6. Two firms, U and L, are identical except for their capital structure. Both will earn $150 in a Boom and $50 in a Slump. There is a 50% chance of each event. Firm U is entirely equity-financed; therefore, shareholders receive the entire income. Its shares are valued at $500. Firm L has issued $400 of risk-free debt at an interest rate of 10%; therefore, $40 of Firm L's income is paid out as interest. There are no taxes. Investors can borrow and lend at risk free rate. a. What is the value of L's stock? b. Suppose you invest $20 in Firm U's stock. Is there an alternative investment in Firm L that would give the same payoffs in a Boom and a Slump? What is the expected payoff from such a strategy? c. Now suppose that you invest $20 in Firm L's stock. Design an alternative strategy with identical payoffs. d. Now show that MM's proposition II holds. 2 of 2

6. Two firms, U and L, are identical except for their capital structure. Both will earn $150 in a Boom and $50 in a Slump. There is a 50% chance of each event. Firm U is entirely equity-financed; therefore, shareholders receive the entire income. Its shares are valued at $500. Firm L has issued $400 of risk-free debt at an interest rate of 10%; therefore, $40 of Firm L's income is paid out as interest. There are no taxes. Investors can borrow and lend at risk free rate. a. What is the value of L's stock? b. Suppose you invest $20 in Firm U's stock. Is there an alternative investment in Firm L that would give the same payoffs in a Boom and a Slump? What is the expected payoff from such a strategy? c. Now suppose that you invest $20 in Firm L's stock. Design an alternative strategy with identical payoffs. d. Now show that MM's proposition II holds. 2 of 2

