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讲解 FINA2222 Corporate Financial Policy 2024 Sem 1讲解 Python语言

FINA2222 Corporate Financial Policy

2024 Sem 1

Your name is Damian Preston, an experienced financial analyst with a business degree from University of New York. Always having a passion for technology and AI, you enjoy your current role as the lead analyst for a chip-making firm, Ndivia, based in Santa Clara, California. In recent years, the firm has experienced rapid growth, benefiting from the intense competition in the development of AI technology among both start- ups and established firms like Microsoft and Alphabet.

This competition has significantly boosted the demand for its products. This morning, you attended a meeting with the top management team to discuss the next financial goal for your firm. The CFO of the company, Fred Cook, who holds an MBA from Harvard university, expressed his view of using the company’s equity to leverage up, and potentially open up more opportunities for future R&D investments. He said:

“S&P500 index has just topped 5,000 early last month (Feb 2024), a sign of enhanced investor confidence in the direction the economy is heading. With this optimism and other economic indicators like high CPI (consumer price index) and low rate of unemployment, we should next expect to see RB (Reserve Bank) revise interest rate down. This could be a good opportunity for us to lever up.

I know, the level of leverage is lower in this industry because of higher risk involved in AI and technological innovations more often seen here than other industries. However, I strongly believe corporate deleveraging has gone too far in our firm;  the  strong sales growth should be  able  to partially cover future interest risk. Presently, we have a leading market share with strong demand, and yet have no debt. We don’t want to miss out valuable opportunities to create value for shareholders. Damian, what if we start planning for a leveraged recapitalisation, through a dividend or major share  repurchase, to take the advantage of an interest rate cut on the horizon? Go and run some numbers on the potential feasibility of a leveraged recapitalization and report back!”

You  noted that your firm’s  market value of common equity was  more than  $15  billion, recently traded  at  $15.69  per  share  (a  76.2%  increase  from the year  before).  You  also discussed with the CFO the current capital-market conditions and decided to focus on the assumption that the firm could borrow up to $10 billion at a credit rating of AA or AAA in the current market.

Below is some relevant information about the company you’ve collected from your research:

Company overview

Ndivia  is  currently  a  leading  global  manufacturer  of  high-end  graphics  processing  units (GPUs). The firm’s industry, technology, was intensely competitive and was dominated by a few large players, Intell, AND, CISKO, to name a few. Its revenues and earnings had grown substantially  in  the   past  five  years,  thanks  to   a   strong  drive  to   develop  AI  related technologies since the foundation of OpenAI in 2015 by Sam Altman, Greg Brockman, Peter Thiel, Elon Musk, and others. (Exhibit 1: Income Statement in Excel). Historically, the firm had been conservatively financed. At the end of 2023, it had total assets just under $1.9 billion and no long-term debt (Exhibit 2: Balance Sheet in Excel). Ndivia’sstock price (Exhibit 4: Other Information in Excel) had significantly outperformed the S&P 500 composite index and was running slightly ahead of its industry index.

Estimating the effect of leveraged recapitalization

Under the proposed leveraged recapitalisation, Ndivia could borrow up to $10 billion and use it either to pay an equivalent dividend or to re-purchase an equivalent value of shares. You knew that this combination of actions could affect the firm’s value, share price, cost of capital, debt coverage, and profitability. Accordingly, you thought to evaluate the effect of therecapitalisation from these aspects.

•    The effect on valuation and share price

You recalled that debt increased the value of a firm by means of shielding cash flows from taxes. Thus, the  present  value  of  debt  tax  shields  could  be  added  to  the  value  of  the underlying unlevered firm to yield the value of the levered enterprise. The marginal tax rate proposed to use was 25%, reflecting the sum of federal, state and local taxes.

•    The effect on the cost of capital

You also knew that the maximum value of the firm was achieved when the weighted average cost of capital (WACC) was minimised. Thus, you intended to estimate what the cost of equity (rE) and the rWACC might be if Ndivia pursued this capital structure change. The projected cost of debt (rD) would depend on the assessment of the firm’s debt rating, AA, given the current capital market rates (Exhibit 3: Credit Rating in Excel).

The cost of equity (rE) could be estimated the capital asset pricing model (CAPM). Exhibit 3 gives yields on U.S. Treasury instruments which afforded possible estimates of the risk-free return (rf) and the equity market risk premium (rm – rf) of 7%. Exhibit 4 gives BT’s current (unlevered) beta.

•    The impact on reported earnings per share

You intended to estimate the expected effect on earnings per share (EPS) that would occur at different levels of operating income (EBIT) with a change in leverage. You planned to draw a graph to illustrate this effect.

