Question

Problem 17-6 Leverage and the cost of capital Macbeth Spot Removers is entirely equity financed. Use the following information. Data Number of shares 1,000 Price per share $ 10 Market value of shares $ 10,000 Expected operating income $ 1,500 Macbeth now decides to issue $5,000 of debt and to use the proceeds to repurchase stock. Suppose that Ms. Macbeth's investment bankers have informed her that since the new issue of debt is risky, debtholders will demand a return of 12.5%, which is 2.5% above the risk-free interest rate. a. Recompute the return of assets (rA) and return on equity (rE)? (Do not round intermediate calculations. Round your answers to 3 decimal places.) Return on assets 0 Return on equity b. Suppose that the beta of the unlevered stock was .6. New capital structure is 50% debt financed. What will βA, βE, and βD be after the change to the capital structure? (Round your answers to 1 decimal place.) Asset beta Debt beta Equity beta

Answer #1

A company is financed entirely with equity. It has 100,000
shares outstanding. The company proposes to issue $250,000 of debt
at an interest rate of 10% per annum and repurchase 25,000 shares
at market. The company pays no taxes (thus, the debt has no tax
shield). Net income before the issuance of debt is expected to be
$125,000.
(a) What is the price per share before the repurchase?
(b) What is the EPS before the repurchase?
(c) What is the...

Boxcars, Inc. has a capital structure consisting of $100MM in
equity and $150MM in debt. With this capital structure, the
expected return to its equity is 18 percent, the expected return to
its debt is 7 percent, and the market beta of Boxcars enterprise
value is 1.68. The risk-free rate is 3 percent. The firm
unexpectedly issues $110MM in new shares, using the cash to
repurchase $110MM of its debt. After the repurchase, the remaining
$40MM in debt is risk-free...

Boxcars, Inc. has a capital structure consisting of $100MM in
equity and $150MM in debt. With this capital structure, the
expected return to its equity is 18 percent, the expected return to
its debt is 7 percent, and the market beta of Boxcars enterprise
value is 1.68. The risk-free rate is 3 percent. The firm
unexpectedly issues $110MM in new shares, using the cash to
repurchase $110MM of its debt. After the repurchase, the remaining
$40MM in debt is risk-free...

Savvy Supermarkets is a chain of grocery stores that is
currently financed with 12.5% debt. The current rate of return on
Savvy’s equity is 16%, only slightly higher than the 14% currently
expected on the stock market index. Suppose the risk free rate is
6% and Savvy has 10 million shares outstanding for a price of $18
per share. For answering the following questions, assume all assets
are priced on the SML.
a) What is the equity beta of Savvy...

6，A
company has an EBIT of $4,865 in perpetuity. The unlevered cost of
capital is 16.70%, and there are 27,970 common shares outstanding.
The company is considering issuing $10,660 in new bonds at par to
add financial leverage. The proceeds of the debt issue will be used
to repurchase equity. The YTM of the new debt is 11.75% and the tax
rate is 36%. What is the cost of the levered equity after the
restructuring?

An all equity firm is expected to generate perpetual EBIT of
$100 million per year forever. The corporate tax rate is 35%. The
firm has an unlevered (asset or EV) Beta of 0.8. The risk-free rate
is 4% and the market risk premium is 6%. The number of outstanding
shares is 10 million.
The firm decides to replace part of the equity financing with
perpetual debt. The firm will issue $100 million of permanent debt
at the riskless interest rate...

The TQM Corporation is
located in a country where there are perfect capital markets and no
taxes. The corporation currently has $120 million in equity and $60
million in risk free debt. The return on equity, rS, is 18% and the
cost of debt, rB, is 9%. Suppose TQM decides to issue additional
equity to repurchase the $60 million in debt so that it will have
an all-equity capital structure.1. If TQM did this, what would the total value of...

An all equity firm is expected to generate perpetual EBIT of
$100 million per year forever. The corporate tax rate is 35%. The
firm has an unlevered (asset or EV) Beta of 0.8. The risk-free rate
is 4% and the market risk premium is 6%. The number of outstanding
shares is 10 million. The firm decides to replace part of the
equity financing with perpetual debt.
2) The firm will issue $100 million of permanent debt at the
riskless interest...

JT Corp.'s uses CAPM for the investment appraisal and is
financed by debt and equity only. JT estimates its WACC at 12% and
its capital structure includes 75% debt and 25% equity. JT pays tax
at 20% and its pre-tax cost of debt amounts to 12.5%. The risk-free
rate is currently 6% and the market risk premium equals 8%. Please
calculate the beta of JT and comment if you would add JT
to your portfolio as a defensive stock .

Your company doesn't face any taxes and has $256 million in
assets, currently financed entirely with equity. Equity is worth
$8.6 per share, and book value of equity is equal to market value
of equity. Also, let's assume that the firm's expected values for
EBIT depend upon which state of the economy occurs this year, with
the possible values of EBIT and their associated probabilities as
shown below: State Pessimistic Optimistic Probability of State .30
.70 Expect EBIT in State...

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