that if
the firm issues $3.50M debt in perpetuity with a return of 8%, and uses this debt to
repurchase some of the shares of the company, it will make the firm more attractive
to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the
logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally
simply states: I do not have to convince you, Gautam, especially since my plan is
fool proof. My debt-based strategy will make our company attractive to any acquirer
because it will lower our price-earnings ratio and, consequently, make them offer us
a lot more money for our assets than they would otherwise. Assume the corporate
tax rate is 25% and the interest payments on debt are tax deductible. What will be
the new P/E ratio of ABC, Inc. if it adopts this new debt-enhanced strategy? (No
more than two decimals in the number.)

Enter answer here

1
point
18.
18. (5 points) Note: Questions 16 - 20 relate to the same "mega" problem. For
convenience we have included the entire set of information in every question. For
purposes of the questions that follow, assume that changes in working capital are
negligible and capex and depreciation are of the same magnitude and therefore
cancel each other. This is the assumption we made in most of the videos to focus on
valuation effects of borrowing and taxes and to figure out the key differences
between alternative valuation methods.

Your company is considering acquiring ABC, Inc., a software company. ABC, Inc. has
expected annual EBIT of $840,000 in perpetuity, and the appropriate discount rate
for the risk associated with the cash flow is 12%. ABC is an all-equity firm and has
700,000 shares outstanding. The CEO of ABC, Inc. has a very exciting plan to make
her company look more attractive to your company. She suggests to her CFO that if
the firm issues $3.50M debt in perpetuity with a return of 8%, and uses this debt to
repurchase some of the shares of the company, it will make the firm more attractive
to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the
logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally
simply states: I do not have to convince you, Gautam, especially since my plan is
fool proof. My debt-based strategy will make our company attractive to any acquirer

because it will lower our price-earnings ratio and, consequently, make them offer us
a lot more money for our assets than they would otherwise. Assume the corporate
tax rate is 25% and interest payments on debt are tax deductible. Is the CEO correct
in concluding that your company will pay more to acquire ABC, Inc.?

No

May be

Yes
1
point
19.
19. (5 points) Note: Questions 16 - 20 relate to the same "mega" problem. For
convenience we have included the entire set of information in every question. For
purposes of the questions that follow, assume that changes in working capital are
negligible and capex and depreciation are of the same magnitude and therefore
cancel each other. This is the assumption we made in most of the videos to focus on
valuation effects of borrowing and taxes and to figure out the key differences
between alternative valuation methods.

Your company is considering acquiring ABC, Inc., a software company. ABC, Inc. has
expected annual EBIT of $840,000 in perpetuity, and the appropriate discount rate
for the risk associated with the cash flow is 12%. ABC is an all-equity firm and has
700,000 shares outstanding. The CEO of ABC, Inc. has a very exciting plan to make
her company look more attractive to your company. She suggests to her CFO that if
the firm issues $3.50M debt in perpetuity with a return of 8%, and uses this debt to
repurchase some of the shares of the company, it will make the firm more attractive
to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the
logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally
simply states: I do not have to convince you, Gautam, especially since my plan is
fool proof. My debt-based strategy will make our company attractive to any acquirer
because it will lower our price-earnings ratio and, consequently, make them offer us
a lot more money for our assets than they would otherwise. Assume the corporate
tax rate is 25% and interest payments on debt are tax deductible. What is the new
enterprise value of ABC, Inc. if the CEO's plan is executed? (Enter just the number
without the $ sign or a comma; round to the nearest whole dollar.)

Enter answer here

1
point
20.
20. (5 points) Note: Questions 16 - 20 relate to the same "mega" problem. For
convenience we have included the entire set of information in every question. For
purposes of the questions that follow, assume that changes in working capital are
negligible and capex and depreciation are of the same magnitude and therefore
cancel each other. This is the assumption we made in most of the videos to focus on
valuation effects of borrowing and taxes and to figure out the key differences
between alternative valuation methods.

Your company is considering acquiring ABC, Inc., a software company. ABC, Inc. has
expected annual EBIT of $840,000 in perpetuity, and the appropriate discount rate
for the risk associated with the cash flow is 12%. ABC is an all-equity firm and has
700,000 shares outstanding. The CEO of ABC, Inc. has a very exciting plan to make
her company look more attractive to your company. She suggests to her CFO that if
the firm issues $3.50M debt in perpetuity with a return of 8%, and uses this debt to
repurchase some of the shares of the company, it will make the firm more attractive
to acquirers. The CFO is skeptical of the CEOs plan and argues with her about the
logic behind it. Frustrated with her CFOs argumentative stance, the CEO finally
simply states: I do not have to convince you, Gautam, especially since my plan is
fool proof. My debt-based strategy will make our company attractive to any acquirer
because it will lower our price-earnings ratio and, consequently, make them offer us
a lot more money for our assets than they would otherwise. Assume the corporate
tax rate is 25% and the interest payments on debt are tax deductible. What is the
return on equity of ABC, Inc. if the CEO's plan is executed? (No more than two
decimals in the percentage rate, but do not enter the % sign.)