PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 17, Problem 18PS
MM proposition 2 Look back to Problem 17. Suppose now that Archimedes repurchases debt and issues equity so that D/V = .3. The reduced borrowing causes rD to fall to 11 %. How do the other variables change?
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1.
Looking at the template pro forma below , make this one change
The firm is not going to pay an interest rate
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If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to increase by $ ____ million dollars(put a negative sign if it is a decrease).
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QUESTION 5
Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5%, and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change?
a.
Yes, cost of capital decreases 1.67%
b.
No, cost of capital increases by 0.85%
c.
Yes, cost of capital decreases by 2.52%
d.
No, stock price would decrease due to increased risk
Chapter 17 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 17 - Homemade leverage Ms. Kraft owns 50,000 shares of...Ch. 17 - Homemade leverage Companies A and B differ only in...Ch. 17 - Corporate leverage Suppose that Macbeth Spot...Ch. 17 - Corporate leverage Reliable Gearing currently is...Ch. 17 - MMs propositions True or false? a. MMs...Ch. 17 - MMs propositions What is wrong with the following...Ch. 17 - Prob. 7PSCh. 17 - MM proposition 1 Executive Cheese has issued debt...Ch. 17 - Prob. 9PSCh. 17 - Prob. 10PS
Ch. 17 - MM proposition 2 Spam Corp. is financed entirely...Ch. 17 - MM proposition 2. Increasing financial leverage...Ch. 17 - Prob. 13PSCh. 17 - MM proposition 2 Look back to Section 17-1....Ch. 17 - MM proposition 2 Hubbards Pet Foods is financed...Ch. 17 - MM proposition 2 Imagine a firm that is expected...Ch. 17 - MM proposition 2 Archimedes Levers is financed by...Ch. 17 - MM proposition 2 Look back to Problem 17. Suppose...Ch. 17 - Prob. 19PSCh. 17 - After-tax WACC Gaucho Services starts life with...Ch. 17 - After-tax WACC Omega Corporation has 10 million...Ch. 17 - After-tax WACC Gamma Airlines has an asset beta of...Ch. 17 - Prob. 23PSCh. 17 - Investor choice People often convey the idea...Ch. 17 - Investor choice Suppose that new security designs...
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- Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at dose to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the company's home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Finally, you can also go to Morningstar.com, which will provide yield to maturity information on the firms various bond issues. A longer-term issues YTM could provide an estimate of the firms current cost of debt to be used in the WACC calculation. Remember that you need the after-tax cost of debt to calculate a firm's WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?arrow_forwardINTEREST RATE DETERMINATION AND YIELD CURVES a. What effect would each of the following events likely have on the level of nominal interest rates? 1. Households dramatically increase their savings rate. 2. Corporations increase their demand for funds following an increase in investment opportunities. 3. The government runs a larger-than-expected budget deficit. 4. There is an increase in expected inflation. b. Suppose you are considering two possible investment opportunities: a 12-year Treasury bond and a 7-year, A-rated corporate bond. The current real risk-free rate is 4%; and inflation is expected to be 2% for the next 2 years, 3% for the following 4 years, and 4% thereafter. The maturity risk premium is estimated by this formula: MRP = 0 02(t 1)%. The liquidity premium (LP) for the corporate bond is estimated to be 0.3%. You may determine the default risk premium (DRP), given the companys bond rating, from the table below. Remember to subtract the bonds LP from the corporate spread given in the table to arrive at the bonds DRP. What yield would you predict for each of these two investments? Rate Corporate Bond Yield Spread = DRP + LP U.S. Treasury 0.83% ---- AAA corporate 0.93 0.10% AA corporate 1.29 0.46 A corporate 1.67 0.84 c. Given the following Treasury bond yield information, construct a graph of the yield curve. Maturity Yield 1 year 5.37% 2 years 5.47 3 years 5.65 4 years 5.71 5 years 5.64 10 years 5.75 20 years 6.33 30 years 5.94 d. Based on the information about the corporate bond provided in part b, calculate yields and then construct a new yield curve graph that shows both the Treasury and the corporate bonds. e. Which part of the yield curve (the left side or right side) is likely to be most volatile over time? f. Using the Treasury yield information in part c, calculate the following rates using geometric averages: 1. The 1-year rate 1 year from now 2. The 5-year rate 5 years from now 3. The 10-year rate 10 years from now 4. The 10-year rate 20 years from nowarrow_forwardSubject: Financial strategy & policy Question No 4 Answer the following. iii) You have a capital structure consisting of 30% debt and 70% equity. There is an 8% yield to maturity. The risk-free rate is 5%, and the market risk premium is 6%. Using the CAPM, the cost of equity is currently 12.5%. There is 40% tax rate. (03) a) Calculate current WACC? b) Calculate the current beta on common stock? c) Calculate the beta if you had no debt in the capital structure, that is unlevered beta?arrow_forward
- Can you please answer this part c follow up question: c) Suppose the initial £90,000 is raised by borrowing at the risk-free interest rateinstead of issuing equity. What are the cash flows to equity and debt holders, andwhat is the initial value of the levered equity according to Modigliani and Miller’sPropositions? Is the company’s cost of equity the same as before? Overall, can thecompany raise the same amount of capital as before? Explain your reasoning.arrow_forwardConsider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%. a. What is the value of the debt at Date 0? What is the value of the equity at Date 0? b. Suppose the government announces that it guarantees the company’s payment to the debtholders. How much is the government guarantee worth?arrow_forward8)Glassmakers has the below characteristics. The premerger debt is $5, the premerger equity is $10. The risk free rate is 6%. The premerger beta is 1.36. The tax rate is 40%. The cost of debt premerger is 11%. The expected market rate of return is 10%. What discount rate should you use to discount Glassmakers' free cash flows and interest tax savings? 10.01% 10.06% 11.29% 11.44% 13.49%arrow_forward
- Leverage and the Cost of Capital. A firm currently has a debt-equity ratio of 1/2. The debt,which is virtually riskless, pays an interest rate of 6%. The expected rate of return on the equityis 12%. What would be the expected rate of return on equity if the firm reduced its debt-equityratio to 1/3? Assume the firm pays no taxes. (LO16-1)arrow_forwardQuantitative Problem: You are given the following information for Wine and Cork Enterprises (WCE): rRF = 4%; rM = 9%; RPM = 5%, and beta = 1 What is WCE's required rate of return? Do not round intermediate calculations. Round your answer to two decimal places. ? % If inflation increases by 1% but there is no change in investors' risk aversion, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places. ? % Assume now that there is no change in inflation, but risk aversion increases by 2%. What is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places. ? % If inflation increases by 1% and risk aversion increases by 2%, what is WCE's required rate of return now? Do not round intermediate calculations. Round your answer to two decimal places. ? %arrow_forwardWalmart (WMT) is currently all-equity financed, its equity rate of return is 15%. Walmart expects believes that if it becomes levered with a D/E ratio of 0.4, it's cost of debt will be 3.5%. What will be the new value of Walmart's cost of equity?arrow_forward
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