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Assignment _4solutions

# Assignment _4solutions - Winter2011...

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Winter 2011 SAINT MARY’S UNIVERSITY FINANCE, INFORMATION SYSTEMS, & MANAGEMENT SCIENCE  FINANCE 3361 ASSIGNMENT #4 - SOLUTIONS DUE FRIDAY, March 18 th  by 12:00 noon Total 56 Problem #1 (20 Marks) As a recent SMU grad, you have been hired by Barrington Inc. to evaluate its target capital structure. The firm is currently all equity financed and is considering issuing debt and using the proceeds to repurchase some of its common stock. Through an analysis of the firm, you determine that the firm is not growing and all earnings are paid out as cash dividends. The current risk free rate is 6%. After some analysis, you have come up with the following schedule: Propor tion Cost of Market Price of Debt EP S Beta Equity per Share 0.00 \$2.00 0.8 10.80% ---------- 0.10 \$2.20 ---------- 11.40% \$19.30 0.20 \$2.38 1 ---------- \$19.83 0.30 \$2.55 1.1 ---------- ---------- 0.40 \$2.68 ---------- 13.50% ---------- 0.50 \$2.80 1.4 ---------- ---------- 0.60 \$2.90 ---------- ---------- \$17.90 i.a) Fill in the schedule above. At what proportion of debt is the market price maximized? i.b)Your boss also asks you to determine the impact of changing the firms’ capital structure on the firm’s overall weighted average cost of capital. To analysis the impact, you decide to provide your boss with the following schedule. Complete the schedule. What is the optimal proportion of debt?

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Proportion After-Tax Cost of Weighted Average of Debt Cost of Debt Equity Cost of Capital 0.00 4.80% 10.80% ---------- 0.10 4.80% 11.40% ---------- 0.20 5.10% ---------- ---------- 0.30 5.40% ---------- ---------- 0.40 6.00% 13.50% ---------- 0.50 6.90% ---------- ---------- 0.60 7.80% ---------- ---------- Solution #1: (a) (13Marks) Proportion of debt EPS Beta Ma rket Pric e 0.00 \$2.00 0.80 10.80 \$18. 52 0.10 \$2.20 0.90 11.40 \$19. 30 0.20 \$2.38 1.00 12.00 \$19. 83 0.30 \$2.55 1.10 12.60 \$20.
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Assignment _4solutions - Winter2011...

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