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Kaelea, Inc., has no debt outstanding and a total market value of $100,000.
Earnings before interest and taxes, EBIT, are projected to be $8,400 if economic conditions are normal.
If there is strong expansion in the economy, then EBIT will be 24 percent higher. If there is a recession, then EBIT will be 31 percent lower.
The company is considering a $35,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock.
There are currently 4,000 shares outstanding. Ignore taxes for this problem.
 
a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued.
(Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
   
b. Calculate the percentage changes in EPS when the economy expands or enters a recession.
(A negative answer should be indicated by a minus sign. Do not round intermediate calculations and
enter your answers as a percent rounded to the nearest whole number, e.g., 32.)


Recession           -31.00% 
Expansion           24.00% 
 
Assume the company goes through with recapitalization.
 
c. Calculate earnings per share, EPS, under each of the three economic scenarios after the recapitalization.
(Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
 
Recession           $1.42 
Normal $2.42 
Expansion           $3.20 

d. Calculate the percentage changes in EPS when the economy expands or enters a recession.
(A negative answer should be indicated by a minus sign. Do not round intermediate calculations and
enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)

Recession   -41.33%

Expansion    32.00%

 
 
Explanation:
a and b.
A table outlining the income statement for the three possible states of the economy is shown below. The EPS is the net income divided by the 4,000 shares outstanding. The last row shows the percentage change in EPS the company will experience in a recession or an expansion economy.

	Recession					Normal				Expansion
EBIT		$	5,796				$	8,400			$	10,416
Interest			0					0				0
NI		$	5,796				$	8,400			$	10,416
EPS		$	1.45				$	2.10			$	2.60
%ΔEPS			–31	%				–				+24	%

c and d.
If the company undergoes the proposed recapitalization, it will repurchase:
Share price = Equity / Shares outstanding
Share price = $100,000 / 4,000
Share price = $25
Shares repurchased = Debt issued / Share price
Shares repurchased = $35,000 / $25
Shares repurchased = 1,400
The interest payment each year under all three scenarios will be:
Interest payment = $35,000(.06)
Interest payment = $2,100
The last row shows the percentage change in EPS the company will experience in a recession or
an expansion economy under the proposed recapitalization.
 

	Recession					Normal				Expansion
EBIT		$	5,796				$	8,400			$	10,416
Interest			2,100					2,100				2,100
NI		$	3,696				$	6,300			$	8,316
EPS		$	1.42				$	2.42			$	3.20
%ΔEPS		–	41.33	%				–				+32.00	%

rev: 04_20_2017_QC_CS-86652  
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?
 
$60,750
$50,400
$48,550
$53,700
$69,600

  Kaelea, Inc., has no debt outstanding and a total market value of $82,000.
Earnings before interest and taxes, EBIT, are projected to be $8,500 if economic conditions are normal.
If there is strong expansion in the economy, then EBIT will be 20 percent higher. If there is a recession, then EBIT will be 25 percent lower.
The company is considering a $28,200 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock.
There are currently 4,100 shares outstanding. Assume the company has a market-to-book ratio of 1.0.
 
a. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued, assuming no taxes.
(Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)
 
Recession           7.7%
Normal 10.37%
Expansion           12.44% 
 
b. Calculate the percentage changes in ROE when the economy expands or enters a recession, assuming no taxes.
(A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your
answers as a percent rounded to the nearest whole number, e.g., 32.)
 
Recession           -25% 
Expansion           20% 
 
Assume the firm goes through with the proposed recapitalization and no taxes.
 
c. Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization.
(Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places, e.g., 32.16.)


Recession           8.18% 
Normal 12.13% 
Expansion           15.29% 
 
d. Calculate the percentage changes in ROE for economic expansion and recession.
(A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter
your answers as a percent rounded to 2 decimal places, e.g., 32.16.)


