Exam 15: Capital Structure: Basic Concepts

The financial manager for a new startup company is faced with a problem of how to finance this new firm.She has estimated EBIT of €200,000; €500,000; €900,000; and €1,500,000 for each of the four equally likely states of the economy.The firm needs €5,000,000 in funds to become operational.The question is whether €5,000,000 of new equity at €20 a share should be sold or a 50/50 debt/equity capital structure with 10% coupon rate debt is better.Calculate the EPS for each plan and economic state.What is the expected EPS for each plan? What should the firm do?

A firm has a debt-to-equity ratio of 1.75.If it had no debt,its cost of equity would be 9%.Its cost of debt is 7%.What is its cost of equity if the corporate tax rate is 50%?

Rosita's has a cost of equity of 13.8% and a pre-tax cost of debt of 8.5%.The debt-equity ratio is .60 and the tax rate is .34.What is Rosita's unlevered cost of capital?

In an EPS-EBI graphical relationship,the slope of the debt ray is steeper than the equity ray.The debt ray has a lower intercept because:

What is its cost of equity for a firm if the corporate tax rate is 40%? The firm has a debt-to-equity ratio of 1.5.If it had no debt,its cost of equity would be 16%.Its current cost of debt is 12%.

A firm has zero debt in its capital structure.Its overall cost of capital is 9%.The firm is considering a new capital structure with 40% debt.The interest rate on the debt would be 4%.Assuming that the corporate tax rate is 34%,what would its cost of equity capital with the new capital structure be?

The concept of homemade leverage is most associated with:

A firm has a debt-to-equity ratio of 1.Its cost of equity is 16%,and its cost of debt is 8%.If the corporate tax rate is 25%,what would its cost of equity be if the debt-to-equity ratio were 0?

Juanita's Steak House has €12,000 of debt outstanding that is selling at par and has a coupon rate of 8%.The tax rate is 34%.What is the present value of the tax shield?

Walter's Distributors have a cost of equity of 13.84% and an unlevered cost of capital of 12%.The company has €5,000 in debt that is selling at par value.The levered value of the firm is €12,000 and the tax rate is 34%.What is the pre-tax cost of debt?

Your firm has a €250,000 bond issue outstanding.These bonds have a 7% coupon,pay interest semiannually,and have a current market price equal to 103% of face value.What is the amount of the annual interest tax shield given a tax rate of 35%?

Suppose the tax authorities allow firms to deduct their interest expense from operating income.Both firm U and firm L are in the 34% tax bracket.Show what happens to the market value of both firms if the debt held by firm L is permanent.Assume MM with taxes.

The interest tax shield has no value for a firm when: I.the tax rate is equal to zero. II.the debt-equity ratio is exactly equal to 1. III.the firm is unlevered. IV.a firm elects 100% equity as its capital structure.

Financial leverage impacts the performance of the firm by:

Hey Guys has debt with both a face and a market value of €3,000.This debt has a coupon rate of 7% and pays interest annually.The expected earnings before interest and taxes is €1,200,the tax rate is 34%,and the unlevered cost of capital is 12%.What is the firm's cost of equity?

A firm has a debt-to-equity ratio of .60.Its cost of debt is 8%.Its overall cost of capital is 12%.What is its cost of equity if there are no taxes or other imperfections?

The Nantucket Nugget is unlevered and is valued at €640,000.Nantucket is currently deciding whether including debt in its capital structure would increase its value.The current cost of equity is 12%.Under consideration is issuing €300,000 in new debt with an 8% interest rate.Nantucket would repurchase €300,000 of equity with the proceeds of the debt issue.There are currently 32,000 shares outstanding and effective marginal tax bracket is zero.What will Nantucket's new WACC be?

In an EPS-EBI graphical relationship,the debt ray and equity ray cross.At this point the equity and debt are:

Bryan invested in Bryco NV shares when the firm was financed solely with equity.The firm is now utilizing debt in its capital structure.To unlever his position,Bryan needs to:

The Winter Wear Company has expected earnings before interest and taxes of €2,100,an unlevered cost of capital of 14% and a tax rate of 34%.The company also has €2,800 of debt that carries a 7% coupon.The debt is selling at par value.What is the value of this firm?