Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity, it has a beta of 1.60, and its tax rate is 35%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk - free rate is 5.0% and the market risk premium is 6.0%. By how much would the firm's cost of equity change as a result of altering its capital structure?

Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity, it has a beta of 1.60, and its tax rate is 35%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk - free rate is 5.0% and the market risk premium is 6.0%. By how much would the firm's cost of equity change as a result of altering its capital structure?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter12: The Cost Of Capital

Section: Chapter Questions

Problem 7P

See similar textbooks

Similar questions

Ogier Incorporated currently has $800 million in sales, which are projected to grow by 10% in Year 1 and by 5% in Year 2. Its operating profitability ratio (OP) is 10%, and its capital requirement ratio (CR) is 80%? What are the projected sales in Years 1 and 2? What are the projected amounts of net operating profit after taxes (NOPAT) for Years 1 and 2? What are the projected amounts of total net operating capital (OpCap) for Years 1 and 2? What is the projected FCF for Year 2?
Vafeas Inc.'s capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 40%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk-free rate is 5.0% and the market risk premium is 6.0%. By how much would the capital structure shift change the firm's cost of equity? (Just calculate the change in the cost of equity). A. -5.20% B. -6.36% C. -7.69% D. -6.99% E. -5.65%
Stephens Electronics is considering a change in its target capital structure, which currently consists of 25% debt and 75% equity. The CFO believes the firm should use more debt, but the CEO is reluctant to increase the debt ratio. The risk-free rate, rRFrRF, is 5.0%, the market risk premium, RPM, is 6.0%, and the firm s tax rate is 40%. Currently, the cost of equity, rsrs, is 11.5% as determined by the CAPM. What would be the estimated cost of equity if the firm used 60% debt?
Serendipity Inc. is re-evaluating its debt level. Its current capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 25%. However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity. The risk-free rate is 5.0% and the market risk premium is 6.0%. By how much would the capital structure shift change the firm's cost of equity? a. −5.40% b. −7.99% c. −6.00% d. −7.26% e. −6.60%
Lucky cement Co. is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Lucky’s cost of equity is 14%, which is determined by the CAPM. What would be Lucky’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? What would be Lucky’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? Based on cost of equity estimations, should the firm change its capital structure? if yes, which point is optimal if the target is to minimize the cost of equity of the firm?
Cyclone Software Co. is trying to establish its optimal capital structure. Its current capital structure consists of 25% debt and 75% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Cyclone’s cost of equity is 14%, which is determined by the CAPM. What would be Cyclone’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? based on cost of equity estimations, Should the firm change its capital structure?
Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of Return 1 $2,000 16.00% 2 3,000 15.00 3 5,000 13.75 4 2,000 12.50 The company estimates that it can issue debt at a rate of rd = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $6 per year at $57 per share. Also, its common stock currently sells for $39 per share; the next expected dividend, D1, is $4.50; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate calculations. Cost of debt _________% Cost…
Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of Return 1 $2,000 16.00% 2 3,000 15.00 3 5,000 13.75 4 2,000 12.50 The company estimates that it can issue debt at a rate of rd = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $3 per year at $44 per share. Also, its common stock currently sells for $36 per share; the next expected dividend, D1, is $3.75; and the dividend is expected to grow at a constant rate of 7% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. A. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate calculations. Cost of debt Cost of preferred stock Cost of retained earnings B. What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7.5%, and Globex Corp.’s beta is 1.25. If the firm’s tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 25%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 8%. First, solve for US Robotics Inc.’s unlevered beta. Use US Robotics Inc.’s unlevered beta…
Daichi Inc. is reassessing its debt position. Its current capital structure is composed of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35%. However, the CFO believes the company has too much debt and is considering switching to a capital structure with 40% debt and 60% equity. The risk-free rate is 4.0 percent, with a 6.0 percent market risk premium. How much does a change in capital structure affect the firm's cost of equity?
Lucky cement Co. is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Lucky’s cost of equity is 14%, which is determined by the CAPM.1. What would be Lucky’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity?2. What would be Lucky’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?3. Based on cost of equity estimations, should the firm change its capital structure? if yes, which point is optimal if the target is to minimize the cost of equity of the firm?
Rolex, Inc. has equity with a market value of $20 million and debt with a market value of $10million. Assume the firm has no default risk and can borrow at the risk-free interest rate. Therisk-free interest rate is 5 percent per year, and the expected return on the market portfolio is11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost ofcapital for an otherwise identical all-equity firm?