Financial Management: Theory & Practice
Financial Management: Theory & Practice
16th Edition
ISBN: 9781337909730
Author: Brigham
Publisher: Cengage
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Chapter 21, Problem 3MC

David Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant:

Now assume that Firms L and U are both subject to a 25% corporate tax rate. Using the data given in part b, repeat the analysis called for in parts b(1) and b(2) using assumptions from the MM model with taxes.

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You are an investment banker who has two meetings today. Each of these meetings entails clients requesting your services in determining the optimal capital structure for their firms. For each of the cases below, describe whether you would recommend that the firm choose leverage which is less than, about the same as, or greater than the average across all firms. Explain your reasoning fully. a) Your morning meeting is with the CEO of a drug company. This firm makes a unique product that historically generated losses that they still have on their books. But now they have high growth projects coming consistently in the future. Investors are a little concerned on which of the many drug options the firm could choose. The firm has $100 Million in debt and is trading at a MTB multiple of 5X with their market value of equity at $500 Million.   b) Your afternoon meeting is with the CEO of a glass producer. They are a mature cash cow with high stable profits. The glass equipment can be used by…
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