Consider this case:Globo-Chem Co. currently has a capital structure consisting of 35% debt and 65% equity. However, Globo-Chem Co.'s CFO hassuggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7.5%, and Globo-Chem Co.'s beta is 1.25.If the firm's tax rate is 35%, what will be the beta of an all-equity firm if its operations were exactly the same?Now consider the case of another company:U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 8%, and its tax rateis 35%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%.U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-taxcost of debt to increase to 10%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weightedaverage cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.),The optimal capital structure is the one that_the WACC andthe firm's stock price. Higher debt levelsthe firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to

Levered beta: Indicates how volatile a company's stock returns are when taking its debt levels into…

Answered: the firm's risk. Consequently, higher…

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the firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Consider this case: Globex Corp. currently has a capital structure consisting of 30% debt and 70% equity. However, Globex Corp.'s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3.5%, the market risk premium is 7.5%, and Globex Corp.'s beta is 1.15. If the firm's tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 25%. It currently has a levered beta of 1.15. The risk-free rate is 3.5%, and the risk premium on the market is 7.5%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt to increase to 12%. First, solve for US Robotics Inc.'s unlevered beta. Use US Robotics Inc.'s unlevered beta to solve…
Globo-Chem Co. currently has a capital structure consisting of 30% debt and 70% equity. However, Globo-Chem Co.'s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3.5%, the market risk premium is 8%, and Globo-Chem Co.'s beta is 1.10. If the firm's tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 25%. It currently has a levered beta of 1.10. The risk-free rate is 3.5%, and the risk premium on the market is 8%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt to increase to 8%. First, solve for US Robotics Inc.'s unlevered beta. Use US Robotics Inc.'s unlevered beta to solve for the firm's levered…
Intuit Inc. (INTU) has a capital structure of 38% debt and 62% equity. The expected return on the market is 6.31%, and the risk-free rate is 2.04%. What discount rate should an analyst use to calculate the net present value (NPV) of a project with an equity beta of 1.08 if the firm’s after-tax cost of debt is 5.56%? A. 3.98%. B. 4.70%. C. 5.48%. D. 6.23%.
Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7.5%, and Globex Corp.’s beta is 1.25. If the firm’s tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 25%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%. US Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 8%. First, solve for US Robotics Inc.’s unlevered beta. Use US Robotics Inc.’s unlevered beta…
Rolex, Inc. has equity with a market value of $20 million and debt with a market value of $20 million. Assume the firm has no default risk and can borrow at the risk-free interest rate. The risk-free interest rate is 5 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost of capital for an otherwise identical all-equity firm? O 7.77% O 9.00% O 10.14% O 8.27%
ABC Company is re-evaluating its debt level. Its current capital structure consists of 72% debt and the remaining as common equity, its beta is 1.63, and its tax rate is 35%. However, as its CFO, you think the company has too much debt, and are considering moving to a capital structure with 36% debt and the remaining as common equity. The risk-free rate is 5.0% and the market risk premium is 6.9%. By how much would the capital structure shift change the company's cost of equity, that is, (current cost of equity - new cost of equity)? Round your final answer to two decimal places of percentage (%), but do not enter % in your answer, e.g., x.xx. (Hint: Compute the new beta using the Hamada equation first and then the new cost of equity using the CAPM.)
Hardmon Enterprises is currently an all-equity firm with an expected return of 18%. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. (Assume perfect capital markets.) a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 5%. What will the expected return of equity be after this transaction? b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 7%. What will the expected return of equity be in this case? c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument? a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost…
LG Co. is trying to estimate its optimal capital structure. Right now, LG has a capital structure that consists of 20 percent debt and 80 percent equity, based on market values. (Its D/S ratio is 0.25.) The risk-free rate is 4 percent and the market risk premium, rM – rRF, is 5 percent. Currently the company’s cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent. What would be LG’s unlevered beta and estimated cost of equity if it were to change its capital structure to 40 percent debt and 60 percent equity? [Use Hamada equation] Group of answer choices 1.60, and 10.84% 1.39, and 13.74% 1.39, and 15.24% 1.60, and 14.34% 1.95 and 18.72% 1.15, and 11.28%
Now consider the case of another company: U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 45%. It currently has a levered beta of 1.15. The risk-free rate is 3.5%, and the risk premium on the market is 7.5%. U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt to increase to 8%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weighted average cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.) Which of the following statements regarding a firm's optimal capital structure are true? Check all that apply. The optimal capital structure maximizes the firm's stock price. The optimal capital structure maximizes the firm's EPS. The optimal capital structure…
DraftKings Inc (DKNG) has a capital structure of 29% debt and 71% equity. The expected return on the market is 7.65%, and the risk-free rate is 2.41%. What discount rate should an analyst use to calculate the NPV of a project with an equity beta of 1.22 if the firm’s after-tax cost of debt is 4.26%? A. 3.15% B. 5.18% C. 7.49% D. 9.01%
Infosystems, Inc. has a debt/equity ratio = 2. The firm has a cost of equity of 12% and a cost of debt of 6%. Calculate the firm’s equity’s beta (β) after the target debt/equity ratio changes to 1.5. Assume that the cost of debt does not change. Ignore taxes and other market imperfections. The risk-free interest rate is 2% and the market risk premium is 7%.
Consider this case: Globex Corp. has a capital structure that consists of 35% debt and 65% equity. The firm’s current beta is 1.10, but management wants to understand Globex Corp.’s market risk without the effect of leverage. If Globex Corp. has a 25% tax rate, what is its unlevered beta? 0.70 0.94 0.62 0.78

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