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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 debt-to-assets ratio is 25%.

b.

Equity beta is 1.4.

c.

Equity required return is 9.5% pa.

d.

Required return on debt is 3.5% pa.

e.

Required return on assets (or WACC before tax) is 8% pa.

part b

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.

part c

The firm then raises $1m more cash by issuing 2 million more shares in a fairly-priced fully-subscribed 4-for-3 rights issue with a $0.50 per share subscription price and $0.50 pre-announcement market price. 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.

$1m increase in equity to $1.75m and cash to $1.5m.

b.

Increase in the total number of shares to 3.5m.

c.

Decrease in the asset beta to 0.5.

d.

Decrease in the equity beta to 0.5.

e.

Asset-to-equity ratio of 1.142857.

part d

The firm then pays $0.5m cash for trucks that are actually worth $0.2m 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.

Bad outcome for the company since the NPV of buying the trucks was -$0.3m.

b.

Unchanged market and book value of equity.

c.

$0.2m increase in the market value of trucks to $0.7m and a $0.5m increase to the book value of trucks to $1m, assuming the accountant doesnt write-down the value yet.

d.

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

e.

$0.30 decrease in the stock price to $0.45 assuming that there are 1 million shares.

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