Question

US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 25%. It currently has a levered beta of 1.10. The risk-free rate is 3%, and the risk premium on the market is 7.5%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 8%. First, solve for US Robotics Inc.’s unlevered beta_______.

Use US Robotics Inc.’s unlevered beta to solve for the firm’s levered beta with the new capital structure. Use US Robotics Inc.’s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure_________.

What will the firm’s weighted average cost of capital (WACC) be if it makes this change in its capital structure?

11.11%

9.59%

7.07%

10.10%

Answer #1

4. Determining the optimal capital
structure
US Robotics Inc. has a current capital structure of 30% debt and
70% equity. Its current before-tax cost of debt is 8%, and its tax
rate is 25%. It currently has a levered beta of 1.10. The risk-free
rate is 2.5%, and the risk premium on the market is 7.5%. US
Robotics Inc. is considering changing its capital structure to 60%
debt and 40% equity. Increasing the firm’s level of debt will cause
its...

Review this situation: Universal Exports Inc. is trying to
identify its optimal capital structure. Universal Exports Inc. has
gathered the following financial information to help with the
analysis.
Debt Ratio
Equity Ratio
rdrd
rsrs
WACC
30%
70%
7.00%
10.50%
8.61%
40%
60%
7.20%
10.80%
8.21%
50%
50%
7.70%
11.40%
8.01%
60%
40%
8.90%
12.20%
8.08%
70%
30%
10.30%
13.50%
8.38%
Which capital structure shown in the preceding table is
Universal Exports Inc.’s optimal capital structure?
____________________
Debt ratio = 60%;...

Understanding the optimal capital structure
Review this situation: Transworld Consortium Corp. is trying to
identify its optimal capital structure. Transworld Consortium Corp.
has gathered the following financial information to help with the
analysis.
Debt Ratio
Equity Ratio
EPS
DPS
Stock Price
30%
70%
1.25
0.55
36.25
40%
60%
1.40
0.60
37.75
50%
50%
1.60
0.65
39.50
60%
40%
1.85
0.75
38.75
70%
30%
1.75
0.70
38.25
1) Which capital structure shown in the
preceding table is Transworld Consortium Corp.’s optimal...

Serendipity Inc. is re-evaluating its debt level. Its current
capital structure consists of 80% debt and 20% common equity, its
beta is 1.60, and its tax rate is 25%. However, the CFO thinks the
company has too much debt, and he is considering moving to a
capital structure with 40% debt and 60% equity. The risk-free rate
is 5.0% and the market risk premium is 6.0%. What's the firm's new
cost of equity under 40% debt?
Group of answer choices...

Best Bagels, Inc. (BB) currently has zero debt, an unleveraged
firm. The firm has a total market value of $461,600. Management is
considering recapitalizing by issuing enough debt so that the firm
has a capital structure consisting of 30% debt and 70% equity,
based on a market value at a before tax cost of 7%. Best Bagels
will use the proceeds to repurchase stock at the new equilibrium
market price. Its earnings before interest and taxes (EBIT) are
$100,000, and...

Mark IV Industries' current debt to equity ratio is 0.4; it has
a (levered) equity beta of 1.4, and a cost of equity 15.2%.
Risk-free rate is 4%, the market risk premium is 8%, the cost of
debt is 4%, and the corporate tax rate is 34%. The firm is in a
matured business, ie. it is not growing anymore. It has long-term
debt outstanding that is rolled over when it matures, so that the
amount of debt outstanding does...

Circle Inc. currently uses no debt, but its new CFO is
considering changing the capital structure to 77.5% debt (wd) by
issuing bonds and using the proceeds to repurchase and retire some
common shares so the percentage of common equity in the capital
structure (wc = 1 – wd). Given the data shown below, the cost of
equity under the new capital structure minus the cost of equity
under the old capital structure is _____%. If your answer is 1.23%...

Circle Inc. currently uses no debt, but its new CFO is
considering changing the capital structure to 77.5% debt
(wd) by issuing bonds and using the proceeds to
repurchase and retire some common shares so the percentage of
common equity in the capital structure (wc = 1 –
wd). Given the data shown below, the cost of equity
under the new capital structure minus the cost of equity under the
old capital structure is _____%. If your answer is 1.23%...

Currently, Forever Flowers Inc. has a capital structure
consisting of 20% debt and 80% equity. Forever's debt currently has
an 8% yield to maturity. The risk-free rate (rRF) is 6%, and the
market risk premium (rM - rRF) is 8%. Using the CAPM, Forever
estimates that its cost of equity is currently 11.5%. The company
has a 25% tax rate.
What is Forever's current WACC? Round your answer to two decimal
places. %
What is the current beta on Forever's...

The Bonnie Situation Int'l
Inc. currently has 60 percent debt in its capital structure, the
corporate tax rate is 0.35 and the before tax cost of debt,
rd, is the same as the risk‑free rate. Given the
following market parameters,
rm = 9% , rf =3.75% , ßL =
1.07
Find the cost of equity, the
weighted average cost of capital, the operating risk, i.e.,
ßu , the cost of equity if The Bonnie Situation Int'l
Inc. were unlevered....

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