The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $20 million, it currently uses only common equity, has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 25%. Neal is a small firm with average sales of $25 million or less during the past years, so it is exempt from the interest deduction limitation. The CFO has estimated next year's EBIT for three possible states of the world: $4.1 million with a 0.2 probability, $2.2 millio with a 0.5 probability, and $700,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. not round intermediate calculations. Round your answers to two decimal places. Debt/Capital ratio is 0. RỘE: % % CV: Debt/Capital ratio is 10%, interest rate is 9%. RÔE: % % CV: Debt/Capital ratio is 50%, interest rate is 11%. RÔE: % % CV: Debt/Capital ratio is 60%, interest rate is 14%. RÔE: % % CV:

The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $20 million, it currently uses only common equity, has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 25%. Neal is a small firm with average sales of $25 million or less during the past years, so it is exempt from the interest deduction limitation. The CFO has estimated next year's EBIT for three possible states of the world: $4.1 million with a 0.2 probability, $2.2 millio with a 0.5 probability, and $700,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. not round intermediate calculations. Round your answers to two decimal places. Debt/Capital ratio is 0. RỘE: % % CV: Debt/Capital ratio is 10%, interest rate is 9%. RÔE: % % CV: Debt/Capital ratio is 50%, interest rate is 11%. RÔE: % % CV: Debt/Capital ratio is 60%, interest rate is 14%. RÔE: % % CV:

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter13: Capital Structure Concepts

Section: Chapter Questions

Problem 3P

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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?
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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.
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The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $20 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 25%. Neal is a small firm with average sales of $25 million or less during the past 3 years, so it is exempt from the interest deduction limitation. The CFO has estimated next year's EBIT for three possible states of the world: $4.7 million with a 0.2 probability, $3.3 million with a 0.5 probability, and $900,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places. Debt/Capital ratio is 60%, interest rate is 14%. RÔE: % σ: % CV:
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