The firm Summer! Has a market capitalization of 800 and debt with a market value of 200. The equity beta is 1. the debt beta is 0, and the riskiness of the tax shield equals the riskiness of the assets. The all equity firm NewSummer! is in a similar line of business and has expected cash flows after tax of 80 in perpetuity (starting next year. The corporate tax rate is 30% and there are no personal taxes. The riskfree rate is 4% and the expected rate of return on the market portfolio is 9%. You have been asked to look into the implications of adding debt to the capital structure of NewSummer: You decide to investigate two debt policies. Policy 1 involves having a constant debt to value ratio of 50%. The debt will be risk free. Policy 2 involves having a fixed amount of debt of 500 in perpetuity, which can be issued at par with a coupon of 4%. Required: Calculate the market values immediately after the change in capital structure. calculate the following questions a) under policy 1 what is the firm value, equity value, debt value, what about unber policy 2 b)what is the reason behind the difference
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
The firm Summer! Has a market capitalization of 800 and debt with a market value of 200. The equity beta is 1. the debt beta is 0, and the riskiness of the tax
shield equals the riskiness of the assets. The all equity firm NewSummer! is in a similar line of business and has expected cash flows after tax of 80 in perpetuity (starting next year. The corporate tax rate is 30% and there are no personal taxes. The riskfree rate is 4% and the expected
You have been asked to look into the implications of adding debt to the capital structure of NewSummer: You decide to investigate two debt policies.
Policy 1 involves having a constant debt to value ratio of 50%. The debt will be risk free.
Policy 2 involves having a fixed amount of debt of 500 in perpetuity, which can be issued at par with a coupon of 4%.
Required: Calculate the market values immediately after the change in capital structure.
calculate the following questions
a) under policy 1 what is the firm value, equity value, debt value, what about unber policy 2
b)what is the reason behind the difference
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