Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 9, Problem 14SP
(Capital structure weights) Wingate Metal Products, Inc. sells materials to contractors who construct metal warehouses, storage buildings, and other structures. The firm has estimated its weighted average cost of capital to be 9.0 percent based on the fact that its after-tax cost of debt financing was 7 percent and its
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Aaron Athletics is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common equity. In order to estimate the cost of capital at various debt levels the company has constructed the following table:
Percent financed with debt (wD)
Percent financed with equity (ws)
Before tax cost of debt
0.10
0.90
7.0%
0.20
0.80
7.2%
0.30
0.70
8.0%
0.40
0.60
8.8%
0.50
0.50
9.6%
The company uses the CAPM to estimate its cost of equity, rS . The risk-free rate is 4% and the market risk premium is 5%. Aaron estimates that if it had no debt its beta would be 1.0. (It’s unlevered beta equals 1.0). The company’s tax rate is 40%.
On the basis of this information, what is the company’s optimal capital structure, and what is the WACC at that capital structure? (Show your calculations at each debt level).
Ilumina Corp is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent financed with debt (wd)
Percent financed with equity (wc)
Debt-to-equity ratio (D/S)
After-tax cost of debt (%)
0.25
0.75
0.25/0.75 = 0.33
6.9%
0.35
0.65
0.35/0.65 = 0.5385
7.1%
0.50
0.50
0.50/0.50 = 1.00
8.0%
The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market risk premium is 6%. Ilumina estimates that its beta with 10% debt is 1. The company’s tax rate, T, is 40%. On the basis of this information, what is the company’s optimal capital structure, and what is the firm’s cost of capital at this optimal capital structure? (Please show work)
Medallion Cooling Systems, has total assets of $10,900,000, EBIT of $1,990,000, and preferred dividends of $205,000and is taxed at a rate of 40%.In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:
Capital structure
debt ratio
Cost of debt, rd
Number of common
stock shares
Required return, rs
0%
0%
198,000
12.1%
15
7.9
171,000
13.2
30
8.9
141,000
13.8
45
12.1
107,000
16.1
60
14.9
76,000
20.1
a. Calculate earnings per share for each level of indebtedness.
Debt Ratio
0%
EBIT
$
1,990,000
Less: Interest
$
EBT
$
Taxes @40%
$
Net profit
$
Less: Preferreddividends
$
Profits available to
common stockholders
$…
Chapter 9 Solutions
Foundations Of Finance
Ch. 9 - Define the term cost of capital.Ch. 9 - Prob. 2RQCh. 9 - Why do firms calculate their weighted average cost...Ch. 9 - Prob. 4RQCh. 9 - Prob. 5RQCh. 9 - Prob. 6RQCh. 9 - Prob. 7RQCh. 9 - Prob. 1SPCh. 9 - Prob. 2SPCh. 9 - (Cost of equity) In the spring of 2018, the Brille...
Ch. 9 - Prob. 4SPCh. 9 - Prob. 5SPCh. 9 - Prob. 6SPCh. 9 - Prob. 7SPCh. 9 - (Cost of internal equity) Pathos Co.s common stock...Ch. 9 - (Cost of equity) The common stock for the Bestsold...Ch. 9 - Prob. 10SPCh. 9 - Prob. 11SPCh. 9 - Prob. 12SPCh. 9 - a. Rework Problem 9-12 as follows: Assume an 8...Ch. 9 - (Capital structure weights) Wingate Metal...Ch. 9 - (Weighted average cost of capital) The capital...Ch. 9 - Prob. 17SPCh. 9 - Prob. 18SPCh. 9 - Prob. 19SPCh. 9 - (Divisional costs of capital and investment...Ch. 9 - Prob. 21SPCh. 9 - Prob. 2.1MCCh. 9 - If you were to evaluate divisional costs of...
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