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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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: 8.66% 9.21% 8.83% Market Debt-to- Value Ratio 9.07% (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 Before-Tax Cost of Debt (rD) 5.00% The company uses the CAPM to estimate its cost of common equity. Currently the risk-free rate is 4%, the market risk premium is 6%, and the company's tax rate is 25%. 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? 6.00% 7.00% 8.00% 9.00%
Labrador technologies Inc. plans to become public soon. The board of directors would like to know the value of common equity and have asked for your opinion. The firm has $1,249,917 in preferred equity and the market value of its outstanding debt equals $2,049,396. The WACC for this firm is estimated to be 8.92%. For this example assume the current assets are zero. Use the DCF valuation model with the expected FCFs shown below; year 1 represents one year from today and so on. The company expects to grow at a 3.0% rate after Year 5. Rounding to the nearest penny, what is the value of common equity? Free Cash Period Flow Year 1 $1,370,274 Year 2 $1,761,479 Year 3 $1,909,652 Year 4 $2,361,090 Year 5 $2,744,645
An outside consultant has suggested that because debt is cheaper than equity, the firm should switch to a capital structure that is 50 percent debt and 50 percent equity. Under this new and more debt-oriented arrangement, the aftertax cost of debt is 9.00 percent, and the cost of common equity (in the form of retained earnings) is 17.00 percent. b. Recalculate the firm's weighted average cost of capital. (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Debt Common equity Weighted average cost of capital Weighted Cost % 0.00 %
Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 60% equity and 40% debt. The firm's cost of debt will be 6%, and it will face a tax rate of 25%. What will Globex Corp.'s beta be if it decides to make this change in its capital structure? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its curre is 25%. It currently has a levered beta of 1.15. The risk-free rate is 3.5%, and the risk 1.65 1.58 1.80 1.50 e-tax cost of debt is 6%, and its tax rate m on the market is 7.5%. US Robotics
Companies that use debt in their capital structure are said to be using financial leverage. Using leverage can increase shareholder returns, but leverage also increases the risk that shareholders bear. Consider the following case: Universal Exports Inc. is a small company and is considering a project that will require $650,000 in assets. The project will be financed with 100% equity. The company faces a tax rate of 25%. What will be the ROE (return on equity) for this project if it produces an EBIT (earnings before interest and taxes) of $140,000? 16.15% 12.11% 11.30% 13.73% Determine what the project’s ROE will be if its EBIT is –$40,000. When calculating the tax effects, assume that Universal Exports Inc. as a whole will have a large, positive income this year. -5.06% -4.37% -4.6% -4.14% Universal Exports Inc. is also considering financing the project with 50% equity and 50% debt. The interest rate on the…
A financial analyst is attempting to assess the future dividend policy of Environmental Systems by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 15 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 33 percent and will eventually reach 57 percent during the maturity stage (IV). a. Assuming earnings per share will be as follows during each of the four stages, indicate the cash dividend per share (if any) during each stage. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places.) Stage I Stage II Stage III Stage IV Stage I Stage II Stage III Stage IV $ 0.30 1.85 2.60 3.80 Aftertax income Dividends b. Assume in Stage IV that an investor owns 335 shares and is in a 15 percent tax…

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