Other effects

Lastly, you wondered whether your analysis covered everything. Where, for instance, should you consider potential costs of bankruptcy and distress or the effects of leverage as the signal for future  operations  of the  company?  More  leverage  would  also  create  certain constraints or incentives for management. Should those be also included in the report for consideration?

Questions to help preparing the report:

To prepare a formal report based on your above understanding so far, you have outlined the following questions to be addressed, providing answers that will serve as the foundation for your report.  In  this  report,  you  will  present  theories  and  supporting  evidence from  the company’s financial statements to evaluate whether the company should pursue a leveraged recapitalization.

Question 1 (Q1) Base case: the MM theory of capital structure

In perfect capital markets, what is the relationship between capital structure and cost of capital  (WACC)?  Apply  the  famous  Miller-Modigliani  propositions  to  Ndivia’s  case  and explain how a different capital structure mayor may not affect its market value.


1.   Complete the table in Excel spreadsheet Q1 Perfect Mkt.

2.   Draw a chart using debt level (D) against rE and  WACC to support the discussion of MM proposition I and II. (Paste the chart in appendix.)

3.   Show your calculations for each variable in row (6) to (15) using debt = $7 billion in a MS Word document.

4.   Provide a succinct discussion based on your analysis.

Question 2 (Q2) The effect of leverage on the firm’sshare price (with corporate tax)

To test the valuation effect of leverage, you assume that Ndivia plan to borrow $7 billion at a pre-tax cost of debt, determined based on the firm’s current AA credit rating, and that the aggregate amount of debt will remain constant in perpetuity.  Also, you assume that the proceeds of the  loan would  be  used  to  repurchase  shares or  pay  a  special  dividend to shareholders.

What is the amount of tax benefit, i.e., the present value of interest tax shields (ITS)? How does Ndivia’s debt, equity, market value, number of shares outstanding and price per share change   in   the   four-stage   process,   that   is,   pre-recapitalization   (or   current),   at   the announcement of debt issuance, when debt is issued, and after the fund is spent on either repurchasing shares, or paying a lumpsum of special dividend?


1.   Complete tables a and bin Excel spreadsheet Q2 Valuation & Q3 WACC.

2.   Show your calculations in a MS Word document.

3.   Provide a succinct discussion based on your analysis.

Question 3 (Q3) The impact of leverage on the company’s cost of capital (WACC)

Combining with your answers to Question 2, discuss how this new debt, in each scenario of  being used to repurchase shares or to pay a special dividend, affect Ndivia’s capital structure, the cost of equity  (rE) and cost of capital  (WACC), total value,  and share  price?  Which  alternative is recommended, why?


1.   Complete the table under Q3 in Excel spreadsheet Q2 Valuation & Q3 WACC.

2.   Show your calculations in a MS Word document.

3.   Provide a succinct discussion based on your analysis.

Question 4 (Q4) The impact of leverage on EPS

You use sensitivity analysis to examine the effect on earnings per share (EPS) of issuing $5 billion of new debt and using the proceeds to repurchase existing shares or pay a special dividend. Comparing the worst against the best-case scenario as shown in your analysis, also considering your conclusions in Q3 and Q2, do you recommend Ndivia should go with share repurchase or dividend in a leverage recapitalization, why?


1.   Complete the tables in Excel spreadsheet Q4 EBIT vs EPS.

2. Paste the graph in appendix.

3.   Show your calculations in a MS Word document.

4.   Provide a succinct discussion based on your analysis.

Question 5 (Q5) other effects of leverage

Are there other factors that may also affect the decision to pursue a leveraged recapitalization? Discuss it from perspectives of signalling, bankruptcy risk, managerial incentives, and any other factor you think  relevant. And finally, considering current  economic condition the NDIVIA’s current financial position, should it go ahead with this  leveraged recapitalization or not? (No calculation is needed for this one. Provide references.)


1.          No calculation is needed for this question. No Excel spreadsheet required).

2.          Show your discussion in a MS Word document.

Final important tips from your experienced colleagues:

1. Instead of using total debt, we usenet debthere to eliminate the complication from cash, that is, D = (Long-term debt + Short-term debt) – Cash & Equivalents.

2. The total number of shares outstanding = common stock + Class B common stock. The cost of debt (rD) is fixed for the life of the debt.

3. While figures given in financial statements are in thousands, for simplicity, all

numbers you calculate in EXCEL spreadsheet (Q1 to Q4) should be in millions with no decimal place, except for percentages and share prices, where two decimal

places are needed.

4. When presenting your workings in MS Word, present your answers in millions with zero decimal place.

5. Use MS Excel’s built-in formulae to complete the tables as they give accurate answers.

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