CONTEMP.FINANCIAL MGMT. (LL)-W/MINDTAP
14th Edition
ISBN: 9780357292877
Author: MOYER
Publisher: CENGAGE L
expand_more
expand_more
format_list_bulleted
Videos
Question
Chapter 12, Problem 16P
Summary Introduction
To determine: The minimum
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Novus Nyet Company has two divisions: Health Foods and Specialty Metals. Each of these divisions
employs debt equal to 30 percent of its total requirements, with equity capital used for the balance. The
current borrowing rate is 8 percent, and the company's tax rate is 40 percent. Novus Nyet wishes to
establish a minimum return standard for each division based on the risk of that division. This standard
then would serve as the transfer price of capital to the division.
The company has thought about using the capital asset pricing model in this regard. It has identified two
samples of companies, with the following mode-value characteristics:
Debt/Totat
Capitalization Ratio
Tax
Rate
Beta
Health Foods
90
.50
.40
Specialty Metals
1.25
.30
.40
Page 1 of 2
The risk-free rate presently is 6 percent, and the expected return on the market portfolio 11 percent. Using
the CAPM approach, what required returns on investment would you recommend for these two divisions?
Ace Enterprises Limited is a large company involved in production and sale of petroleum products. The Finance Department of the company is trying to determine the company’s optimal capital structure. The firms’ financial advisors have developed the following table:Equity-Ratio Debt-Ratio Before Tax Cost of Debt (Kd)100% 0% 7.00%80% 20% 8.00%60% 40% 10%40% 60% 12%20% 80% 15%The company uses and applies the Capital Assets Pricing Model to estimate its cost of common equity. The company estimates that the risk free rate is 4.0%. The market risk premium is 6.0%, and its tax rate is 30 percent. The company estimates that if it had no debt, its unlevered beta would be 1.2. Required:A. Based on the above…
Ace Enterprises Limited is a large company involved in production and sale of petroleum products. The Finance Department of the company is trying to determine the company’s optimal capital structure. The firms’ financial advisors have developed the following table:
Equity Ratio
Debt Ratio
Before Tax Cost of Debt
100%
0%
7%
80%
20%
8%
60%
40%
10%
40%
60%
12%
20%
80%
15%
The company uses and applies the Capital Assets Pricing Model to estimate its cost of common equity. The company estimates that the risk free rate is 4.0%. The market risk premium is 6.0%, and its tax rate is 30 percent. The company estimates that if it had no debt, its unlevered beta would be 1.2.
Required:
A. Based on the above information, what is the firm’s optimal capital structure?
B. What would the weighted average cost of capital be at the optimal capital structure?
C. If a firm went from zero debt to successively higher levels of debt, why would you expect its stock price to first rise, then hit…
Chapter 12 Solutions
CONTEMP.FINANCIAL MGMT. (LL)-W/MINDTAP
Ch. 12 - Prob. 1QTDCh. 12 - Prob. 2QTDCh. 12 - Prob. 3QTDCh. 12 - Prob. 4QTDCh. 12 - Prob. 5QTDCh. 12 - Prob. 6QTDCh. 12 - Prob. 7QTDCh. 12 - Prob. 8QTDCh. 12 - Prob. 9QTDCh. 12 - Prob. 10QTD
Ch. 12 - Prob. 11QTDCh. 12 - Prob. 12QTDCh. 12 - Prob. 13QTDCh. 12 - Prob. 1PCh. 12 - Prob. 2PCh. 12 - Prob. 3PCh. 12 - Prob. 4PCh. 12 - Prob. 5PCh. 12 - Prob. 6PCh. 12 - Prob. 7PCh. 12 - Prob. 8PCh. 12 - Prob. 9PCh. 12 - Prob. 10PCh. 12 - Prob. 11PCh. 12 - Prob. 12PCh. 12 - Prob. 13PCh. 12 - Prob. 14PCh. 12 - Prob. 15PCh. 12 - Prob. 16PCh. 12 - Prob. 17PCh. 12 - Prob. 18PCh. 12 - Prob. 19PCh. 12 - Prob. 20PCh. 12 - Prob. 21PCh. 12 - Prob. 22PCh. 12 - Prob. 23PCh. 12 - Prob. 24PCh. 12 - Prob. 26P
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- You are helping XYZ — a 100°/0 equity financed diversified industrial group - on the required rate of return it should be using to evaluate the performance of its various business divisions. XYZ has three divisions — Ceramics, Sanitary equipment, and Solar panels — with similar asset base. The beta values of (the listed firms comparable to) each division are as follows: • Ceramics 2.0 • Sanitary equipment 1.2 • Solar panels 2.5 (a) Estimate the cost of equity for the firm and for each division assuming a risk free rate of 10% and market risk premium of 6%. (b) The capital budgeting department uses XYZ's composite beta to fix the required rate of return on projects proposed by any division. How might this standard distort capital allocation decisions across different divisions?arrow_forwardDynamic World Vista Industries (DWVI) wishes to estimate its cost of capital for use in analyzing projects that are similar to those that already exist. The firm's current capital structure, in terms of market value, includes 30 percent corporate bond, 10 percent irredeemable loan notes, 10 percent preference shares and 50 percent ordinary shares. The firm's corporate bond has an average yield to maturity of 8.3 percent. DWVI also has an irredeemable loan notes currently trading at GHc 40 ex interest an interest rate of five (5) percent. Its preference shares have a Gllc 70 par value, an 8 percent dividend, and are currently selling for GHc 76 per share. DWVI's beta is 1.05, return on riskless asset is 4 percent and the return on the GSE (the market proxy) is 11.4 percent. The industry is in the 40 percent marginal tax bracket. Required: a) What are DWVI's pre-tax costs…arrow_forwardChelsea Gonzales Industries is trying to estimate the firm's optimal capital structure. The company has $100 million in assets, which is financed with $40 million of debt and $60 million in equity. The risk-free rate, KRF, is 3 percent, the market risk premium, km – krf, is 8 percent, and the firm's tax rate is 40 percent. Currently, the firm's cost of equity (ks) is 16.72 percent (determined on the basis of the CAPM). What would the firm's estimated cost of equity be if it were to change its capital structure from its present capital structure to 30 percent debt and 70 percent equity? A. 16.76 percent B. 15.32 percent C. 16.28 percent D. 15.69 percent E. 15.22 percent A B O D ΟΕarrow_forward
