Capital Structure and Net Operating Income Study Guide

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Ch.14 (Problems and Solutions) 36. Net operating income The Congress Company has identified two methods for producing playing cards. One method involves using a machine having a fixed cost of $10,000 and variable costs of $1.00 per deck of cards. The other method would use a less expensive machine (fixed cost = $5,000), but it would require greater variable costs ($1.50 per deck of cards). If the selling price per deck of cards will be the same under each method, at what level of output will the two methods produce the same net operating income? a. 5,000 decks b. 10,000 decks c. 15,000 decks d. 20,000 decks e. 25,000 decks 36. Answer: b Diff: M Total costMethod 1 = $1.00(Q) +…show more content…
Aaron estimates that if it had no debt its beta would be 1.0. (Its “unlevered beta,” bU, equals 1.0.) On the basis of this information, what is the company’s optimal capital structure, and what is the firm’s cost of capital at this optimal capital structure? a. wc = 0.9; wd = 0.1; WACC = 14.96% b. wc = 0.8; wd = 0.2; WACC = 10.96% c. wc = 0.7; wd = 0.3; WACC = 7.83% d. wc = 0.6; wd = 0.4; WACC = 10.15% e. wc = 0.5; wd = 0.5; WACC = 10.18% 44. Optimal capital structure and Hamada equation Answer: d Diff: T N kRF = 5%; kM - kRF = 6%. ks = kRF + (kM - kRF)b. WACC = kd ( wd ( (1 - T) + ks ( wc. You need to use the D/E ratio given for each capital structure to find the levered beta using the Hamada equation. Then, use each of these betas with the CAPM to find the ks for that capital structure. Use this ks and kd for each capital structure to find the WACC. The optimal capital structure is the one that minimizes the WACC. (D/E) b = bU[1 + (1-T)(D/E)] ks = kRF + (kM - kRF)b wc kd wd WACC 0.11 1.0667 11.4005% 0.9 7.0% 0.1 10.68% 0.25 1.1500 11.9000 0.8 7.2 0.2 10.38 0.43 1.2571 12.5429 0.7 8.0 0.3 10.22 0.67 1.4000 13.4000 0.6 8.8 0.4 10.15 1.00 1.6000 14.6000 0.5 9.6 0.5 10.18 For example, if the D/E is 0.11: b = 1.0[1 + (1 - T)(D/E)] = 1.0[1 + (1 - 0.4)(0.1111)] = 1.0667. ks = kRF + (kM - kRF)b = 5% +
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