Exam 14: Capital Structure in a Perfect Market

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.

Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the value of the firm's levered equity from the project is closest to:

At the conclusion of this transaction,the number of shares that d'Anconia Copper will have outstanding is closest to:

Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the cash flow that equity holders will receive in one year in a strong economy is closest to:

Suppose you are a shareholder in d'Anconia Copper holding 300 shares,and you disagree with the decision to lever the firm.You can undo the effect of this decision by

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 you borrow $60,000 in financing the project.According to MM proposition II,the firm's equity cost of capital will be closest to:

Which of the following statements is FALSE?

Consider the following equation: β_U = β_E + β_D The term β_D in the equation is:

After the repurchase how many shares will Luther have outstanding?

Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?

Equity in a firm with debt is called:

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.Construct a table detailing the percentage returns to the equity holders of both the levered and unlevered firms for both the weak and strong economy.

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?

Following the borrowing of $12 and subsequent share repurchase,the equity cost of capital for RC is closest to:

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?

Which of the following statements is FALSE?

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. 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. -Prior to any borrowing and share repurchase,RC's EPS is closest to:

Use the information for the question(s) below. Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order to fund this expansion, Rockwood will need to raise $100 million in new capital. After the expansion, Rockwood is expected to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares outstanding and following the expansion announcement these shares are trading at $25 per share. Rockwood has the ability to borrow at a rate of 5% or to issue new equity at $25 per share. -If Rockwood finances their expansion by issuing $100 million in debt at 5%,what will Rockwood's cost of equity capital be?