Advanced Corporate Finance (6012B0207Y)

What are the three main methods of depreciation?

Imagine that firms X and Y at the same time set their target capital structure
according to the principles of the Agency Trade-Off Theory exposed in Part a.,
and set their financing decisions according to the Pecking Order Theory. Each
firm starts with an initial debt/ total value ratio of 50%. The firm with the largest
agency cost of debt has a target debt/ total value ratio of 40%, and the other one has
a target debt/ total value ratio of 60%. Each firm considers incremental financing
decisions should not lead their ratio to leave a range of +/-20% with respect to their
optimal ratio. Both firms have the following possibilities (that can be combined with
each other) to finance their yearly capital expenditures:
• Use retained earnings. They amount to 10% of the initial value of equity (i.e. €
2 million for X and € 10 million for Y);
• Use bank debt for tuop€ 10 million;
• Float a new straight bond issue for at least € 100 million;
• Float new shares for at least € 100 million.
Consider that both firms try to marry the POT, the TOT, and the MTT theories in the
most effective way, and adopt the integrated framework discussed in class.
i. What sequence of financing for the next 6 years would you advise to company
X? to company Y? Please provide year after year the debt/total value ratio and
the decision you advocate.

Companies X and Y both have 1 million shares outstanding with a market price of € 20 (for X) and € 100 (for Y) respectively. Company X is active in the biotechnology sector.
Its operational cash flows are very volatile, its profits are sometimes negative, and its orientation towards growth requires large and sustained capital expenditures of € 10
million per year. Company Y works in the water distribution industry. It enjoys a very stable, always positive pattern of cash flows, and to sustain its core activities, it only requires an additional investment of € 10 million per year. According to the Pecking Order Theory, what do you expect to observe as the most frequently used financing device for the additional investments of firm X? And of firm Y?

Companies X and Y both have 1 million shares outstanding with a market price of € 20 (for X) and € 100 (for Y) respectively. Company X is active in the biotechnology sector.
Its operational cash flows are very volatile, its profits are sometimes negative, and its orientation towards growth requires large and sustained capital expenditures of € 10
million per year. Company Y works in the water distribution industry. It enjoys a very stable, always positive pattern of cash flows, and to sustain its core activities, it only requires an additional investment of € 10 million per year. Explain the kind of agency problems that each company is likely to experience and what would be the role of debt (positive or negative) in this context. Provide an example showing how changing the level of debt could be beneficial for company X and company Y.

Let us suppose that Jeroen also has to compute the WACC for the Aerospace & Defense Division of Boeing but he does not have the time to do that himself. So, he
decides to ask an intern from the office to do that job. Please write down for the intern a clear and sufficiently detailed instruction on how to compute WACC for this
division and (if necessary) what additional data the intern also needs to collect. Note that the intern should from your instruction be able to determine what data
she needs to specifically collect, and what type of computations/calculations need to be performed in order to arrive at divisional WACC. (i.e., think of a detailed manual for the intern that leaves her without doubt on what to do).

Let's reflect on the COVID-19 pandemic that became apparent not long thereafter.
One month later, Jeroen updates his estimate of Boeing's cost of capital, and he is
wondering if/how the firm's WACC will be affected by the pandemic. Can you provide
Jeroen with theoretical arguments as to why/why not Boeing's WACC (or specific
components of WACC) will be affected by the potentially worsening pandemic? If
so, what specific components of WACC will be affected?