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Unformatted text preview: Chapter 13 Solutions to EndofChapter Problems 131 Q BE = V P F Q BE = 00 . 3 $ 00 . 4 $ 000 , 500 $ Q BE = 500,000 units. 132 The optimal capital structure is that capital structure where WACC is minimized and stock price is maximized. Because Jacksons stock price is maximized at a 30% debt ratio, the firms optimal capital structure is 30% debt and 70% equity. This is also the debt level where the firms WACC is minimized. 133 a. Expected EPS for Firm C: E(EPS C ) = 0.1($2.40) + 0.2($1.35) + 0.4($5.10) + 0.2($8.85) + 0.1($12.60) = $0.24 + $0.27 + $2.04 + $1.77 + $1.26 = $5.10. (Note that the table values and probabilities are dispersed in a symmetric manner such that the answer to this problem could have been obtained by simple inspection.) b. According to the standard deviations of EPS, Firm B is the least risky, while C is the riskiest. However, this analysis does not consider portfolio effectsif Cs earnings increase when most other companies decline (that is, its beta is low), its apparent riskiness would be reduced. Also, standard deviation is related to size, or scale, and to correct for scale we could calculate a coefficient of variation ( /mean): E(EPS) CV = /E(EPS) A $5.10 $3.61 0.71 B 4.20 2.96 0.70 C 5.10 4.11 0.81 By this criterion, C is still the most risky. 134 From the Hamada equation, b = b U [1 + (1 T)(D/E)], we can calculate b U as b U = b/[1 + (1 T) (D/E)]. b U = 1.2/[1 + (1 0.4)($2,000,000/$8,000,000)] b U = 1.2/[1 + 0.15] b U = 1.0435. 135 a. LL: D/TA = 30%. EBIT $4,000,000 Interest ($6,000,000 0.10) 600,000 EBT $3,400,000 Tax (40%) 1,360,000 Net income $2,040,000 Return on equity = $2,040,000/$14,000,000 = 14.6%. HL: D/TA = 50%. EBIT $4,000,000 Interest ($10,000,000 0.12) 1,200,000 EBT $2,800,000 Tax (40%) 1,120,000 Net income $1,680,000 Return on equity = $1,680,000/$10,000,000 = 16.8%. b. LL: D/TA = 60%. EBIT $4,000,000 Interest ($12,000,000 0.15) 1,800,000 EBT $2,200,000 Tax (40%) 880,000 Net income $1,320,000 Return on equity = $1,320,000/$8,000,000 = 16.5%. Although LLs return on equity is higher than it was at the 30% leverage ratio, it is lower than the 16.8% return of HL. Initially, as leverage is increased, the return on equity also increases. But, the interest rate rises when leverage is increased. Therefore, the return on equity will reach a maximum and then decline....
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This homework help was uploaded on 04/07/2008 for the course FNBSLW 344 taught by Professor Bocksteigle during the Spring '08 term at Wisc Whitewater.
 Spring '08
 Bocksteigle

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