Capital Structure and Leverage - Solutions10

Capital Structure and Leverage - Solutions10 - Old Exam...

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Unformatted text preview: Old Exam Questions - Capital Structure and Leverage - Solutions Page 50 of 59 Pages the Hamada equations to relever the firms beta, determine what the firms new cost of stock will be. A. 17.54% B. 20.18% C. 22.82% * D. 18.86% E. 21.50% r RF = 5.00% (Given) r M = 12.00% (Given) U = 0.90 (Given) r S = 5.00% + (12.00% - 5.00%)*( L ) = 15.08% (Given) L = (15.08% - 5.00%) / (12.00% - 5.00%) = 10.08% / 7.00% = 1.44 L = 1.44 = [1 + (D/E)*(1-.40)]*[0.90] = 0.90 + (D/E)*(.54) (D/E) = (1.44 - 0.90) / (0.54) = (1/1) = 1.0 Now double the D/E ratio = (1.0)*(2) = 2.0 Calculate the new levered beta: L = [1 + (2)*(1-.40)]*[0.90] = 1.98 Calculate the new cost of equity: r S = 5.00% + (12.00% - 5.00%)*(1.98) = 18.86% 52. Assume that a company generates $35,600,000 in sales by selling 3,560,000 units at $10 per unit. The firm has variable costs equal to 80 percent of sales, interest expense of $2,768,888.89, and a degree of financial leverage of 2.40. The company estimates that if its sales were to increase 8 percent, its return on equity would increase by 28.80 percent. Based on this information, and assuming that a change in sales will have no effect on the companys tax rate, total assets, or number of shares outstanding, determine the current amount of the companys fixed costs. A. $1,500,000.00 B. $1,891,111.11 C. $2,232,222.22 * D. $2,373,333.33 E. $3,164,444.44 DFL = 2.40 (Given) Old Exam Questions - Capital Structure and Leverage - Solutions Page 51 of 59 Pages DTL = 28.8% / 8.0% = 3.60 DOL = DTL / DFL = 3.60 / 2.40 = 1.50 DOL = [(P - V)Q] / [(P - V)Q - F] DOL = [($10.00 - $8.00)(3,560,000)] / [($10.00 - $8.00)(3,560,000) - F] = 1.5 (1.5)*($7,120,000 - F) = $7,120,000 $10,680,000 - 1.50F = $7,120,000 F = ($10,680,000 - $7,120,000) / (1.5) = $2,373,333.33 Check: DOL = $7,120,000.00 / ($7,120,000.00 - $2,373,333.33) DOL = $7,120,000 / $4,746,666.67 = 1.50 DFL = ($7,120,000 - $2,373,333.33) / ($7,120,000 - $2,373,333.33 - $2,768,888.89) DFL = $4,746,666.67 / $1,977,77.78 = 2.40 53. Assume that your company is an all-equity firm with 1,000,000 shares outstanding. The companys EBIT is currently $10,000,000, and EBIT is expected to remain constant over time. The company pays out all of its earnings each year; its growth is zero, its earnings per share equals its dividends per share, and the companys tax rate...
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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 - Solutions10 - Old Exam...

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