Probability that equity financing is better than debt financing.

Question

Suppose that the borrowing rate that your client faces is 5%. Assume that the equity market index has an expected return of 8% and standard deviation of 24%, that r = 28. What is the range of risk aversion for which a client will neither borrow nor lend, that is, for which y=1? Note: Do not round intermediate calculations. Round your answers to 2 decimal places. y = 1 for 9.60 SAS 0.48

Answer 1

Question

Chapter 14, Problem 23P

a.

Summary Introduction

To compute: Probability that equity financing is better than debt financing.

b.

Summary Introduction

To compute: Probability of losing money under debt option.

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Suppose that the borrowing rate that your client faces is 5%. Assume that the equity market index has an expected return of 8% and standard deviation of 24%, that r = 28. What is the range of risk aversion for which a client will neither borrow nor lend, that is, for which y=1? Note: Do not round intermediate calculations. Round your answers to 2 decimal places. y = 1 for 9.60 SAS 0.48

You have the following initial information on which to base your calculations and discussion: Debt yield = 2.5% Required Rate of Return on Equity = 13% Expected return on S&P500 = 8% Risk-free rate (rF) = 1.5% Inflation = 2.5% Corporate tax rate (TC) = 30% Current long-term and target debt-equity ratio (D:E) = 1:3 a. What is the unlevered cost of equity (rE*) for this firm? Assume that the management of the firm is considering a leveraged buyout of the above company. They believe that they can gear the company to a higher level due to their ability to extract efficiencies from the firm’s operations. Thus, they wish to use a target debt-equity ratio of 3:1 in their valuation calculations. b. What would the levered cost of equity equal for this firm at a debt-equity ratio (D:E) of 3:1? c. What would the required rate of return for the company equal if it were to be acquired under the leveraged buyout structure (i.e., what would the estimated firm WACC equal to under a…

You have the following initial information on which to base your calculations and discussion: Debt yield = 2.5% Required Rate of Return on Equity = 13% Expected return on S&P500 = 8% Risk-free rate (rF) = 1.5% Inflation = 2.5% Corporate tax rate (TC) = 30% Current long-term and target debt-equity ratio (D:E) = 1:3 a. What is the unlevered cost of equity (rE*) for this firm? Assume that the management of the firm is considering a leveraged buyout of the above company. They believe that they can gear the company to a higher level due to their ability to extract efficiencies from the firm’s operations. Thus, they wish to use a target debt-equity ratio of 3:1 in their valuation calculations.