Question

Explain why the use of debt by a firm nessitates an estimate of the
cost of equity and the cost of debt and why the beta of a company
is a function of a number; identify the most important three
factors in priority order

Answer #1

1. When the business uses debt, the risk of the firm increases. It is because the firm has to make fixed debt interest payments and principal re-payment at regular intervals. This cash outflow at regular intervals increases the burden and hence increases risk of the firm

2. As the risk of the firm increases, investors who invest in the business will require a higher rate of return because of the higher risk being taken. Hence the cost of equity increases.

3. Beta being a measure of the risk the business is calculated as covariance of the return on the stock with market / variance of the return on the market.

4. The numerator "covariance of the return on the stock with market” increases because as pointed in #2, the cost of equity increases. As the numerator increases and the denominator remains constant, the beta of the firm increases.

Explain the standard CAPM method to estimating cost of equity,
and how we estimate the market risk premium and risk-free rate (and
why we use this method) Where might we find a beta estimate?
Explain the potential problems with this approach. Explain why we
might need to rely on data from the company’s 10-k to determine the
cost of debt, rather than using only the firm’s market-traded
bonds. Why would we want to know more than the interest expense
reported...

no growth firm reports the following
cost of equity 12% / cost of debt 8% / target debt-to-value
ratio 40%
current value of debt $105.26M
EBIT $40M
Depreciation=15M / capital expenditure $15
tax rate $40
use WACC valuation method estimate:
enterprise value and value of equity

Microsoft wants to estimate the average variable cost function
of producing computer diskettes. The firm believes that AVC varies
with the level of output and wages. Alan Anderson, the economist in
the research department the firm, collects monthly data on output
(the number of diskettes produced), average variable costs, and
wage rates paid by the firm over the past two years. He deflates
costs and wages by their respective price indexes in order to
eliminate inflationary influences. He them regresses...

Suppose you are trying to estimate the after tax cost of debt
for a firm as part of the calculation of the Weighted Average Cost
of Capital (WACC). The corporate tax rate for this firm is 37%. The
firm's bonds pay interest semiannually with a 5.7% coupon rate and
have a maturity of 6 years. If the current price of the bonds is
$932.56, what is the after tax cost of debt for this firm? (Answer
to the nearest tenth...

A firm is considering recapitalization, and will estimate the
cost of equity with theHamada equation. The firm is able
to buy back stock at the current market price. That is,
if the firm obtains $X million in new debt, it can buy back $X
million of common stock.
The current amount of debt is $60 million and rD =
8%. The current amount of equity is $200 million.
The firm’s current ß = 1.2. The tax rate is
40%. We observe rRF = 6% and...

Identify a good you commonly use or would like to use. Explain
at least three factors that would result in a shift in the demand
curve for that good and three factors that would result in a shift
in the supply curve for that good. Describe the effect on
equilibrium price and quantity of each factor. Finally, explain how
the shifts in demand and supply are different from movements along
the demand curve or movements along the supply curve and...

Chiquitica Company currently does not use any debt at all? (it
is an? all-equity firm). The firm has three million shares selling
for ?$37 per share. Its beta is 1.2, and the current? risk-free
rate is 2.7%. The expected return on the market for the coming year
is 10.5%. Chiquitica Company will sell ?$37,000,000 in corporate
bonds with a???$1,000 par value and use the proceeds to retire
stock. The bonds have a yield to maturity of 12?%. When the bonds...

Bounds on the Weighted Average Cost of Capital. The firm is
financed by 30% of debt and 70% of equity. The corporate tax rate
is 35%. The firm pays 2% interest rate on its debt to investors.
The risk-free rate in the economy is also 2% and the firm equity
has beta of 2.5.
a) What is the lower bound for the firm’s weighted average cost
of capital?
b) What is the upper bound for the firm’s weighted average cost...

What is the weighted average cost of capital of a company that
has debt of $8.505 million and equity of $11.143 million? The
average before-tax cost of debt is 7.30% per annum and the average
cost of equity is 10.10% per annum. The company tax rate is 30%.
Please use three methods – a mathematical formula,
SUMPRODUCT function and SUM array function, to compute the weighted
average cost of capital.

A firm is considering recapitalization, and will estimate the
cost of equity with theHamada equation. The firm is able to buy
back stock at the current market price. That is, if the firm
obtains $X million in new debt, it can buy back $X million of
common stock. The current amount of debt is $60 million and rD =
8%. The current amount of equity is $200 million. The firm’s
current ß = 1.2. The tax rate is 40%. We...

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