CONTEMP. FINANCIAL MGT.-W/MINDTAP V3
14th Edition
ISBN: 9780357292839
Author: MOYER
Publisher: CENGAGE L
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Chapter 15, Problem 9P
a.
Summary Introduction
To Discribe: The factors that can we cite for the accounts of phenomenon.
b.
Summary Introduction
To Discribe: The suggestion of an optimal dividend policy for both the companies, and that might increase in both of the share price.
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Two firms, No Leverage Inc. and High Leverage Inc. have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $600,000 of perpetual debt in its capital structure. Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. You are given the following data:
No Leverage, Inc.
High Leverage, Inc.
Equity in capital structure
$
1,400,000
$
800,000
Cost of equity, ke
10
%
11
%
Debt in capital structure
-
$
600,000
Pretax cost of debt, kd
-
8.5
%
Net operating income (EBIT)
$
150,000
$
150,000
Determine the
Market value of No Leverage, Inc. Round your answer to the nearest dollar.$
Market value of High Leverage, Inc. Round your answer to the…
Two companies, A and B, have the same expected earnings in the current year. Each
company is equally risky, but company A pays out 50% of earnings while company B pays out
only 10% of earnings. (Both companies are all equity financed.) As a result, company B's
shares are priced at a discount in the market, and it is anticipated that this state of affairs will
continue. The rate of return on reinvestment in company B is the same as that in company A
which is merely expanding. The current share price of company A's share is 110p ex div., and
the earnings per share at the end of the current year are expected to be 22p. The current
share price of company B's shares is 88p ex div. (Both companies have the same number of
shares in issue.)
Required
(i)
Assuming company A's shares are 'correctly' priced, what is the return on
company B's shares at the end of the current year (show both the dividend and
the capital gain)? In which company would you advise an individual to invest?
Fully explain…
Consider two firms that are identical in every respect EXCEPT for their capital structures. The unlevered firm is financed entirely by equity whereas the capital structure of the levered firm includes $30,000 of debt at 12%.The annual earnings of both companies before interest are the same, $10,000. The cost of equity in the unlevered firm is 15% and in the levered company at 16%.
A) Determine the market values of the two companies.
B) Suppose an investor owns 1% of the equity in the levered firm, describe the arbitrage process.
Chapter 15 Solutions
CONTEMP. FINANCIAL MGT.-W/MINDTAP V3
Ch. 15 - Prob. 1QTDCh. 15 - Prob. 2QTDCh. 15 - Prob. 3QTDCh. 15 - Prob. 4QTDCh. 15 - Prob. 5QTDCh. 15 - Prob. 6QTDCh. 15 - Prob. 7QTDCh. 15 - Prob. 8QTDCh. 15 - Prob. 9QTDCh. 15 - Prob. 10QTD
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