Kyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company isconsidering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used torepurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would causethe required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would theWACC change, i.e., what is WACCold - WACCNew?New Debt/Assets35%Orig. cost of equity, rs10.0%New Equity/Assets65%New cost of equity = rs11.0%Interest rate new = rd 7.0%Tax rate40.0%O1.72%O2.06%1.38%1.04%

WACC is the overall average cost of the all sources of the finance. It is equal to the sum of…

Answered: Kyma Inc. currently has zero debt. It…

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Similar questions

We live in a perfect Modigliani Miller World without frictions. Vencidario Inc. has a mixed capital structure, with both equity and debt. We know the following about its cost of capital:.(i) risk-free rate rf = 10%; (ii) beta of equity bE = 1.5; (iii) cost of debt rD = 12%; (iv) market return rm = 18%; (v) debt-to-value ratio D/V = 0.5. Explain in detail the mechanism behind the reduction of the cost of debt from question 1a) to question 1b). Compare how the cost of equity would have changed from subitem a) to subitem b) if there were no reduction on the cost of debt.
Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering using some debt and reducing its outstanding equity. The firm's unlevered beta is 1.1, and its cost of equity is 11.80%. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 11.80%. The risk-free rate of interest (rRF) is 3%, and the market risk premium (RP) is 8%. Blue Ram's marginal tax rate is 35%. Blue Ram is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its weighted average cost of capital (WACC). Complete the following table. D/Cap E/Сap Bond Before-Tax Cost of Levered Beta Cost of Equity ( Ratio Ratio D/E Ratio Rating Debt (ra) (b) Is) WACC 0.0 1.0 0.00 1.1 11.80% 11.80% 0.2 0.8 0.25 A 8.4% 13.232% 11.678% 0.4 0.6 0.67 BBB 8.9% 1.577 15.616% 0.6 0.4 1.50 BB 11.1% 2.173 12.483% 0.8 0.2 14.3% 3.960…
You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is P400,000. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL − ROEU?
Currently, Hotel California has no debt (i.e., leverage=0). The CEO of Hotel California considers increasing leverage (=debt/(debt+equity)) 0.4. Currently, Hotel California’s CAPM beta is 1.5. The cost of debt (??) will be 10%, riskfree rate (??) is 2%, and market return (??) is 13.5%. Assume that the corporate tax rate (τ) is 50%. Your task, as the CFO of Hotel California, is to provide the cost of capital under this proposed capital structure (i.e., 25% leverage). What is the weighted average cost of capital under the proposed capital structure (i.e., 40% leverage)?
Remex (RMX) currently has no debt in its capital structure. The beta of its equity is 1.44. For each year into the indefinite future, Remex's free cash flow is expected to equal $26 million. Remex is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 25% debt-equity ratio after the change, and it will maintain this debt-equity ratio forever. Assume that Remex's debt cost of capital will be 6.37%. Remex faces a corporate tax rate of 15%. Except for the corporate tax rate of 15%, there are no market imperfections. Assume that the CAPM holds, the risk-free rate of interest is 4.9%, and the expected return on the market is 10.78%. a. Using the information provided, fill in the table below. b. Using the information provided and your calculations in part (a), determine the value of the tax shield acquired by Remex if it changes its capital structure in the way it is…
“Increasing financial leverage increases both the cost of debt (rdebt) and the cost of equity (requity). So the overall cost of capital cannot stay constant.” This problem is designed to show that the speaker is confused. Buggins Inc. is financed equally by debt and equity, each with a market value of $1 million. The cost of debt is 5%, and the cost of equity is 10%. The company now makes a further $250,000 issue of debt and uses the proceeds to repurchase equity. This causes the cost of debt to rise to 6% and the cost of equity to rise to 12%. Assume the firm pays no taxes. a. After the debt issue, what percent of the firm is financed with debt? (Do not round intermediate calculations. Enter your answer as a whole percent.) b. After the debt issue, what percent of the firm is financed with equity? (Do not round intermediate calculations. Enter your answer as a whole percent.) c. What is the overall cost of capital? (Enter your answer as a percent rounded to 1 decimal…
An unlevered firm has expected earnings of $2,401 and a market value of equity of $19,600. The firm is planning to issue $4,000 of debt at 6 percent interest and use the proceeds to repurchase shares at their current market value. Ignore taxes. What will be the cost of equity after the repurchase?
Give typing answer with explanation and conclusion
B.F. Pierce & Company is considering changing its capital structure. The company currently has no debt and no preferred stock, but it would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: 9.21% 9.07% 8.83% Market Debt-to- Value Ratio 8.66% (WD) 0.00 0.20 0.40 0.60 0.80 Market Equity-to- Value Ratio (WE) 1.00 0.80 0.60 0.40 0.20 Market Debt-to- Equity Ratio (D/E) 0.00 0.25 0.67 1.50 4.00 The company uses the CAPM to estimate its cost of common equity. Currently the risk-free rate is 5%, the market risk premium is 6%, and the company's tax rate is 35%. The company estimates that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this information, what is the firm's weighted average cost of capital at its optimal capital structure? Before-Tax Cost of Debt (rD) 4.00% 6.00% 8.00% 10.00% 12.00%
Executives at XYZ Corporation realize that they have too much liquid assets. They want to use this cash to buy a company that has decent returns to maximize their asset utilization. They find two companies they can buy, and want to decide if they should acquire company A or Company B. The expected returns from both companies depending on the state of the economy are shown in the table below. Each state of the economy is equally likely to happen. State of the economy Return on company A(%) Return on company B (%) Worse than expected 7.3% -4.7% Expected 11.5% 5.4% Better than expected 16.6% 24.3% Calculate the expected rate of return, and standard deviation of each company. Critically evaluate the importance of the standard deviation factor in comparing investments.
Consider the setting of Problem 18. You decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a second firm, Thurbinar Design, which is also engaged in a similar line of business. Thurbinar has a stock price of $20 per share, with 15 million shares outstanding. It also has $100 million in outstanding debt, with a yield on the debt of 4.5%. Thurbinar’s equity beta is 1.00. (1) Assume Thurbinar’s debt has a beta of zero. Estimate Thurbinar’s unlevered beta. Use the unlevered beta and the CAPM to estimate Thurbinar’s unlevered cost of capital. (2) Estimate Thurbinar’s equity cost of capital using the CAPM. Then assume its debt cost of capital equals its yield, and using these results, estimate Thurbinar’s unlevered cost of capital. (3) Explain the difference between your estimates in part (1) and part (2). (4) You decide to average your results in part (1) and part (2), and then average this result with your estimate from Problem 18.…
Company X is considering an expansion. The project has an estimated internal rate of return equal to 8%. The company has a debt to equity ratio equal to one. The yield to maturity on its bonds is 5%, while the cost of the company’s equity is estimated to be 15%. The company’s CEO, who is keen on the expansion project, argues that the project would be profitable if the company were to entirely finance it by issuing debt. The CFO, however, is sceptical and believes there is a logical flaw in the CEO’s argument. Who do you think is right? In no more than 200 words, give reasons for your answer by referencing relevant corporate finance theories.

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