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

Your company doesn't face any taxes 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 as shown below: 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?

Explain how the firm apportions risk and return amongst stockholders and bondholders in a "perfect world."

Why is debt often referred to as leverage in finance?

If a firm changes their capital structure by immediately selling additional claims of one type of capital and using the proceeds to retire another kind of claims, they are using this type of capital structure change.

Daddi Mac, Inc., doesn't face any taxes and has $250 million in assets, currently financed entirely with equity. Equity is worth $13 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 10 percent yield on perpetual debt. What will be the level of expected EPS if they switch to the proposed capital structure?

Your company doesn't face any taxes and has $750 million in assets, currently financed entirely with equity. Equity is worth $25 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 10 percent yield on perpetual debt in either event. What will be the break-even level of EBIT?

JJJ Corp has $10 million in assets and is currently financed with 100% equity. The firm decides to switch to a 60% equity/40% debt structure and decides to fund the next $4 million of assets for future projects entirely with debt, resulting in the desired capital structure at some point in the future. This is an example of _________________.

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 standard deviation in EPS if they switch to the proposed capital structure?

How can an investor leverage itself more than the firm?

All of the following are examples of the costs of financial distress except __________________.

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?

Suppose that Papa Bell Inc.'s equity is currently selling for $30 per share, with 4 million shares outstanding. If the firm also has 70 thousand bonds outstanding, which are selling at 95 percent of par ($1,000), what are the firm's current capital structure weights?

All of the following are examples of the costs of financial distress except __________________.

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?

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

If a firm changes their capital structure by waiting until the firm requires additional capital to cover capital budgeting needs and then selling more of the type of claims they wish to increase, they are using this type of capital structure change.

Your company has a 38% 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 as shown below: 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?

When a stockholder's stake is worthless the firm runs the risk of ____________.

Describe "The More Debt, The Better" statement with regard to the optimal capital structure.

Why is debt often referred to as leverage in finance?