EBIT-EPS and capital structure Data-Check is considering two capital structures. The key information is shown in the following table. Assume a 40% tax rate. Source of capital Long-term debt Common stock Structure A $99,000 at 15.6% coupon rate 5,000 shares Structure B $198,000 at 16.6% coupon rate 2,500 shares a. Calculate two EBIT-EPS coordinates for each of the structures by selecting any two EBIT values and finding their associated EPS values. b. Plot the two capital structures on a set of EBIT-EPS axes. c. Indicate over what EBIT range, if any, each structure is preferred. d. Discuss the leverage and risk aspects of each structure. e. If the firm is fairly certain that its EBIT will exceed $78,000, which structure would you recommend? Why?
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- Eaton Electronic Company's treasurer uses both the capital asset pricing model and the dividend valuation model to compute the cost of common equity (also referred to as the required rate of return for common equity). Assume: Rf Km = 8% = 6% = В D₁ = $0.60 Po = $20 8 = 5% = 1.8 a. Compute K; (required rate of return on common equity based on the capital asset pricing model). Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places. Ki 0.10% b. Compute Ke (required rate of return on common equity based on the dividend valuation model). Note: Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places. Ke %Estimate the weighted-average cost of capital for Home Depot (HD), Altria (MO), Caterpillar (CAT), and Intel (INTC). You can estimate the expected stock returns for these companies by using the betas shown on finance.yahoo.com. You can also use Yahoo! Finance to find the relative proportions of equity and debt for each company. Remember, though, to use the mar- ket value of the equity, not its book value. Finding the yield on the debt is a little trickier. One possibility it to log on to the Federal Reserve Bank of St. Louis site at https://fred.stlouisfed .org/ to find the current level of Treasury yields and the yield spreads (i.e., the extra yield for bonds with different ratings). An alternative is to view recent transactions at www.finra.org /industry/trace/corporate-bond-data. Note: As we write this, Moody's provides an A rating for all four companies.The financial manager has determined the following schedules for the cost of funds: Cost of the Ratio Cost of Debt Equity 0% 5% 13% 10 5 13 20 5 13 30 5 13 40 5 14 50 6 15 60 8 16 a. Determine the firm’s optimal capital structure. b. Construct a simple pro forma balance sheet that shows the firm’s opti- mal combination of debt and equity for its current level of…
- A company hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.50. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference? Group of answer choices 2.61% 2.67% 3.54% 3.00% 3.72%Suppose that Mr. Dubinski has obtained from Blaine’s banker the quotes (the one in the template, ignore the one provided in the case) for default spreads over 10-year Treasury bonds. What do these quotes imply about BKI’s cost of debt at the various debt levels and credit ratings? Compute BKI’s weighted average cost of capital at each of the indicated debt levels. What do your calculations imply about Blaine’s optimal capital structure?The following were gathered for estimating the cost of equity of KKK Corporation: Return on Treasury Bonds = 4%; Return on the Market = 10%; Return on KKK Bonds = 6%. Upon analysis, you determined that the beta of KKK shares relating to the market return is 1.2 while a risk premium of 4% should be given to KKK's investors over its creditors. How much is the cost of equity using the capital asset pricing model?
- Evans Technology has the following capital structure. Debt Common equity The aftertax cost of debt is 8.50 percent, and the cost of common equity (in the form of retained earnings) is 15.50 percent. a. What is the firm's weighted average cost of capital? Note: Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places. 48% 60 Debt Common equity Weighted average cost of capital Weighted Cost % % An outside consultant has suggested that because debt is cheaper than equity, the firm should switch to a capital structure that is 50 percent debt and 50 percent equity. Under this new and more debt-oriented arrangement, the aftertax cost of debt is 9.50 percent, and the cost of common equity (in the form of retained earnings) is 17.50 percent. b. Recalculate the firm's weighted average cost of canitalDeSoto Tools Incorporated is planning to expand production. The expansion will cost $3,000,000, which can be financed either by bonds at an interest rate of 8 percent or by selling 60,000 shares of common stock at $50 per share. The current income statement before expansion is as follows: DESOTO TOOLS INCORPORATED Income Statement 20x1 Sales Variable costs Fixed costs Earnings before interest and taxes Interest expense Earnings before taxes Taxes 30% Earnings after taxes Shares Earnings per share $ 3,100,000 620,000 810,000 $ 1,670,000 500,000 $ 1,170,000 351,000 $ 819,000 200,000 $4.10 After the expansion, sales are expected to increase by $1,600,000. Variable costs will remain at 20 percent of sales, and fixed costs will increase to $1,370,000. The tax rate is 30 percent. a. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before expansion. (For the degree of operating leverage, use the formula: DOL= For the degree of…The CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm's bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) TRF = 5.00%, RPM = 6.00%, and b = 1.45. (3) D₁ = $1.20, Po = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference? O 2.35% O 2.13% 2.84% 2.40% 2.70%
- Suppose you manage an equity fund with the following securities. Use the following data to calculate the information ratio of each stock. Input Data Vogt Industries Isher Corporation Hedrock, Incorporated Alpha 0.012 0.006 0.016 Beta 0.277 1.015 1.630 Standard Deviation 0.156 0.168 0.181 Residual Standard Deviation 0.117 0.048 0.113 Required: Using the information in the table above, please calculate the information ratio for each stock. (Use cells A5 to D8 from the given information to complete this question.) Vogt Industries Isher Corporation Hedrock, Incorporated Information RatioThe CFO of Lenox Industries hired you as a consultant to help estimate its cost of capital. You have obtained the following data: (1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%. (2) rRF = 5.00%, RPM = 6.00%, and b = 1.05. (3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant). You were asked to estimate the cost of equity based on the three most commonly used methods and then to indicate the difference between the highest and lowest of these estimates. What is that difference? 0.43% 0.49% 0.48% 0.38% 0.37%Q2. Suppose you are the chief financial officer of Toktik Co. and you are trying to determine the optimal capital structure for the company using the cost of capital approach. On the day of this exam, you have collected the following company and market data: The beta of the company is 2.6; • 10-year Treasury bond rate is 1.6% and the current market equity risk premium is 6.9%; • The company's current bond rating is BB by Standard & Poor's; • The firm currently has 5.2 billion shares outstanding with share price at $120 and the firm's market value of debt is $264 billion • The company's marginal tax rate is 35%. Also you are given the following table concerning the latest information on bond rating and the corresponding default spread: Default spread Rating AAA 0.69% AA 0.85% A+ 1.07% A 1.18% А- 1.33% BBB 1.71% BB+ 2.31% BB 2.77% B+ 4.05% 4.86% В- 5.94% ССС 9.46% CC 9.97% 13.09% D 17.44% Required: a) Briefly explain, by referencing relevant capital structure theories, the mechanisms…