15–3. (Calculating capital structure weights) (Related to Checkpoint 15.1 on page 502) Winchell Investment Advisors is evaluating the capital structure of Ojai Foods. Ojai's balance sheet indicates that the firm has $50 million in total liabilities. Ojai has only $40 million in short- and long-term debt on its balance sheet. However, because inter- est rates have fallen dramatically since the debt was issued, Ojai's short- and long-term debt has a current market price that is 10 percent over its book value, or $44 million. The book value of Ojai's common equity is $50 million, but its market value is cur- rently $100 million. a. What are Ojai's debt ratio and interest-bearing debt ratio calculated using book values b. What is Ojai's debt-to-enterprise-value ratio calculated using the market values of the firm's debt and equity and assuming excess cash is zero? c. If you were trying to describe Ojai's capital structure to a potential lender (i.e., a bank), would you use the book-value-based debt ratio or the market-value-based doht to voluo rotio? Whu?

15–3. (Calculating capital structure weights) (Related to Checkpoint 15.1 on page 502) Winchell Investment Advisors is evaluating the capital structure of Ojai Foods. Ojai's balance sheet indicates that the firm has $50 million in total liabilities. Ojai has only $40 million in short- and long-term debt on its balance sheet. However, because inter- est rates have fallen dramatically since the debt was issued, Ojai's short- and long-term debt has a current market price that is 10 percent over its book value, or $44 million. The book value of Ojai's common equity is $50 million, but its market value is cur- rently $100 million. a. What are Ojai's debt ratio and interest-bearing debt ratio calculated using book values b. What is Ojai's debt-to-enterprise-value ratio calculated using the market values of the firm's debt and equity and assuming excess cash is zero? c. If you were trying to describe Ojai's capital structure to a potential lender (i.e., a bank), would you use the book-value-based debt ratio or the market-value-based doht to voluo rotio? Whu?

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

8th Edition

ISBN:9781285065137

Author:Eugene F. Brigham, Joel F. Houston

Publisher:Eugene F. Brigham, Joel F. Houston

Chapter13: Capital Structure And Leverage

Section: Chapter Questions

Problem 14SP: WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital...

