Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
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Textbook Question
Chapter 14, Problem 12P
Hardmon Enterprises is currently an all-equity firm with an expected return of 12%. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares.
- a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 6%. What will the expected return of equity be after this transaction?
- b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon’s debt will be much riskier. As a result, the debt cost of capital will be 8%. What will the expected return of equity be in this case?
- c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument?
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Pastel Interiors is currently an all-equity firm that has an annual projected BIT of $136,900. The current cost of equity is 16.5% and the tax rate is 20%. The firm is considering adding $118,000 of debt with a coupon rate of 7.5% to its capital structure. The debt will be sold at par value. What is the value of the unlevered firm (pre-debt)?
A
$763,570
B
$663.758
C
$730,133
(D)
$696,945
) $630,570
Hardmon Enterprises is currently an all-equity firm with an expected return of
18.3%.
It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume perfect capital markets.
a.
Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is
5%.
What will be the expected return of equity after this transaction?
b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be
7%.
What will be the expected return of equity in this case?
c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument?
Biotec has estimated the costs of debt and equity capital for various proportions of debt in its
capital structure:
% of Debt Cost of Debt (%) Cost of Equity (%)
35 5.4 13.8
40 5.6 14.0
45 5.9 14.3
50 6.4 14.7
If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure?
Chapter 14 Solutions
Corporate Finance
Ch. 14.1 - How does the risk and cost of capital of levered...Ch. 14.2 - Why are investors indifferent to the firms capital...Ch. 14.2 - What is a market value balance sheet?Ch. 14.2 - In a perfect capital market, how will a firms...Ch. 14.3 - How do we compute the weighted average cost of...Ch. 14.3 - With perfect capital markets, as a firm increases...Ch. 14.4 - If a change in leverage raises a firm's earnings...Ch. 14.4 - True or False: When a firm issues equity, it...Ch. 14.5 - Consider the questions facing Dan Harris, CFO of...Ch. 14.5 - Prob. 2CC
Ch. 14 - Consider a project with free cash flows in one...Ch. 14 - You are an entrepreneur starting a biotechnology...Ch. 14 - Acort Industries owns assets that will have an 80%...Ch. 14 - Wolfrum Technology (WT) has no debt. Its assets...Ch. 14 - Suppose there are no taxes. Firm ABC has no debt,...Ch. 14 - Suppose Alpha Industries and Omega Technology have...Ch. 14 - Prob. 7PCh. 14 - Prob. 8PCh. 14 - Zetatron is an all-equity firm with 100 million...Ch. 14 - Explain what is wrong with the following argument:...Ch. 14 - Prob. 11PCh. 14 - Hardmon Enterprises is currently an all-equity...Ch. 14 - Prob. 13PCh. 14 - Prob. 14PCh. 14 - Prob. 15PCh. 14 - Hartford Mining has 50 million shares that are...Ch. 14 - Mercer Corp. has 10 million shares outstanding and...Ch. 14 - Prob. 18PCh. 14 - Prob. 19PCh. 14 - Prob. 20PCh. 14 - Prob. 21PCh. 14 - Prob. 22PCh. 14 - Prob. 23P
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