North Star is trying to determine its optimal capital structure, which now consists of onlycommon equity. The firm will add debt to its capital structure if it minimizes its WACC,but the firm has no plans to use preferred stock in its capital structure. In addition, thefirm's size will remain the same, so funds obtained from debt issued will be used torepurchase stock. The percentage of shares repurchased will be equal to the percentageof debt added to the firm's capital structure. (In other words, if the firm's debt-to-capitalratio increases from 0 to 25%, then 25% of the shares outstanding will be repurchased.)North Star is a small firm with average sales of $25 million or less during the past 3 years,so it is exempt from the interest deduction limitation.Its treasury staff has consulted with investment bankers. On the basis of thosediscussions, the staff has created the following table showing the firm's debt cost atdifferent debt levels:Debt-to-CapitalEquity-to-Debt-to-EquityBefore-Tax CostRatioCapital RatioRatioBond Ratingof Debt(Wa)(W)(D/E)(ra)0.00|1.000.0000AA5.0%0.250.750.3333A|6.00.500.501.0000BBB8.30.750.253.0000BB11.0The firm has total capital of $5 million and 200,000 shares of common stock outstanding.Its EBIT is $500,000 and will not change if debt, at any of the levels shown in thepreceding table, is added to the firm's capital structure. North Star uses the CAPM toestimate its cost of common equity, . It estimates that the risk-free rate is 3.5%, themarket risk premium is 4.5%, and its tax rate is 25%. North Star's current beta, which isbecause it has no debt, is 1.25.Calculate the beta for each of the capital structures shown in the preceding table.(Wa) (W)(D/E)(ra)bL0.001.000.00005.0%1.25000.250.750.33336.01.56250.500.501.00008.31.18750.750.253.000011.04.0625Note: enter results with four (4) decimal places North Star is trying to determine its optimal capital structure, which now consists of onlycommon equity. The firm will add debt to its capital structure if it minimizes its WACC,but the firm has no plans to use preferred stock in its capital structure. In addition, thefirm's size will remain the same, so funds obtained from debt issued will be used torepurchase stock. The percentage of shares repurchased will be equal to the percentageof debt added to the firm's capital structure. (In other words, if the firm's debt-to-capitalratio increases from 0 to 25%, then 25% of the shares outstanding will be repurchased.)North Star is a small fırm with average sales of $25 million or less during the past 3 years,so it is exempt from the interest deduction limitation.Its treasury staff has consulted with investment bankers. On the basis of thosediscussions, the staff has created the following table showing the firm's debt cost atdifferent debt levels:Debt-to-CapitalEquity-to-Debt-to-EquityBefore-Tax CostRatioCapital RatioRatioBond Ratingof Debt(Wa)(W)(D/E)0.001.000.0000AA5.0%0.250.750.3333A6.00.500.501.0000BBB8.30.750.253.0000BB|11.0The firm has total capital of $5 million and 200,000 shares of common stock outstanding.Its EBIT is $500,000 and will not change if debt, at any of the levels shown in thepreceding table, is added to the firm's capital structure. North Star uses the CAPM toestimate its cost of common equity, . It estimates that the risk-free rate is 3.5%, themarket risk premium is 4.5%, and its tax rate is 25%. North Star's current beta, which isbecause it has no debt, is 1.25.Calculate the cost of equity for each of the capital structures shown in the precedingtable.(Wd) (W)(D/E)(rd)'s0.001.000.00005.0%%0.250.750.33336.00.500.501.00008.30.750.253.000011.0Note: enter results with two decimal places

Cost of equity: It is the amount paid by a company to its shareholders for taking the risk of…

North Star is trying to determine its optimal capital structure, which now consists of only common equity. The firm will add debt to its capital structure if it minimizes its WACC, but the firm has no plans to use preferred stock in its capital structure. In addition, the fırm's size will remain the same, so funds obtained from debt issued will be used to repurchase stock. The percentage of shares repurchased will be equal to the percentage of debt added to the firm's capital structure. (In other words, if the firm's debt-to-capital ratio increases from 0 to 25%, then 25% of the shares outstanding will be repurchased.) North Star is a small firm with average sales of $25 million or less during the past 3 years, so it is exempt from the interest deduction limitation. Its treasury staff has consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firm's debt cost at different debt levels: Debt-to-Capital Equity-to- Debt-to-Equity Before-Tax Cost Ratio Capital Ratio Ratio Bond Rating of Debt (Wd) (W) (D/E) (ra) 0.00 1.00 0.0000 AA 5.0% 0.25 0.75 0.3333 A |6.0 0.50 0.50 |1.0000 BBB 8.3 0.75 0.25 3.0000 BB 11.0 The firm has total capital of $5 million and 200,000 shares of common stock outstanding. Its EBIT is $500,000 and will not change if debt, at any of the levels shown in the preceding table, is added to the firm's capital structure. North Star uses the CAPM to estimate its cost of common equity, . It estimates that the risk-free rate is 3.5%, the market risk premium is 4.5%, and its tax rate is 25%. North Star's current beta, which is because it has no debt, is 1.25. Calculate the beta for each of the capital structures shown in the preceding table. (Wa) (W) (D/E) (rd) bL 0.00 1.00 0.0000 5.0% 1.2500 0.25 0.75 0.3333 6.0 1.5625 0.50 0.50 1.0000 8.3 1.1875 0.75 0.25 3.0000 11.0 4.0625 Note: enter results with four (4) decimal places

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