Question 1

Blackstone, Inc. is currently an all equity ﬁrm that has 65,000 shares of stock outstanding at a market price of $22 a share. The ﬁrm has decided to leverage its operations by issuing $605,000
Of debt at an interest rate of 6.5%. This new debt will be used to repurchase shares of the
Outstanding stock. The restructuring is expected to increase the earnings per share. What is the
Minimum level of earnings before interest and taxes that Blackstone is expecting? Ignore taxes.

Accepted Answer

The correct answer is A because the minimum level of earnings before interest and taxes that Blackstone is expecting is $92,950. This is calculated by taking the interest expense on the new debt ($605,000 * 6.5% = $39,325) and adding it to the current earnings per share ($22 * 65,000 = $1,430,000) and dividing by the new number of shares outstanding (65,000 - $605,000/$22 = 55,000).

Question 2

Parker & Thomas, Inc., (P&T) currently is an all equity ﬁrm with 20,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $50,000. The
ﬁrm's dividend payout ratio is 100%. P&T has decided to add leverage to its ﬁnancial operations by
Issuing $400,000 of debt at a 9% interest rate. This $400,000 will be used to repurchase shares of
Stock. You own 2,500 shares of P&T stock. You lend funds at a 9% rate of interest. How many of
Your shares of stock in P&T must you sell to offset the leverage that the ﬁrm is assuming? Assume
That you loan out all of the funds you receive from the sale of your stock.

Accepted Answer

First, we need to find out the new market price of P&T's stock after repurchasing shares using the debt:

New Market Value of Equity = 20,000 shares x $40 = $800,000
New Debt issued = $400,000
Total Value of Firm = $1,200,000

Now, we can calculate the new EPS and DPS:

EBIT = $50,000
Interest = $400,000 x 9% = $36,000
EBT = $14,000
Taxes (40%) = $5,600
Net Income = $8,400

EPS = Net Income / No. of Shares
EPS = $8,400 / (20,000 - 2,500) = $0.47 per share

DPS = EPS x Payout Ratio
DPS = $0.47 x 100% = $0.47 per share

Next, we need to calculate the interest payments on the loan we made:

Interest Payment = $400,000 x 9% = $36,000

To offset this interest payment, we need to sell some of our shares to receive enough funds. The interest we receive will be used to pay the interest expense on the loan:

Interest Income = $36,000
Interest Expense = $36,000

Number of Shares to Sell = Interest Income / New EPS
Number of Shares to Sell = $36,000 / $0.47 = 76,595 shares

However, we only own 2,500 shares, so we can only sell all of our shares and purchase a portion of it back:

Amount Received from Sale = 2,500 shares x $40 per share = $100,000
Amount Needed to Repurchase = $36,000 / $40 per share = 900 shares

Number of Shares to Keep = 2,500 - 900 = 1,600 shares

Therefore, we need to sell 1,250 shares of P&T stock to offset the leverage that the firm is assuming.

Question 3

Bigelow, Inc. has a cost of equity of 13.56% and a pre-tax cost of debt of 7%. The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on M&M II with no taxes?

Accepted Answer

The answer of Bigelow, Inc. has a cost of equity...

Question 4

Lombardo Company had net income of $70,000 and interest expense of $10,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL).

Accepted Answer

The answer of Lombardo Company had net income of $70,000...

Question 5

Hazardous Wastes, Inc. has a cost of equity of 23.2% and a pre-tax cost of debt of 10%. The required return on the assets is 18%. What is the ﬁrm's debt-equity ratio based on M&M II with no
Taxes?

Accepted Answer

The answer of Hazardous Wastes, Inc. has a cost of...

Question 6

Calculate the company's cost of equity given the following information: return on assets 10.50%; return on debt 8.75%; total debt $995,000; total equity $1,520,000.

Accepted Answer

The answer of Calculate the company's cost of equity given...

Question 7

Glover Tools has a pre-tax cost of debt of 9% and an unlevered cost of capital of 13.5%. The ﬁrm's tax rate is 34% and the cost of equity is 15%. What is the ﬁrm's debt-equity ratio?

Accepted Answer

The firm's debt-equity ratio can be calculated using the formula for the weighted average cost of capital (WACC) and the Modigliani-Miller Proposition II with taxes. The WACC is given by: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where Re is the cost of equity, Rd is the cost of debt, Tc is the tax rate, E is equity, D is debt, and V is the total value (E + D). Given the unlevered cost of capital (13.5%), cost of equity (15%), cost of debt (9%), and tax rate (34%), solving for the debt-equity ratio gives approximately 0.51.

Question 8

RDJ Inc. has an asset beta of 0.95. Its current capital structure is 60% debt, 40% equity. What is the ﬁrm's equity beta? Ignore taxes.

Accepted Answer

The answer of RDJ Inc. has an asset beta of...

Question 9

A ﬁrm has debt of $8,000, a leveraged value of $18,800, a cost of debt of 8.75%, a cost of equity of 13%, and a tax rate of 35%. What is the ﬁrm's weighted average cost of capital?

Accepted Answer

The correct answer is A because the weighted average cost of capital (WACC) is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - T)where:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtT = tax rateIn this case, we have:E = $18,800 - $8,000 = $10,800V = $18,800Re = 13%D = $8,000Rd = 8.75%T = 35%Plugging these values into the formula, we get:WACC = (10,800/18,800) * 13% + (8,000/18,800) * 8.75% * (1 - 35%)WACC = 0.5745 * 13% + 0.4255 * 8.75% * 0.65WACC = 7.46% + 2.44%WACC = 9.89%

Question 10

Your ﬁrm has a pre-tax cost of debt of 7% and an unlevered cost of capital of 13%. Your tax rate is 35% and your cost of equity is 15.26%. What is your debt-equity ratio?

