EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN: 9781337514835
Author: MOYER
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 14, Problem 10QTD
Summary Introduction
To discuss: The way public utilities usually have capital structures ratios with 50% debt, while major oil firms have an average debt in their capital of about 25%.
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Industries vary with regard to their capital structure. In the observed
capital structure, which of the following tends to have the LEAST debt
leverage?
All industries have about 50% debt and 50% equity.
Electrical utilities
O Airline operators
O Drug manufacturers
Comment on each of the following statements:a) Equity cost of a company with debt is higher than that of a company without debt due to risk of bankruptcy.b) Only risks associated with corporate bonds are interest rate and reinvestment risk.c) In Modigliani-Miller model (from 1963) cost of capital depends positively on cost of debt.d) Weighted average cost of capital (WACC) can always be used to value projects or companies.e) All projects with positive NPV should be accepted and those with negative NPV should be rejected.f) Greater the growth opportunities, higher the level of indebtedness of companies.g) More tangible assets the firm has, the higher the level of indebtedness.
Aaron Athletics is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common equity. In order to estimate the cost of capital at various debt levels the company has constructed the following table:
Percent financed with debt (wD)
Percent financed with equity (ws)
Before tax cost of debt
0.10
0.90
7.0%
0.20
0.80
7.2%
0.30
0.70
8.0%
0.40
0.60
8.8%
0.50
0.50
9.6%
The company uses the CAPM to estimate its cost of equity, rS . The risk-free rate is 4% and the market risk premium is 5%. Aaron estimates that if it had no debt its beta would be 1.0. (It’s unlevered beta equals 1.0). The company’s tax rate is 40%.
On the basis of this information, what is the company’s optimal capital structure, and what is the WACC at that capital structure? (Show your calculations at each debt level).
Chapter 14 Solutions
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Ch. 14.A - Prob. 1QTDCh. 14.A - Prob. 2QTDCh. 14.A - Prob. 3QTDCh. 14.A - Prob. 2PCh. 14.A - Prob. 3PCh. 14.A - Prob. 4PCh. 14.A - Prob. 5PCh. 14.A - Prob. 6PCh. 14.A - Prob. 7PCh. 14.A - Prob. 8P
Ch. 14 - Prob. 1QTDCh. 14 - Prob. 2QTDCh. 14 - Prob. 3QTDCh. 14 - Prob. 4QTDCh. 14 - Prob. 5QTDCh. 14 - Prob. 6QTDCh. 14 - Prob. 7QTDCh. 14 - Prob. 8QTDCh. 14 - Prob. 9QTDCh. 14 - Prob. 10QTDCh. 14 - Prob. 11QTDCh. 14 - Prob. 1PCh. 14 - Prob. 2PCh. 14 - Prob. 3PCh. 14 - Prob. 4PCh. 14 - Prob. 5PCh. 14 - Prob. 6PCh. 14 - Prob. 7PCh. 14 - Prob. 8PCh. 14 - Prob. 9PCh. 14 - Prob. 10PCh. 14 - Prob. 11PCh. 14 - Prob. 12PCh. 14 - Prob. 13PCh. 14 - Prob. 14PCh. 14 - Prob. 15PCh. 14 - Prob. 16PCh. 14 - Prob. 17PCh. 14 - Prob. 18PCh. 14 - Prob. 19PCh. 14 - Prob. 20PCh. 14 - Prob. 21PCh. 14 - Prob. 22PCh. 14 - Prob. 23PCh. 14 - Prob. 24PCh. 14 - Prob. 25PCh. 14 - Prob. 26PCh. 14 - Prob. 27PCh. 14 - Prob. 28PCh. 14 - Prob. 29PCh. 14 - Prob. 30PCh. 14 - Prob. 31PCh. 14 - Prob. 32PCh. 14 - Prob. 33PCh. 14 - Prob. 34P
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