Recession           -32.56% 
Expansion           26.05% 
 
Assume the firm has a tax rate of 40 percent.
 
e. Calculate return on equity, ROE, under each of the three economic scenarios before any debt is issued.
Also, calculate the percentage changes in ROE for economic expansion and recession.
(A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answers
as a percent rounded to 2 decimal places, e.g., 32.16.)
 
                                ROE
Recession           4.66% 
Normal 6.22% 
Expansion           7.46% 
 
%AROE
 
Recession           -25% 
Expansion           20% 
 
f. Calculate return on equity, ROE, under each of the three economic scenarios after the recapitalization.
Also, calculate the percentage changes in ROE for economic expansion and recession,
assuming the firm goes through with the proposed recapitalization.
(A negative answer should be indicated by a minus sign.
Do not round intermediate calculations and enter your answers as a percent rounded to 2 decimal places.)
 
Recession           4.91%
Normal                7.28%
Expansion           9.17%
 
                                %ROE
Recession           -32.55%
Expansion           25.96%
 
Explanation:
a and b.
A table outlining the income statement for the three possible states of the economy is shown below.
The EPS is the net income divided by the 4,100 shares outstanding. The last row shows the percentage
change in EPS the company will experience in a recession or an expansion economy.
 

	Recession					Normal				Expansion
EBIT		$	6,375				$	8,500			$	10,200
Interest			0					0				0
NI		$	6,375				$	8,500			$	10,200
EPS		$	1.55				$	2.07			$	2.49
%ΔEPS			–25	%				–				+20	%

Since the company has a market-to-book ratio of 1.0, the total equity of the firm is equal
to the market value of equity. Using the equation for ROE:
 
ROE = NI / $82,000
 
The ROE for each state of the economy under the current capital structure and no taxes is: 
 

	Recession					Normal				Expansion
ROE			7.77	%			10.37	%				12.44	%
%ΔROE			–25	%			–					+20	%

c and d.
If the company undergoes the proposed recapitalization, it will repurchase:
 
Share price = Equity / Shares outstanding
Share price = $82,000 / 4,100
Share price = $20
 
Shares repurchased = Debt issued / Share price
Shares repurchased = $28,200 / $20
Shares repurchased = 1,410
 
The interest payment each year under all three scenarios will be:
 
Interest payment = $28,200(.07)
Interest payment = $1,974
 
The last row shows the percentage change in EPS the company will experience in a recession or an
expansion economy under the proposed recapitalization.
 

	Recession					Normal				Expansion
EBIT		$	6,375				$	8,500			$	10,200
Interest			1,974					1,974				1,974
NI		$	4,401				$	6,526			$	8,226
EPS		$	1.64				$	2.43			$	3.06
%ΔEPS		–	32.56	%				–				+26.05	%

If the company undertakes the proposed recapitalization, the new equity value will be:
 
Equity = $82,000 – 28,200
Equity = $53,800
 
So, the ROE for each state of the economy is:
 
ROE = NI / $53,800
 

	Recession					Normal				Expansion
ROE			8.18	%			12.13	%				15.29	%
%ΔROE			–32.56	%			–					+26.05	%

e and f.
A table outlining the income statement with taxes for the three possible states of the economy is shown below.
The share price is $20, and there are 4,100 shares outstanding. The last row shows the percentage change in EPS
the company will experience in a recession or an expansion economy.
 

	Recession					Normal				Expansion
EBIT		$	6,375				$	8,500			$	10,200
Interest			0					0				0
Taxes			2,550					3,400				4,080
NI		$	3,825				$	5,100			$	6,120
EPS		$	.93				$	1.24			$	1.49
%ΔEPS			–25	%				–				+20	%

If there are corporate taxes and the company maintains its current capital structure, the ROE is:
 

	Recession					Normal				Expansion
ROE			4.66	%			6.22	%				7.46	%
%ΔROE			–25	%			–					+20	%

If the company undergoes the proposed recapitalization, it will repurchase:
 
Share price = Equity / Shares outstanding
Share price = $82,000 / 4,100
Share price = $20
 
Shares repurchased = Debt issued / Share price
Shares repurchased = $28,200 / $20
Shares repurchased = 1,410
The interest payment each year under all three scenarios will be:
Interest payment = $28,200(.07)
Interest payment = $1,974
A table outlining the income statement with taxes for the three possible states of the economy and
assuming the company undertakes the proposed capitalization is shown below.
 

