Exam 15: Capital Structure Decisions

Wilson Dover Inc. The total value (debt plus equity) of Wilson Dover Inc.is $500 million and the face value of its 1-year coupon debt is $200 million.The volatility (σ) of Wilson Dover's total value is 0.60, and the risk-free rate is 5%.Assume that N(d₁) = 0.9720 and N(d₂) = 0.9050. ​ -Refer to the data for Wilson Dover Inc.What is the yield on Wilson Dover's debt?

Which of the following statements is CORRECT?

Larsen Films' is analyzing its cost structure.Its fixed operating costs are $470,000, its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit.What is the company's breakeven point, i.e., at what unit sales volume would income equal costs?

Which of the following statements is CORRECT?

Which of these items will not generally be affected by an increase in the debt ratio?

VanMannen Foundations, Inc.(VF) VanMannen Foundations, Inc.(VF) is a zero-growth company that currently has zero debt, and it has the data shown below. EBIT = \ 80,000 Growth = 0\% Orig cost of equity, = 10.0\% No. of shares = 10,000 Price per share = \ 60.00 Tax rate = 25\% ​ -Refer to the data for VanMannen Foundations, Inc.(VF).Now the company is considering using some debt, moving to the market value capital structure indicated below.The money raised would be used to repurchase stock.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.If this plan were carried out, what would be VF's new WACC and its new value of operations? ? ? New interest rate == 6.00\% New cost of equity == 10.75\% New Debt / Value == 20\% New Equity / Value == 80\% $\underline{ \text { WACC } } \quad \underline { \text { Value } }$ a. $9.50 \% \quad\$ 631,579$ b. $9.80 \% \quad \$ 644,211$ c. $10.10 \% \quad \$ 657,095$ d. $10.40 \% \quad \$ 670,237$ e. $10.70 \% \quad \$ 683,641$

Eccles Inccorporated Eccles Incorporated, a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 25%.Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -Refer to the data for Eccles Incorporated.Assume that the firm's gain from leverage according to the Miller model is $126,667.If the effective personal tax rate on stock income is T_S = 20%, what is the implied personal tax rate on debt income?

Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant?

A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.

NorthWest Water (NWW) Five years ago, NorthWest Water (NWW) issued $50,000,000 face value of 30-year bonds carrying a 14% (annual payment) coupon.NWW is now considering refunding these bonds.It has been amortizing $3 million of flotation costs on these bonds over their 30-year life.The company could sell a new issue of 25-year bonds at an annual interest rate of 11.67% in today's market.A call premium of 14% would be required to retire the old bonds, and flotation costs on the new issue would amount to $3 million.NWW's marginal tax rate is 40%.The new bonds would be issued when the old bonds are called. -Refer to the data for NorthWest Water (NWW).What is the required after-tax refunding investment outlay, i.e., the cash outlay at the time of the refunding?

Merriwether Building has operating income of $20 million, a tax rate of 25%, and no debt.It pays out all of its net income as dividends and has a zero growth rate.The current stock price is $27 per share, and it has 5 million shares of stock outstanding.If it moves to a capital structure that has 40% debt and 60% equity (based on market values), its investment bankers believe its weighted average cost of capital would be 10%.What would its stock price be if it changes to the new capital structure?

LeCompte Learning Solutions is considering making a change to its capital structure in hopes of increasing its value.The company's capital structure consists of debt and common stock.In order to estimate the cost of debt, the company has produced the following table: Percent financed with debt Percent financed with equity Debt-to-equity ratio =/=(/) B ond Rating Before-tax cost of debt 0.10 0.90 0.10/0.90=0.11 AAA 7.0\% 0.20 0.80 0.20/0.80=0.25 AA 7.2 0.30 0.70 0.30/0.70=0.43 8.0 0.40 0.60 0.40/0.60=0.67 8.8 0.50 0.50 0.50/0.50=1.00 9.6 The company uses the CAPM to estimate its cost of common equity, r_s.The risk-free rate is 5% and the market risk premium is 6%.LeCompte estimates that if it had no debt its beta would be 1.0.(Its "unlevered beta," b_U, equals 1.0.) The company's tax rate, T, is 25%. On the basis of this information, what is LeCompte's optimal capital structure, and what is the firm's cost of capital at this optimal capital structure?

Whenever a firm borrows money, it is using financial leverage.

Anson Jackson Court Company (AJC) The Anson Jackson Court (AJC) currently has $150,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%.Its earnings before interest and taxes (EBIT) are $89,000, and it is a zero growth company.AJC's current cost of equity is 10%, and its tax rate is 25%.The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00. -Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense.The company would issue new bonds and use the proceeds to buy back shares of its common stock.The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS).Assuming the CFO's estimates are correct, which of the following statements is CORRECT?

The firm's target capital structure should be consistent with which of the following statements?

The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing.

A new company to produce state-of-the-art car stereo systems is being considered by Jagger Enterprises.The sales price would be set at 1.5 times the variable cost per unit; the VC/unit is estimated to be $2.50; and fixed costs are estimated at $120,000.What sales volume would be required in order to break even, i.e., to have an EBIT of zero for the stereo business?

Which of the following statements is CORRECT?

An all-equity firm with 200,000 shares outstanding, Antwerther Inc., has $2,000,000 of EBIT, which is expected to remain constant in the future.The company pays out all of its earnings, so earnings per share (EPS) equal dividends per shares (DPS).Its tax rate is 25%. ​ The company is considering issuing $5,000,000 of 10.0% bonds and using the proceeds to repurchase stock.The risk-free rate is 6.5%, the market risk premium is 5.0%, and the beta is currently 0.90, but the CFO believes beta would rise to 1.10 if the recapitalization occurs. ​ Assuming that the shares can be repurchased at the price that existed prior to the recapitalization, what would the price be following the recapitalization?

Which of the following statements is CORRECT, holding other things constant?