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.)

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.)

Name: The total market value of the common stock of the Okefenokee Real Esta
Uploaded: 2024-03-20T06:51:32.000Z
Channel: Bartleby
Description: 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

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter15: Capital Structure Decisions

Section: Chapter Questions

Problem 8P

See similar textbooks

Similar questions

The total market value of the equity of Okefenokee Condos is $8 million, and the total value of its debt is $2 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 12%. The Treasury bill rate is 3%, and investors believe that Okefenokee's debt is essentially free of default risk. a. Estimate the WACC assuming a tax rate of 21%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) b. Estimate the discount rate for an expansion of the company’s present business. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) c. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is 1.0. What is the required rate of return on Okefenokee’s new venture? (You should assume that the risky project will not enable the firm to issue any…
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Debt can be issued at a yield of 10.4 percent, and the corporate tax rate is 25 percent. Preferred stock will be priced at $61 and pay a dividend of $5.20. The flotation cost on the preferred stock is $7. a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) b. Compute the
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3 percent less than that for preferred stock. Debt can be issued at a yield of 11.0 percent, and the corporate tax rate is 20 percent. Preferred stock will be priced at $60 and pay a dividend of $6.40. The flotation cost on the preferred stock is $6. a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input the answer as a percent rounded to 2 decimal places.) Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Based on the facts given above, is the treasurer correct?
The treasurer of Sutton Security Systems is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 1 percent less than that for preferred stock. Debt can be issued at a yield of 7.5 percent, and the corporate tax rate is 40 percent. Preferred shares will be priced at $68 and pay a dividend of $3.50. The flotation cost on the preferred stock is $5. (Do not round intermediate calculations. Round the final answers to 2 decimal places.) a. Compute the aftertax cost of debt. Aftertax cost of debt % b. Compute the aftertax cost of preferred stock. Aftertax cost of preferred stock % c. Based on the facts given above, is she correct? multiple choice Yes No
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?
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 has 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 pretax cost of debt from Question 7, what is the cost of equity, RS?
In the Miller-Modigliani world of no taxes, the Granville Corporation (GC) has a zero-coupon bond issue with a face value of $2,000 that is coming due in one year. The value of GC's assets is currently $2,400. Chris Denison, the omnipotent CEO, believes that the assets in the firm will be worth $1,400 or $3,400 in a year. The risk-free rate is 2 percent per annum. What is the current value of the firm's equity? The current value of the debt? Brad Batman, the CFO, argues that GC can reconfigure its existing assets such that the value in a year will be $400 or $4,000. If the current value of the assets remains unchanged, would the stockholders favor such a move? Explain why or why not?
Fujita, Incorporated, has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. The company is considering a debt issue of $75,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares of stock. There are currently 8,000 shares outstanding. Ignore taxes for this problem. Assume the stock price is constant under all scenarios. a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued. (Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession. (A negative answer should be indicated by a minus sign. Do not round…
City Council Limited has 5 million shares outstanding, selling at $25 per share and there is no debt. The beta of the stock is 1.20, and its debt yielding 10%. The firm is proposing borrowing $25 million in debt and repurchasing stock. If it does so its interest rate of debt would become 12%. At the same time the beta of the stock will increase to 1.45. Assume a tax rate of 35% and debt beta of zero. The current risk-free rate is 9% and the market risk premium is 6.5%. Required: a) Calculate the company’s current weighted average cost of capital? b) Estimate the weighted average cost pf capital of the company following the introduction of debt (financial restructuring)? c) Estimate the new price of stock following the financial restructuring. d) Briefly explain the impact of increase in leverage on the expected return of equity holders.
The treasurer of a large corporation wants to invest $22 million in excess short-term cash in a particular money market investment. The prospectus quotes the instrument at a true yield of 3.33 percent; that is, the EAR for this investment is 3.33 percent. However, the treasurer wants to know the money market yield on this instrument to make it comparable to the T-bills and CDs she has already bought. If the term of the instrument is 78 days, what are the bond equivalent and discount yields on this investment? (Do not round intermediate calculations. Enter your answers as a percent rounded to 3 decimal places.) Bond equivalent yield % Discount yield %
The common stock and debt of Northern Sludge are valued at $70 million and $30 million, respectively. Investors currently require a 16.0% return on the common stock and a/an 7.7% return on the debt. If Northern Sludge issues an additional $13 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the interest rate on Northern’s debt and that there are no taxes. a. What is the new return on equity?
Rauch Inc.’s current stock price is $2 per share and it has 300 million shares outstanding. The book value of its equity is $200 million and the book value of its debt is $400 million. Assume that the beta of the firm’s debt is 0.5 and the beta of the firm’s equity is 1.5. The risk-free rate is 3% and the expected return on the market is 9%. Assume that there are no taxes or other market imperfections. What is Rauch’s asset beta? What is Rauch’s asset cost of capital? Assume that Rauch Inc. issues an additional $100 million in debt and uses the proceeds to buy back its equity. What is Rauch’s asset beta after recapitalization? What is Rauch’s asset cost of capital after recapitalization? After the recapitalization described in part (b), Rauch’s debt beta is now 0.6. What is Rauch’s equity beta after recapitalization? What is Rauch’s cost of equity after recapitalization? From the standpoint of Rauch Inc. (i.e., the firm as a whole), what is the net present value(NPV) of the…