EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN: 9781337514835
Author: MOYER
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 13, Problem 1P
Summary Introduction
To determine: The market value of firm L.
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Referring to table below, calculate the market value of firm L (without a corporate income tax) if the equity amount in its capital structure decreases to $5,000 and the debt amount increases to $5,000. At this capital structure, the cost of equity is 15 percent. Round your answer to the nearest dollar.
Firm U
Firm L
Net operating income (EBIT)
$
1,000
$
1,000
Less: Interest payments to debt holders, I
-
100
Income available to stockholders (dividends), D
$
1,000
$
900
Total income available to security holders, I + D
$
1,000
$
1,000
Required rate of return on debt, kd
-
5
%
Market value of debt, B = I/kd
-
$
2,000
Required rate of return on equity,ke
10
%
11.25
%
Market value of equity, E = D/ke
$
10,000
$
8,000
Market value of firm, E + B
$
10,000
$
10,000
$
A company has determined that its optimal capital structure consists of 34 percent
debt and the rest is equity. Given the following information, calculate the firm's
weighted average cost of capital. Rd = 7.8%; Tax rate = 28 %: Po = $ 39.01; Growth
= 5.1%; and D1 = $ 1.02. Show your answer to the nearest .1%
Your Answer:
Answer
What is the firm’s cost of capital? The firm gets ¼ of its capital from debt; ¾ from equity. Assume the following:
Required return on stock = 12%
Required return on bonds = 8%
Tax rate = 0%
Chapter 13 Solutions
EBK CONTEMPORARY FINANCIAL MANAGEMENT
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- 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%…arrow_forwardSuppose Alcatel-Lucent has an equity cost of capital of 9.2%, market capitalization of $10.95 billion, and an enterprise value of $15 billion. Suppose Alcatel-Lucent's debt cost of capital is 6.9% and its marginal tax rate is 38%. a. What is Alcatel-Lucent's WACC? b. If Alcatel-Lucent maintains a constant debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown here,? c. If Alcatel-Lucent maintains its debt-equity ratio, what is the debt capacity of the project in part (b)? a. What is Alcatel-Lucent's WACC? Alcatel-Lucent's WACC is%. (Round to two decimal places.) Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Year 0 1 FCF ($ million) - 100 50 Print C Done 2 99 3 66 Xarrow_forwardThe ABCCompany has a cost of equity of 21.2 percent, a pre-tax cost of debt of 5.2percent, and a tax rate of 30 percent. What is the firm’s weighted average costof capital if the proportion of debt is 65.6%?Note: Enter your answer rounded off to two decimal points.Do not enter % in the answer box. For example, if your answer is 0.12345 thenenter as 12.35 in the answer box.arrow_forward
- A firm has two components in its capital structure, debt and equity. The after-tax cost of debt is 3% and the cost of equity is 11%. The proportion of equity in the capital structure is 75%. What is the firm's Weighted Average Cost of Capital? Select one: a. 9.47% b. 8.78% c. 9.00% d. 8.37%arrow_forwardGive typing answer with explanation and conclusion Suppose Abraxas Corp. has an equity cost of capital of 8.2%, market capitalization of $11.37 billion, and an enterprise value of $17.12 billion. Suppose Abraxas's debt cost of capital is 5.6% and its marginal tax rate is 21%. What is Abraxas's WACC?arrow_forwardSuppose Alcatel-Lucent has an equity cost of capital of 10.4%, market capitalization of $11.52 billion, and an enterprise value of $16 billion. Suppose Alcatel-Lucent's debt cost of capital is 6.6% and its marginal tax rate is 34%. a. What is Alcatel-Lucent's WACC? b. If Alcatel-Lucent maintains a constant debt-equity ratio, what is the value of a project with average risk and the expected free cash flows as shown here, ? c. If Alcatel-Lucent maintains its debt-equity ratio, what is the debt capacity of the project in part (b)? a. What is Alcatel-Lucent's WACC? Alcatel-Lucent's WACC is 9.34 %. (Round to two decimal places.) Data table (Click on the following icon in order to copy its contents into a spreadsheet.) Year 1 FCF ($ million) 45 Print 0 - 100 Done 2 101 3 66 - Xarrow_forward
- A firm's cost of equity Ue) is 25%. Its before-tax cost of debt is 12%, and itsmarginal tax rate is 40%. The firm's capital structure calls for a debt-to-equityratio of 40%. Calculate the firm's cost of capital (k).arrow_forwardA company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm’s weighted average cost of capital (WACC). Assume external equity for cost of equity calculation. rd before Tax = 8% , Tax = 40% , P0 = $40, Growth = 6% , D0 = $3.00, Flotation cost = 7% of market pricearrow_forwardConsider a firm that has 15% of debt. The rate of return for debt is 6% and the rate of return for equity is 12%. The corporate tax rate is 40%. What is the weighted average cost of capital? Enter your answer as a percentage and rounded to 2 DECIMAL PLACES. Do not include the percentage sign in your answer. Enter your response below. %arrow_forward
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