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

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 shown as follows: 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?

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

An all-equity financed firm has $500 in assets and the stock price is $20.If the firm restructures with 15 percent debt which creates interest expense of $30 per year and the firm's tax rate is 40 percent,what is the break-even EBIT?

Which type of bankruptcy involves a business liquidating their assets?

HiLo,Inc.,faces a 38 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: 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?

The policy of changing the capital structure gradually over time by funding new capital projects disproportionately with the type of capital you want to increase in the capital structure is referred as:

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 level of expected EPS if they switch to the proposed capital structure?

Your company doesn't face any taxes and has $500 million in assets,currently financed entirely with equity.Equity is worth $40 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 as follows: 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?

Which of the following is NOT a feature of the "perfect world" in M&M's theorem for optimal capital structure?

Your company has a 25 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: 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?

Why does the optimal capital structure shift from "debt doesn't matter" to "the more debt,the better" when we add corporate taxation to our assumptions?

An all-equity financed firm has $450 in assets and the stock price is $45.If the firm restructures with 20 percent debt which creates interest expense of $10 per year and the firm's tax rate is 40 percent,what is the break-even EBIT?

Explain why utility firms tend to have fairly high debt ratios.

Your company faces a 34 percent tax rate 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 shown as follows: 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 level of expected EPS if they switch to the proposed capital structure?

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

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

What causes the change in optimal strategy when taxes are added back to the M&M theorem?

Which of these is a situation that arises when a firm's equity is close to worthless,and equity holders will prefer to not invest in safe projects?

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

Your company faces a 25 percent tax rate 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 shown as follows: 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 standard deviation in EPS if they switch to the proposed capital structure?