Intermediate Financial Management (MindTap Course List)
12th Edition
ISBN: 9781285850030
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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Chapter 17, Problem 8MC
Summary Introduction
Case-summary:
Company L CEO Person D is worried about the amount of debt financing for his company. The business employments short-term obligation to fund its needs for immediate working capital but has no fixed debt. Another companies with sun powered innovation normal approximately 30% obligation, and Person L is wondering why they are using so much more obligation and the manner in which it influences share prices. To get some insight into the matter, he asks you, his recently hired assistant, and the following questions.
To determine: The value of debt and yield and value of equity.
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A company has a zero coupon bond issue with a face value of $2.2 million that matures in one year. The assets of the firm are currently valued at $3.4 million, but this amount is expected to either decrease to $2.5 million or increase to $3.8 million in a year's time. Assume the risk-free rate is 6%. What is the value of the equity?
The total market value of the equity of Okefenokee Condos is $6 million, and the total value of its debt is $4 million. The treasurer estimates that the beta of the stock currently is 0.5 and that the expected risk premium on the market is 12%. The Treasury bill rate is 4%, and investors believe that Okefenokee's debt is essentially free of default risk.
a. What is the required rate of return on Okefenokee stock? (Do not round intermediate calculations. Enter your answer as a whole percent.)
b. Estimate the WACC assuming a tax rate of 21%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
c. Estimate the discount rate for an expansion of the company’s present business. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
d. Suppose the company wants to diversify into the manufacture of rose-colored glasses. The beta of optical manufacturers with no debt outstanding is 1.5. What is the…
Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
a. A 5-year corporate bond must have a lower yield than a 7-year Treasury security.
b. The yield curve for U.S. Treasury securities will be upward sloping.
c. A 5-year corporate bond must have a lower yield than a 5-year Treasury security.
d. The real risk-free rate cannot be constant if inflation is not expected to remain constant.
e. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
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