FRL301 CH16

New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt? A. $29,871.17 B. $31,796.47 C. $32,407.16 D. $34,552.08 E. $37,119.30

$31,796.47

Stacy owns 38 percent of The Town Centre. She has decided to retire and wants to sell all of her shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $650,000 to purchase her shares of stock. What is the total market value of The Town Centre? Ignore taxes. A. $1,710,526 B. $1,748,219 C. $1,771,089 D. $1,801,406 E. $1,808,649

A. $1,710,526

Georga's Restaurants has 4,500 bonds outstanding with a face value of $1,000 each and a coupon rate of 8.25 percent. The interest is paid semi-annually. What is the amount of the annual interest tax shield if the tax rate is 37 percent? A. $137,362.50 B. $162,411.90 C. $187,750.00 D. $210,420.00 E. $233,887.50

A. $137,362.50

Holly's is currently an all equity firm that has 9,000 shares of stock outstanding at a market price of $42 a share. The firm has decided to leverage its operations by issuing $120,000 of debt at an interest rate of 9.5 percent. This new debt will be used to repurchase shares of the outstanding stock. The restructuring is expected to increase the earnings per share. What is the minimum level of earnings before interest and taxes that the firm is expecting? Ignore taxes. A. $35,910 B. $38,516 C. $42,000 D. $44,141 E. $45,020

A. $35,910

East Side, Inc. has no debt outstanding and a total market value of $136,000. Earnings before interest and taxes, EBIT, are projected to be $12,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 27 percent higher. If there is a recession, then EBIT will be 55 percent lower. East Side is considering a $54,000 debt issue with a 5 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,000 shares outstanding. Ignore taxes. If the economy enters a recession, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes. A. -70.97 percent B. -63.15 percent C. -58.08 percent D. -42.29 percent E. -38.87 percent

A. -70.97 percent

Jefferson & Daughter has a cost of equity of 14.6 percent and a pre-tax cost of debt of 7.8 percent. The required return on the assets is 13.2 percent. What is the firm's debt-equity ratio based on M&M II with no taxes? A. 0.26 B. 0.33 C. 0.37 D. 0.43 E. 0.45

A. 0.26

The Green Paddle has a cost of equity of 13.73 percent and a pre-tax cost of debt of 7.6 percent. The debt-equity ratio is 0.65 and the tax rate is 32 percent. What is Green Paddle's unlevered cost of capital? A. 11.85 percent B. 12.78 percent C. 14.29 percent D. 14.46 percent E. 15.08 percent

A. 11.85 percent

W.V. Trees, Inc. has a debt-equity ratio of 1.4. Its WACC is 10 percent, and its cost of debt is 9 percent. The corporate tax rate is 33 percent. What is the firm's unlevered cost of equity capital? A. 12.38 percent B. 12.79 percent C. 13.68 percent D. 14.10 percent E. 14.45 percent

A. 12.38 percent

Country Markets has an unlevered cost of capital of 12 percent, a tax rate of 38 percent, and expected earnings before interest and taxes of $15,700. The company has $11,000 in bonds outstanding that have a 6 percent coupon and pay interest annually. The bonds are selling at par value. What is the cost of equity? A. 12.55 percent B. 13.36 percent C. 13.64 percent D. 14.07 percent E. 14.29 percent

A. 12.55 percent

Sewer's Paradise is an all equity firm that has 5,000 shares of stock outstanding at a market price of $15 a share. The firm's management has decided to issue $30,000 worth of debt and use the funds to repurchase shares of the outstanding stock. The interest rate on the debt will be 10 percent. What are the earnings per share at the break-even level of earnings before interest and taxes? Ignore taxes.

B. $1.50

Galaxy Products is comparing two different capital structures, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, Galaxy would have 178,500 shares of stock outstanding. Under Plan II, there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes. What is the breakeven EBIT? A. $287,878.78 B. $298,333.33 C. $351,111.11 D. $333,333.33 E. $341,414.14

B. $298,333.33

Pewter & Glass is an all equity firm that has 80,000 shares of stock outstanding. The company is in the process of borrowing $600,000 at 9 percent interest to repurchase 12,000 shares of the outstanding stock. What is the value of this firm if you ignore taxes? A. $2.5 million B. $4.0 million C. $5.0 million D. $5.5 million E. $6.0 million

B. $4.0 million

Hanover Tech is currently an all equity firm that has 320,000 shares of stock outstanding with a market price of $19 a share. The current cost of equity is 15.4 percent and the tax rate is 36 percent. The firm is considering adding $1.2 million of debt with a coupon rate of 8 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? A. $5.209 million B. $5.312 million C. $5.436 million D. $6.512 million E. $6.708 million

B. $5.312 million

Jemisen's has expected earnings before interest and taxes of $6,200. Its unlevered cost of capital is 13 percent and its tax rate is 34 percent. The firm has debt with both a book and a face value of $2,500. This debt has a 9 percent coupon and pays interest annually. What is the firm's weighted average cost of capital? A. 12.48 percent B. 12.66 percent C. 13.87 percent D. 14.14 percent E. 14.37 percent

