Exam 14: Capital Structure in a Perfect Market

The cost of capital of levered equity is ________ the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.

Use the information for the question(s) below. Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on which it pays interest of 5% per year. Both companies have identical projects that generate free cash flows of $1000 or $2000 each year. Suppose that there are no taxes, and after paying any interest on debt, both companies use all remaining cash free cash flows to pay dividends each year. -Suppose you own 10% of the equity of Without.What is another portfolio you could hold that would provide you with the same exact cash flows?

Use the information for the question(s) below. Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00. -Following the borrowing of $12 million and the subsequent share repurchase,the number of shares that RC will have outstanding is closest to:

Use the information for the question(s) below. You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects: -Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?

Use the information for the question(s) below. Assume that Rose Corporation's (RC) EBIT is not expected to grow in the future and that all earnings are paid out as dividends. RC is currently an all equity firm. It expects to generate earnings before interest and taxes (EBIT) of $6 million over the next year. Currently RC has 5 million shares outstanding and its stock is trading for a price of $12.00 per share. RC is considering borrowing $12 million at a rate of 6% and using the proceeds to repurchase shares at the current price of $12.00. -Following the borrowing of $12 million and the subsequent share repurchase,the expected earnings per share for RC is closest to:

Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. -Two separate firms are considering investing in this project.Firm Unlevered plans to fund the entire $80,000 investment using equity,while Firm Levered plans to borrow $45,000 at the risk-free rate and use equity to finance the remainder of the initial investment.Calculate the risk premiums for both the levered and unlevered firm.

Use the information for the question(s) below. Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. -Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying With stock.Using homemade (un)leverage,how much do you need to invest at the risk-free rate so that the payoff of your account will be the same as a $5000 investment in Without stock?

Which of the following statements is false?

Which of the following statements is false?

Use the information for the question(s) below. Luther is a successful logistical services firm that currently has $5 billion in cash. Luther has decided to use this cash to repurchase shares from its investors, and has already announced the stock repurchase plan. Currently Luther is an all equity firm with 1.25 billion shares outstanding. Luther's shares are currently trading at $20 per share. -Assume that in addition to 1.25 billion common shares outstanding,Luther has stock options given to employees valued at $2 billion.After the repurchase how many shares will Luther have outstanding?

Consider the following equation: E + D = U = A The A in this equation represents

Use the information for the question(s) below. Consider two firms: firm Without has no debt, and firm With has debt of $10,000 on which it pays interest of 5% per year. Both companies have identical projects that generate free cash flows of $1000 or $2000 each year. Suppose that there are no taxes, and after paying any interest on debt, both companies use all remaining cash free cash flows to pay dividends each year. -Fill in the table below showing the payments debt and equity holders of each firm will receive given each of the two possible levels of free cash flows:

Which of the following statements is false?

Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. -Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder.In this situation,the cost of capital for the firm's levered equity is closest to:

Use the information for the question(s) below. You are evaluating a new project and need an estimate for your project's beta. You have identified the following information about three firms with comparable projects: -The unlevered beta for Lincoln is closest to:

Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. -The NPV for this project is closest to:

Use the information for the question(s) below. Consider two firms, With and Without, that have identical assets that generate identical cash flows. Without is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. With has 2 million shares outstanding and $12 million dollars in debt at an interest rate of 5%. -Assume that MM's perfect capital markets conditions are met and that you can borrow and lend at the same 5% rate as With.You have $5000 of your own money to invest and you plan on buying Without stock.Using homemade leverage you borrow enough in your margin account so that the payoff of your margined purchase of Without stock will be the same as a $5000 investment in With stock.The number of shares of Without stock you purchased is closest to:

Which of the following statements is false?

Which of the following statements is false?

Use the information for the question(s) below. Consider a project with free cash flows in one year of $90,000 in a weak economy or $117,000 in a strong economy, with each outcome being equally likely. The initial investment required for the project is $80,000, and the project's cost of capital is 15%. The risk-free interest rate is 5%. -Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder.In this situation,the cash flow that equity holders will receive in one year in a weak economy is closest to: