Exam 16: Assessing Long-Term Debt, Equity, and Capital Structure

A firm faces a 21 percent tax rate and has $6m in assets, currently financed entirely with equity. Equity is worth $200 per share, and book value of equity is equal to market value of equity. Also, let's assume that the firm's expected EBIT is $50m. The firm is considering switching to a 50 percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt. How much will ROE change if they switch to the proposed capital structure?

If bondholders of a firm in financial distress felt that they could recoup more of their investment by renegotiating their claims with the firm and allowing it to continue to operate, what type of bankruptcy would they probably push for?

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 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 shown as follows: State Pessimistic optimistic Probability of state 0.65 0.35 Expected EBIT in state \ 5 million \ 19 million The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 15 percent yield on perpetual debt. What will be the break-even level of EBIT?

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 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 shown as follows: State Recession Average Boom Probability of state 0.20 0.60 0.20 Expected EBIT in state \ 5 million \ 10 million \ 15 million The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the standard deviation in EPS if they switched to the proposed capital structure?

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $20 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 shown as follows: State Recession Average Boom Probability of state 0.20 0.60 0.20 Expected EBIT in state \ 5 million \ 10 million \ 15 million The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

HiLo, Inc., doesn't face any taxes and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 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 shown as follows: State Pessimistic optimistic Probability of state 0.33 0.67 Expected EBIT in state \ 8 million \ 15 million The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

Ultras Inc. has a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $90 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 shown as follows: State Recession Average Boom Probability of state 0.25 0.55 0.20 Expected EBIT in state \ 6 million \ 10 million \ 17 million The firm is considering switching to a 10 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

HiLo, Inc., faces a 21 percent tax rate and has $100 million in assets, currently financed entirely with equity. Equity is worth $50 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 0.65 0.35 Expected EBIT in state \ 5 million \ 15 million The firm is considering switching to a 40 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

Suppose that a company's equity is currently selling for $20 per share and that there are 2 million shares outstanding. If the firm also has 8 thousand bonds outstanding, which are selling at 99 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?

Your company has a 21% tax rate and has $800 million in assets, currently financed entirely with equity. Equity is worth $60 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 shown as follows: State Recession Average Boom Probability of state 0.15 0.60 0.25 Expected EBIT in state \ 20 million \ 50 million \ 100 million The firm is considering switching to a 20 percent debt capital structure, and has determined that they would have to pay a 10 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

Which of the following is NOT a factor for determining whether to use the active or passive approach to capital structure changes?

An all-equity financed firm has $45,000 in assets and the stock price is $10. If the firm restructures with 30 percent debt which creates interest expense of $810 per year and the firm's tax rate is 21 percent, what is the break-even EBIT?

Your company faces a 21 percent tax rate and has $300 million in assets, currently financed entirely with equity. Equity is worth $10 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 shown as follows: State Pessimistic optimistic Probability of state 0.4 0.6 Expected EBIT in state \ 8 million \ 30 million The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the level of expected EPS if they switch to the proposed capital structure?

Suppose that a company's equity is currently selling for $22 per share and that there are 4 million shares outstanding and 30 thousand bonds outstanding, which are selling at 101 percent of par ($1,000). If the firm was considering an active change to their capital structure so that the firm would have a D/E of 0.9, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell?

A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is referred to as:

All of the following are examples of the costs of financial distress EXCEPT:

Which of the following makes this a true statement? In this slightly more realistic world with corporate taxes, managers can:

Your company has a 21 percent tax rate and has $600 million in assets, currently financed entirely with equity. Equity is worth $20 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 shown as follows: State Recession Average Boom Probability of state 0.05 0.70 0.25 Expected EBIT in state \ 5 million \ 20 million \ 50 million The firm is considering switching to a 30 percent debt capital structure, and has determined that they would have to pay a 9 percent yield on perpetual debt in either event. What will be the standard deviation in EPS if they switch to the proposed capital structure?

Suppose that Papa Bell Inc.'s equity is currently selling for $95 per share, with 4 million shares outstanding. If the firm also has 80 thousand bonds outstanding, which are selling at 91.5 percent of par ($1,000), what are the firm's current capital structure weights?

An all-equity financed firm has $6m in assets and the stock price is $200. If the firm restructures with 40 percent debt which creates interest expense of $240,000 per year and the firm's tax rate is 21 percent, what is the break-even EBIT?