Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote's value. Statement 2: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Elona's Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? O Statement 1: Static trade-off theory; Statement 2: MM's propositions O Statement 1: MM's propositions; Statement 2: Pecking order theory O Statement 1: Pecking order theory; Statement 2: Static trade-off theory O Statement 1: MM's propositions; Statement 2: Static trade-off theory

Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote's value. Statement 2: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Elona's Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? O Statement 1: Static trade-off theory; Statement 2: MM's propositions O Statement 1: MM's propositions; Statement 2: Pecking order theory O Statement 1: Pecking order theory; Statement 2: Static trade-off theory O Statement 1: MM's propositions; Statement 2: Static trade-off theory

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 3MC: 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: 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?
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: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during 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 128,000, 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 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.
Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Statement 2: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote’s value. Elona’s Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? Group of answer choices Statement 1: Pecking order theory; Statement 2: Static trade-off theory Statement 1: MM’s propositions; Statement 2: Pecking order theory Statement 1: Static trade-off theory; Statement 2: MM’s propositions Statement 1: MM’s propositions; Statement 2: Static trade-off theory
Elona Zuckerberg is the CFO of Facenote company. made the following statements in a conference call after the financial report of fiscal year 2020 was released: Statement 1: Increasing the debt-to-equity ratio will also make the payoff to equity investors more volatile (riskier) even with constant bankruptcy risk. Statement 2: We need to conduct a careful analysis to decide how much debt to issue because increasing our financial leverage could either increase or decrease Facenote’s value. Elona’s Statements 1 and 2, respectively, correspond most closely to which of the following theories regarding capital structure? Group of answer choices Statement 1: Pecking order theory; Statement 2: Static trade-off theory Statement 1: MM’s propositions; Statement 2: Pecking order theory Statement 1: Static trade-off theory; Statement 2: MM’s propositions Statement 1: MM’s propositions; Statement 2: Static trade-off theory PreviousNext
You work for a public company that has relied heavily ondebt financing in the past and is now considering a preferredstock issuance to reduce its debt-to-assets ratio. Debt-to-assetsis one of the key ratios in your company’s loan covenants.Should the preferred stock have a fixed annual dividend rateor a dividend that is determined yearly? In what way mightthis decision be affected by IFRS?
You have the following initial information on CMR Co. on which to base your calculations and discussion for questions 1) and 2):• Current long-term and target debt-equity ratio (D:E) = 1:4• Corporate tax rate (TC) = 30%• Expected Inflation = 1.75%• Equity beta (E) = 1.6385• Debt beta (D) = 0.2055• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) = 2.15% 1) The CEO of CMR Co., for which you are CFO, has requested that you evaluate a potential investment in a new project. The proposed project requires an initial outlay of $7.15 billion. Once completed (1 year from initial outlay) it will provide a real net cash flow of $575 million in perpetuity following its completion. It has the same business risk as CMR Co.’s existing activities and will be funded using the firm’s current target D:E ratio. a) What is the nominal weighted-average cost of capital (WACC) for this project?b) As CFO, do you recommend investment in this project? Justify your answer (numerically). Assume now…
You have the following initial information on CMR Co. on which to base your calculationsand discussion for questions 1) and 2):• Current long-term and target debt-equity ratio (D:E) = 1:4• Corporate tax rate (TC) = 30%• Expected Inflation = 1.75%• Equity beta (E) = 1.6385• Debt beta (D) = 0.2055• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) = 2.15%1) The CEO of CMR Co., for which you are CFO, has requested that you evaluate apotential investment in a new project. The proposed project requires an initial outlay of$7.15 billion. Once completed (1 year from initial outlay) it will provide a real net cashflow of $575 million in perpetuity following its completion. It has the same business riskas CMR Co.’s existing activities and will be funded using the firm’s current target D:Eratio.a) What is the nominal weighted-average cost of capital (WACC) for this project?
You have the following initial information on Financeur Co. on which to base your calculationsand discussion for questions 1) and 2):• Current long-term and target debt-equity ratio (D:E) = 1:3• Corporate tax rate (TC) = 30%• Expected Inflation = 1.55%• Equity beta (E) = 1.6325• Debt beta (D) = 0.203• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) =2.05%1) The CEO of Financeur Co., for which you are CFO, has requested that you evaluate apotential investment in a new project. The proposed project requires an initial outlay of$7.25 billion. Once completed (1 year from initial outlay) it will provide a real net cashflow of $556 million in perpetuity following its completion. It has the same business riskas Financeur Co.’s existing activities and will be funded using the firm’s current target D:Eratio.a) What is the nominal weighted-average cost of capital (WACC) for this project?b) As CFO, do you recommend investment in this project? Justify your answer(numerically).
You have the following initial information on Financeur Co. on which to base your calculations and discussion for question 2): • Current long-term and target debt-equity ratio (D:E) = 1:3 • Corporate tax rate (TC) = 30% • Expected Inflation = 1.55% • Equity beta (E) = 1.6325 • Debt beta (D) = 0.203 • Expected market premium (rM – rF) = 6.00% • Risk-free rate (rF) =2.05% 2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firm’s management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customer’s firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations. a) What would the required…
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?
General Electric Capital, a division of General Electric, uses long-term debt extensively. In a recent year, GE Capital issued 11 billion in long-term debt to investors, then within days filed legal documents to prepare for another 50 billion long-term debt issue. As a result of the 50 billion filing, the price of the initial 11 billion offering declined (due to higher risk of more debt). Bill Gross, a manager of a bond investment fund, denounced a lack in candor related to GEs recent debt deal. It was the most recent and most egregious example of how bondholders are mistreated. Gross argued that GE was not forthright when GE Capital recently issued 11 billion in bonds, one of the largest issues ever from a U.S. corporation. What bothered Gross is that three days after the issue the company announced its intention to sell as much as 50 billion in additional debt, warrants, preferred stock, guarantees, letters of credit and promissory notes at some future date. In your opinion, did GE Capital act unethically by selling 11 billion of long-term debt without telling those investors that a few days later it would be filing documents to prepare for another 50 billion debt offering? Source: Jennifer Ablan, Gross Shakes the Bond Market; GE Calms It, a Bit, Barrons, March 25, 2002.