Weeks 1 - 7 Homework Answer Key

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FI516 – WEEK 1 – HOMEWORK ANSWER KEY
Problem 14-10 14-10
a. 1. 2011 Dividends = (1.10)(2010 Dividends) = (1.10)($3,600,000) = $3,960,000
2. 2010 Payout = $3,600,000/$10,800,000 = 0.33 = 33% 2011 Dividends = (0.33)(2009 Net income) = (0.33)($14,400,000) = $4,800,000 (Note: If the payout ratio is rounded off to 33%, 2011 dividends are then calculated as $4,752,000.)
3. Equity financing = $8,400,000(0.60) = $5,040,000 2011 Dividends = Net income - Equity financing = $14,400,000 - $5,040,000 = $9,360,000 All of the equity financing is done with retained earnings as long as they are available.
4. The regular dividends would be 10% above the 2010 dividends: Regular dividends = (1.10)($3,600,000) = $3,960,000. The residual policy calls
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The additional funds, especially under 3, may enable the firm to become more current on its trade credit. Also, the bonds will no doubt be subordinated debentures.

Both Alternatives 2 and 3 are favorable alternatives. If the principal owner is willing to assume the risk of higher leverage, then 3 is slightly more attractive than 2. The actual attractiveness of Alternative 3 depends, of course, on the assumption that funds can be invested to yield 20% before interest and taxes. It is this fact that makes the additional leverage favorable and raises the earnings per share.

Problem 15-9: Capital Structure Analysis Present situation (50% debt): WACC = wd rd(1-T) + wcers = (0.5)(10%)(1-0.15) + (0.5)(14%) = 11.25%. V = FCF/WACC = (EBIT)(1 − T)/WACC = ($13.24)(1 0.15)/ 0.1125 = $100million 70 percent debt: WACC = wd rd(1-T) + wcers = (0.7)(12%)(1-0.15) + (0.3)(16%) = 11.94%. V = FCF/WACC = (EBIT)(1 − T)/WACC = ($13.24)(1 0.15)/ 0.1194 = $94.26million 30 percent debt: WACC = wd rd(1-T) + wcers = (0.3)(8%)(1-0.15) + (0.7)(13%) = 11.14%. V = FCF/WACC = (EBIT)(1 − T)/WACC = ($13.24)(1 0.15)/ 0.1114 = $101.2million

Problem 15-10: Optimal Capital Structure with Hamada a. BEA’s unlevered beta is 0.870 bU =b/(1+ (1-T)(D/S)) =1.0/(1+(1-0.40)(20/80)) = 0.870

b. b = bU (1 + (1-T)(D/S)) At 40 percent debt: bL = 0.87 (1 + 0.6(40%/60%)) = 1.218 rS = 6 + 1.218(4) = 10.872% = wd rd(1-T) + wcers =

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