	Recession					Normal				Expansion
EBIT		$	6,375				$	8,500			$	10,200
Interest			1,974					1,974				1,974
Taxes			1,760					2,610				3,290
NI		$	2,641				$	3,916			$	4,936
EPS		$	.98				$	1.46			$	1.83
%ΔEPS		–	32.56	%				–				+26.05	%

If the company undertakes the proposed recapitalization, and there are corporate taxes,
the ROE for each state of the economy is:
 

	Recession					Normal				Expansion
ROE			4.91	%			7.28	%				9.17	%
%ΔROE			–32.56	%			–					+26.05	%

Notice that the percentage change in ROE is the same with or without taxes.
   
Bird Houses is an all-equity firm with a total market value of $388,980 and18,000 shares of stock outstanding.
Management is considering issuing $68,000 of debt at an interest rate of 6.5 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.)
 
3,116 shares
3,167 shares
3,021 shares
3,207 shares
3,146 shares
 

   
Kyle Corporation is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II).
Under Plan I, the company would have 790,000 shares of stock outstanding. Under Plan II, there would be 540,000
shares of stock outstanding and $10.5 million in debt outstanding. The interest rate on the debt is 8 percent, and there are no taxes.
 
a. Assume that EBIT is $3.1 million. Compute the EPS for both Plan I and Plan II.
(Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
 
EPS
Plan I                     $3.92
Plan II                   $4.18
 
b. Assume that EBIT is $3.6 million. Compute the EPS for both Plan I and Plan II.
(Do not round intermediate calculations and round your answers to 2 decimal places, 32.16.)
 
EPS
Plan I                     $4.55
Plan II                   $5.11
 
c. What is the break-even EBIT?
(Do not round intermediate calculations and enter your answer in dollars,
not millions of dollars, e.g., 1,234,567. Round your answer to the nearest whole number, e.g., 32.)
 
Break-even EBIT            2,654,400


Explanation:
a.
Under Plan I, the unlevered company, net income is the same as EBIT with no corporate tax.
The EPS under this capitalization will be: 
 
EPS = $3,100,000 / 790,000 shares
EPS = $3.92
 
Under Plan II, the levered company, net income will be reduced by the interest payment.
The interest payment is the amount of debt times the interest rate, so:
 
Net income = $3,100,000 – .08($10,500,000)
Net income = $2,260,000
 
And the EPS will be:
 
EPS = $2,260,000 / 540,000 shares
EPS = $4.19
 
Plan II has the higher EPS when EBIT is $3,100,000.
 
b.
Under Plan I, the net income is $3,600,000 and the EPS is:
 
EPS = $3,600,000 / 790,000 shares
EPS = $4.56
 
Under Plan II, the net income is:
 
Net income = $3,600,000 – .08($10,500,000)
Net income = $2,760,000
 
And the EPS is:
 
EPS = $2,760,000 / 540,000 shares
EPS = $5.11
 
Plan II has the higher EPS when EBIT is $3,600,000.
 
c.
To find the breakeven EBIT for two different capital structures, we set the equations for EPS equal
to each other and solve for EBIT. The breakeven EBIT is:
 
EBIT / 790,000 = [EBIT – .08($10,500,000)] / 540,000
EBIT = $2,654,400
   
Northwestern Lumber Products currently has 12,400 shares of stock outstanding and no debt.
Patricia, the financial manager, is considering issuing $160,000 of debt at an interest rate of 6.95 percent and using the
proceeds to repurchase shares. Given this, how many shares of stock will be outstanding once the debt is issued if the
break-even level of EBIT between these two capital structure options is $48,000?
Ignore taxes.
 
