Question

Asked Oct 30, 2019

428 views

- XYZ company has the following expected cash flows for three scenarios that could occur:

Recession Expected Expansion

(prob. = .2) (prob. = .5) (prob. =.3)

EBIT $10,000 $20,000 $30,000

MV Assets ______ ______ ______

(a) Complete the table above if the company is 100% equity financed and the non-levered return on equity is expected to be 12%

(b) If the company pays tax at a 30% rate and it wants to recapitalize (debt for equity swap) to save on taxes, what is the most debt the company can add (at a 6% rate) so that it will never go bankrupt under the above scenarios? (Assume the company goes bankrupty if EBIT < Interest owed)

(c) Calculate the WACC for the unlevered case and for the result in part (b).

(d) What is the market value of the assets if the firm chooses the debt level in part (b)?

(e) If further analysis suggests that the following can be used to predict the cash flows of the company: EBIT = $1500 x random number chosen from 1 to 20

What is the optimal deb/equity ratio if the company wants to limit the probability of bankruptcy to 5% or less?

Step 1

In an levered firm, there is no debt amount therefore no interest amount is payable that is 0. The EPS stands for earning per share deteremined by dividing the net Profit after interest and taxes with the number of equity share holders of the company. In the given case, no tax rate is given therefore it is taken is 0. The ROA stands for return on assets and it it obtained by dividing the net progit with the total average assets of the company. The ROE stands for return on equity and it is ascertained by dividing the net income with the shareholder’s equity amount of the company.

Step 2

Under unlevered firm, the EPS in each scenario recession, expected and expansion is $1, $2, $3 respectively.

The ROA is $0.05, $0.10, $0.15 and ROE is $0.05, $0.10 and $0.15.

Step 3

In an levered firm, the interest is calcultaed by multiplying the interest rate with the debt amount. The EPS stands for earning per share deteremined by dividing the net Profit after interest and taxes with the number of equity share holders of the company. In the given case, no tax rate is given ther...

Tagged in

Find answers to questions asked by student like you

Show more Q&A

Q: Is there an easily identifiable debt-equity ratio that will maximize the value of a firm?

A: Theoretically, there exists a debt equity ratio at which the value of the firm gets maximized. Howev...

Q: On January 1, 2013, your brother's business obtained a 30-year amortized mortgage loan for $350,000 ...

A: We can find the interest expenses for the year 2014 by accumulating the interest portion of each fo ...

Q: A family spends $46,000 a year in living expenses.If prices increase 3% a year for the next 3 years ...

A: The value of the asset that is expected to be in future due to specified growth rate is known as fut...

Q: Please show all equations and work as needed. Make the correct answer clear. If possible, please typ...

A: Note: Calculations are typed as per request for your convenienceWhen an IPO is priced below the poss...

Q: On March 11, the existing or current (spot) 1-, 2-, 3-, and 4-year zero-coupon Treasury security rat...

A: Calculate the one-year forward rate on year 2 as follows:

Q: Atlantic Corporation is the largest logging company in the north eastern part of the United States. ...

A: Last years dividend = D0 = $ 5 per shareGrowth rate in dividend, g = -5%Ke = the required rate of re...

Q: You were hired as a consultant to XYZ Company, whose target capital structure is 30% debt, 8% prefe...

A: target capital structure:Proportion of debt = Wd = 30%Proportion of preferred capital = Ws = 8% andP...

Q: (Solving for i of an annuity) You lend a friend $30,000, which your friend will repay in five equal ...

A: We can solve the rate of return using the Financial calculator or excel. I will demonstrate both the...

Q: 3. Your client has a 2-year old child whose college education they plan to fund when the child turns...

A: Calculation of Lump Sum Payment and Monthly Payments:The lump sum payment is $746,005.43 and monthly...