B. 12.66 percent

Douglass & Frank has a debt-equity ratio of 0.45. The pre-tax cost of debt is 7.6 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent? A. 13.79 percent B. 14.86 percent C. 15.92 percent D. 18.40 percent E. 18.87 percent

B. 14.86 percent

Bright Morning Foods has expected earnings before interest and taxes of $48,600, an unlevered cost of capital of 13.2 percent, and debt with both a book and face value of $25,000. The debt has an 8.5 percent coupon. The tax rate is 34 percent. What is the value of the firm? A. $245,500 B. $247,600 C. $251,500 D. $264,800 E. $271,300

C. $251,500

Exports Unlimited is an unlevered firm with an aftertax net income of $47,800. The unlevered cost of capital is 14.1 percent and the tax rate is 32 percent. What is the value of this firm? A. $270,867 B. $294,380 C. $339,007 D. $378,444 E. $447,489

C. $339,007

Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 10 percent. Bruce currently has no debt, and its cost of equity is 20 percent. The tax rate is 31 percent. What will the value of Bruce & Co. be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares? A. $280,130 B. $346,600 C. $361,740 D. $378,900 E. $381,520

C. $361,740

The SLG Corp. uses no debt. The weighted average cost of capital is 12 percent. The current market value of the equity is $31 million and the corporate tax rate is 34 percent. What is EBIT? A. $4,180,000 B. $4,821,194 C. $5,636,364 D. $6,230,018 E. $6,568,500

C. $5,636,364

Down Bedding has an unlevered cost of capital of 13 percent, a cost of debt of 7.8 percent, and a tax rate of 32 percent. What is the target debt-equity ratio if the targeted cost of equity is 15.51 percent? A. .63 B. .68 C. .71 D. .76 E. .84

C. .71

The Corner Bakery has a debt-equity ratio of 0.54. The firm's required return on assets is 14.2 percent and its cost of equity is 16.1 percent. What is the pre-tax cost of debt based on M&M Proposition II with no taxes? A. 7.10 percent B. 8.79 percent C. 10.68 percent D. 17.56 percent E. 18.40 percent

C. 10.68 percent

ABC Co. and XYZ Co. are identical firms in all respects except for their capital structure. ABC is all equity financed with $480,000 in stock. XYZ uses both stock and perpetual debt; its stock is worth $240,000 and the interest rate on its debt is 11 percent. Both firms expect EBIT to be $58,400. Ignore taxes. The cost of equity for ABC is _____ percent, and for XYZ it is ______ percent. A. 12.17; 12.68 B. 12.17; 12.94 C. 12.17; 13.33 D. 12.29; 12.68 E. 12.29; 13.33

C. 12.17; 13.33

Percy's Wholesale Supply has earnings before interest and taxes of $106,000. Both the book and the market value of debt is $170,000. The unlevered cost of equity is 15.5 percent while the pre-tax cost of debt is 8.6 percent. The tax rate is 38 percent. What is the firm's weighted average cost of capital? A. 11.94 percent B. 12.65 percent C. 13.45 percent D. 14.01 percent E. 14.37 percent

C. 13.45 percent

Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 11 percent. Bruce currently has no debt, and its cost of equity is 18 percent. The tax rate is 31 percent. Bruce will borrow $61,000 and use the proceeds to repurchase shares. What will the WACC be after recapitalization? A. 16.30 percent B. 16.87 percent C. 17.15 percent D. 18.29 percent E. 18.86 percent

C. 17.15 percent

Johnson Tire Distributors has debt with both a face and a market value of $12,000. This debt has a coupon rate of 6 percent and pays interest annually. The expected earnings before interest and taxes are $2,100, the tax rate is 30 percent, and the unlevered cost of capital is 11.7 percent. What is the firm's cost of equity? A. 22.46 percent B. 22.87 percent C. 23.20 percent D. 23.59 percent E. 25.14 percent

C. 23.20 percent

Naylor's is an all equity firm with 60,000 shares of stock outstanding at a market price of $50 a share. The company has earnings before interest and taxes of $87,000. Naylor's has decided to issue $750,000 of debt at 7.5 percent. The debt will be used to repurchase shares of the outstanding stock. Currently, you own 500 shares of Naylor's stock. How many shares of Naylor's stock will you continue to own if you unlever this position? Assume you can loan out funds at 7.5 percent interest. Ignore taxes. A. 300 shares B. 350 shares C. 375 shares D. 425 shares E. 500 shares

C. 375 shares

Miller's Dry Goods is an all equity firm with 45,000 shares of stock outstanding at a market price of $50 a share. The company's earnings before interest and taxes are $128,000. Miller's has decided to add leverage to its financial operations by issuing $250,000 of debt at 8 percent interest. The debt will be used to repurchase shares of stock. You own 400 shares of Miller's stock. You also loan out funds at 8 percent interest. How many shares of Miller's stock must you sell to offset the leverage that Miller's is assuming? Assume you loan out all of the funds you receive from the sale of stock. Ignore taxes. A. 35.6 shares B. 40.0 shares C. 44.4 shares D. 47.5 shares E. 50.1 shares

