Question

**I HAVE ALL ANSWERS EXCEPT FOR D.**

Locomotive Corporation is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 35 percent to 50 percent. The firm currently has $3.4 million worth of debt outstanding. The cost of this debt is 8 percent per year. The firm expects to have an EBIT of $1.33 million per year in perpetuity and pays no taxes. |

a. |
What is the market value of the firm before and after the
repurchase announcement? |

Market value | |

Before | $ 13114286 |

After | $ 13114286 |

b. |
What is the expected return on the firm’s equity before the
announcement of the stock repurchase plan? |

Expected return | % 10.89 |

c. |
What is the expected return on the equity of an otherwise
identical all-equity firm? |

Expected return | % 10.14 |

d. |
What is the expected return on the firm’s equity after the
announcement of the stock repurchase plan? |

Expected return | % ??? |

Answer #1

**ANSWER:**

**Required d)**

**Expected return on the firm’s equity after the
announcement of the stock repurchase plan**

**Given:**

Old debt-equity ratio = 35%

New debt-equity ratio = 50%

Worth of debt outstanding = $3,400,000

Cost of debt = 8% per year

EBIT = $1,330,000 per year

As given in the (c) part expected return on the equity of an otherwise identical all-equity firm is 10.14%

i.e. R1 = 10.14%

Cost of equity = R1 + [New debt-equity ratio * (R1 - Cost of debt)]

Cost of equity = 10.14% + [50% * (10.14% - 8%)]

Cost of equity = 0.1014 + (0.50 * 0.0214)

Cost of equity = 0.1014 + 0.0107

Cost of equity = 0.1121 or 11.21%

Taco Salad Manufacturing, Inc., plans to announce that it will
issue $2.03 million of perpetual debt and use the proceeds to
repurchase common stock. The bonds will sell at par with a coupon
rate of 5 percent. The company is currently all-equity and worth
$6.50 million with 186,000 shares of common stock outstanding.
After the sale of the bonds, the company will maintain the new
capital structure indefinitely. The annual pretax earnings of $1.27
million are expected to remain constant...

Bruin Industries just issued $350,000 of perpetual 6.1 percent
debt and used the proceeds to repurchase stock. The company expects
to generate $161,000 of earnings before interest and taxes in
perpetuity. The company distributes all its earnings as dividends
at the end of each year. The firm’s unlevered cost of capital is
11.1 percent and the corporate tax rate is 25 percent.
a.
What is the value of the company as an unlevered firm?
(Do not round intermediate calculations...

Bruin Industries just issued $275,000 of perpetual 6 percent
debt and used the proceeds to repurchase stock. The company expects
to generate $126,000 of earnings before interest and taxes in
perpetuity. The company distributes all its earnings as dividends
at the end of each year. The firm’s unlevered cost of capital is 12
percent, and the corporate tax rate is 34 percent.
A. What is the value of the company as an unlevered firm?
(Do not round intermediate calculations and...

Shadow Corp. has no debt but can borrow at 6.8 percent. The
firm’s WACC is currently 8.6 percent, and the tax rate is 35
percent.
a. What is the firm’s cost of equity? (Do not
round intermediate calculations. Enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)
Cost of equity %
b. If the firm converts to 30 percent debt, what will
its cost of equity be? (Do not round intermediate
calculations. Enter your answer as...

Ghost, Inc., has no debt outstanding and a total market value of
$262,500. Earnings before interest and taxes, EBIT, are projected
to be $42,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 16 percent higher. If
there is a recession, then EBIT will be 27 percent lower. The
company is considering a $140,000 debt issue with an interest rate
of 5 percent. The proceeds will be used to repurchase shares of...

Ghost, Inc., has no debt outstanding and a total market value of
$273,600. Earnings before interest and taxes, EBIT, are projected
to be $43,000 if economic conditions are normal. If there is strong
expansion in the economy, then EBIT will be 17 percent higher. If
there is a recession, then EBIT will be 28 percent lower. The
company is considering a $145,000 debt issue with an interest rate
of 6 percent. The proceeds will be used to repurchase shares of...

Irving Corp. has no debt but can borrow at 7 percent. The firm’s
WACC is currently 13 percent, and there is no corporate tax.
a. What is the company’s cost of equity? (Do not round
intermediate calculations and enter your answer as a percent
rounded to the nearest whole number, e.g., 32.)
b. If the firm converts to 30 percent debt, what will its cost
of equity be? (Do not round intermediate calculations and enter
your answer as a percent...

Citee Corp. has no debt but can borrow at 5.2 percent. The
firm’s WACC is currently 8.9 percent, and the tax rate is 24
percent.
a.
What is the company’s cost of equity? (Do not round
intermediate calculations and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)
b.
If the firm converts to 25 percent debt, what will its cost of
equity be? (Do not round intermediate calculations and
enter your answer as a...

Shadow Corp. has no debt but can borrow at 5.2 percent. The
firm’s WACC is currently 8.9 percent and the tax rate is 24
percent.
a.
What is the company’s cost of equity? (Do not round
intermediate calculations and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)
b.
If the firm converts to 25 percent debt, what will its cost of
equity be? (Do not round intermediate calculations and
enter your answer as a...

Citee Corp. has no debt but can borrow at 6.7 percent. The
firm’s WACC is currently 9.3 percent, and the tax rate is 23
percent.
a.
What is the company’s cost of equity? (Do not round
intermediate calculations and enter your answer as a percent
rounded to 2 decimal places, e.g., 32.16.)
b.
If the firm converts to 25 percent debt, what will its cost of
equity be? (Do not round intermediate calculations and
enter your answer as a...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 38 seconds ago

asked 5 minutes ago

asked 5 minutes ago

asked 6 minutes ago

asked 6 minutes ago

asked 12 minutes ago

asked 12 minutes ago

asked 16 minutes ago

asked 16 minutes ago

asked 20 minutes ago

asked 21 minutes ago

asked 21 minutes ago