The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The market value of Knight Company's 5 percent bonds is $2.00 million. Financial information for the two firms appears here. All earnings streams are perpetuities. Neither firm pays taxes. Both firms distribute all earnings available to common stockholders immediately. Firms and individuals can borrow and lend at the same rate. Projected operating income Year-end interest on debt Market value of stock Market value of debt Veblen $ 1,200,000 4,500,000 Knight $1,200,000 100,000 O Investor should invest in Knight because strategy 1) gives larger annual payoff. O Investor should invest in Knight because strategy 2) gives larger annual payoff. O Investor should invest in Veblen because strategy 2) gives larger annual payoff. O Investor should invest in Veblen because strategy 1) gives larger annual payoff. 2,250,000 2,000,000 Compare two trading strategies: 1) purchase 5% of Knight's equity; 2) purchase 5% of Veblen's equity on margin so that the investment in each company is equal. Which of the following is true?

The Veblen Company and the Knight Company are identical in every respect except that Veblen is not levered. The market value of Knight Company's 5 percent bonds is $2.00 million. Financial information for the two firms appears here. All earnings streams are perpetuities. Neither firm pays taxes. Both firms distribute all earnings available to common stockholders immediately. Firms and individuals can borrow and lend at the same rate. Projected operating income Year-end interest on debt Market value of stock Market value of debt Veblen $ 1,200,000 4,500,000 Knight $1,200,000 100,000 O Investor should invest in Knight because strategy 1) gives larger annual payoff. O Investor should invest in Knight because strategy 2) gives larger annual payoff. O Investor should invest in Veblen because strategy 2) gives larger annual payoff. O Investor should invest in Veblen because strategy 1) gives larger annual payoff. 2,250,000 2,000,000 Compare two trading strategies: 1) purchase 5% of Knight's equity; 2) purchase 5% of Veblen's equity on margin so that the investment in each company is equal. Which of the following is true?

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter15: Capital Structure Decisions

Section: Chapter Questions

Problem 11P: The Rivoli Company has no debt outstanding, and its financial position is given by the following...

See similar textbooks

Similar questions

Which of the following choices best describes reasonable conclusions that you might make about the two companies’ ability to pay their current and long-term obligations? A. Company A’s current ratio of 4.0 indicates it is more liquid than Company B, whose current ratio is only 1.2, and Company A is also more solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B’s debt-to-equity ratio of only 30 percent. B. Company A’s current ratio of 0.25 indicates it is less liquid than Company B, whose current ratio is 0.83, and Company A is also less solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B’s debt-to-equity ratio of only 30 percent. C. Company A’s current ratio of 4.0 indicates it is more liquid than Company B, whose current ratio is only 1.2, but Company B is more solvent, as indicated by its lower debt-to- equity ratio.
Consider two firms that are identical in every respect EXCEPT for their capital structures. The unlevered firm is financed entirely by equity whereas the capital structure of the levered firm includes $30,000 of debt at 12%.The annual earnings of both companies before interest are the same, $10,000. The cost of equity in the unlevered firm is 15% and in the levered company at 16%. A) Determine the market values of the two companies. B) Suppose an investor owns 1% of the equity in the levered firm, describe the arbitrage process.
ABC Company and XYZ Company are identical firms in all respects except for their capital structure. ABC is all - equity financed with $650,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $325,000 and the interest rate on its debt is 6.5 percent. Both firms expect EBIT to be $ 71,000. Ignore taxes. What is the cost of equity for ABC and XYZ?
ABC and XYZ are identical firms in all respects except for their capital structures. ABC is all-equity financed with $530,000 in stock. XYZ has the same total value but uses both stock and perpetual debt; its stock is worth $310,000 and the interest rate on its debt is 7.9 percent. Both firms expect EBIT to be $62,222. Ignore taxes. Compute the costs of equity for both ABC and XYZ.
Qwert Typewriter Company and Yuiop Typewriters SAOG are identical except for capital structures. Qwert has 50 % debt and 50 % equity financing, whereas Yuiop has 20 % debt and 80 % equity financing. The borrowing rate for both companies is 13 % in a no-tax world and capital markets are assumed to be perfect. The earnings of both companies are not expected to grow, and all earnings are paid out to shareholders in the form of dividends.) a) If you own 2 % of the common stock of Qwert, what is your OMR return if the company has net operating income of OMR 360,000 and the overall capitalization rate of the company, Ko is 18 %? What is the inferred equity capitalization rate, ke? b) Yuiop has the same net operating income as Qwert. What is the inferred equity capitalization rate of Yuiop? Why does it differ from that of Qwert?
You plan to purchase debenture bonds from one of two companies in the same industry that are similar in size and performance. The first company has $800,000 in total liabilities, and $1,200,000 in equity. the second company has $600,000 in total liabilities, and $400,000 in equity. 2. Which company's debenture bonds are less risky based on the debt-to-equity ratio? Explain. Show your calculations to support your decision.
Companies U and L are identical in every respect except that U is unlevered while L has $20 million of 8% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $3 million. (4) The unlevered cost of equity is 12%. What value would MM now estimate for each firm? Company U:Company L:
ABC co and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $780,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $390,000 and the interest rate on its debt is 8 percent. Both firms expect EBIT to be $87,000. Ignore taxes. (SHOW YOUR WORK) What is the cost of equity for ABC? What is it for XYZ? What is the WACC for ABC? For XYZ? What principle have you illustrated?
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?
Whirlpool manufactures and sells home appliances under various brand names. IBM develops and manufactures computer hardware and offers related technology services. Target operates a chain of general merchandise discount retail stores. The data in the following table apply to these companies (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value. REQUIRED a. Assume that the intermediate-term yields on U.S. government Treasury securities are 3.5%. Assume that the market risk premium is 5.0%. Compute the cost of equity capital for each of the three companies. b. Compute the weighted-average cost of capital for each of the three companies. c. Compute the unlevered market (asset) beta for each of the three companies. d. Assume that each company is a candidate for a potential leveraged buyout. The buyers intend to implement a capital structure that has 75% debt (with a pretax borrowing cost of 8.0%) and 25% common equity. Project the weighted-average cost of capital for each company based on the new capital structure. To what extent do these revised weighted-average costs of capital differ from those computed in Requirement b?
Chunky Cheese Pizza has $60 million in bonds payable. The bond agreement states that the debt to equity ratio cannot exceed 3.02. Chunky’s total assets are $200 million, and its liabilities other than the bonds payable are $90 million. The company is considering some additional financing through leasing. Required: 1. Calculate total stockholders’ equity using the balance sheet equation.
Garwryk, inc., which is financed with debt and equity, presently has a debt ratio of 78 percent. What is the firm’s equity multiplier? How is the equity multiplier related to the firm’s use of debt financing (i.e., if the firm increased its use of debt financing would this increase or decrease its equity multiplier)? Explain How is the multiplier related to the firm’s use of debt financing (i.e., if the firm’s increase its use of debt financing would this increase or decrease its equity multiplier)? Explain