Capital Structure and Leverage 16

# Capital Structure and Leverage 16 - \$75.00 E \$85.00 25 Your...

This preview shows page 1. Sign up to view the full content.

Old Exam Questions - Capital Structure and Leverage Page 16 of 31 Pages 24. Assume that an all-equity firm has \$1,000 of assets and faces the possible states of nature listed in the table below. Now assume that the firm plans to issue \$500 of debt and use the proceeds to repurchase \$500 of its own stock (capital structure would then be equal to \$500 of debt and \$500 of equity). Determine how much interest expense the firm can pay before the expected ROE begins to decrease. (Hint: think about at what interest rate it is beneficial, at least in terms of expected ROE, for a firm to issue debt.) Firm A Unlevered Bad Average Good Probability 20% 40% 40% EBIT \$125.00 \$150.00 \$175.00 Interest \$0.00 \$0.00 \$0.00 EBT \$125.00 \$150.00 \$175.00 Taxes (40%) -\$50.00 -\$60.00 -\$70.00 Net Income \$75.00 \$90.00 \$105.00 Expected BEP 12.5% 15.0% 17.5% 15.5% ROA 7.5% 9.0% 10.5% 9.3% ROE 7.5% 9.0% 10.5% 9.3% Economy A. \$80.00 B. \$77.50 C. \$82.50 D.
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: \$75.00 E. \$85.00 25. Your company has collected the following information: Item Value Total Assets (BV) \$3,000 million Operating Income (EBIT) \$800 million Interest Expense \$0 Net Income \$480 million Share Price (MV Common) \$32.00 Tax Rate 40% Debt Ratio 0% WACC 10% EPS = DPS \$3.20 The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS) and expects to make no additional investment in net operating working capital or gross fixed assets and has zero depreciation expense (you should now be able to calculate FCF). A consultant believes that if the company moves to a capital structure financed with 20 percent debt and 80 percent equity (based on market values) that the cost of equity will increase to 11 percent and that the pre-tax cost of debt will be 8 percent (you should now be able to calculate WACC)....
View Full Document

## 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.

Ask a homework question - tutors are online