2,667 shares
2,873 shares
3,051 shares
2,558 shares
3,025 shares
 

   
Crosby Industries has a debt–equity ratio of 1.6. Its WACC is 9 percent, and its cost of debt is 4 percent. There is no corporate tax.
 
a. What is the company’s cost of equity capital?
(Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
 
Cost of equity    17%
 
b. What would the cost of equity be if the debt–equity ratio were 2?
(Do not round intermediate calculations and enter your answer as a percent rounded to the nearest whole number, e.g., 32.)
 
Cost of equity     19%
 
What would the cost of equity be if the debt–equity ratio were .5?
(Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
 
Cost of equity     11.5%
 
What would the cost of equity be if the debt–equity ratio were zero?
(Do not round intermediate calculations and enter your answer as a percent rounded to the nearest whole number, e.g., 32.)
 
Cost of equity    9%
 
Explanation:
a.
With the information provided, we can use the equation for calculating WACC to find the cost of equity. The equation for WACC (assuming no taxes) is:
 
WACC = (E / V)R_E + (D / V)R_D
 
The company has a debt–equity ratio of 1.6, which implies the weight of debt is 1.6/2.6, and the weight of equity is 1/2.6, so
 
WACC = .09 = (1 / 2.6)R_E + (1.6 / 2.6)(.04)
R_E = .1700, or 17.00%
b.
To find the cost of equity under different capital structures, we can again use the WACC equation.
With a debt–equity ratio of 2, the cost of equity is:
.09 = (1 / 3)R_E + (2 / 3)(.04)
R_E = .1900, or 19.00%
With a debt–equity ratio of .5, the cost of equity is:
.09 = (1 / 1.5)R_E + (.5 / 1.5)(.04)
R_E = .1150, or 11.50%
And with a debt–equity ratio of 0, the cost of equity is:
.09 = (1)R_E + (0)(.04)
R_E = WACC = .0900, or 9.00%
   
Calvert Corporation expects an EBIT of $19,750 every year forever.
The company currently has no debt, and its cost of equity is 14.0 percent.
The company can borrow at 8.5 percent and the corporate tax rate is 40.
 
a. What is the current value of the company?
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
 
Value of the firm            $ 84,642.86
 
b. What will the value of the firm be if the company takes on debt equal to 50 percent of its unlevered value?
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
 
Value of the firm            $ 101,571.43
 
What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value?
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
 
Value of the firm            $ 118,500
 
c. What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value?
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
 
Value of the firm            $ 105,803.58
 
What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value?
(Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
 
Value of the firm            $ 141,071.43
 
Explanation:
a.
With no debt, we are finding the value of an unlevered firm, so:
 
V_U = EBIT(1 – T_C) / R_A
V_U = $19,750(1 − .40) / .140
V_U = $84,642.86
 
b.
The general expression for the value of a leveraged firm is:
 
V_L = V_U + T_CD
 
If debt is 50 percent of V_U, then D = (.50)V_U, and we have:
 
V_L = V_U + T_C[(.50)V_U]
V_L = $84,642.86 + .40(.50)($84,642.86)
V_L = $101,571.43
 
If debt is 100 percent of V_U, then D = (1)V_U, and we have:
 
V_L = V_U + T_C[(1)V_U]
V_L = $84,642.86 + .40(1)($84,642.86)
V_L = $118,500.00
 
c.
According to M&M Proposition I with taxes:
 
V_L = V_U + T_CD
 
With debt being 50 percent of the value of the levered firm, D must equal (.50)V_L, so:
 
V_L = V_U + T_C[(.50)V_L]
V_L = $84,642.86 + .40(.50)(V_L)
V_L = $105,803.57
 
If the debt is 100 percent of the levered value, D must equal V_L, so:
 
V_L = V_U + T_C[(1)V_L]
V_L = $84,642.86 + .40(1)(V_L)
V_L = $141,071.43
   
Debbie's Cookies has a return on assets of 12.6 percent and a cost of equity of 14.8 percent.
What is the pretax cost of debt if the debt-equity ratio is .38? Ignore taxes.
 
