R2 You would like to know the beta of debt for cooper Industries. The value of coopersoutstanding equity is $40 million, and you have estimated its beta to be 1.2. However,you cannot find enough market data to estimate the beta of its debt, so you decide touse the Black-Scholes formula to find an approximate value for the debt beta. cooperhas four-year zero-coupon debt outstanding with a face value of $100 million thatcurrently trades for $75 million. Cooper pays no dividends and reinvests all of itsearnings. The four-year risk-free rate of interest is currently 5.13%. What is the beta ofcooper's debt?

Unlevered beta (or asset beta) measures the market risk of the company without the impact of debt.…

Answered: You would like to know the beta of debt…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section: Chapter Questions

Problem 25P

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Liu Industries is a highly levered firm. Suppose there is a large probability that Liu will default on its debt. The value of Lius operations is 4 million. The firms debt consists of 1-year, zero coupon bonds with a face value of 2 million. Lius volatility, , is 0.60, and the risk-free rate rRF is 6%. Because Lius debt is risky, its equity is like a call option and can be valued with the Black-Scholes Option Pricing Model (OPM). (See Chapter 8 for details of the OPM.) (1) What are the values of Lius stock and debt? What is the yield on the debt? (2) What are the values of Lius stock and debt for volatilities of 0.40 and 0.80? What are yields on the debt? (3) What incentives might the manager of Liu have if she understands the relationship between equity value and volatility? What might debtholders do in response?
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 0.6 and that the expected risk premium on the market is 10%. The Treasury bill rate is 4%, and investors believe that Okefenokee's debt is essentially free of default risk. a. What is the required rate of return on Okefenokee stock? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. 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.) c. 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.) d. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is .8. What is the…
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 0.6 and that the expected risk premium on the market is 10%. The Treasury bill rate is 4%, and investors believe that Okefenokee's debt is essentially free of default risk. a. What is the required rate of return on Okefenokee stock? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. 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.) c. 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.) d. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is .8. What is the…
Higgs Bassoon Corporation is a custom manufacturer of bassoons and other wind instruments. Its current value of operations, which is also its value of debt plus equity, is estimated to be $200 million. Higgs has $110 million face value, zero coupon debt that is due in 3 years. The risk-free rate is 5%, and the standard deviation of returns for similar companies is 60%. The owners of Higgs Bassoon view their equity investment as an option and would like to know the value of their investment. Using the Black-Scholes Option Pricing Model, how much is the equity worth? How much is the debt worth today? What is its yield? How much would the equity value and the yield on the debt change if Fethe's management were able to use risk management techniques to reduce its volatility to 45 percent? Can you explain this?
You are thinking about buying the debt in a private firm that has very similar risk and capital structure as SleazCo. SleazeCo has zero-coupon debt that requires them to pay back $160,000,000 three years from now. Given this loan, the market value of SleazCo’s equity is $25,000,000 and has a volatility of 80% per year. The annual risk-free rate is .02 at all maturities. SleazeCo has no other debt. What are the estimates of the following values for SleazCo based on the Merton Model? Volatility of Assets () = _______________ Value of Assets (V0) = _________________ Market Value of the Debt now = _________________ Value of Debt if it is risk free = _________________ Expected Loss from default = __________________ Probability of default on the debt = _______________ Expected recovery rate on the debt = ______________
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 0.6 and that the expected risk premium on the market is 10%. The Treasury bill rate is 5%, and investors believe that Okefenokee's debt is essentially free of default risk. What is the required rate of return on Okefenokee stock? Note: Do not round intermediate
Vega Inc. is a company that is only an all equity firm. In the near future, the company plans to offer 12-year bonds that will be sold at nominal value (par), but the annual nominal interest rate (coupon rate) is 7%. As an ungeared company, the beta value is 1.10, which will change after the bonds are sold but then the debt-to-equity ratio will be = 0.30 . The market's expected rate of return (Rm) is 14% and the risk-free rate (Rf) is 2.5%. Income tax is 28% A) what is the required return on credit (YTM) for indebtedness? B) What will be the rate of return on equity in case of indebtedness? C) What will be the rate of return on total capital (WACC) with leverage?
The company you work for wants you to estimate the company’s WACC; but before you do so, you need to estimate the cost of debt and equity. You have obtained the following info. 1) the firms non-callable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000 and a market price of $1,225.00. 2) the company’s tax rate is 40%. 3)the risk-free rate is 4.50%, the market risk premium is 5.50%, and the stocks beta is 1.20. 4) the target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any common stock. WHAT is the WACC?
If the financial Manager of Evergreen wants to decrease its cost of capital by adding more debt to its capital structure and arrive at a debt-equity ratio of 0.60. If its debt is in the form of a 6% semiannual bond issue outstanding with 15 years to maturity. The bond currently sells for 95% of its face value of $1000. On the other hand, suppose the risk-free rate is 3% and the market portfolio has an expected return of 9% and the company has a beta of 2. If the tax rate is 40%. Question 1 Calculate the company,s after-tax cost of debt. Question 2 Calculate the company,s cost of equity. Question 3 What would be the company’s overall cost of capital (WACC) at the targeted capital structure of debt equity ratio of 0.60? Question 4 If the company achieves this new cost of capital, would your investment decision change regarding the previous two investment opportunities? Explain your answer.
The company you work for wants you to estimate the company’s WACC; but before you do so, you need to estimate the cost of debt and equity. You have obtained the following info. 1) the firms non-callable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000 and a market price of $1,225.00. 2) thecompany’s tax rate is 40%. 3) the risk-free rate is 4.50%, the market risk premium 5.50%, and the stocks betta is 1.20. 4) the target capital structure consists of 35% debt and the balance common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. Calculate the company’s cost of retained earnings using the CAPM approach.
Jollibee is a fast-growing chain of fast-food restaurants, and the company's management is seeking to calculate its cost of equity. As an initial step, the company intends to use McDonald's beta value of 0.56 as a substitute for its own beta. McDonald's has an enterprise value of about $80 billion and a debt of $15 billion. Furthermore, Jollibee's financial analyst researched the current yield on ten-year US Treasury bonds, which is currently at 4.2%. The market risk premium is approximated to be 5%. If Jollibee has no debt financing, what is the estimate of Jollibee's beta coefficient if assuming that McDonald’s debt has a beta of 0.20?
he Finance Manager is exploring options to further reduce the company’s weighted average cost of capital. He has suggested to the company’s CEO, that increasing the company’s debt and decreasing equity may be the best option, as the cost of equity is higher than the cost of debt. As such, the company is considering issuing a $100,000 20-year bond, with an annual coupon rate of 6%, and quarterly interest payments. Required: If the company anticipates that the bond will close at a yield to maturity of 8%, given the company’s credit ratings and current market conditions, how much would an investor be willing to pay for $1,000 face value of this bond at issue?

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