Imagine a firm with one period of operations. In case of a strong economy, the FCF from operations at year 1 will be $2,800. In case of a weak economy, the FCF at year 1 will be $1,800. Both scenarios are equally likely to happen. The risk-free rate is 3% and the equity risk premium is 12% per year. Under these circumstances, if the cost of levered equity is 28%, how much debt financing does the firm use?

Imagine a firm with one period of operations. In case of a strong economy, the FCF from operations at year 1 will be $2,800. In case of a weak economy, the FCF at year 1 will be $1,800. Both scenarios are equally likely to happen. The risk-free rate is 3% and the equity risk premium is 12% per year. Under these circumstances, if the cost of levered equity is 28%, how much debt financing does the firm use?

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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Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Cost Expected Rate of Return $2,000 16.00% 3,000 15.00 5,000 13.75 4 2,000 12.50 The company estimates that it can issue debt at a rate of rd = 11%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $6.0 per year at $60.00 per share. Also, its common stock currently sells for $52.00 per share; the next expected dividend, D₁, is $5.75; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. Project a. What is the cost of each of the capital components? Do not round intermediate calculations. Round your answers to two decimal places. Cost of debt: 123 % Project 1 Project 2 Project 3 Project 4 Cost of preferred stock: Cost of retained earnings: b. What is Adamson's WACC? Do not round intermediate calculations. Round your answer to two…
You are going to value Lauryn's Doll Co. using the FCF model. After consulting various sources, you find that Lauryn's has a reported equity beta of 1.5, a debt-to-equity ratio of .4, and a tax rate of 21 percent. Assume a risk-free rate of 5 percent and a market risk premium of 7 percent. Lauryn's Doll Co. had EBIT last year of $46 million, which is net of a depreciation expense of $4.6 million. In addition, Lauryn's made $6.25 million in capital expenditures and increased net working capital by $3.6 million. Assume the FCF is expected to grow at a rate of 3 percent into perpetuity. What is the value of the firm? (Do not round intermediate calculations. Enter your answer in millions rounded to 2 decimal places.) Firm value million
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