A. 5.87 percent
B. 95.29 percent
C. 9.04 percent
D. 7.31 percent
E. 6.81 percent
 
.148 = .126 + [(.126 -RD) ×.38]
RD = .0681, or 6.81 percent
   
The Park Place has a return on assets of 12.9 percent, a cost of equity of 16.2 percent, and a pretax cost of debt of 7.7 percent.
What is the debt-equity ratio? Ignore taxes.
 
A. .44
B. .47
C. .67
D. .91
E. .63
 
.162 = .129 + [(.129 -.077) × D/E]
D/E = .63
 
An all-equity firm has a return on assets of 13.3 percent. The firm is considering converting to a debt-equity ratio of .48.
The pretax cost of debt is 8.6 percent.
Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?
 
A. 16.01 percent
B. 15.28 percent
C. 16.60 percent
D. 17.03 percent
E. 15.56 percent
 
RE = .133 + [(.133 -.086) × .48]
RE=.1556, or 15.56 percent
   
Brick House Markets has a tax rate of 34 percent and taxable income of $308,211.
What is the value of the interest tax shield if the interest expense is $39,700?
 
A. $14,887
B. $15,010
C. $15,595
D. $13,498
E. $16,023
 
Interest tax shield = .34 ×$39,700 = $13,498
   
Green Tea House has a tax rate of 35 percent and an interest tax shield valued at $8,046 for the year.
How much did the firm pay in annual interest?
 
A. $2,816.10
B. $2,304.11
C. $23,468.09
D. $21,107.99
E. $22,988.57
 
Interest = $8,046/.35 = $22,988.57
   
Newborn Nursery has 12,000 bonds outstanding with a face value of $1,000 each.
The coupon rate is 6.9 percent and the tax rate is 34 percent. What is the present value of the interest tax shield?
 
A. $4.14 million
B. $4.86 million
C. $3.87 million
D. $3.92 million
E. $4.08 million
 
PV of tax shield = .34 ×12,000 ×$1,000 = $4.08 million
   
Southern Foods has a $13 million bond issue outstanding with a coupon rate of 7.15 percent and a yield to maturity of 7.39 percent.
What is the present value of the tax shield if the tax rate is 34 percent?
 
A. $283,140
B. $316,030
C. $4,053,400
D. $3,960,000
E. $4,420,000
 
PV of tax shield = .34×$13,000,000= $4,420,000
   
Granny's Home Remedy has a $27 million bond issue outstanding with a coupon rate of 8.75 percent and a current yield of 8.13 percent.
What is the present value of the tax shield if the tax rate is 35 percent?
 
A. $768,285
B. $826,875
C. $839,002
D. $8,160,000
E. $9,450,000
 
PV of tax shield = .35×$27,000,000 = $9,450,000
   
Forbidden Fruit Extracts expects its earnings before interest and taxes to be $287,600 a year forever.
Currently, the firm has no debt. The cost of equity is 15.4 percent and the tax rate is 34 percent.
The company is in the process of issuing $3 million of bonds at par that carry an annual coupon rate of 7.6 percent.
What is the unlevered value of the firm?
 
A. $1,371,429
B. $1,331,971
C. $1,107,405
D. $969,325
E. $1,232,571
 
VU = [287,600 × (1 -.34)] / 0.154 = 1,232,571
   
Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $628,000.
The current cost of equity is 17.6 percent and the tax rate is 35percent. The company is in the process of issuing $4.3 million
of 8.3 percent annual coupon bonds at par. What is the levered value of the firm?
 
