Orange Inc., an orange juice producer with a current debt-to-equity ratio of 2, is considering expanding its operations to produce toothpaste Unsurprisingly, the toothpaste industry faces a different set of risks than the orange juice industry. However, the executives at Orange Inc. observe that Paste Inc., a toothpaste company, has a cost of equity of 12%, a cost of debt of 6%, and a debt-to-value ratio of 40%. Orange Inc. plans to finance its expansion into toothpaste production with 50% debt and 50% equity. The cost of debt for Orange Inc. is also 6%, and the corporate tax rate is 25%. Solve for the discount rate that Orange Inc. should use when evaluating whether to go forward with the expansion. Note: Orange Inc. does not want to use the Adjusted Present Value method. Appropriate Rate = 12.08% Appropriate Rate = 9.60% 13.20% Appropriate Rate 8.85% Appropriate Rate

Orange Inc., an orange juice producer with a current debt-to-equity ratio of 2, is considering expanding its operations to produce toothpaste Unsurprisingly, the toothpaste industry faces a different set of risks than the orange juice industry. However, the executives at Orange Inc. observe that Paste Inc., a toothpaste company, has a cost of equity of 12%, a cost of debt of 6%, and a debt-to-value ratio of 40%. Orange Inc. plans to finance its expansion into toothpaste production with 50% debt and 50% equity. The cost of debt for Orange Inc. is also 6%, and the corporate tax rate is 25%. Solve for the discount rate that Orange Inc. should use when evaluating whether to go forward with the expansion. Note: Orange Inc. does not want to use the Adjusted Present Value method. Appropriate Rate = 12.08% Appropriate Rate = 9.60% 13.20% Appropriate Rate 8.85% Appropriate Rate

Financial Management: Theory & Practice

16th Edition

ISBN:9781337909730

Author:Brigham

Publisher:Brigham

Chapter21: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 5MC: David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing....

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Ferrari Corp., an automotive producer with a current debt-to-equity ratio of 3, is considering expanding its operations to produce bicycles. Unsurprisingly, the bicycle industry faces a different set of risks than the automotive industry. However, the executives at Ferrari Corp. observe that Bikes Inc., a bicycle company, has a cost of equity of 14%, a cost of debt of 6%, and a debt-to-value ratio of 40%. Ferrari plans to finance its expansion into bicycle production with 50% debt and 50% equity. The cost of debt for Ferrari is 8%, and the corporate tax rate is 25%. Solve for the discount rate that Ferrari Corp. should use when evaluating whether to go forward with the expansion.
AAA Inc. has a current debt-to-equity ratio of 3, and is considering expanding its operations into a new industry. Firms in this new industry face a different set of risks than AAA Inc. However, the executives at AAA Inc. observe that a company in the new industry (BBB Inc.) has a cost of equity of 14%, a cost of debt of 7%, and a debt-to-value ratio of 40%. AAA Inc. plans to finance its expansion into the new industry with 50% debt and 50% equity. The cost of debt for AAA Inc. is also 7%, and the corporate tax rate is 25%. Solve for the discount rate that AAA Inc. should use when evaluating whether to go forward with the expansion
Mini CaseDavid Lyons, CEO of Lyons Solar Technologies, is concerned about his firm’s level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies average about 30% debt, and Mr. Lyons wonders why they use so much more debt and how it affects stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant. Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its cost of equity is rsU=14%. Firm L has $1 million of debt outstanding at a cost of rd=8%. There are no taxes. Assume that the MM assumptions hold. Find V, S, rs, and WACC for Firms U and L.
Roxy Broadcasting, Inc. is currently a low-levered firm with a debt-to-equity ratio of 2/7. The company wants to increase its leverage to 7/2 for debt to equity. If the current return on assets is 10% and the cost of debt is 8%, what are the current and the new costs of equity if Roxy operates in a world of no taxes?
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: d. Suppose that Firms U and L have the same input values as in Part c except for debt of 980,000. Also, both firms have total net operating capital of 2,000,000 and both firms are expected to grow at a constant rate of 7%. (Assume that the EBIT in part c is expected at t = 1.) Use the compressed adjusted present value (APV) model to estimate the value of U and L. Also estimate the levered cost of equity and the weighted average cost of capital.
David Lyons, CEO of Lyons Solar Technologies, is concerned about his firms level of debt financing. The company uses short-term debt to finance its temporary working capital needs, but it does not use any permanent (long-term) debt. Other solar technology companies have debt, and Mr. Lyons wonders why they use debt and what its effects are on stock prices. To gain some insights into the matter, he poses the following questions to you, his recently hired assistant: Now assume that Firms L and U are both subject to a 25% corporate tax rate. Using the data given in part b, repeat the analysis called for in parts b(1) and b(2) using assumptions from the MM model with taxes.
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Consider two firms – Alpha Co. and Omega Co. – that operate in the manufacturing of mountain bikes and have the same degree of operating leverage. Alpha Co. and Omega Co. have, respectively, no debt and 50 percent debt in their capital structure. Which of the following statements is most accurate? Compared to the Alpha Co., the Omega Co. has: a. the same sensitivity of net income to changes in operating income. b. a lower sensitivity of net income to changes in unit sales. c. the same sensitivity of operating income to changes in unit sales.
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