Question

Answer the question in an Excel spreadsheet, being sure to provide all work and reasoning as...

Answer the question in an Excel spreadsheet, being sure to provide all work and reasoning as needed to fully answer the question.

If a firm has $25 million of debt and $75 million of equity, what fraction of the firm’s value was financed with debt?

Corporate control is a factor that the firm’s decision makers use but it doesn’t necessarily work out well for firm value. Acme Inc., was founded by the Acme family and its members own the majority of its stock. Not wishing to lose control of the company, Acme has done all new borrowing with debt and it now has the highest Debt/Equity in its industry. How might this hurt the value of Acme Inc. eventually?

If a firm changes its capital structure by decreasing its ratio of debt to equity, does it increase or decrease the percent of the company finance with equity?

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Homework Answers

Answer #1

Fraction of firm's value financed by debt = 25/(25+75) = 25%

By raising the debt levels the risk in the firm ACME inc. has increased . As a result of which the cost of equity will increase making the intrinsic value of firm to lower level. The high leverage value will lower the value of firm.

If there is decrease ratio of debt to equity , then there is an increase of the company finance with equity.

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