Q1. Consider an all-equity firm that is contemplating going into debt. The market value of equity is calculated as Free Cash Flow/required rate of return. Current Proposed Assets $10,000 $18,000 Debt $0 $8,000 Equity $10,000 $10,000 Debt/Equity ratio 0.00 1.00 Interest rate n/a 7% Shares outstanding 500 500 Share price $20 $20 (b) If the company adds the proposed amount of debt and EBIT is expected to expand proportionally, fill out the table in (a) after the debt is issued.

Q1. Consider an all-equity firm that is contemplating going into debt. The market value of equity is calculated as Free Cash Flow/required rate of return. Current Proposed Assets $10,000 $18,000 Debt $0 $8,000 Equity $10,000 $10,000 Debt/Equity ratio 0.00 1.00 Interest rate n/a 7% Shares outstanding 500 500 Share price $20 $20 (b) If the company adds the proposed amount of debt and EBIT is expected to expand proportionally, fill out the table in (a) after the debt is issued.

Entrepreneurial Finance

6th Edition

ISBN:9781337635653

Author:Leach

Publisher:Leach

Chapter14: Security Structures And Determining Enterprise Values

Section: Chapter Questions

Problem 1hM

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Q1. Consider an all-equity firm that is contemplating going into debt. The market value of equity is calculated as Free Cash Flow/required rate of return. Current Proposed Assets $10,000 $18,000 Debt $0 $8,000 Equity $10,000 $10,000 Debt/Equity ratio 0.00 1.00 Interest rate n/a 7% Shares outstanding 500 500 Share price $20 $20 (e ) If the company stock price goes up by 2% from announcing it is adding debt to expand the business, what effect does this have on the WACC?
Assume there are two firms with a MV of $50,000,000. Firm A consists of 10% debt and 90% equity. Firm B consists of 40% debt and 60% equity. Assume perfect capital markets and M&M Proposition 2 holds. Which firm will have a higher expected return for equity holders? Why? For the toolhar prace ALT+F10/PC or ALT+FN+F10 (Mac).
Q3) Tanten Company has 200% debt and 80% equity. The borrowing rate is 12%. A. If you own 4% of the stock of Abacus, what is your dollar return if the company has net operating income of $750,000 and the over all capitalization rate , Ko, is 15%? Value of the firm is 500,000 B. What is the implied required rate of return on equity? C. What is the market value of stock and the return of stock? D. What is the market value of debt?
6. Company cost of capital (S9.2) Nero Violins has the following capital structure: Total Market Value ($ millions) $100 Security Debt Preferred stock Common stock Beta 0 0.20 1.20 40 299 a. What is the firm's asset beta? (Hint: What is the beta of a portfolio of all the firm's securities?) b. Assume that the CAPM is correct. What discount rate should Nero set for investments that expand the scale of its operations without changing its asset beta? Assume a risk-free interest rate of 5% and a market risk premium of 6%. Ignore taxes.
A company needs ghc1000 to finance its activities. The firm can finance this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghe 160 in good years and ghc80 in bad years. Assuming the firm faces one-quarter probability of good years; What will be the stream of returns on both bonds and equity if the company chooses the following financing options? i. a. 100% equity financing ii. 50% equity financing iii. 20% equity financing iv. 0% equity financing Estimate the equity risk associated with each option in (a) As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why? b. C.
Consider a simple firm that has the following market-value balance sheet: Assets Liabilities end equity $1 040 Debt Equity $400 640 Next year, there are two possible values for its assets, each equally likely: $1 180 and $960. Its debt will be due with 4.9% interest. Because all of the cash flows from the assets must go to either the debt or the equity, if you hold a portfolio of the debt and equity in the same proportions as the firm's capital structure, your portfolio should earn exactly the expected return on the firm's assets. Show that a portfolio invested 38% in the firm's debt and 62% in its equity will have the same expected return as the assets of the firm. That is, show that the firm's pre-tax WACC is the same as the expected return on its assets. If the assets will be worth $1 180 in one year, the expected return on assets will be %. (Round to one decimal place.)
M12-15. Estimating Cost of Equity Capital Assume that a company’s market beta equals 0.6, the risk-free rate is 5%, and the market return equals 13%. Compute the company’s cost of equity capital. Round answer to one decimal place (ex: 0.0245 = 2.5%) Answer%
A company needed ghc 1000 to finance its activities. The firm can financed this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghc 160 in good years and ghc80 in bad years. Assuming the firm faces equal probability of good and bad years; i What will be the stream of returns on both bonds and equity if the company chooses the following financing options a 100% equity financing b 50% equity financing c 20% equity financing d 0% equity financing ii Estimate the equity risk associated with each option in (i) iii As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why????
Show calculation steps A firm is solely financed by equity with market value of $50,000 and cost of equity of 10%. It wishes to raise another $30,000 via corporate bonds with cost of debt of 5% and use all of it to buy back outstanding equity (no cash holding). Hold investment policies fixed. a)In a MM world without taxes, 1)What would the firm value be after debt issuance? Firm Value = Equity Value + Debt Value - Cash. 2)What would be the cost of equity after debt is raised? 3)What would be the WACC after debt is raised?
Assume a firm is financed with $7500 debt and $2500 equity. The beta of the equity is 1.1. The risk-free rate is 3%, and the equity premium is 6%. If the overall cost of capital of the firm is 8%, what is the beta of the firmʹs debt? Group of answer choices 0.28 0.14 0.92 0.74
Q2. Suppose you are the chief financial officer of Toktik Co. and you are trying to determine the optimal capital structure for the company using the cost of capital approach. On the day of this exam, you have collected the following company and market data: The beta of the company is 2.6; • 10-year Treasury bond rate is 1.6% and the current market equity risk premium is 6.9%; • The company's current bond rating is BB by Standard & Poor's; • The firm currently has 5.2 billion shares outstanding with share price at $120 and the firm's market value of debt is $264 billion • The company's marginal tax rate is 35%. Also you are given the following table concerning the latest information on bond rating and the corresponding default spread: Default spread Rating AAA 0.69% AA 0.85% A+ 1.07% A 1.18% А- 1.33% BBB 1.71% BB+ 2.31% BB 2.77% B+ 4.05% 4.86% В- 5.94% ССС 9.46% CC 9.97% 13.09% D 17.44% Required: a) Briefly explain, by referencing relevant capital structure theories, the mechanisms…
5. Company cost of capital (S9.2) You are given the following information for Golden Fleece Financial: Long-term debt outstanding: $300,000 Current yield to maturity (rdebt): Number of shares of common stock: Price per share: Book value per share: Expected rate of return on stock (requity): Calculate Golden Fleece's company cost of capital. 8% 10,000 $50 $25 15%