Capital Structure and Leverage - Solutions3

# Capital Structure and Leverage - Solutions3 - After the...

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Old Exam Questions - Capital Structure and Leverage - Solutions Page 11 of 59 Pages After the debt is issued, the new equilibrium price will be: \$22,285,714 / 408,375 = \$54.57 9. The unlevered beta of a firm is 0.7273. However, this firm has an actual capital structure of 50% debt and 50% equity. If you assume that the beta of debt is 0, the tax rate is 35 percent, the risk free-rate is 4%, and the risk premium on the market is 8%, then what rate of return should be required by stockholders according to the CAPM? * A. 13.60% B. 14.20% C. 14.00% D. 13.80% E. 14.40% β L = β U + ( β U )(D/E)(1-T) β L = 0.7273 + (0.7273)(.5/.5)(1-.35)] = 1.2 K = .04 + (.08)(1.2) = 13.60% 10. A company generates \$5,000,000 in sales (1,000,000 units sold at a price of \$5 per unit). Its variable costs equal 80 percent of sales, its fixed costs are \$500,000, its interest expense is equal to \$100,000, its tax rate is equal to 40%, and it has 2,000,000 shares of common stock outstanding. Assuming that the change in sales will have no effect on the company's tax rate and that we can use standard degree of leverage functions (operating, financial, total, etc.), what will be the expected dollar change in EPS if sales decrease by 20% A. -\$0.02 B. -\$0.03 C. -\$0.04 D. -\$0.05 * E. -\$0.06 DTL = [(P-V)Q] / [(P-V)Q - F - I] DTL = [\$1,000,000]/[\$1,000,000 - \$500,000 - \$100,000] = 2.50 % Δ EPS = (-.20)(2.50) = -50% Original EPS = \$0.12; New EPS = (\$0.12)(1 - .50) = \$0.06 Δ EPS = \$0.12 - \$0.06 = \$0.06 Original New Sales \$5,000,000.00 Sales \$4,000,000.00 Variable Costs -\$4,000,000.00 Variable Costs -\$3,200,000.00

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Old Exam Questions - Capital Structure and Leverage - Solutions Page 12 of 59 Pages Fixed Costs -\$ 500,000.00 Fixed Costs -\$ 500,000.00 EBIT \$ 500,000.00 EBIT \$ 300,000.00 Interest -\$ 100,000.00 Interest -\$ 100,000.00 EBT \$ 400,000.00 EBT \$ 200,000.00 Taxes -\$ 160,000.00 Taxes -\$ 80,000.00 Net Income \$ 240,000.00 Net Income \$ 120,000.00 EPS \$0.12 EPS \$0.06 11. A company generates \$5,000,000 in sales (1,000,000 units sold at a price of \$5 per unit). Its variable costs equal 80 percent of sales (\$4 per unit), its fixed costs are \$500,000, its interest expense is equal to \$100,000, its tax rate is equal to 40%, and it has 2,000,000 shares of common stock outstanding. The firm is considering a new type of machine for its existing production lines. With the new machine, fixed costs
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## This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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Capital Structure and Leverage - Solutions3 - After the...

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