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4. A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.

Selected Company Details
Item	Market value ($m)	Beta
Cash asset	0.5	0
Truck asset	0.5	2
Loan liabilities	0.25	0.1
Equity funding	?	?

Which of the following statements is NOT correct? The:

Select one:

a.Firms market value of equity is $0.75m. and debt-to-assets ratio is 25%.

b.Equity beta is 1.3.

c.Equity required return is 10% pa.

d.Required return on debt is 3.5% pa.

e.WACC before tax is 8% pa.

The firm then pays off (retires) all of its loan liabilities using its cash. Ignore interest tax shields. Which of the following statements is NOT correct? All answers are given to 6 decimal places. This event led to a:

Select one:

a.$0.25m decrease in loans to zero and cash to $0.25m.

b.Rise in the asset beta to 1.333333 and required return on assets (or WACC before tax) to 9.666667% pa.

c.Rise in the equity beta to 2 and required return on equity to 13% pa.

d.Fall in the debt-to-assets ratio to zero.

The firm then raises $1.5m more cash by writing more loans. Assume that the beta and yield on the new and existing loan liabilities are equal and unchanged compared to before. Ignore interest tax shields. All figures are given to 6 decimal places. Which of the following statements is NOT correct? This event led to a:

Select one:

a.$1.5m increase in loan liabilities to $1.75m and cash to $2m.

b.Asset beta of 0.4 and required return (or WACC before tax) of 5% pa.

c.Equity beta of 1.1 and required return of 8.5% pa.

d.$1.50 share price increase assuming that there are 1 million shares.

The firm then pays $0.5m cash for trucks that are actually worth $0.7m on the market. Assume that the beta and yield on the existing loan liabilities are unchanged compared to before. All figures are given to 6 decimal places. Which of the following statements is NOT correct? This event led to a:

Select one:

a.Good outcome for the company since the NPV of buying the trucks was $0.2m.

b.$0.2m increase in the market value of equity to $0.95m but no change in the book value of equity.

c.$0.7m increase in the market value of trucks to $1.2m but only a $0.5m increase to the book value of trucks to $1m.

d.$0.5m decrease in the market and book value of cash to zero.

e.$0.70 increase in the stock price to $0.95 assuming that there are 1 million shares.

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