EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN: 9781337514835
Author: MOYER
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 12, Problem 16P
Summary Introduction
To determine: The minimum
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Ace Enterprises Limited is a large company involved in production and sale of petroleum products. The Finance Department of the company is trying to determine the company’s optimal capital structure. The firms’ financial advisors have developed the following table:
Equity Ratio
Debt Ratio
Before Tax Cost of Debt
100%
0%
7%
80%
20%
8%
60%
40%
10%
40%
60%
12%
20%
80%
15%
The company uses and applies the Capital Assets Pricing Model to estimate its cost of common equity. The company estimates that the risk free rate is 4.0%. The market risk premium is 6.0%, and its tax rate is 30 percent. The company estimates that if it had no debt, its unlevered beta would be 1.2.
Required:
A. Based on the above information, what is the firm’s optimal capital structure?
B. What would the weighted average cost of capital be at the optimal capital structure?
C. If a firm went from zero debt to successively higher levels of debt, why would you expect its stock price to first rise, then hit…
Ace Enterprises Limited is a large company involved in production and sale of petroleum products. The Finance Department of the company is trying to determine the company’s optimal capital structure. The firms’ financial advisors have developed the following table:Equity-Ratio Debt-Ratio Before Tax Cost of Debt (Kd)100% 0% 7.00%80% 20% 8.00%60% 40% 10%40% 60% 12%20% 80% 15%The company uses and applies the Capital Assets Pricing Model to estimate its cost of common equity. The company estimates that the risk free rate is 4.0%. The market risk premium is 6.0%, and its tax rate is 30 percent. The company estimates that if it had no debt, its unlevered beta would be 1.2. Required:A. Based on the above…
You are helping XYZ — a 100°/0 equity financed diversified industrial group - on the required rate of return it should be using to evaluate the performance of its various business divisions. XYZ has three divisions — Ceramics, Sanitary equipment, and Solar panels — with similar asset base. The beta values of (the listed firms comparable to) each division are as follows: • Ceramics 2.0 • Sanitary equipment 1.2 • Solar panels 2.5 (a) Estimate the cost of equity for the firm and for each division assuming a risk free rate of 10% and market risk premium of 6%. (b) The capital budgeting department uses XYZ's composite beta to fix the required rate of return on projects proposed by any division. How might this standard distort capital allocation decisions across different divisions?
Chapter 12 Solutions
EBK CONTEMPORARY FINANCIAL MANAGEMENT
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