Exam 16: Capital Structure: Basic Concepts

A firm has a debt-to-equity ratio of 1. Its cost of equity is 16%, and its cost of debt is 8%. If there are no taxes or other imperfections, what would be its cost of equity if the debt-to-equity ratio were 0?

The Boston Firm is unlevered with assets of $30 million and EBIT of $6 million. If the firm's tax rate is 34%, calculate both its after-tax cash flow and its value given a risk adjusted discount rate of 12%.

Financial leverage impacts the performance of the firm by:

The difference between a market value balance sheet and a book value balance sheet is that a market value balance sheet:

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:

A firm has a debt-to-equity ratio of 1.20. If it had no debt, its cost of equity would be 15%. Its cost of debt is 10%. What is its cost of equity if there are no taxes or other imperfections?

Consider two firms, U and L, both with $50,000 in assets. Firm U is unlevered, and firm L has $20,000 of debt that pays 8% interest. Firm U has 1,000 shares outstanding, while firm L has 600 shares outstanding. Mike owns 20% of firm L and believes that leverage works in his favor. Steve tells Mike that this is an illusion, and that with the possibility of borrowing on his own account at 8% interest, he can replicate Mike's payout from firm L. -Mike tells Steve that while his analysis looks good on paper, Steve will never be able to borrow at 8%, but would have to pay a more realistic rate of 12%. If Mike is right, what will Steve's payout be?

A firm has a debt-to-equity ratio of .5. Its cost of equity is 22%, and its cost of debt is 16%. If the corporate tax rate is .40, what would its cost of equity be if the debt-to-equity ratio were 0?

The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding whether including debt in their capital structure would increase their value. The current of 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 stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is 34%. What will Nantucket's new WACC be?

If a firm is unlevered and has a cost of equity capital 12% what would the cost of equity be if the firms became levered at 2:1. The expected cost of debt would be 8%.

The value of the firm is maximized by taking on as much debt as possible. Show graphically how adding debt can increase value through the overall cost of capital. Explain under what conditions how this impacts the cost of capital and translates into firm value.

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%?

A firm is all equity with 5,000 shares outstanding worth $7 each. They are planning on issuing $10,000 of new perpetual debt at the 8% market rate of interest. The effective tax rate is 25%. What is the change in equity value if they make the debt for equity exchange?

A firm has zero debt in its capital structure. Its overall cost of capital is 10%. The firm is considering a new capital structure with 60% debt. The interest rate on the debt would be 8%. Assuming there are no taxes or other imperfections, its cost of equity capital with the new capital structure would be:

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?

The increase in risk to equityholders when financial leverage is introduced is evidenced by:

In a world of no corporate taxes if the use of leverage does not change the value of the levered firm relative to the unlevered firm this is known as:

Eigner Engineering is currently unlevered with 2,000 shares outstanding and assets valued at $50,000. The company expects operating income in the current period to be $6,000. Suppose that the company can exchange 400 shares of stock for $10,000 in debt paying 10% interest. From the standpoint of EPS, would the exchange be wise? Assume no taxes.

The Nantucket Nugget is unlevered and is valued at $640,000. Nantucket is currently deciding whether including debt in their capital structure would increase their 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 stock with the proceeds of the debt issue. There are currently 32,000 shares outstanding and their effective marginal tax bracket is zero. What will Nantucket's new WACC be?

The JumpStart Corporation is unlevered and valued at $500,000. JumpStart has 200,000 shares outstanding. The company announces that in the near future it will issue $200,000 of debt and buy back $200,000 of stock. If the firm is in the 34% tax bracket, how many shares of stock will be repurchased?