Practice_problems_capital_structure1-KEY.pdf - Finance 550...

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1Finance 550 Practice Problems Capital Structure - KEY Questions 1-14: Cap_tal _t_uctu_e in a world without the IRS. Dewey, Cheatham and Howe (DCH) is a financial services firm in the country of Utopistan that offers advice for firms looking to undertake merger and acquisition (M&A) activity. You know the following: A.The company currently has no debt and has 100 shares of stock outstanding. The stock is not as volatile as the general market and has only 80% of the risk of the market portfolio. The expected return on that market portfolio is 13.75%. B.The company’s operating income (EBIT) depends on whether the takeover market is hot or cold. The firm believes that there is an equal chance every year that the market may be hot or cold. If the market is hot, the firm’s EBIT is $400, while it is only half that if the market is cold. The firm believes that this EBIT forecast will be perpetually accurate. The firm expects to pay out all of its earnings as dividends. C.Utopistan is a country with well developed capital markets and some interesting features. Investors love the place because there are no taxes and no costs associated with bankruptcy. Additionally, everyone in the country (both individuals and corporations) is able to borrow or lend as much as they want at the risk-free rate. The capital markets there really are perfect. D.The current price of the 1-year Utopistan Perfecto Bill (the equivalent to a US Treasury Bill) with a face value of $10,000 is 9,523.81. 1.Construct the income statement and determine the EPS for DCH in each state of the world (i.e. hot and cold market)?
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22.What is the EXPECTED per share dividend for DCH stockholders every year?
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