See similar textbooks

Similar questions

WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury staff has consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firm's debt cost at different debt levels: Elliott uses the CAPM to estimate its cost of common equity, rs, and estimates that the risk-free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its unlevered beta, bU, would be 1.2. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure? d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1) the debt/capital ratio and (2) the debt/equity ratio.
As a first step, we need to estimate what percentage of MMMs capital comes from debt, preferred stock, and common equity. This information can be found on the firms latest annual balance sheet. (As of year end 2014, MMM had no preferred stock.) Total debt includes all interest-bearing debt and is the sum of short-term debt and long-term debt. a. Recall that the weights used in the WACC are based on the companys target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its balance sheet, what weights should you use to estimate the WACC for MMM? b. Find MMMs market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the balance sheet (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firms debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.
The market value of Glenwood's debt and equity capital totals $180 million, 80% of which is equity related. An analysis conducted by the company's finance department revealed a 7% after-tax cost of debt capital and a 10% cost of equity capital. On the basis of this information, Glenwood's weighted-average cost of capital: Select one: a. is 7.6%. b. is 8.5%. c. is 9.4%. d. cannot be determined based on the data presented because the cost of debt capital must be stated on a before-tax basis. e. cannot be determined based on the data presented because the cost of equity capital must be stated on an after-tax basis.
The company wants to take a $500.0 mil loan to rebuild its position and expand its line of business to heavy equipment. Should the company take the loan or seek other forms of investment? notes -Business overseas- 40% of company revenues -Domestic market- 60% of company revenues -Increase in competition -The company has over the years relied mainly on issuing long-term bonds to finance its capital projects. -As of today, the firm has 50.0 million shares of common stock outstanding. Ratio Analysis 2021 Est. 2020 2019 Industry Average Liquidity Ratios Current Ratio (times) 2.34 3.22 3.68 4.2 Quick Ratio (times) 0.91 1.24 1.79 2.1 Asset Management Ratios Average sales/day 10.96 8.22 7.81 9 Inventory Turnover Ratio (times) 4.43 3.74 5.06 9 Days Sales Outstanding (days) 38.32 45.62 40.34 36 Fixed Assets Turnover…
Nelco Inc. has decided in favour of a capital structuring that involvesincreasing its existing $80 million in debt to $125 million. The interestrate on debt is 9% and is not expected to change. The firm currently has 10million shares outstanding and the price per share is $45. If therestructuring is expected to increase the ROE, what is the minimum level ofEBIT that Nelco’s management must be expecting. Ignore taxes in your answer.
11-15. Tropical Tours is considering an expansion of its operations, which will require the company to issue new debt and equity. Tropical’s investment banker provided the following information about the cost of issuing new debt: If Tropical’s capital structure consists of 60 percent debt, what WACC break points are associated with issuing new debt? (LO 11-2)
8.4 Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures: Debt (%) After-Tax Cost of Debt (%) Cost of Equity (%) 0 — 16.0 20 6.6 17.0 40 7.8 19.0 60 10.2 22.0 80 14.0 27.0 What is the firm’s optimal capital structure? (Hint: Calculate its corporate cost of capital at each structure. Also, note that data on component costs at alternative capital structures are not reliable in real-world situations)
The management of the Silver Steel Company learned the firm needed to reevaluate its weighted average cost of capital (WACC) due to a significant issue of debt. The firm now has financed 40%. of its assets with debt and 60% using equity. Calculate the firms WACC where the firms borrowing rate is 6%, it faces a 40% tax rate and the common shareholders require a 15% rate of return: a. 11.44% b. 12.44% c. 6.44% d. 15%
Delights, Inc., recently issued new securities to finance a new TV show. The project cost $35 million, and the company paid $2.2 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debt-equity ratio?
Apollo Corporation is a private equity firm that focuses on reusable energy projects. Its major shareholders include the United Nations (UN) and other sovereign wealth funds. Apollo adopts a simple capital structure of 40% debt and 60% common equity. With the blessing of the UN, the firm is not required to pay any tax in the coming five years. The current weighted average cost of capital (WACC) of the firm is 16%, which is believed to be optimal and should remain the same in future. Further financial information on Apollo is as follows: Debt: Apollo Corporation has issued $15 million 13-year 8% p.a. coupon bonds with a par value of $1,000 and semi-annual coupon payments. The bonds will mature exactly 10 years from today with a current market price of $875.38. The firm can raise an unlimited amount of debt by selling similar issues in future. Retained earnings: The firm is expected to have $660,000 of retained earnings available in the coming year. Once these retained earnings are…
Apollo Corporation is a private equity firm that focuses on reusable energy projects. Its major shareholders include the United Nations (UN) and other sovereign wealth funds. Apollo adopts a simple capital structure of 40% debt and 60% common equity. With the blessing of the UN, the firm is not required to pay any tax in the coming five years. The current weighted average cost of capital (WACC) of the firm is 16%, which is believed to be optimal and should remain the same in future. Further financial information on Apollo is as follows: Debt: Apollo Corporation has issued $15 million 13-year 8% p.a. coupon bonds with a par value of $1,000 and semi-annual coupon payments. The bonds will mature exactly 10 years from today with a current market price of $875.38. The firm can raise an unlimited amount of debt by selling similar issues in future. Retained earnings: The firm is expected to have $660,000 of retained earnings available in the coming year. Once these retained earnings are…
Tiger Valley Inc recently had you estimate the cost of each of its capital sources. The firm typically finances with a combination of long-term debt, preferred stock, and common equity. The firm has a target of 40% debt financing and 15% preferred stock financing with the remainder of funds being raised from common equity. The after-tax cost of preferred stock has been estimated to be 4.4% while the after-tax cost of long-term debt has been estimated to be 5.2%. Due to its riskiness, the after-tax cost of equity has been estimated at a much higher rate of 12.8%. Estimate the firm’s WACC. Assume a tax rate of 40%.