A. $3,824,318
B. $3,541,085
C. $3,422,225
D. $2,713,185
E. $3,385,695
 
VU = [628,000 ×(1 -.35)] / 0.176 = $2,319,318
VL = 2,319,318 + (0.35 × 4,300,000) = 3,824,318
   
Stevenson's Bakery is an all-equity company that has projected perpetual earnings before interest and taxes of $43,700 a year.
The cost of equity is 15.2 percent and the tax rate is 34 percent. The company can borrow money at 7.15 percent.
If the company borrows $50,000, what will be its levered value?
 
A. $187,613
B. $189,919
C. $206,750
D. $229,507
E. $203,682
 
VU = [$43,700 ×(1 -.34)]/.152 = $189,750
VL = $189,750 + (.34 ×$50,000) = $206,750
   
Ready To Go is an all-equity firm specializing in hot ready-to-eat meals.
Management has estimated the firm's earnings before interest and taxes will be $68,000 annually forever.
The present cost of equity is 14.1 percent. Currently, the firm has no debt but is considering borrowing $450,000 at 8 percent interest.
The tax rate is 34 percent. What is the value of the unlevered firm?
 
A. $323,017
B. $346,511
C. $314,141
D. $318,298
E. $305,200
 
VU = [$68,000 ×(1 -.34)]/.141 = $318,298
   
Great Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $386,000 annually forever.
The present cost of equity is 17.1 percent. Currently, the firm has no debt but is considering  borrowing $1.48
million at 8.5 percent interest. The tax rate is 35 percent. What is the value of the levered firm?
 
A. $1,985,251
B. $2,006,519
C. $1,888,47
D. $1,666,667
E. $2,018,181
 
VU = [$386,000 ×(1 -.35)]/.171 = $1,467,251.46
VL = $1,467,251.46 + (.35 ×$1,480,000) = $1,985,251
   
Jericho Snacks is an all-equity firm with estimated earnings before interest and taxes of $624,000 annually forever.
Currently, the firm has no debt but is considering borrowing $725,000 at 6.75 percent interest.
The tax rate is 35 percent and the current cost of equity is 15.2 percent. What is the value of the levered firm?
 
A. $3,187,271
B. $2,769,535
C. $3,307,271
D. $2,922,171
E. $3,506,418
 
VU = [$624,000 ×(1 -.35)]/.152 = $2,668,421.05
VL = $2,668,421.05 + (.35 ×$725,000) = $2,922,171
   
The Fruit Mart is an all-equity firm with a current cost of equity of 17.4 percent.
The estimated earnings before interest and taxes are $169,500 annually forever.
Currently, the firm has no debt but is in the process of borrowing $400,000 at 9.5 percent interest.
The tax rate is 35 percent. What is the value of the unlevered firm?
 
A. $649,207
B. $753,571
C. $656,411
D. $719,307
E. $633,190
 
VU = [$169,500 ×(1 -.35)]/.174 = $633,190
   
Roller Coaster's has a WACC of 11.6 percent, ignoring taxes. It has a target capital structure of 60 percent equity and 40 percent debt
and a cost of equity of 14.27 percent. What is the cost of debt?
 
A. 5.5 percent
B. 7.6 percent
C. 9.3 percent
D. 9.4 percent
E. 18.7 percent
 
.1427 = .116 + (.116 - RD) × (.40 / .60)
RD = .076
   
A firm has a cost of debt of 7.8 percent and a cost of equity of 15.6 percent.
The debt-equity ratio is .52. There are no taxes. What is the firm's weighted average cost of capital?
 
A. 11.76 percent
B. 11.29 percent
C. 12.93 percent
D. 12.47 percent
E. 10.20 percent
12.93 percent
 
WACC = [(1/1.52) ×.156] + [(.52 /1.52) ×.078] = .1293, or 12.93 percent
   
A firm has a weighted average cost of capital of 11.28 percent and a
cost of equity of 14.7 percent. The debt-equity ratio is .72. There are
no taxes. What is the firm's cost of debt?
 
