Finance questions capital structure | Business & Finance homework help

Exercise

#1

–

BMW

Corporation

is

comparing

two

different

capital

structures,

an

alli equity

plan

(Plan

I)

and

a

levered

plan

(Plan

II).

Under

Plan

I,

BMW

would

have

265,000

shares

of

stock

outstanding.

Under

Plan

II

there

would

be

185,000

shares

of

stock

outstanding

and

$2.8

million

in

debt

outstanding.

The

interest

rate

on

the

debt

is

10

percent

and

there

are

no

taxes.

If

EBIT

is

$750,000,

which

plan

will

result

in

the

higher

EPS?

________________

If

EBIT

is

$1,500,000,

which

plan

will

result

in

the

higher

EPS?

_______________

What

is

the

break-°©‐even

EBIT?

______________

Exercise

#2

–

In

Exercise

1

(above),

use

MM

proposition

I

to

find

the

price

per

share

of

equity

under

each

of

the

two

proposed

plans.

What

is

the

stock

price

per

share?

$

___________________

What

is

the

value

of

the

firm?

$

____________________

Exercise

#3

–

BESTBUY

Co.

and

STAPLES

Co.

are

identical

firms

in

all

respects

except

for

their

capital

structure.

BESTBUY

is

all

equity

financed

with

$750,000

in

stock.

STAPLES

uses

both

stock

and

perpetual

debt;

its

stock

is

worth

$375,000

and

the

interest

rate

on

its

debt

is

8

percent.

Both

firms

expect

EBIT

to

be

$86,000.

Ignore

taxes.

Richard

owns

$30,000

worth

of

STAPLE’s

stock.

What

rate

of

return

is

he

expecting?

__________%

Show

how

Skyler

could

generate

exactly

the

same

cash

flows

and

rate

of

return

by

investing

in

BESTBUY

and

using

homemade

leverage.

Assume

Richard

sells

all

his

shares

in

STAPLES.

He

then

uses

the

$30,000

proceeds

and

borrows

additional

$30,000

to

buy

share

in

BESTBUY.

minus

the

His

BESTBUY

dividends

will

be

____________

for

interest

charge

of

_____________

the

total

cash

flow

of

____________.

His

return

on

a

$30,000

investment

is

_______

%.

What

is

the

cost

of

equity

for

BESTBUY?

_______%

For

STAPLES?

_____________

%

What

is

the

WACC

for

BESTBUY?

__________%

For

STAPLES?

_____________

%

What

principle

have

you

illustrated?

______________________________

Exercise

#4

FORD,

Inc.,

has

equity

with

a

market

value

of

$23

million

and

debt

with

a

market

value

of

$7

million.

Treasury

bills

that

mature

in

one

year

yield

5

percent

per

year,

and

the

expected

return

on

the

market

portfolio

is

12

percent.

The

beta

of

FORD’s

equity

is

1.15.

The

firm

pays

no

taxes.

What

is

FORD’s

debt- equity

ratio?

_______________

What

is

the

firm’s

weighted

average

cost

of

capital?

________________%

What

is

the

cost

of

capital

for

an

otherwise

identical

all-°©‐equity

firm?

_________________%

Exercise

#5

–

GRANNY

Corp.

has

an

EBIT

rate

of

$975,000

per

year

that

is

expected

to

continue

in

perpetuity.

The

unlevered

cost

of

equity

for

the

company

is

14

percent,

and

the

corporate

tax

rate

is

35

percent.

The

company

also

has

a

perpetual

bond

issue

outstanding

with

a

market

value

of

$1.9

million.

What

is

the

value

of

the

company?

$

___________________

Exercise

#6

–

Yu Jianguo is

the

owner,

president,

and

primary

salesperson

for

Asa

Manufacturing.

Because

of

this,

the

company’s

profits

are

driven

by

the

amount

of

work

Yu

does.

If

he

works

40

hours

each

week,

the

company’s

EBIT

will

be

$550,000

per

year;

if

he

works

a

50- hour

week,

the

company’s

EBIT

will

be

$625,000

per

year.

The

company

is

currently

worth

$3.2

million.

The

company

needs

a

cash

infusion

of

$1.3

million,

and

it

can

issue

equity

or

issue

debt

with

an

interest

rate

of

8

percent.

Assume

there

are

no

corporate

taxes.

What

are

the

cash

flows

to

Yu

under

each

scenario?

Under

Debt

Issue:

40-°©‐hour

week:

$

_______________

50-°©‐hour

week:

$

_______________

Under

Equity

Issue:

40-°©‐hour

week:

$

_______________

50-°©‐hour

week:

$

_______________

Under

which

form

of

financing

is

Yu

likely

to

work

harder?

å Under

Debt

Issue

å Under

Equity

Issue

Exercise

#7

–

MGM,

Inc.

has

debt

outstanding

with

a

face

value

of

$6

million.

The

value

of

the

firm

if

it

were

entirely

financed

by

equity

would

be

$17.85

million.

The

company

also

has

350,000

shares

of

stock

outstanding

that

sell

at

a

price

of

$38

per

share.

The

corporate

tax

rate

is

35

percent.

What

is

the

decrease

in

the

value

of

the

company

due

to

expected

bankruptcy

costs?

 

$________