C. 44.4 shares

North Side, Inc. has no debt outstanding and a total market value of $175,000. Earnings before interest and taxes, EBIT, are projected to be $16,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 35 percent higher. If there is a recession, then EBIT will be 70 percent lower. North Side is considering a $70,000 debt issue with a 7 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares outstanding. North Side has a tax rate of 34 percent. If the economy expands strongly, EPS will change by ____ percent as compared to a normal economy, assuming that the firm recapitalizes. A. 38.80 percent B. 45.26 percent C. 50.45 percent D. 53.92 percent E. 61.07 percent

C. 50.45 percent

An unlevered firm has a cost of capital of 17.5 percent and earnings before interest and taxes of $327,500. A levered firm with the same operations and assets has both a book value and a face value of debt of $650,000 with a 7.5 percent annual coupon. The applicable tax rate is 38 percent. What is the value of the levered firm? A. $1,397,212 B. $1,398,256 C. $1,402,509 D. $1,407,286 E. $1,414,414

D. $1,407,286

L.A. Clothing has expected earnings before interest and taxes of $48,900, an unlevered cost of capital of 14.5 percent, and a tax rate of 34 percent. The company also has $8,000 of debt that carries a 7 percent coupon. The debt is selling at par value. What is the value of this firm? A. $222,579.31 B. $223,333.33 C. $224,108.16 D. $225,299.31 E. $225,476.91

D. $225,299.31

The June Bug has a $270,000 bond issue outstanding. These bonds have a 7.5 percent coupon, pay interest semiannually, and have a current market price equal to 98.6 percent of face value. The tax rate is 39 percent. What is the amount of the annual interest tax shield? A. $3,948.75 B. $4,112.60 C. $5,311.22 D. $7,897.50 E. $8,225.20

D. $7,897.50

A firm has debt of $12,000, a leveraged value of $26,400, a pre-tax cost of debt of 9.20 percent, a cost of equity of 17.6 percent, and a tax rate of 37 percent. What is the firm's weighted average cost of capital? A. 11.47 percent B. 11.52 percent C. 11.69 percent D. 12.23 percent E. 12.48 percent

D. 12.23 percent

You currently own 600 shares of JKL, Inc. JKL is an all equity firm that has 75,000 shares of stock outstanding at a market price of $40 a share. The company's earnings before interest and taxes are $140,000. JKL has decided to issue $1 million of debt at 8 percent interest. This debt will be used to repurchase shares of stock. How many shares of JKL stock must you sell to unlever your position if you can loan out funds at 8 percent interest? A. 120 shares B. 150 shares C. 180 shares D. 200 shares E. 250 shares

D. 200 shares

The Pizza Palace has a cost of equity of 15.3 percent and an unlevered cost of capital of 11.8 percent. The company has $22,000 in debt that is selling at par value. The levered value of the firm is $41,000 and the tax rate is 34 percent. What is the pre-tax cost of debt? A. 4.73 percent B. 6.18 percent C. 6.59 percent D. 7.22 percent E. 9.92 percent

D. 7.22 percent

The Jean Outlet is an all equity firm that has 146,000 shares of stock outstanding. The company has decided to borrow the $1.1 million to repurchase 7,500 shares of its stock from the estate of a deceased shareholder. What is the total value of the firm if you ignore taxes? A. $18,387,702 B. $18,500,000 C. $19,666,667 D. $21,000,000 E. $21,413,333

E. $21,413,333

Lamont Corp. uses no debt. The weighted average cost of capital is 11 percent. The current market value of the equity is $38 million and there are no taxes. What is EBIT? A. $3,423,000 B. $3,508,600 C. $3,781,100 D. $3,898,700 E. $4,180,000

E. $4,180,000

Kelso Electric is debating between a leveraged and an unleveraged capital structure. The all equity capital structure would consist of 40,000 shares of stock. The debt and equity option would consist of 25,000 shares of stock plus $280,000 of debt with an interest rate of 7 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes. A. $42,208 B. $44,141 C. $46,333 D. $49,667 E. $52,267

E. $52,267

D. L. Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent. The tax rate is 32 percent. What is the present value of the tax shield? A. $504 B. $615 C. $644 D. $6,200 E. $6,720

E. $6,720

Bob's Warehouse has a pre-tax cost of debt of 8.4 percent and an unlevered cost of capital of 14.6 percent. The firm's tax rate is 37 percent and the cost of equity is 18 percent. What is the firm's debt-equity ratio? A. 0.72 B. 0.76 C. 0.79 D. 0.82 E. 0.87

E. 0.87

Young's Home Supply has a debt-equity ratio of 0.80. The cost of equity is 14.5 percent and the aftertax cost of debt is 4.9 percent. What will the firm's cost of equity be if the debt-equity ratio is revised to 0.75? A. 10.89 percent B. 11.47 percent C. 11.70 percent D. 13.89 percent E. 14.23 percent

E. 14.23 percent

Winter's Toyland has a debt-equity ratio of 0.72. The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent. What is the cost of equity if you ignore taxes? A. 19.31 percent B. 19.74 percent C. 20.29 percent D. 20.46 percent E. 21.43 percent

E. 21.43 percent