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you use and briefly discuss elements of each step.
5. Create a "As-is", "Should-be" process model for
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Hand in Problem Set 2
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Hand in Problem Set 2 Please hand a paper copy of your work to your
class teacher at the beginning of class 8 (week 9).
Thorndike Oil (TO) is a diversified company with two operating
divisions: Oil and Telecom which
represent 70% and 30% of the firm’s value, respectively. TO has no
debt on its balance sheet. To
estimate the cost of capital for each division, TO has identified one
principal competitor for each of its
two divisions. The competitors are pure-plays, i.e., they are not
diversified and operate in only one
industry each. They maintain a constant Debt-Equity ratio at all times.
Assume that the debt of the two
competitors is risk-free, the risk-free interest rate is 1%, the expected
return on the market portfolio is
6% and that the CAPM holds.
Competitor
VP-Oil
AB&B-Telecom Equity Beta
0.8
1.5 D/E
2/6
1/4 a. Estimate the expected return on TO’s equity.
Now assume that TO is considering a change in its capital structure
that will increase its leverage. Two
plans are considered:
1. Issue $55 million immediately in debt and maintain its level in
perpetuity.
2. Issue $90 million immediately in debt, repay $20 million of its
principal in one year, $20