Your firm's debt ratio is only 5.00%, but the new CFO thinks that more debt should be employed. She wants to sell bonds and use the proceeds to buy back and retire common shares so the percentage of common equity in the capital structure (wc) = 1 - wd . Other things held constant, and based on the data below, if the firm increases the percentage of debt in its capital structure (wd) 60.0%, by how much would the ROE change, i.e., what is ROE - ROE? Operating Data Other Data Capital $150,000 Old 5% ROIC = EBIT (1 - T)/Capital 13.00% Old interest ratio 10% Tax rate 35% New 60% New interest rate 12%

Your firm's debt ratio is only 5.00%, but the new CFO thinks that more debt should be employed. She wants to sell bonds and use the proceeds to buy back and retire common shares so the percentage of common equity in the capital structure (wc) = 1 - wd . Other things held constant, and based on the data below, if the firm increases the percentage of debt in its capital structure (wd) 60.0%, by how much would the ROE change, i.e., what is ROE - ROE? Operating Data Other Data Capital $150,000 Old 5% ROIC = EBIT (1 - T)/Capital 13.00% Old interest ratio 10% Tax rate 35% New 60% New interest rate 12%

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter10: Decentralization: Responsibility Accounting, Performance Evaluation, And Transfer Pricing

Section: Chapter Questions

Problem 24E: A company had WACC (weighted average cost of capital) equal to 8. % If the company pays off mortgage...

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1) A firm that is currently unlevered has WACC = rS = 10%/year. This company plans to do a recapitalization by issuing debt and repurchasing equity. After the recapitalization, the debt-to-equity (D/E) ratio will be 0.5. If the cost of debt, rD, is 6%, what will be rS after the recapitalization? 2) A firm with wD = 0.35 and wS = 0.65 plans to issue another $100 million of permanent debt. The firm's tax rate is 21%. The bonds will be issued at par with coupon rate = rD = 7%/year. The firm's WACC is 11%/year. By how much will the new debt change the value of the firm, and who will receive this value? A) Firm value will increase by $21 million, and all $21 million will go to the shareholders B) Firm value will increase by $9 million, and 35% will go to the bondholders, 65% to the shareholders C) Firm value will increase by $18.6 million, and 35% will go to the bondholders, 65% to the stockholders D) Firm value will increase by $21 million, and all $21 million will go to the…
Hardmon Enterprises is currently an all-equity firm with an expected return of 18%. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. (Assume perfect capital markets.) a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 5%. What will the expected return of equity be after this transaction? b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 7%. What will the expected return of equity be in this case? c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument? a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost…
You’ve collected the following information about Odyssey, Inc.:Sales =$165,000Net income = $14,800Dividends = $9,300Total debt = $68,000Total equity = $51,000What is the sustainable growth rate for the company? If it does grow at this rate, how much new borrowing will take place in the coming year, assuming a constant debt –equity ratio? What growth rate could be supported with no outside financing at all?
A firm that is currently unlevered has WACC = rS = 10%/year. This company plans to do a recapitalization by issuing debt and repurchasing equity. After the recapitalization, the debt-to-equity (D/E) ratio will be 0.5. If the cost of debt, rD, is 6%, what will be rS after the recapitalization?
concatti corporation hired your consulting firm to help them estimate the cost of equity. the yeild on the firms bonds is 10.50% and your firms economist believe that the cost of equity can be estimated using a risk premium of 4.85% over a firms own cost of debt. what is an estimate of the firms cost of equity from retained earnings?
Hardmon Enterprises is currently an all-equity firm with an expected return of 18.3%. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume perfect capital markets. a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 5%. What will be the expected return of equity after this transaction? b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 7%. What will be the expected return of equity in this case? c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument?
2. Concatti Corporation hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 10.50%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 4.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?
Your firm is financed 100% with equity and has a cost of equity capital of 13%. You are considering your first debt issue, which would change your capital structure to 27% debt and 73% equity. If your cost of debt is 6%, what will be your new cost of equity? Assume no change in your firm's WACC due to the change in capital structures. The new cost of equity is%. (Round to two decimal places.) ……..
Assume there are no corporate taxes. An all equity-financed firm, Imperial Industry, is considering changing its capital structure to ½ debt ½ equity. If currently the firm has a beta of 1.4, the return to the market is expected to be 10%, the risk-free rate is 5%, and the cost of debt is 5%, what is the cost of equity for the firm after the change in capital structure? a I do not want to answer this question. b 25% c 14% d 19% e 18% f 15%
Here is the problem: Famas's LLamas has a weighted average cost of capital of 7.9%. The company's cost of equity is 11% and its pretaxt cost of debt is 5.8%. The taxt rate is 25%. What is the company's target debt-equity ratio? Here is the solution: Here we have the WACC and need to find the debt-equity ratio of the company. Setting up the WACC equation, we find: WACC = .0790 = .11(E/V) + .058(D/V)(1 – .25) Rearranging the equation, we find: .0790(V/E) = .11 + .058(.75)(D/E) Now we must realize that the V/E is just the equity multiplier, which is equal to: V/E = 1 + D/E .0790(D/E + 1) = .11 + .0435(D/E) Now we can solve for D/E as: .0355(D/E) = .031 D/E = .8732 Question: I need help especifically with the part where they rearrange the equation as: .0790(V/E) = .11 + .058(.75)(D/E). How do they get an inverse (V/E) on the left side without the .11. And how do they get a (D/E) ratio. I understand…
You have been hired by a new firm that is just being started. The CFO wants to finance with 60% debt, but the president thinks it would be better to hold the percentage of debt in the capital structure (wa) to only 10%. The company is small, so it is not subject to the interest deduction limitation. Other things held constant, and based on th data below, if the firm uses more debt, by how much would the ROE change, i.e., what is ROEHigher - ROELower? Do not round your intermediate calculations. Operating Data Other Data Capital $4,000 Higher wd 60% ROIC = EBIT(1 - T)/Capital 12.00% Higher interest rate 13% %3D Tax rate 25% Lower wd 10% Lower interest rate 9% a. 3.75% b. 2.22% C 2.80% d. 2.54% e. 1,87%
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.