Exam 16: Capital Structure Decisions

Bailey and Sons has a levered beta of 1.10,its capital structure consists of 40% debt and 60% equity,and its tax rate is 40%.What would Bailey's beta be if it used no debt,i.e.,what is its unlevered beta?

Exhibit 16.4 The Anson Jackson Court Company (AJC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6%. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. AJC's current cost of equity is 8.8%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00. -Refer to Exhibit 16.4.What is AJC's current total market value and weighted average cost of capital?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Serendipity Inc.is re-evaluating its debt level.Its current capital structure consists of 80% debt and 20% common equity,its beta is 1.60,and its tax rate is 35%.However,the CFO thinks the company has too much debt,and he is considering moving to a capital structure with 40% debt and 60% equity.The risk-free rate is 5.0% and the market risk premium is 6.0%.By how much would the capital structure shift change the firm's cost of equity?

Morales Publishing's tax rate is 40%,its beta is 1.10,and it uses no debt.However,the CFO is considering moving to a capital structure with 30% debt and 70% equity.If the risk-free rate is 5.0% and the market risk premium is 6.0%,by how much would the capital structure shift change the firm's cost of equity?

Exhibit 16.1 Pennewell Publishing Inc. (PP) is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00. -Refer to Exhibit 16.1.Assume that PP is considering changing from its original capital structure to a new capital structure with 35% debt and 65% equity.This results in a weighted average cost of capital equal to 9.4% and a new value of operations of $510,638.Assume PP raises $178,723 in new debt and purchases T-bills to hold until it makes the stock repurchase.PP then sells the T-bills and uses the proceeds to repurchase stock.How many shares remain after the repurchase,and what is the stock price per share immediately after the repurchase?

Two firms,although they operate in different industries,have the same expected earnings per share and the same standard deviation of expected EPS.Thus,the two firms must have the same business risk.

Which of the following statements is CORRECT?

A firm's business risk is largely determined by the financial characteristics of its industry,especially by the amount of debt the average firm in the industry uses.

The following information has been presented to you about the Gibson Corporation. Total assets \ 3,000 millionTax rate 40\% Operating income (EB IT) \ 800 millionDebt ratio 0\% Interest expense \ 0 millionWACC 10\% Net income \ 480 millionM/B ratio 1.00× Share price \ 32.00= \3 .20 The company has no growth opportunities (g = 0),so the company pays out all of its earnings as dividends (EPS = DPS).The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values)that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%.If the company makes this change,what would be the total market value (in millions)of the firm?

Which of the following statements is CORRECT?