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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 allequity 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.
 Spring '08
 Staff
 Leverage

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