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

See similar textbooks

Similar questions

H3. An unlevered firm with 300,000 shares outstanding has net income of $625,000. The firm’s stock sells for $9.50 per share and the book value per share is $12.00. The firm is considering an investment that is expected to cost $1 million and increase net income by $125,000. The cost of the investment will be financed with the issue of new shares. Assume the firm’s price-earnings ratio will remain constant. Does accounting dilution and/or market value dilution take place? Why? Show proper step by step calculation
Consider a company with different EBIT for different states of the world: Bad = $15,000; Average = $20,000; and Good = $25,000. The company has 1000 shares outstanding, and each share is valued at $300. The company is considering changing its capital structure to 50% debt which it can secure at 6%. What are the EPS for the company under each state of the world and under each capital structure (there are 6 total EPS)?
Two firms, U and L, are identical except for their capital structure. Both will earn $150in a Boom and $50 in a Slump. There is a 50% chance of each event. Firm U is entirelyequity-financed; therefore, shareholders receive the entire income. Its shares are valued at$500. Firm L has issued $400 of risk-free debt at an interest rate of 10%; therefore, $40 ofFirm L’s income is paid out as interest. There are no taxes. Investors can borrow and lendat risk free rate.a. What is the value of L’s stock?b. Suppose you invest $20 in Firm U’s stock. Is there an alternative investment inFirm L that would give the same payoffs in a Boom and a Slump? What is theexpected payoff from such a strategy?c. Now suppose that you invest $20 in Firm L’s stock. Design an alternative strategywith identical payoffs.d. Now show that MM’s proposition II holds.
Assume there are two firms with a MV of $50,000,000. Firm A consists of 10% debt and 90% equity. Firm B consists of 40% debt and 60% equity. Assume perfect capital markets and M&M Proposition 2 holds. Which firm will have a higher expected return for equity holders? Why? For the toolhar prace ALT+F10/PC or ALT+FN+F10 (Mac).
23:07 C Vol). е. Who (if anyone) gains or loses? 5. MM Proposition 2: McLaren Corp is financed entirely by common stock and has a beta of 1.0. The firm is expected to generate a level, perpetual stream of earnings and dividends. The stock has a price-earnings ratio of 8 and a cost of equity of 12.5%. The company's stock is selling for $50. The firm decides to repurchase half its shares and substitute an equal value of debt (issue debt and use the proceeds to buy back shares). The debt is riskOfree, with an interest rate of 5%. The company is exempt from corporate income taxes. Assuming MM are correct, calculate the following items after refinancing. a. The cost of equity. b. The overall cost of capital. c. The price-earnings ratio. d. The stock price. e. The stock's beta. 2 of 2 6. Two firms, U and L, are identical except for their capital structure. Both will earn $150
The Rogers Company is currently in this situation: (1) EBIT = $4.7 million; (2) tax rate, T = 40%; (3) value of debt, D = $2 million; (4) rd = 10%; (5) rs = 15%; (6) shares of stock outstanding, n = 600,000; and stock price, P = $30 Suppose the firm can increase its debt so that its capital structure has 50% debt, based on market values (it will issue debt and buy back stock). At this level of debt, its cost of equity rises to 18.5% and its interest rate on all debt will rise to 12% (it will have to call and refund the old debt). What is the WACC under this capital structure? What is the total value? How much debt will it issue, and what is the stock price after the repurchase? How many shares will remain outstanding after the repurchase?
Reactive Power Generation has the following capital structure. Its corporate tax rate is 21%. Required Rate of Return Security Market Value Debt $ 30 million 4% Preferred stock 30 million Common stock 40 million 10 What is its WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) WACC %
Give only typing answer with explanation and conclusion U and L are two firms with the same EBIT of $115,000. They are identical in every respect except firm L has a debt of $900,000 at 6% rate of interest. The cost of equity of firm U is 8% and that of firm L is 10%. Assume that arbitrage principle will be applied in this setting and it is possible to make an arbitrage profit (surplus). Also, all earnings streams are perpetuities, taxes are ignored and both firms distribute?
A5 6e DEF Company is comparing three different capital structures. Plan A is an all-equity plan and would result in 1000 shares of stock. Plan B would result in 700 shares of stock and $13,500 in debt. Plan C would result in 800 shares of stock and $9000 in debt. The firm’s EBIT will be $10,000 per year until infinity. The interest rate on the debt is 12%. e. Ignoring taxes, what is the break-even EBIT that will cause the EPS on Plan B to be equal to the EPS on Plan C?
4. Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of £24 per share. Firm X has 2 million shares outstanding and £12 million in debt at an interest rate of 5%. According to MM Proposition I, the share price for Firm X is closest to ________. A. £8.00 B. £24.00 C. £6.00 D. £12.00
2. Major Bagel is an all-equity firm. It has 20 million outstanding shares currently priced at $25 per share. Its cost of equity is 18%. Management considers borrowing $100 million at a cost of 8% per annum. They will use the money to buy back stocks. Major Bagel pays no taxes. a. After the buy back, what will be the cost of equity? b. What will be the weighted average cost of capital of the Major Bagel?
ASAP!! IN 20 minns Q.F Corporation needs additional capital of Rs. 1b. Firm decided to develop the following capital structure. Security Market value required return Debt Rs. 20,000,000 6.5% Preferred stock Rs. 30,000,000 9% Common stock Rs. 50,000,000 12.5% Its corporate tax rate is 35 percent. What is the firms weighted average cost of capital? State the pecking order theory. How will your shuffle the above capital structure in order to follow the Pecking order theory. Calculate the firm’s weighted average cost of capital, if…

SEE MORE QUESTIONS

Recommended textbooks for you

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

Foundations Of Finance

Finance

ISBN:

9780134897264

Author:

KEOWN, Arthur J., Martin, John D., PETTY, J. William

Publisher:

Pearson,

Fundamentals of Financial Management (MindTap Cou…

Finance

ISBN:

9781337395250

Author:

Eugene F. Brigham, Joel F. Houston

Publisher:

Cengage Learning

Corporate Finance (The Mcgraw-hill/Irwin Series i…

Finance

ISBN:

9780077861759

Author:

Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor

Publisher:

McGraw-Hill Education

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

Foundations Of Finance

Finance

ISBN:

9780134897264

Author:

KEOWN, Arthur J., Martin, John D., PETTY, J. William

Publisher:

Pearson,

Fundamentals of Financial Management (MindTap Cou…

Finance

ISBN:

9781337395250

Author:

Eugene F. Brigham, Joel F. Houston

Publisher:

Cengage Learning

Corporate Finance (The Mcgraw-hill/Irwin Series i…

Finance

ISBN:

9780077861759

Author:

Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor

Publisher:

McGraw-Hill Education

SEE MORE TEXTBOOKS