A. 6.53 percent
B. 6.27 percent
C. 6.44 percent
D. 7.23 percent
E. 7.08 percent
 
1128 = [(1/1.72 × .147] + [(.72 /1.72) ×RD]
RD = 6.53 percent
   
Jasper Industrial has no debt outstanding and a total market value of $216,000. Earnings before interest and taxes, EBIT
are projected to be $15,000 if economic conditions are normal. If there is strong expansion in the economy,
then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 15 percent lower. There are currently 8,600
shares outstanding. Ignore taxes. What is the percentage change in EPS when a normal economy slips into recession?
 
A. -15.5 percent
B. -15.2 percent
C. -15.0 percent
D. -16.1 percent
E. -14.8 percent
 
EPSNormal = $15,000/8,600 = $1.744
EPSRecession = $15,000(1 - .15)/ 8,600 = $1.483
Percentage change ($1.483 -1.744)/$1.744 = -15 percent
   
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 ____.
 
A. Plan I; Plan II
B. Plan II; the all-equity plan
C. Plan II; Plan I
D. Plan I; the all-equity plan
E. the all-equity plan; Plan I
 
EPSAll-equity = $52,000/25,000 = $2.08
EPSPlan I = [$52,000 - ($210,000 × .08)]/15,000 = $2.35
EPSPlan II = [$52,000 - ($252,000 × .08)]/13,000 = $2.45
   
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?
 
A. $48,550
B. $50,400
C. $69,600
D. $53,700
E. $60,750
 
[EBIT - ($160,000 ×.09)]/16,000 = [EBIT -($110,000 ×.09)]/18,000
EBIT = $50,400
   
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?
 
A. $998
B. $1,109
C. $1,115
D. $1,037
E. $1,016
 
All-equity value = 7,500 ×$39 = $292,500
Shares repurchased = 7,500 ×.30= 2,250 shares
EPS = [$23,000 - ($292,500)(.30)(.075)]/(7,500 -2,250) = $3.1274
Cash flow = ($3.1274) ($12,675/$39) = $1,016
   
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?
 
A. 12.60 percent
B. 14.26 percent
C. 13.83 percent
D. 14.29 percent
E. 14.80 percent
 
WACC = .118 = (1/1.6) RE + (.6/1.6)(.077) = .1426, or 14.26 percent
   
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?
 
A. 16.67 percent
B. 12.95 percent
C. 14.47 percent
D. 16.39 percent
E. 15.43 percent
15.43 percent
 
WACC = .132 = .70RE + .30(.08)
RE = .1543, or 15.43 percent
   
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.
 
A. $820,000
B. $540,000
C. $750,000
D. $571,000
E. $729,000
 
VL = $680,000 + (.35)($140,000) = $729,000
   
Sand Mountain Resort has a tax rate of 32 percent. Its total interest payment for the year just ended was $41,000.
What is the interest tax shield for the year?
 
A. $27,590
B. $13,120
C. $13,410
D. 427,880
E. $41,000
$13,120
 
Interest tax shield = $41,000 ×.32 = 13,120
   
Marcos & Sons has no debt. Its current total value is $13 million.
What will the company's value be if it sells $5 million in debt and has a tax rate of 35 percent?
Assume all debt proceeds are used to repurchase equity.
 
A. $16.25 million
B. $18.00 million
C. $11.25 million
D. $13.00 million
E. $14.75 million
 
VL = $13 million + ($5 million× .35) = $14.75 million
   
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 companys new cost of equity? Ignore taxes.
 
A. 12.85 percent
B. 11.13 percent
C. 12.36 percent
D. 12.44 percent
E. 11.61 percent
 
WACC = .111 = (1/1.46)(RE) + (.46 /1.46)(.073)
RE= .1285, or 12.85 percent