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
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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
Find V, S, rs, and WACC for Firms U
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- Suppose there is a large probability that L will default on its debt. For the purpose of this example, assume that the value of Ls operations is 4 million (the value of its debt plus equity). Assume also that its debt consists of 1-year, zero coupon bonds with a face value of 2 million. Finally, assume that Ls volatility, , is 0.60 and that the risk-free rate rRF is 6%.The Rivoli Company has no debt outstanding, and its financial position is given by the following data: What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share? Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?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. Graph (a) the relationships between capital costs and leverage as measured by D/V and (b) the relationship between V and D. Now assume that Firms L and U are both subject to a 40% corporate tax rate. Using the data given in Part b, repeat the analysis called for in b(1) and b(2) using assumptions from the MM model with taxes.
- Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £50m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk free rate. Some of the relevant numbers are provided in the following table (in £ m): A. In the absence of arbitrage opportunities, the value of B is £100m B. In the absence of arbitrage opportunities, B’s weighted average cost of capital is 10% C. In the absence of arbitrage opportunities, B’s return on equity is 15% D. In the absence of arbitrage opportunities, B’s return on equity is higher than A’s return on equity.Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 51.5% debt (wd) by issuing bonds and using the proceeds to repurchase and retire some common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL - rU? Do not round your intermediate calculations. Risk-free rate, rRF 5.00% Tax rate, T 25% Market risk prem, RPM 4.00% Current wd 0% Current beta, bU 1.20 Target wd 51.5% 4.78% 3.06% 4.40% 3.63% 3.82%Tomorrow Co is financed entirely by equity that is priced to offer a 14% expected return on equity. If the company repurchases 40% of equity and substitutes an equal value of debt yielding 8%, what is the expected return on equity after refinancing? (Ignore taxes and cost of financial distress.)
- There are two firms in the same business: Air Wolf and Red Wolf. Both are in the same risk class, and each has an EBIT (Earnings Before Interest & Taxes) of $10 million. Air Wolf has no debt and Red Wolf has $4 million of debt. The cost of equity is 8% and the cost of debt is 10%. Assume a tax rate of 30%. Calculate the: (a) total value of each firm and (b) the breakdown of value or capital structure in terms of its components (debt & equity).Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m): Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his risk constant. How much does he need to borrow (in £m)? [Borrow] What fraction of A’s equity can he buy with the money raised from the sale of the 5% stake in B and his personal debt? [Astake] What is the after interests return from the investor’s position (in £m)? [AfterIntReturn] What is the profit from this arbitrage (in £m)? [Arbitrage_profit]Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m): A) Please fill in the following statements. 1) B's return on equity is [B_ROE] 2) B's debt to equity ratio is [B_D_E] 3) A's weighted average cost of capital is [A_WACC], 4) B's weighted average cost of capital is [B_WACC] B) Please answer the following questions. 5) A’s shares carry less risk than B’s shares, true or false (T/F)? [ALessRisk] 6) Assume A is fairly priced, what would be B’s weighted average cost of capital in the absence of arbitrage opportunities? [B_WACC_noarbitrage] B) Please answer the following questions. Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his…
- The DestitutusVentis Company (DV Co) has the following items on its balance sheet (question mark means that the quantity is unknown): Type of asset/liability Market value Risk (beta) Cash holdings £20m 0 Fixed investments £180m ? Short term debt £10m 0 Long term debt £70m 0.05 Equity £120m 1.1 The risk-free rate is 3%, and the average return on the market index is 7%. The number of shares outstanding for DV Co is 100m. The corporate and investor tax rates are zero. Modigliani-Miller irrelevance of dividend policy and capital structure holds. What is the weighted average cost of capital (WACC) for DV Co? The company plans to pay a dividend per share of £0.10, which is funded by increasing the company’s long-term debt correspondingly. The new debt has the same beta as the old long-term debt. What is the value per share of the DV Co’s stock on ex-dividend day if the dividend payment goes ahead? What is the beta of the equity on…Shadow Corp. has no debt but can borrow at 7.9 percent. The firm's WACC is currently 9.7 percent, and the tax rate is 23 percent. a. c. What is the firm's cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If the firm converts to 35 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) If the firm converts to 50 percent debt, what will its cost of equity be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) d-1. If the firm converts to 35 percent debt, what will the company's WACC be? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) d-2. If the firm converts to 50 percent debt, what will the company's WACC be? (Do not round intermediate calculations and…The total market value of the common stock of the Okefenokee Real Estate Company is $11.5 million, and the total value of its debt is $7.5 million. The treasurer estimates that the beta of the stock is currently 1.8 and that the expected risk premium on the market is 7%. The Treasury bill rate is 3%. Assume for simplicity that Okefenokee debt is risk-free and the company does not pay tax. Suppose the company wants to diversify into the manufacture of rose-colored spectacles. The beta of unleveraged optical manufacturers is 1.05. Estimate the required return on Okefenokee's new venture. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)