Operating Costs are 60% of Sales. Fixed Costs are $35 million. The corporate
tax rate is 40%. The cost of equity ks is 15%. Benelux Corp. is a no-growth
rm and 20% of its earnings are paid out as dividends. Moreover earnings
are expected to be constant over time. The company has 2 million shares
outstanding. Assuming 10% as cost of debt capital.
(a) What is the operating leverage ratio of the company?
(b) What would be the value of the rm if it had no debt?
(c) What would be the new value of the rm if it issued $200 million in debt
and used it to buy back some of its stock?
(d) What is the rate of return on equity of the rm with and without leverage?
2. Assume that the corporate tax rate is 40%, cost of debt (pre-tax)=12%, cost
of preferred stock =8% and the cost of common stock is 15%. Assume that
debts total 60% of Common Equity. Assets are $960 million. Common equity
is 30% of total assets. Preferred stock comprise the remainder of total assets.
(d) What capital structure could the rm have if WACC=13.05%, and if the
cost of the capital components were unchanged?
3. Magister Corp. wants to change its current capital structure and increase
its size. The corporation has total assets of 2 billion dollars. Debt totals $750million and equity $1250 million. The corporations goal is to increase its total assets by 250%.
(a) Can the rm achieve this goal by issuing debt alone? If so how should
this be done?
(b) Can the rm achieve its goal and also have a debt /equity ratio of 45%? If
so how should this be done?
(c) If prior to increasing its size the corporation ROA was 12%, what was its
(d) how do the new ROA and ROE change if net income doubles after the
capital structure change?
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