- Medallion Cooling Systems, has total assets of $10,900,000, EBIT of $1,990,000, and preferred dividends of $205,000and is taxed at a rate of 40%.In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment: Capital structure debt ratio Cost of debt, rd Number of common stock shares Required return, rs 0% 0% 198,000 12.1% 15 7.9 171,000 13.2 30 8.9 141,000 13.8 45 12.1 107,000 16.1 60 14.9 76,000 20.1 a. Calculate earnings per share for each level of indebtedness. Debt Ratio 0% EBIT $ 1,990,000 Less: Interest $ EBT $ Taxes @40% $ Net profit $ Less: Preferreddividends $ Profits available to common stockholders $…arrow_forwardDynamic World Vista Industries (DWVI) wishes to estimate its cost of capital for use in analyzing projects that are similar to those that already exist. The firm’s current capital structure, in terms of market value, includes 30 percent corporate bond, 10 percent irredeemable loan notes, 10 percent preference shares and 50 percent ordinary shares. The firm’s corporate bond has an average yield to maturity of 8.3 percent. DWVI also has an irredeemable loan notes currently trading at GHc 40 ex interest an interest rate of five (5) percent. Its preference shares have a Gllc 70 par value, an 8 percent dividend, and are currently selling for GHc 76 per share. DWVI's beta is 1.05, return on riskless asset is 4 percent and the return on the GSE (the market proxy) is 11.4 percent. The industry is in the 40 percent marginal tax bracket. Required: a) What are DWVI's pre-tax costs of debts,…arrow_forwardMid-States is a multi-divisional utility company. Mid-States has fourdivisions with the following betas and proportions of the firm's totalassets:Division Beta % of AssetsElectric & Gas 0.75 45Bus transportation 1.21 20Real estate 2.80 25Recreation 1.85 10The risk-free rate is 2 percent and the return on the stock market as awhole is 15%. If Mid-States is considering a residential development,what should the firm use as its cost of equity in evaluating this project?arrow_forward
- Situational Software Co. (SSC) 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, faF, is 3%; the market risk premium, RPM, is 5%; and the firm's tax rate is 40%. Currently, SSC's cost of equity is 15%, which is determined by the CAPM. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below. Open spreadsheet What would be SSC's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? Round your answer to two decimal places. Do not round intermediate steps. Check My Work Reset Problem @om ईarrow_forwardSituational Software Co. (SSC) is trying to establish its optimalcapital 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, rRF,is 4%; the market risk premium, RPM, is 5%; and the firm’s tax rate is 40%. Currently,SSC’s cost of equity is 12%, which is determined by the CAPM. What would beSSC’s estimated cost of equity if it changed its capital structure to 40% debt and60% equity?arrow_forwardLCG Distribution Company is in the process of setting its target capital structure. The CFO believes that the optimal debt ratio is somewherebetween 20% and 50%, and her staff has compiled the following projections for EPS and the stock price at various debt levels. What is LCG’s optimal capital structure?arrow_forward
- A firm has two divisions, Retail and Production. The firm's overall asset beta is 1.2, and that of the Retail division is 1.5. Almost 60% of the firm's assets are in Retail division. If the target debt ratio of Production division is 25%, the risk-free rate is 4% and the (expected) market risk-premium is 6%, what is the Production division's cost of equity?arrow_forwardNetglobe Ltd is a well established company providing telecommunications services. An analyst has collected the following information and wants to estimate the enterprise value of Netglobe using the discounted free cash flow (FCF) model: ● ● ● . . The cost of equity is 15%. The cost of debt is 6%. • The weighted average cost of capital is 10%. Using the discounted free cash flow model and the information above, the the enterprise value of Netglobe is $ million. Note: Please provide your answer with two decimal points in $ million the format of xx.xx (for example, if the answer is $12.34 million, type in 12.34). Netglobe's FCF was $16 million in year 0 (historical FCF in the year just passed). Netglobe expects its FCF to grow by 5% per year for the next three years (in year 1, year 2 and year 3). Netglobe expects its FCF to grow by 3% per year indefinitely thereafter. Assume all cash flows occur at the end of the year. ● 4arrow_forwardWestern Wear is considering a project that requires an initial investment of $602,000. The firm maintains a debt-equity ratio of .55 and has a flotation cost of debt of 4.9 percent and a flotation cost of equity of 10.2 percent. The firm has sufficient internally generated equity to cover the equity portion of this project. What is the initial cost of the project including the flotation costs?arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY