Macbeth Spot Removers is entirely equity financed with values as shown below: Data Number of shares Price per share 500 $ 10 Market value of shares $ 5,000 Market value of debt $ 5,000 $ 500 Interest at 4% Although it expects to have an income of $1,500 a year in perpetuity, this income is not certain. This table shows the return to stockholders under different assumptions about operating income. We assume no taxes. Outcomes Operating income (5) 500 1,000 Interest ($) 500 500 Equity earnings ($) 0 500 Earnings per share ($) 0 Return on shares (%) 0 1.00 10 1,500 500 1,000 2.00 20 2,000 500 1,500 3.00 38 Expected outcome Suppose that Macbeth Spot Removers issues only $3,000 of debt and uses the proceeds to repurchase 300 shares. The interest rate on the debt is 4%. a. Calculate the equity earnings, earnings per share, and return on shares for each operating income assumption. b. If the beta of Macbeth's assets is 0.85 and its debt is risk-free, what would be the beta of the equity after the debt issue?

Macbeth Spot Removers is entirely equity financed with values as shown below: Data Number of shares Price per share 500 $ 10 Market value of shares $ 5,000 Market value of debt $ 5,000 $ 500 Interest at 4% Although it expects to have an income of $1,500 a year in perpetuity, this income is not certain. This table shows the return to stockholders under different assumptions about operating income. We assume no taxes. Outcomes Operating income (5) 500 1,000 Interest ($) 500 500 Equity earnings ($) 0 500 Earnings per share ($) 0 Return on shares (%) 0 1.00 10 1,500 500 1,000 2.00 20 2,000 500 1,500 3.00 38 Expected outcome Suppose that Macbeth Spot Removers issues only $3,000 of debt and uses the proceeds to repurchase 300 shares. The interest rate on the debt is 4%. a. Calculate the equity earnings, earnings per share, and return on shares for each operating income assumption. b. If the beta of Macbeth's assets is 0.85 and its debt is risk-free, what would be the beta of the equity after the debt issue?

Corporate Fin Focused Approach

5th Edition

ISBN:9781285660516

Author:EHRHARDT

Publisher:EHRHARDT

Chapter15: Capital Structure Decisions

Section: Chapter Questions

Problem 8P

See similar textbooks

Similar questions

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?
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 %
The Rivoli Company has no debt outstanding, and its financial position is given by the following data: What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share? Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?
The cost of retained earnings True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. True False The cost of equity using the CAPM approach The current risk-free rate of return (rRF ) is 4.23% while the market risk premium is 6.17%. The D’Amico Company has a beta of 1.56. Using the capital asset pricing model (CAPM) approach, D’Amico’s cost of equity is . The cost of equity using the bond yield plus risk premium approach The Kennedy Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Kennedy’s bonds yield 10.28%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 5.89. Based on the bond-yield-plus-risk-premium approach, Kennedy’s cost of internal equity is:…
Whispering Pines Inc. is all-equity-financed. The expected rate of return on the company's shares is 9.65%. a. What is the opportunity cost of capital for an average-risk Whispering Pines investment? (Enter your answer as a percent rounded to 2 decimal places.) Opportunity cost of capital % b. Suppose the company issues debt, repurchases shares, and moves to a 24% debt-to-value ratio (D/ V = 0.24). What will be the company's weighted-average cost of capital at the new capital structure? The borrowing rate is 5.75% and the tax rate is 21%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Weighted-average cost of capital
An unlevered firm has expected earnings of $2,401 and a market value of equity of $19,600. The firm is planning to issue $4,000 of debt at 6 percent interest and use the proceeds to repurchase shares at their current market value. Ignore taxes. What will be the cost of equity after the repurchase?
As an analyst, you were task to compute for the WACC of various companies given the following information. Income tax rate is 30%. Risk free rate Beta Market return Debt to equity ratio Dettmargin Accenture Co. 4% 1.25 12% 2.50 2% Nestle Co. 3% 1.5 11% 3.00 3% Which compeny nes the nighest cost of equity? FedEx Co. 2% 1.3 10% 4.00 2.50% Cadence Co. 3.50% 1.4 8% 3.50 1.50%
True or False: It is free for a company to raise money through retained earnings, because retained earnings represent money that is left over after dividends are paid out to shareholders. False True The cost of equity using the CAPM approach The current risk-free rate of return (rRFrRF) is 4.23% while the market risk premium is 6.63%. The Allen Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Allen’s cost of equity is (9.40%, 8.46, 11.28, 9.87) . The cost of equity using the bond yield plus risk premium approach The Hoover Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Hoover’s bonds yield 10.28%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Hoover’s cost of internal equity is: 13.83%…
You have the following information on a company on which to base your calculations and discussion: Cost of equity capital (rE) = 18.55% Cost of debt (rD) = 7.85% Expected market premium (rM –rF) = 8.35% Risk-free rate (rF) = 5.95% Inflation = 0% Corporate tax rate (TC) = 35% Current long-term and target debt-equity ratio (D:E) = 2:5 a. What are the equity beta (bE) and debt beta (bD) of the firm described above?[Hint: Assume that the above costs of capital have been generated by an appropriate equilibrium model.] b. What is the weighted-average cost of capital (WACC) for this firm at the current debt-equity ratio? c. What would the company’s cost of equity capital become if you unlevered the capital structure (i.e. reduced gearing until there is no debt)
Labrador technologies Inc. plans to become public soon. The board of directors would like to know the value of common equity and have asked for your opinion. The firm has $1,249,917 in preferred equity and the market value of its outstanding debt equals $2,049,396. The WACC for this firm is estimated to be 8.92%. For this example assume the current assets are zero. Use the DCF valuation model with the expected FCFs shown below; year 1 represents one year from today and so on. The company expects to grow at a 3.0% rate after Year 5. Rounding to the nearest penny, what is the value of common equity? Free Cash Period Flow Year 1 $1,370,274 Year 2 $1,761,479 Year 3 $1,909,652 Year 4 $2,361,090 Year 5 $2,744,645
1.Unikai company LLC have some surplus funds for a short period of time which they want to invest in some short-term securities. Which of the following is not an appropriate source for the company? a.All of these b.Commercial paper c.Equity shares d.Treasury bills 2.In Muscat SAOG company, there are 400000 shares and the management declared OMR 800000 as net profit. What would be the earning per share? a. OMR 5 b. None of the options c. OMR 4 d. OMR 2
Wealth and Health Company is financed entirely by common stock that is priced to offer a 15 percent expected return. The common stock price is $40/share. The earnings per share (EPS) is expected to be $6. If the company repurchases 25 percent of the common stock and substitutes an equal value of debt yielding 6 percent, what is the expected value of earnings per share after refinancing? (Ignore taxes.) $7.20 $7.52 $6.00 $6.90