EBK FUNDAMENTALS OF CORPORATE FINANCE A
10th Edition
ISBN: 9780100342613
Author: Ross
Publisher: YUZU
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Textbook Question
Chapter 14, Problem 8CRCT
Cost of Capital [LO5] Suppose Tom O’Bedlam, president of Bedlam Products, Inc., has hired you to determine the firm’s cost of debt and
a. The stock currently sells for $50 per share, and the dividend per share will probably be about $5. Tom argues, “It will cost us $5 per share to use the stockholders’ money this year, so the cost of equity is equal to 10 percent (= $5/50).” What’s wrong with this conclusion?
b. Based on the most recent financial statements, Bedlam Products’ total liabilities are $8 million. Total interest expense for the coming year will be about $1 million. Tom therefore reasons, “We owe $8 million, and we will pay $1 million interest. Therefore, our cost of debt is obviously $1 million/8 million = 12.5%.” What’s wrong with this conclusion?
c. Based on his own analysis, Tom is recommending that the company increase its use of equity financing because “Debt costs 12.5 percent, but equity costs only 10 percent; thus equity is cheaper.” Ignoring all the other issues, what do you think about the conclusion that the cost of equity is less than the cost of debt?
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Now, take the same firm, but put it in an environment where there is a 28% tax rate.
h. What is the value of the unleveraged firm in the world with taxes and what will be the price of
each equity share?
i. Calculate each of the following for the unleveraged firm:
ROA
ROE
•
EPS
•
Cost of Equity (Rs)
WACC
Now add the $140 million in perpetual debt.
j. What is the value of the leveraged firm in the world with taxes and what will be the price of each
equity share?
k. How many shares will be left outstanding after the change in capital structure this time
1. Calculate each of the following for the leveraged firm:
•
ROA
ROE
•
EPS
•
Cost of Equity
WACC
m. Using Rs & Rb and the relevant annual CF to equity and debt, calculate the value of the Equity
(S), the value of debt (B), and the value of the firm (V).
n. Using WACC and the relevant annual CF to the firm, calculate the value of the firm (V).
Q.An all-equity company is considering borrowing $10,000,000 and using the borrowed funds to repurchase shares. The company's cost of equity is 9%. EBIT is expected to be $3,600,000 every year forever. Assume all available earnings are immediately distributed to common shareholders and all the M&M assumptions are satisfied. If the company proceeds with the capital restructing, what will be the value of the company according to M&M Proposition I without taxes?
2) Suppose Company XYZ is evaluating a potential capital restructuring
decision. The company is evaluating its decision of taking 1 million loan
and will use the fund to repurchase shares. Currently the company do not
have any debt. The interest rate on the debt will be 10 percent. Company
XYZ currently has 150,000 shares outstanding, and the price per share is
$20. What will be the break even EBIT?
290,000
300,000
310,000
315,000
None of the above
Chapter 14 Solutions
EBK FUNDAMENTALS OF CORPORATE FINANCE A
Ch. 14.1 - What is the primary determinant of the cost of...Ch. 14.1 - What is the relationship between the required...Ch. 14.2 - What do we mean when we say that a corporations...Ch. 14.2 - Prob. 14.2BCQCh. 14.3 - Why is the coupon rate a bad estimate of a firms...Ch. 14.3 - How can the cost of debt be calculated?Ch. 14.3 - How can the cost of preferred stock be calculated?Ch. 14.4 - Prob. 14.4ACQCh. 14.4 - Prob. 14.4BCQCh. 14.4 - Under what conditions is it correct to use the...
Ch. 14.5 - Prob. 14.5ACQCh. 14.5 - Prob. 14.5BCQCh. 14.6 - Prob. 14.6ACQCh. 14.6 - Prob. 14.6BCQCh. 14 - A firm has paid dividends of 1.02, 1.10, 1.25, and...Ch. 14 - Prob. 14.3CTFCh. 14 - Why is the tax rate applied to the cost of debt...Ch. 14 - What approach to a projects costs of capital...Ch. 14 - What is the flotation cost of equity for a firm...Ch. 14 - WACC [LO3] On the most basic level, if a firms...Ch. 14 - Book Values versus Market Values [LO3] In...Ch. 14 - Project Risk [LO5] If you can borrow all the money...Ch. 14 - Prob. 4CRCTCh. 14 - DCF Cost of Equity Estimation [LO1] What are the...Ch. 14 - SML Cost of Equity Estimation [LO1] What are the...Ch. 14 - Prob. 7CRCTCh. 14 - Cost of Capital [LO5] Suppose Tom OBedlam,...Ch. 14 - Company Risk versus Project Risk [LO5] Both Dow...Ch. 14 - Divisional Cost of Capital [LO5] Under what...Ch. 14 - Prob. 1QPCh. 14 - Prob. 2QPCh. 14 - Prob. 3QPCh. 14 - Prob. 4QPCh. 14 - Prob. 5QPCh. 14 - Prob. 6QPCh. 14 - Prob. 7QPCh. 14 - Prob. 8QPCh. 14 - Prob. 9QPCh. 14 - Prob. 10QPCh. 14 - Prob. 11QPCh. 14 - Prob. 12QPCh. 14 - Prob. 13QPCh. 14 - Prob. 14QPCh. 14 - Prob. 15QPCh. 14 - Prob. 16QPCh. 14 - Prob. 17QPCh. 14 - Prob. 18QPCh. 14 - Prob. 19QPCh. 14 - Prob. 20QPCh. 14 - Prob. 21QPCh. 14 - Prob. 22QPCh. 14 - Prob. 23QPCh. 14 - 24. Flotation Costs and NPV [LO3, 4]...Ch. 14 - Prob. 25QP
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