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

Your company doesn't face any taxes and has $750 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: 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?

Your company has a 25% 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 as shown below: 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?

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 as shown below: 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?

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 schedule payments is referred to as _____________________.

This is one of the most extreme examples of firm re-leveraging which occurs when someone uses a firm's debt capacity to buy out the majority of the firm's equity holders.

The two main factors that determine a firm's capital structure are ____________________.

Which of the following statements is correct?

Suppose that a company's equity is currently selling for $19 per share and that there are 3 million shares outstanding and 10 thousand bonds outstanding, which are selling at 100 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 0.5, which type of security (stocks or bonds) would they need to sell to accomplish this, and how much would they have to sell?

Your company has a 25% 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 as shown below: 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 break-even level of EBIT?

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?

Your company doesn't face any taxes and has $150 million in assets, currently financed entirely with equity. Equity is worth $8 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: The firm is considering switching to a 25-percent debt capital structure, and has determined that they would have to pay a 12 percent yield on perpetual debt in either event. What will be the break-even EBIT?

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

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 as shown below: 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?

We use the term leverage to describe the use of debt in the firm' capital structure because:

Explain why, in a world with both corporate taxes and the chance of bankruptcy, a small firm with volatile EBIT is unlikely to have much debt?

Your company has a 40% tax rate and has $750 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: 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?

This type of bankruptcy involves a business liquidating their assets.

Which of the following is incorrect with respect to leverage buyouts (LBOs)?

Your company doesn't face any taxes and has $200 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 as shown below: The firm is considering switching to a 40-percent debt capital structure, and has determined that they would have to pay an 8 percent yield on perpetual debt in either event. What will be the break-even EBIT?

An all-equity financed firm has $650 in assets and the stock price is $20. If the firm restructures with 40% debt which creates interest expense of $17 per year and the firm's tax rate is 40%, what is the break-even EBIT?