Question 1

A firm is considering two different capital structures.The first option is an all-equity firm with 110,000 shares of stock.The second option is 75,000 shares of stock plus some debt.Ignoring taxes, the break-even level of earnings before interest and taxes between these two options is $136,000.How much money is the firm considering borrowing if the interest rate is 8 percent?

Accepted Answer

The break-even EBIT is where the earnings per share (EPS) are the same for both capital structures. The difference in the number of shares is 35,000 (110,000 - 75,000). The interest expense at break-even EBIT is $136,000 * 0.08 = $10,880. Therefore, the debt amount is $10,880 / 0.08 = $540,909.

Question 2

Bruno's is considering changing from its current all-equity capital structure to 30 percent debt.There are currently 7,500 shares outstanding at a price per share of $39.EBIT is expected to remain constant at $23,000.The interest rate on new debt is 7.5 percent and there are no taxes.Tracie owns $12,675 worth of stock in the company.The firm has a 100 percent payout.What would Tracie's cash flow be under the new capital structure assuming that she keeps all of her shares?

Accepted Answer

Under the new capital structure, the firm will have interest expenses. The interest expense is 30% of the firm's value ($292,500) at 7.5%, which is $6,570. EBIT is $23,000, so the earnings after interest is $16,430. With 100% payout, Tracie's cash flow is her proportion of the earnings, which is ($12,675 / $292,500) * $16,430 = $1,016.

Question 3

Burkhart and Mueller has no debt.Its current total value is $9.5 million.What will the company's value be if it sells $4 million in debt and has a tax rate of 21 percent? Assume all debt proceeds are used to repurchase equity.

Accepted Answer

The answer of Burkhart and Mueller has no debt.Its current...

Question 4

Glass Growers has a cost of capital of 11.1 percent.The company is considering converting to a debt-equity ratio of .46.The interest rate on debt is7.3 percent.What would be the company's new cost of equity? Ignore taxes.

Accepted Answer

The cost of equity can be calculated using the formula: Cost of Equity = Cost of Capital + (Cost of Capital - Cost of Debt) * Debt-Equity Ratio. Substituting the given values: 11.1% + (11.1% - 7.3%) * 0.46 = 12.85%.

Question 5

Infinity Completion, Inc.currently has 50,000 shares of stock outstanding and no debt.The price per share is $23.75.The firm is considering borrowing funds at 6 percent interest and using the proceeds to repurchase 5,000 shares of stock.Ignore taxes.How much is the firm borrowing?

Accepted Answer

The answer of Infinity Completion, Inc.currently has 50,000 shares of...

Question 6

Demolition Construction Services has 12,500 shares of stock outstanding and no debt.The new CFO is considering issuing $75,000 of debt and using the proceeds to retire 2,500 shares of stock.The coupon rate on the debt is 6.8 percent.What is the break-even level of earnings before interest and taxes between these two capital structure options?

Accepted Answer

The answer of Demolition Construction Services has 12,500 shares of...

Question 7

Petrol Service Stations has a tax rate of .percent.Its total interest payment for the year just ended was $41,000.What is the interest tax shield for the year?

Accepted Answer

The answer of Petrol Service Stations has a tax rate...

Question 8

An all-equity firm has a return on assets of 21 percent.The firm is considering converting to a debt-equity ratio of .48.The pretax cost of debt is 6.9 percent.Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?

Accepted Answer

The answer of An all-equity firm has a return on...

Question 9

The Piano Movers can borrow at 7.8 percent.The firm currently has no debt, and the cost of equity is 15 percent.The current value of the firm is $680,000.What will the value be if the firm borrows $140,000 and uses the proceeds to repurchase shares? The corporate tax rate is 35 percent.

Accepted Answer

The answer of The Piano Movers can borrow at 7.8...

Question 10

Omnipotent, LLC is an all-equity firm with 75,000 shares of stock outstanding and a total market value of $984,000.Based on its current capital structure, the firm is expected to have earnings before interest and taxes of $226,560 if the economy is normal, $64,000 if the economy is in a recession, and $356,000 if the economy booms.Ignore taxes.Management is considering issuing $165,000 of debt at a coupon rate of 7.5 percent.If the firm issues the debt, the proceeds will be used to repurchase stock.What will the earnings per share be if the debt is issued and the economy is in a recession? (Round the number of shares repurchased down to the nearest whole share.)

