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Dark Creek Corporation's CEO is selecting between two mutually exclusive projects. The
company needs to make a $3,500 payment to bondholders at the end of the year. To minimize agency costs, the firm's bondholders decide to use a bond covenant to stipulate that the bondholders can demand an additional payment if the company chooses to take on the high- volatility project. How much additional payment to bondholders would make stockholders indifferent between the two projects? Cash flows pertaining to the two projects are shown in the table
![Economy Probability Low-Volatility Project Payoff
Bad
.40
Good
.60
$4,000
4,800
High-Volatility Project Payoff
$2,900
6,300](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F66deab6a-cfc7-4e2d-a349-a8777e518a15%2F98889b7d-262e-4b08-b5cc-627034018ba2%2Fdfhrzd_processed.png&w=3840&q=75)
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- Hw.16. Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .45, but the industry target debt–equity ratio is .40. The industry average beta is 1.30. The market risk premium is 8 percent, and the risk-free rate is 6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 35 percent. The project requires an initial outlay of $676,000 and is expected to result in a $96,000 cash inflow at the end of the first year. The project will be financed at the company’s target debt–equity ratio. Annual cash flows from the project will grow at a constant rate of 6 percent until the end of the fifth year and remain constant forever thereafter. Calculate the NPV of the project.The treasurer of a large corporation wants to invest $23 million in excess short-term cash in a particular money market investment. The prospectus quotes the instrument at a true yield of 3.42 percent; that is, the EAR for this investment is 3.42 percent. However, the treasurer wants to know the money market yield on this instrument to make it comparable to the T-bills and CDs she has already bought. If the term of the instrument is 122 days, what are the bond equivalent and discount yields on this investment? Note: Do not round intermediate calculations. Enter your answers as a percent rounded to 3 decimal places. Bond equivalent yield Discount yield % %F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: Market Debt-to Equity Ratio (D/S) 0.00 0.1111 0.2500 0.4286 0.6667 Market Equity-to- Value Ratio (ws) 1.0 0.90 6.0% 6.4 0.80 7.0 8.2 0.70 0.60 10.0 F. Pierce uses the CAPM to estimate its cost of common equity, rs, and at the time of the analaysis the risk-free rate is 6%, the market risk premium is 8%, and the company's tax rate is 25%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.7. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure? Do not round intermediate calculations. Round your answers to two…
- 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%Assume that you were recently hired as assistant to Jerry Lehman, financial VP of Coleman Technologies. Your first task is to estimate Coleman’s cost of capital. Lehman has provided you with the following data, which he believes is relevant to your task: The firm’s marginal tax rate is 40%. The current price of Coleman’s 12 % coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Coleman does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm’s 10%, $100 par value, quarterly dividend, perpetual preferred stock is $113.10. Coleman would incur flotation costs of $2 per share on a new issue. Coleman’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Coleman’s beta is 1.2, the yield on Treasury bonds is 7%, and the market risk…John Tye has just been hired as the new corporate finance analyst at I-Ell Enterprises and has received his first assignment. John is to take the $25 million in cash received from a recent divestiture and use part of these proceeds to retire an outstanding $10 million bond issue and the remainder to repurchase common stock. However, the bond issue cannot be retired for another two years. If John can place the funds necessary to retire this $10 million debt into an account earning 6 percent compounded monthly,how much of the $25 million remains to repurchase stock?
- You plan to purchase debenture bonds from one of two companies in the same industry that are similar in size and performance. The first company has $800,000 in total liabilities, and $1,200,000 in equity. the second company has $600,000 in total liabilities, and $400,000 in equity. 2. Which company's debenture bonds are less risky based on the debt-to-equity ratio? Explain. Show your calculations to support your decision.The Optical World Corporation, a manufacturerof peripheral vision storage systems, needs $10 million to market its new robotics-based vision systems.The firm is considering two financing options: common stock and bonds. If the firm decides to raise thecapital through issuing common stock, the flotationcosts will be 6%, and the share price will be $25. Ifthe firm decides to use debt financing, it can sell a10-year, 12% bond with a par value of $1,000. Thebond flotation costs will be 1.9%.(a) For equity financing, determine the flotationcosts and the number of shares to be sold to net$10 million.(b) For debt financing, determine the flotation costsand the number of $1,000 par value bonds tobe sold to net $10 million. What is the requiredannual interest payment?Mark Sexton and Todd Story, the owners of S&S Air, have decided to expand their operations. They instructed their newly hired financial analyst, Chris Guthrie, to enlist an underwriter to help sell $20 million in new 10-year bonds to finance construction. Chris has entered into discussions with Renata Harper, an underwriter from the firm of Crowe & Mallard, about which bond features S&S Air should consider and what coupon rate the issue will likely have. Although Chris is aware of the bond features, he is uncertain as to the costs and benefits of some features, so he isn’t clear on how each feature would affect the coupon rate of the bond issue. You are Renata’s assistant, and she has asked you to prepare a memo to Chris describing the effect of each of the following bond features on the coupon rate of the bond. She would also like you to list any advantages or disadvantages of each feature. QUESTIONS 1. The security of the bond—that is, whether the bond…
- Suppose that a firm has 5 bondholders each expecting to be paid today their principal of $1 million each. The firm is in default, as its going-concern value is only $3 million, falling short of the $5 million to be repaid. The firm could liquidate and sell all of its assets for a value of $1 million, so that each bondholder would recover $200,000 on their claim. The firm offers its bondholders a debt-for-equity swap, but four of out the five bondholders must participate and become equityholders for the swap to succeed. In the table below, calculate the "lower bound" payoff if only four bondholders participate and the "upper bound" payoff if all five bondholders participate. The correct answer is lower bound=$500,000 and upper bound=$600,000Foundation, Incorporated, is comparing two different capital structures: an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the company would have 200,000 shares of stock outstanding. Under Plan II. there would be 150,000 shares of stock outstanding and $2.15 million in debt outstanding. The Interest rate on the debt is 5 percent and there are no taxes. a. Use M&M Proposition I to find the price per share. (Do not round Intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What is the value of the firm under each of the two proposed plans? (Do not round Intermediate calculations and round your answers to the nearest whole dollar amount, e.g., 32) a. Share price b. All-equity firm value b. Levered plan firm valueDark Creek Corporation's CEO is selecting between two mutually exclusive projects. The company is obligated to make a $3,700 payment to bondholders at the end of the year. To minimize agency cost, the firm's bondholders decide to use a bond covenant to stipulate that the bondholders can demand an additional payment if the company chooses to take on the high-volatility project. How much additional payment to bondholders would make stockholders indifferent between the two projects? Cash flows pertaining to the two projects are shown in the table below. Economy Probability Low-Volatility Project Payoff High-Volatility Project Payoff $2,900 $4,000 4,800 Bad 40 Good .60 6,300 O $1366.67 O $1166.67 O $1300.00 O $1233,33
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