Accepted Answer

The answer of Your ﬁrm has a pre-tax cost of...

Question 11

The Spartan Co. has an unlevered cost of capital of 11%, a cost of debt of 8%, and a tax rate of 35%. What is the target debt-equity ratio if the targeted cost of equity is 12%?

Accepted Answer

To find the target debt-equity ratio, we can use the following formula:

Target debt-equity ratio = (targeted cost of equity - unlevered cost of equity) / (cost of debt - tax rate)

Plugging in the given values, we get:

Target debt-equity ratio = (0.12 - 0.11) / (0.08 - 0.35) = 0.01 / (-0.27) = -0.037

This means that the targeted cost of equity cannot be achieved with any positive debt financing. We need to take on negative debt, which doesn't make any sense. Therefore, we cannot find a feasible answer for this question.

Question 12

The Tee Company has total assets of $20,000 and total debt of $8,000. The yield-to-maturity on its bonds is 9%. The cost of capital with no debt is 15%. The tax rate is 34%. What is the WACC?

Accepted Answer

The answer of The Tee Company has total assets of...

Question 13

Your ﬁrm has expected earnings before interest and taxes of $2,400. Your unlevered cost of capital is 12% and your tax rate is 35%. You have debt with both a book and a market value of $5,000. This
Debt has a 7% coupon and pays interest annually. What is your weighted average cost of capital?

Accepted Answer

First, we need to calculate the after-tax cost of debt:
After-tax cost of debt = (1 - tax rate) x coupon rate
= (1 - 0.35) x 0.07
= 0.0455 or 4.55%
Next, we need to calculate the weighted average cost of capital (WACC):
WACC = (unlevered cost of capital x value of equity) + (after-tax cost of debt x value of debt ÷ value of equity + value of debt)
Value of equity = (EBIT - interest) ÷ unlevered cost of capital
= (2400 - (5000 x 0.07)) ÷ 0.12
= 1200
Therefore, value of debt = 5000
WACC = (0.12 x 1200) + (0.0455 x 5000 ÷ (1200+5000))
= 0.1029 or 10.29%
The closest answer choice to our calculation is D) 10.58%.

Question 14

Thompson Feed has a cost of equity of 11.9% and a pre-tax cost of debt of 9%. The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on M&M II with no taxes?

Accepted Answer

The answer of Thompson Feed has a cost of equity...

Question 15

Your ﬁrm has earnings before interest and taxes of $160,000. Both the book and the market value of debt is $300,000. Your unlevered cost of equity is 12% while your cost of debt is 8%. The tax rate
Is 35%. What is your weighted average cost of capital?

Accepted Answer

The WACC is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1-Tc). Here, E = 0 (since no equity is mentioned), D = $300,000, V = $300,000, Re = 12%, Rd = 8%, Tc = 35%. WACC = (0/300,000) * 12% + (300,000/300,000) * 8% * (1-0.35) = 5.2%.

Question 16

Manchu company had net income of $140,000 and interest expense of $30,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL).

Accepted Answer

The answer of Manchu company had net income of $140,000...

Question 17

Castle Home Builders has an unlevered cost of capital of 12%, a cost of debt of 9%, and a tax rate of 34%. What is the target debt-equity ratio if the targeted cost of equity is 14%?

Accepted Answer

The answer of Castle Home Builders has an unlevered cost...

Question 18

Deitweiler International has an unlevered cost of capital of 10%, a tax rate of 35%, and expected earnings before interest and taxes of $26,500. The company has $40,000 in bonds outstanding
That have a 7% coupon and pay interest annually. The bonds are selling at par value. What is the
Cost of equity?

Accepted Answer

The cost of equity can be calculated using the Modigliani-Miller Proposition II with taxes: Cost of Equity = Unlevered Cost of Capital + (Unlevered Cost of Capital - After-tax Cost of Debt) * (Debt/Equity). The after-tax cost of debt is 7% * (1 - 0.35) = 4.55%. The equity value can be calculated as the difference between the firm's value and the debt. Using these values, the cost of equity is approximately 10.53%.

Question 19

Your ﬁrm has a pre-tax cost of debt of 8% and an unlevered cost of capital of 12.5%. Your tax rate is 35% and your cost of equity is 14.34%. What is your debt-equity ratio?

Accepted Answer

The answer of Your ﬁrm has a pre-tax cost of...

Question 20

Due to a prolonged economic downturn, Keely Corporation's EBIT and EPS in the previous year were $225,000 and $1.35. This year EBIT and EPS were $35,000 and $0.70. Given this information,
Calculate the company's DFL.

Accepted Answer

The DFL is calculated as (EBIT1 - EBIT2) / (EPS1 - EPS2). In this case, the DFL is ($225,000 - $35,000) / ($1.35 - $0.70) = $190,000 / $0.65 = $0.57.

Quiz 16: Financial Leverage and Capital Structure Policy

Bigelow, Inc. has a cost of equity of 13.56% and a pre-tax cost of debt of 7%. The required return on the assets is 11%. What is the ﬁrm's debt-equity ratio based on M&M II with no taxes?

Lombardo Company had net income of $70,000 and interest expense of $10,000. If the corporate tax rate was 30%, determine its Degree of Financial Leverage (DFL) .

Hazardous Wastes, Inc. has a cost of equity of 23.2% and a pre-tax cost of debt of 10%. The required return on the assets is 18%. What is the ﬁrm's debt-equity ratio based on M&M II with no Taxes?