6. Break-Even EBIT and Leverage [LO1, 2] Keenan Corp. is comparing two different capital structures. Plan I would result in 7,000 shares of stock and $160,000 in debt. Plan II would result in 5,000 shares of stock and $240,000 in debt. The interest rate on the debt is 10 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $39,000. The all-equity plan would result in 11,000 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest? b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why? c. Ignoring taxes, when will EPS be identical for Plans I and II? d. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not? 7. Leverage and Stock Value [L01] Ignoring taxes in Problem 6.. price per share of eanitu ndn

6. Break-Even EBIT and Leverage [LO1, 2] Keenan Corp. is comparing two different capital structures. Plan I would result in 7,000 shares of stock and $160,000 in debt. Plan II would result in 5,000 shares of stock and $240,000 in debt. The interest rate on the debt is 10 percent. a. Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $39,000. The all-equity plan would result in 11,000 shares of stock outstanding. Which of the three plans has the highest EPS? The lowest? b. In part (a), what are the break-even levels of EBIT for each plan as compared to that for an all-equity plan? Is one higher than the other? Why? c. Ignoring taxes, when will EPS be identical for Plans I and II? d. Repeat parts (a), (b), and (c) assuming that the corporate tax rate is 40 percent. Are the break-even levels of EBIT different from before? Why or why not? 7. Leverage and Stock Value [L01] Ignoring taxes in Problem 6.. price per share of eanitu ndn

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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A5 6e DEF Company is comparing three different capital structures. Plan A is an all-equity plan and would result in 1000 shares of stock. Plan B would result in 700 shares of stock and $13,500 in debt. Plan C would result in 800 shares of stock and $9000 in debt. The firm’s EBIT will be $10,000 per year until infinity. The interest rate on the debt is 12%. e. Ignoring taxes, what is the break-even EBIT that will cause the EPS on Plan B to be equal to the EPS on Plan C?
Leverage and the Cost of Capital. The common stock and debt of Northern Sludge are valuedat $70 million and $30 million, respectively. Investors currently require a 16% return onthe common stock and an 8% return on the debt. If Northern Sludge issues an additional$10 million of common stock and uses this money to retire debt, what happens to the expectedreturn on the stock? Assume that the change in capital structure does not affect the interest rateon Northern’s debt and that there are no taxes. (LO16-1)
Please answer this question: Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity? Question 4 options: 1) 11.4% 2) 12.0% 3) 12.6% 4) 13.3% 5) 14.0%
which one is correct please confirm? QUESTION 5 Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5%, and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change? a. Yes, cost of capital decreases 1.67% b. No, cost of capital increases by 0.85% c. Yes, cost of capital decreases by 2.52% d. No, stock price would decrease due to increased risk
1.10 Norwell Inc. has equity with a market value of $900 million and a current debt to capital ratio of 10%. If Norwell has an optimal debt ratio of 40% and would like to borrow money and buy back stock right now, how much additional debt will the firm have to issue? a. $260 million b. $300 million c. $400 million d. $600 million e. None of the above
The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate, T = 40%; (3) value of debt, D = $2 million; (4) rd = 10%; (5) rs = 15%; (6) shares of stock outstanding, n = 600,000; and stock price, P = $30 Suppose the firm can increase its debt so that its capital structure has 50% debt, based on market values (it will issue debt and buy back stock). At this level of debt, its cost of equity rises to 18.5% and its interest rate on all debt will rise to 12% (it will have to call and refund the old debt). What is the WACC under this capital structure? What is the total value? How much debt will it issue, and what is the stock price after the repurchase? How many shares will remain outstanding after the repurchase?
Currently, Hotel California has no debt (i.e., leverage=0). The CEO of Hotel California considers increasing leverage (=debt/(debt+equity)) 0.4. Currently, Hotel California’s CAPM beta is 1.5. The cost of debt (??) will be 10%, riskfree rate (??) is 2%, and market return (??) is 13.5%. Assume that the corporate tax rate (τ) is 50%. Your task, as the CFO of Hotel California, is to provide the cost of capital under this proposed capital structure (i.e., 25% leverage). What is the weighted average cost of capital under the proposed capital structure (i.e., 40% leverage)?
3.1 A, B, C and C have a capital of 5 000 000 where the first is with company capital, the second has 30% debt while the 3rd is 70% with borrowed capital? What is the level of leverage for each? How much return on investment, but in capital if the value of shares increases by 20%? Which company is safer if we expect a market decline of 30%, explain?
A5 6c DEF Company is comparing three different capital structures. Plan A is an all-equity plan and would result in 1000 shares of stock. Plan B would result in 700 shares of stock and $13,500 in debt. Plan C would result in 800 shares of stock and $9000 in debt. The firm’s EBIT will be $10,000 per year until infinity. The interest rate on the debt is 12%. c. Compute the break-even EBIT that will cause the EPS on Plan C to be equal to the all-equity EPS (Plan A).
The Rogers Company is currently in this situation: (1) EBIT = $5.7 million; (2) tax rate, T = 35%; (3) value of debt, D = $2.5 million; (4) rd = 12%; (5) rs = 14%; (6) shares of stock outstanding, n = 600,000; and stock price, P = $30. The firm’s market is stable and it expects no growth, so all earnings are paid out as dividends. The debt consists of perpetual bonds. a. What is the firm’s weighted average cost of capital?b. Suppose the firm can increase its debt so that its capital structure has 50% debt, based on market values (it will issue debt and buy back stock). At this level of debt, its cost of equity rises to 17.5% and its interest rate on all debt will rise to 13% (it will have to call and refund the old debt). What is the WACC under this capital structure? What is the total value? How much debt will it issue, and what is the stock price after the repurchase? How many shares will remain outstanding after the repurchase?
Q.An all-equity company is considering borrowing $10,000,000 and using the borrowed funds to repurchase shares. The company's cost of equity is 9%. EBIT is expected to be $3,600,000 every year forever. Assume all available earnings are immediately distributed to common shareholders and all the M&M assumptions are satisfied. If the company proceeds with the capital restructing, what will be the value of the company according to M&M Proposition I without taxes?
5. Answer all questions: a) Increasing financial leverage can increase both the cost of debt and the cost of equity. How can the overall cost of capital stay unchanged in this situation? Assume there is no income tax paid by the firm. b) In (a) above, why should the value of the firm remain unchanged when the capital structure changes? Explain carefully. c) A share of stock with a beta of .75 now sells for $50. The investors expect the stock to pay a year-end dividend of $2. The Treasury bill rate is 4%, and the market risk premium is 7%. If the stock price is perceived to be fair today, what must be the investors’ expectation for the price of the stock at the end of the year? [Hint: at what rate should the stock price change annually?] d) XYZ borrows $800 million at an interest rate of 7.6%. Prior to this borrowing, it was an all-equity firm. It expects to maintain this debt level indefinitely. XYZ pays taxes at an effective rate of 37%. By how is the market value of…

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