Question

You are currently the CFO of a firm worth $1 billion and you are considering issuing some additional perpetual debt in order to change your firm's capital structure. Your current beta is 0.93 and you currently have $124 million in debt. You are planning to issue $215 million in additional perpetual debt. Your firm faces a 35% corporate tax rate. Given that the current risk free rate is 2.83% and the current market risk premium is 5.11%, what will be the new required return for your firm's equity holders?

Answer #1

*Current Capital
Structure*

Total Worth = $ 1000 Million

Debt = $ 124 Million

Equity = 1000-124 = $ 876 Million

**Debt to Equity Ratio = 124/876 = 0.1416**

**Beta (Unlevered) = Beta (Levered) / [ 1 + (1-T) *
D/E]**

Beta (Unlevered) = 0.93 / [ 1 + (1-0) * 0.1416]

Beta (Unlevered) = 0.93 / 1.1416

Beta (Unlevered) = 0.8147

*New Capital
Structure*

Total Worth = $ 1000 Million + 215 Million = $ 1215 Million

Debt = $ 124 Million + 215 Million = $ 339 Million

Equity = 1000-124 = $ 876 Million

**Debt to Equity Ratio = 339/876 = 0.3870**

**Beta (Levered) = Beta (Unlevered) * [ 1 + (1-T) *
D/E]**

Beta (Levered) = 0.8147 * [ 1 + (1-0) * 0.3870]

Beta (Levered) = 0.8147 * 1.3870

Beta (Levered) = 1.13

Risk Free Rate = 2.83%

Market Risk Premium = 5.11%

**Required return for your firm's equity holders = Risk
Free Rate + Beta*Market Risk Premium**

r = 2.83% + 1.13*5.11%

**r = 8.60%**

Fortune Enterprises is an all-equity firm that is considering
issuing $13.5 million of perpetual debt. The interest rate is 10%.
The firm will use the proceeds of the bond sale to repurchase
equity. Fortune distributes all earnings available to stockholders
immediately as dividends. The firm will generate $3 million of
earnings before interest and taxes (EBIT) every year into
perpetuity. Fortune is subject to a corporate tax rate of 40%.
Suppose the personal tax rate on interest income is 55%,...

is considering issuing $10,000,000 worth of perpetual bonds
yielding $600,000 interest per year. ABC currently has no debt
outstanding and will use the bond proceeds to repurchase equity.
ABC has 100% dividend payout ratio and EBIT is $2,000,000 per year
forever. Corporate tax rate is 30%.
If the personal tax rate is 28%, which plan (all equity or debt
+ equity) offers the investors the highest cash flows? Why?
If the shareholders require a 15% return before personal taxes,
what...

6. Fortune Enterprises is an all-equity firm that is considering
issuing $13.5 million of perpetual debt. The interest rate is 10%.
The firm will use the proceeds of the bond sale to repurchase
equity. Fortune distributes all earnings available to stockholders
immediately as dividends. The firm will generate $3 million of
earnings before interest and taxes (EBIT) every year into
perpetuity. Fortune is subject to a corporate tax rate of 40%.
Suppose the personal tax rate on interest income is...

A firm has an equity beta of 1.28. Currently, the market value
of the firm’s debt is $10.00 million, while the market value of the
firm’s equity is $30.00 million. The firm is considering adjusting
their capital structure by either paying down debt or issuing
additional debt. They want to consider the options.
The firm faces a tax rate of 40.00%. The risk free rate in the
economy is 2.00%, while the market portfolio risk premium is 6.00%.
The cost...

Mizer Corp. currently has 80 million shares worth $45 each and
no debt. Mizer is considering issuing some debt and using the
proceeds to pay a dividend, such that the scale of firm operations
would not change. Debt would be sold at a fair price. Following are
the possible debt amounts with corresponding effects on the
firm:
Value of Debt
Present Value of Tax Shields
Present Value of Bankruptcy Costs
$400 million
$95 million
$5 million
$500 million
$180 million...

Federal Inc. currently finances with 25% debt (i.e., wd = 25%),
but its new CFO is considering changing the capital structure so wd
= 50% by issuing additional bonds and using the proceeds to
repurchase and retire common shares so the percentage of common
equity in the capital structure (wc) = 1 – wd. Given the data shown
below, by how much would this recapitalization change the firm's
cost of equity? (Hint: You must unlever the current beta and then...

ART's CEO is considering a change to the company's capital
structure, which currently consists of 25% debt and 75% equity. The
CFO believes the firm should use more debt, but the CEO is
reluctant to increase the debt ratio. The risk-free rate,
rRF, is 5.0%, the market risk premium, RPM,
is 6.0%, and the firm's tax rate is 40%. Currently, the cost of
equity, rs, is 11.5% as determined by the
CAPM. What would be the estimated cost of equity...

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%...

Firm C currently has 250,000 shares outstanding with current
market value of $42.00 per share and generates an annual EBIT of
$1,250,000. Firm C also has $1 million of debt outstanding. The
current cost of equity is 8 percent and the current cost of debt is
5 percent. The firm is considering issuing another $2 million of
debt and using the proceeds of the debt issue to repurchase shares
(a pure capital structure change). It is estimated that the cost...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 17 minutes ago

asked 33 minutes ago

asked 35 minutes ago

asked 39 minutes ago

asked 45 minutes ago

asked 57 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 2 hours ago

asked 2 hours ago