Capital Structure and Leverage 20

Capital Structure and Leverage 20 - equilibrium price per...

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Old Exam Questions - Capital Structure and Leverage Page 20 of 31 Pages determine the maximum dollar interest the firm can pay before it begins to decrease the expected return on equity. Economy Firm A: Unlevered Bad Average Good Probability 20% 50% 30% EBIT $100.00 $150.00 $220.00 Interest $0.00 $0.00 $0.00 EBT $100.00 $150.00 $220.00 Taxes (40%) -$40.00 -$60.00 -$88.00 Net Income $60.00 $90.00 $132.00 BEP 10.00% 15.00% 22.00% ROA 6.00% 9.00% 13.20% ROE 6.00% 9.00% 13.20% A. $79.70 B. $77.30 C. $78.90 D. $80.50 E. $78.10 34. Your company is currently unlevered and pays all of its after-tax earnings out in the form of dividends. Its EBIT is $9,000,000, its tax rate is 40 percent, its current cost of equity is 12 percent, and it has 1,000,000 shares outstanding. As you can calculate, its current price is $45.00 per share. Your company can borrow $5,000,000 of new perpetual debt at a before-tax cost of debt of 4.0 percent. The increased financial leverage will result in the cost of equity going up to 12.5 percent. Determine the new
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Unformatted text preview: equilibrium price per share if the firm is able to use the proceeds of the debt issue to buy back $5,000,000 of stock, and if investors anticipate an increase in value (from the increased leverage) so that the firm is required to repurchase stock at the anticipated expected equilibrium price. A. $47.57 B. $46.91 C. $46.25 D. $47.24 E. $46.58 35. Your company is currently unlevered, has 500,000 shares outstanding, and pays all of its after-tax earnings out in the form of dividends. The current price of the firm’s stock is $30.00 per share. Your company can borrow $1,000,000 of new perpetual debt and use the proceeds to repurchase $1,000,000 of the firm’s own stock. If the market/investors correctly anticipate an increase in value (from the increased leverage) the firm will be required to repurchase the stock at a new equilibrium price of $31.15 per share. If the market does not anticipate this increase in value, the firm will...
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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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