Accepted Answer

The answer of Omnipotent, LLC is an all-equity firm with...

Question 11

Gabe's Market is comparing two different capital structures.Plan I would result in 15,000 shares of stock and $210,000 in debt.Plan II would result in 13,000 shares of stock and $252,000 in debt.The interest rate on the debt is 8 percent.Ignoring taxes, compare both of these plans to an all-equity plan assuming that EBIT will be $52,000.The all-equity plan would result in 25,000 shares of stock outstanding.Of the three plans, the firm will have the highest EPS with _____ and the lowest EPS with ____.

Accepted Answer

Plan II will have the highest EPS because it has fewer shares and higher debt, which increases leverage and EPS when EBIT is high. The all-equity plan will have the lowest EPS because it has the most shares outstanding, diluting earnings per share.

Question 12

Crowded Fund Capital is an all-equity firm with a total market value of $1,015,000 and 20,000 shares of stock outstanding.Management is considering issuing $300,000 of debt at an interest rate of 5.5 percent and using the proceeds on a stock repurchase.As an all-equity firm, management believes its earnings before interest and taxes (EBIT) will be $266,000 if the economy is normal, $110,000 if it is in a recession, and $387,000 if the economy booms.Ignore taxes.What will the EPS be if the economy falls into a recession and the firm maintains its all-equity status?

Accepted Answer

If the firm maintains its all-equity status, the EPS during a recession is calculated by dividing the EBIT by the number of shares. With an EBIT of $110,000 and 20,000 shares, EPS = $110,000 / 20,000 = $5.50.

Question 13

Catapult Movers has determined that $98,000 is the break-even level of earnings before interest and taxes for the two capital structures it is considering.The one structure consists of all equity with 30,000 shares of stock.The second structure consists of 20,000 shares of stock and $400,000 of debt.What is the interest rate on the debt?

Accepted Answer

The answer of Catapult Movers has determined that $98,000 is...

Question 14

Uptown Construction is comparing two different capital structures.Plan I would result in 16,000 shares of stock and $160,000 in debt.Plan II would result in 18,000 shares of stock and $110,000 in debt.The interest rate on the debt is 9 percent.Ignoring taxes, EPS will be identical for Plans I and II when EBIT equals which one of the following?

Accepted Answer

The answer of Uptown Construction is comparing two different capital...

Question 15

Triangle Enterprises has no debt but can borrow at 8 percent.The firm's WACC is currently 13.2 percent, and there is no corporate tax.If the firm converts to 30 percent debt, what will its cost of equity be?

Accepted Answer

The answer of Triangle Enterprises has no debt but can...

Question 16

Wookie's is an all-equity firm that has 250,000 shares of stock outstanding.Neal, the financial vice president, is considering borrowing $450,000 at 7 percent interest to repurchase 60,000 shares.Ignoring taxes, what is the current value of the firm?

Accepted Answer

The value of an all-equity firm is the market value of its equity. Since the firm is considering borrowing to repurchase shares, the current value of the firm is the total value of its equity before the repurchase, which is $1,875,000 (250,000 shares x $7.50 per share).

Question 17

Regional Fleet Sales has a pretax cost of debt of 7.30 percent and a return on assets of 20.5 percent.The debt-equity ratio is .46.Ignore taxes.What is the cost of equity?

Accepted Answer

The answer of Regional Fleet Sales has a pretax cost...

Question 18

Last Minute Loan Services is an all-equity firm with a total market value of $1,221,350 and 50,000 shares of stock outstanding.Management is considering issuing $225,000 of debt at an interest rate of 6.25 percent and using the proceeds on a stock repurchase.Ignore taxes.How many shares will the firm repurchase if it issues the debt securities? (Round the number of shares repurchased down to the nearest whole share.)

Accepted Answer

The answer of Last Minute Loan Services is an all-equity...

Question 19

Delta Mowers has a debt-equity ratio of .6.Its WACC is 11.8 percent, and its cost of debt is 7.7 percent.There is no corporate tax.What is the firm's cost of equity capital?

Accepted Answer

The answer of Delta Mowers has a debt-equity ratio of...

Quiz 13: Leverage and Capital Structure