Use the information for the question(s)below.
Omicron Industries' Market Value Balance Sheet ($ Millions)
and Cost of Capital Omicron Industries' New Project Free Cash Flows (Millions) Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
-The debt capacity for Omicron's new project in year 0 is closest to:
A)$38.75 million.
B)$75.50 million.
C)$50.00 million.
D)$10.25 million.

Question

Use the information for the question(s)below.
Omicron Industries' Market Value Balance Sheet ($ Millions)
and Cost of Capital  Omicron Industries' New Project Free Cash Flows (Millions)  Assume that this new project is of average risk for Omicron and that the firm wants to hold constant its debt to equity ratio.
-The debt capacity for Omicron's new project in year 0 is closest to:
A)$38.75 million. 
B)$75.50 million. 
C)$50.00 million. 
D)$10.25 million.

Quizplus · Accepted Answer

The debt capacity for Omicron's new project can be calculated by finding the total amount of debt that the company can take on while keeping its debt to equity ratio constant. Using the market value balance sheet, Omicron has $100 million in debt and $200 million in equity for a debt-to-equity ratio of 0.5. Therefore, the total amount of debt the company can take on while keeping this ratio constant is $200 million * 0.5 = $100 million. Since the company already has $100 million in debt, the debt capacity for the new project in year 0 is $100 million - $50 million (project cost) = $50 million.

Use the Information for the Question(s)below