Instructions: Please submit assignment by 11:59PM on Apr 7, 2019 on Blackboard. Questions 1 and 2 should be answered in a Word! PDF ﬁle. Questions 3 and 4 can be submitted in ExceUWordiPDF

ﬁle. Name the ﬁles with the pattern “Assignment 10 YourLastName YourFirstName. docsl'xlsxfpdf’. Clearly indicate where you have answer to each part. Points allocated to each question are shown after the question. . Answer the following using part of the paper “The Determinants of Capital Structure Choice”. a.

b. Answer the following using the section “Agency costs and ﬁnancial objectives of ﬁrm” of the paper by Myers. a.

b. C. Describe the determinants of capital structure. (6) How do each determine capital structure? (10} What are the main points of the tradeoff theory, pecking order theory and the free-cash flow theory? (6) What is wrong with the pecking order theory? (4) What are the two conﬂicts described in the section “Agency costs and ﬁnancial objectives of ﬁrm”? Clearly describe

the conﬂicts. (8) . An unlevered ﬁrm has a book value of equity $100 million and is considering borrowing $40 million at 8% interest rate to buy back stocks. Once the company issues the debt, it becomes a levered company. The company is in a 35%

tax bracket and has an EBIT of $15 million. a.

b. !" What is the net income of the unlevered company? (2} Assuming that all net income is distributed as dividend and this amount is expected to remain constant forever,

what is market price of equity of the unlevered company? Assume cost of equity to be 9.75%. (Hint: Use perpetuity

formula)( 1) What is the net income after debt is issued? (2} d. What is the tax savings per year for the levered company? (1) 01° Assuming that all net income is distributed as dividend and this amount is expected to remain constant forever, what is market price of equity of the levered company? Assume cost of equity to be 10.51%. (Hint: Use perpetuity

formula)( 1) What is the total value of equity and debt of the levered company? (1)

What is the WACC of the levered company? (1} What is the present value of this tax savings if we assume that income statement will remain same forever? (Hint:

Discount tax savings by the WACC) (1) Suppose a ﬁrm has invested $500,000 in plant, equipment and working capital. The investment generates EBIT of $120,000 in perpetuity. Annual depreciation charges exactly equal capital expenditures and the ﬁrm pays all of its earnings as dividends. The ﬁrm’s sales do not grow, but remain stable over time. The ﬁrm is deciding on its capital

structure by considering all debt levels of 0%, 10%, 20%, 30%, 40% and 50% of current total assets ($500,000). Tax

rate is 50%. Cost of debt and equity at different debt levels are as follows: 99.057.» Debt Level 0% 10% l 20% 30% 40% 50%

Cost of debt 3.00% 8.25% 8.75% 9.75% 11.00% 12.50% Cost of Equity 12.00% 12.50% 13.00% 13.50% 14.50% 16.00% Find the net income at different debt levels. (4) Find market value of equity and total ﬁrm at different debt levels. (4) Find the value of WACC at different debt levels. (3) Graph debt ratio (X-axis} vs market value of ﬁrm and debt ratio (X-axis} vs WACC. (4} What can you comment from the two graphs? (1)