Consider the following data towards a firm's potential leverage. Assumethat the firm can lever up in increments of 10% of firm value upto 60%debt in the capital mix. Further assume that the CAPM holds. How muchdebt should the firm use to minimize its financing cost?Corporate Income tax rateAsset beta45%1.2Treasury instrument rateExpected return on market portfolio6%10%Debt/Value Credit rating for the debtCredit spread0% AAA2%10% AA4%20% A6%30% A-8%40% BAA10%50% BBA14%60% BBB20%>60% JunkCredit not available

Answered: Consider the following data towards a…

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 2P

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A company had WACC (weighted average cost of capital) equal to 8. % If the company pays off mortgage bonds with an interest rate of 4% and issues an equal amount of new stock considered to be relatively risky by the market, which of the following is true? a. residual income will increase. b. ROI will decrease. c. WACC will increase. d. WACC will decrease.
A company is considering its optimal capital structure. The firm currently has 1 million shares outstanding at $ 20 per share (tax rate = 40%) and a debt balance of $5 million. Currently, its (levered) beta is 1.5 and its ERP is 5.5%. The current risk-free rate is 5%. Your research indicate the following ratings and pre-tax cost of debt across the different debt ratios: D/(D+E) Rating Pre-tax cost of debt 0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18% 80% C 20% 90% D 25% a. Using the optimal WACC approach, what is the firm's optimal debt ratio? b. Calculate the company's unlevered value, assuming that the probability of default is 5% and the company loses 30% of its value in the event of a default.
A company’s equity is valued at $10 million and debt is valued at $2 million. Its bonds tradeat the risk-free rate of 2%. If its WACC is 12.2% and its CAPM equity beta is 0.8, what must be theexpected rate of return on market portfolio? Assume that tax rate is 40%.
A firm has 17M in debt and 83M in equity. It's cost of debt is 3.8% , tax rate 23% and beta of 1.8. Current market indicates the risk free rate is 2.7% and expected return on market is 11.0%. If firm were to increase its weight of debt by 14% what would change in its WACC?
You want to estimate the Weighted Average Cost of Capital (WACC) for Levi Inc. The company’s tax rate is 21% and it has the equity beta of 1.24. Its debt value is $2,304 million and the equity market value is $70,080 million. The company’s interest expense is $83 million. Assume that the risk-free rate is 5% and the market return is 12%. Based on the information, compute the WACC for Levi
Morrison Medical Inc., an all-equity firm, has earnings before interest and taxes of $950,000, an un-levered beta of .80 and a tax rate = 35%. In the market, you observe that Government T-bills are being sold to yield 2% and the S&P/TSX Composite Index is expected to yield 9%. Assume a world with taxes and a cost for the risk of default. All general M&M assumptions apply. You have also been provided the following information: Value of Debt Cost of Debt (Rd) Beta PV of Financial Distress Costs $ 0 - .80 0 $ 5,000,000 5.5% ? $800,000 $ 7,000,000 7.0% 2 ? What is the market value of the firm? What is the market value of the firm and the market value of the equity if they issue $5,000,000 in debt with a coupon rate of 4.5% and use the proceeds to repurchase shares? What is the new cost of equity? According to CAPM, what is the new beta? What is the market value of the firm if the firm issues $7,000,000 in debt? What would be the PV of financial distress costs if…
Morrison Medical Inc., an all-equity firm, has earnings before interest and taxes of $950,000, an un-levered beta of .80 and a tax rate = 35%. In the market, you observe that Government T-bills are being sold to yield 2% and the S&P/TSX Composite Index is expected to yield 9%. Assume a world with taxes and a cost for the risk of default. All general M&M assumptions apply. You have also been provided the following information: Value of Debt Cost of Debt (Rd) Beta PV of Financial Distress Costs $ 0 - .80 0 $ 5,000,000 5.5% ? $800,000 $ 7,000,000 7.0% 2 ? What is the market value of the firm if the firm issues $7,000,000 in debt? What would be the PV of financial distress costs if the firm issues $7,000,000 in debt?
A company is estimating its optimal capital structure. Now the company has a capital structure that consists of 20% debt and 80% equity, based on market values (debt to equity D/S ratio is 0.25). The risk-free rate (rRF) is 5% and the market risk premium (rM – rRF) is 6%. Currently the company’s cost of equity, which is based on the CAPM, is 14% and its tax rate is 20%. Find the firm’s current leveraged beta using the CAPM 1.0 1.5 1.6 1.7
You have the following initial information on which to base your calculations and discussion: Debt yield = 2.6% Required Rate of Return on Equity = 12% Expected return on S&P500 = 10% Risk-free rate (rF) = 1.5% Inflation = 2.5% Corporate tax rate (TC) = 30% Current long-term and target debt-equity ratio (D:E) = 1:3 a. What is the unlevered cost of equity (rE*) for this firm? Assume that the management of the firm is considering a leveraged buyout of the above company. They believe that they can gear the company to a higher level due to their ability to extract efficiencies from the firm’s operations. Thus, they wish to use a target debt-equity ratio of 3:1 in their valuation calculations. b. What would the levered cost of equity equal for this firm at a debt-equity ratio (D:E) of 3:1? c. What would the required rate of return for the company equal if it were to be acquired under the leveraged buyout structure (i.e., what would the estimated firm WACC equal to under a…
A firm is firanced with market values of $295 million in nsk-free debt and $575 million in equity. The firm's asset beta is 0.93. Assume a risk-free rate of 2.5%, a market risk-premium of 6.2% and a tax rate of 25%. Assume the firm's debt beta is 0. What is the firms after- tax weighted average cost of capital? (answer to the fourth decimal place)
Your firm has a Return on Assets of 8.00 % , the firm can issue debt at 3.50% regardless of the leverage, and the firm's marginal tax rate is 25% . If the firm'sdebt - to - asset ratio is 24 % , what is the Cost of Equity Capital within the 1963 Miller & Modigliani framework? Group of answer choices9.35% 9.78% 6.77% 9.07% 8.81%
Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and as a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. Using the answers from Questions 7 and 8, what is the firm’s WACC?

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