14. LeCompte Learning Solutions is considering making a change to its capital structure in hopes of increasing its value.The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company hasproduced the following table:Percent financedPercent financedDebt-to-equityratio (D/S)BondBefore-taxwith debt (wd)with equity (wc)Ratingcost of debt0.100.900.10/0.90 = 0.11AAA7.0%0.200.800.20/0.80 = 0.25AA7.20.300.400.700.30/0.70 = 0.43А8.00.600.40/0.60 = 0.67BBB8.80.500.500.50/0.50 = 1.00BB9.6The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market riskpremium is 6%. LeCompte estimates that if it had no debt its beta would be 1.0. (Its "unlevered beta," bu, equals 1.0.) Thecompany's tax rate, T, is 40%.On the basis of this information, what is LeCompte's optimal capital structure, and what is the firm's cost of capital at thisoptimal capital structure?a. Wc = 0.5; wd = 0.5; WACC = 10.18%b. Wc = 0.6; wd= 0.4; WACC = 10.15%C. Wc = 0.8; wd= 0.2; WACC = 10.96%d.Wc = 0.9; wd = 0.1; WACC = 14.96%e. wc = 0.7; wd = 0.3; WACC=7.83%

Beta shows the relation between expected return of investment and systematic risk. CAPM use beta to…

Answered: On the basis of this information, what…

On the basis of this information, what is LeCompte's optimal capital structure, and what is the firm's cost of capital at this

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter13: Capital Structure Concepts

Section: Chapter Questions

Problem 5P

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Aaron Athletics is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common equity. In order to estimate the cost of capital at various debt levels the company has constructed the following table: Percent financed with debt (wD) Percent financed with equity (ws) Before tax cost of debt 0.10 0.90 7.0% 0.20 0.80 7.2% 0.30 0.70 8.0% 0.40 0.60 8.8% 0.50 0.50 9.6% The company uses the CAPM to estimate its cost of equity, rS . The risk-free rate is 4% and the market risk premium is 5%. Aaron estimates that if it had no debt its beta would be 1.0. (It’s unlevered beta equals 1.0). The company’s tax rate is 40%. On the basis of this information, what is the company’s optimal capital structure, and what is the WACC at that capital structure? (Show your calculations at each debt level).
Give typing answer with explanation and conclusion If the company were to borrow more (or less), how would that impact the cost of debt and the WACC? Provide a specific assumed example. Weight of Equity 76.10% Weight of Debt 23.90% Cost of Equity 6.98% Cost of Debt 2.55% Tax Rate WACC 5.92%
Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: 09.86% 9.56% Percent Financed With Debt 10.16% 8.96% 9.26% 0.10 0.20 0.30 0.40 0.50 Percent Financed With Equity 0.90 0.80 0.70 0.60 0.50 Debt/Equity Ratio Now assume that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, Ks, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). 0.10/0.90 0.11 0.20/0.80 0.25 Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. 0.30/0.70=0.43 0.40/0.600.67 0.50/0.50 = 1.00 Bond Rating AA A A BB B Before-Tax Cost of Debt 7.0% 7.2%…
6. Calculate and explain the Weighted Average Cost of Capital (WACC)based on the details below.a. Market Value of Equity: $7Mb. Market Value of Debt: $3Mc. Cost of equity 7%d. Cost of debt: 5%e. Tax Rate: 32 (use .32 for calculation)
In the graph below, three different debt funding approaches (A, B & C) – where the red line shows the liquidity situation. Explain these briefly and suggest the appropriate approach for a company by providing specific reasons and explain what firm should do when outlying. Dollars B Cumulative capital requirement Time Year 1 Year 2 Year 3
8.4 Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures: Debt (%) After-Tax Cost of Debt (%) Cost of Equity (%) 0 — 16.0 20 6.6 17.0 40 7.8 19.0 60 10.2 22.0 80 14.0 27.0 What is the firm’s optimal capital structure? (Hint: Calculate its corporate cost of capital at each structure. Also, note that data on component costs at alternative capital structures are not reliable in real-world situations)
Calculate the Weighted Average Cost of Capital (WACC) for McCormick and Company using the formula WACC = (WD x RD x (1-T)) + (WS x Rs) Note that -- Rs = the cost of equity Rd = the cost of debt T = the tax rate WD = Value of debt / (Value of debt plus value of equity) WS = Value of equity / (Value of debt plus value of equity) **Note that the weight of debt plus the weight of equity must total to 100%, as there are only two components in the capital structure.** In order to estimate the weights of debt and equity in the total capital structure, the CFO suggests using the book value of debt and the market value of equity. To determine the book value of debt, use data from the year end November 2019 McCormick 10-K. Look on the Balance sheet and add the following -- Short term borrowings, Current portion of long term debt, and Long term debt. To determine the market value of equity, use the following data: On March 17, 2020 the market value of equity (or "Market Cap")…
As a first step, we need to estimate what percentage of MMMs capital comes from debt, preferred stock, and common equity. This information can be found on the firms latest annual balance sheet. (As of year end 2014, MMM had no preferred stock.) Total debt includes all interest-bearing debt and is the sum of short-term debt and long-term debt. a. Recall that the weights used in the WACC are based on the companys target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its balance sheet, what weights should you use to estimate the WACC for MMM? b. Find MMMs market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the balance sheet (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firms debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.
CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 3. Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it. One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the companys home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firms WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?
The cost of equity is _______. A. the interest associated with debt B. the rate of return required by investors to incentivize them to invest in a company C. the weighted average cost of capital D. equal to the amount of asset turnover
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…
DIRECTIONS. Analyze the situation and answer the question on a separate sheet of раper. One of the VP for Finance of the Financial Manager is to determine the appropriate capital structure of the company. To illustrate, show/draw the figure below: Sample Capital Structure 100% 75% Equity 50% Assets 25% Liabilities 0% Total Assets Total Structure - In the figure above, the total assets are financed by 60% debt and 40% equity. Accordingly, the capital structure is 60% debt and 40% equity. Question: Do you think there is an ideal mix of debt and equity across corporations? Elaborate your answer.