12. Fill in the blank (or type your choice if you email your responses in the virtual world): A company is faced with a real problem. Because of bad decisions two years back, the company owes its banks a considerable amount of money. The firm has the opportunity to invest in a positive NPV project, but unfortunately, any value created will go straight to the banks. This type of influence of debt on the the passing up actions of shareholders and of good investments is called the

12. Fill in the blank (or type your choice if you email your responses in the virtual world): A company is faced with a real problem. Because of bad decisions two years back, the company owes its banks a considerable amount of money. The firm has the opportunity to invest in a positive NPV project, but unfortunately, any value created will go straight to the banks. This type of influence of debt on the the passing up actions of shareholders and of good investments is called the

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 4MC: David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing....

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David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: Now assume that Firms L and U are both subject to a 25% corporate tax rate. Using the data given in part b, repeat the analysis called for in parts b(1) and b(2) using assumptions from the MM model with taxes.
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: d. Suppose that Firms U and L have the same input values as in Part c except for debt of 980,000. Also, both firms have total net operating capital of 2,000,000 and both firms are expected to grow at a constant rate of 7%. (Assume that the EBIT in part c is expected at t = 1.) Use the compressed adjusted present value (APV) model to estimate the value of U and L. Also estimate the levered cost of equity and the weighted average cost of capital.
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: Who were Modigliani and Miller (MM), and what assumptions are embedded in the MM and Miller models?
A company needs to raise $9 million and issues bonds for that amount rather than additional capital stock. Which of the following is not a likely reason the company chose debt financing? A. Management hopes to increase profits by using financial leveraging. B. The cost of borrowing is reduced because interest expense is tax deductible. C. Adding new owners increases the possibility of bankruptcy if economic conditions get worse. D. If money becomes available, the company can rid itself of debts.
Mini CaseDavid Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30% debt, and Mr. Lyons wonders why they use so much more debt and how it affects stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant. Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its cost of equity is rsU=14%. Firm L has $1 million of debt outstanding at a cost of rd=8%. There are no taxes. Assume that the MM assumptions hold. Find V, S, rs, and WACC for Firms U and L.
A financial analyst at your firm notes that the firm's total interest payments this year were $10 million while total debt outstanding was $80 million, and he concludes that the cost of debt was 12.5%. What is wrong with this conclusion? Only long term debt should be used Only current liabilities should be used Excluded taxes will overestimate the cost of debt Excluding taxes will underestimate the cost of debt None of the above are correct
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30% debt, and Mr. Lyons wonders why they use so much more debt and how it affects stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant. Suppose the expected free cash flow for Year 1 is $250,000 but it is expected to grow unevenly over the next 3 years: FCF2=$290,000 and FCF3=$320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is $80,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be $95,000, at Year 3 it will be $120,000, and it will grow at 7% thereafter. What is the estimated horizon unlevered…
Notice that, like Pierre Foods, we can simplify this by examining the most important details: the $519 million of revolving credit, the $318 million of senior secured notes, and the $419 million of equity. By late 2009, GSO was impressed with the progress Crosstex had made in 2008–2009 in managing its debt and was interested in providing the energy company with rescue financing. GSO knew that Crosstex would need a large-scale debt refinancing in a highly volatile unsecured bond market to satisfy its revised debt obligations. The credit markets had all but dried up in the wake of the global financial crisis. Meanwhile, Crosstex was also considering an equity injection from a third party. For GSO, the potential plan of action had three steps: Inject cash into Crosstex through GSO funding Refinance Crosstex’s debt by issuing unsecured debt and repaying the loan (deflate the $519 million in revolving credit and inflate the $318 million in senior secured notes) Restore the dividend Given…
You have been hired by a new firm that is just being started. The CFO wants to finance with 60% debt, but the president thinks it would be better to hold the percentage of debt in the capital structure (wd) to only 10%. Both companies are small, so they are not subject to the interest deduction limitation. Other things held constant, and based on the data below, if the firm uses more debt, by how much would the ROE change, i.e., what is ROEHigher - ROELower? Do not round your intermediate calculations. Operating Data Other Data Capital $4,000 Higher wd 60% ROIC = EBIT(1 – T)/Capital 13.00% Higher interest rate 13% Tax rate 25% Lower wd 10% Lower interest rate 9% Group of answer choices 4.68% 4.77% 3.72% 4.18% 3.93%
Chang Consulting. Inc., has a $15,000 overdue debt with Supplier No. 1. The company is low on cash, with only $4,000 in the checking account and does not want to borrow any more cash. Supplier No. 1 agrees to settle the account in one of two ways: Option 1: Pay $4,000 now and $18.750 when some large projects are finished, two years from today. Option 2: Pay $25,000 three years from today, when even larger projects are finished. Assuming that the only factor in the decision is the cost of money (8%), which option should Clary choose?
Ralston Consulting. Inc., has a $25,000 overdue debt with Supplier No. 1. The company is low on cash, with only $7,000 in the checking account and does not want to borrow any more cash. Supplier No. 1 agrees to settle the account in one of two ways: Option 1: Pay 57,000 now and $23,750 when some large projects are finished, two years from today. Option 2: Pay $35,000 three years from today, when even larger projects are finished. Assuming that the only factor in the decision is the cost of money (8%). which option should Ralston choose?
Reed plc is considering how to improve its debtor collection policy. The following information is available. Current Credit Sales: £912,000 Average debtor collection period (days): 94 days Wishing to introduce a new policy of payment within (days): 60 days Anticipated reduction in sales per year: £40,000 Increased collection costs per yer: £2,000 Short-term cost of borrowing (%): 30% Sales contribution to profit: 20% Required What will be the net benefit if Reed successfully enforces the new policy? When a corporation raises finance, there are two options: long-term debt finance (bank loan or corporate bonds) and equity finance (ordinary shares). The two approaches have fundamental consequences to the corporation. What are the main differences between the two approaches?