Suppose you own a clothing boutique to pass the time in your retirement. This business currently has no debt, no short-term investments, 100,000 shares outstanding, a beta of 1.2, current-year free cash flows of $ 100,000, and expected growth of 4% per year. a. If the current business tax rate is 40%, the risk-free rate is 4%, and the market risk premium is 8%, find the weighted average cost of capital (WACC), value of equity, and price per share for your firm. You know from your MBA finance course that leverage can add value to your firm, so you consider changing your capital structure. The banker gives you interest rate quotes for the following capital structures: wd 12.5% 25% 37.5% 50% rd 5.00% 7.00% 10.00% 12.00% b. Assuming you repurchase shares of stock with the money raised from the debt issuance, for each capital structure, calculate the new cost of equity, WACC, value of operations, and the amount of debt issued. What is the optimal capital structure for your boutique, and why? c. For the optimal capital structure, calculate the number of shares to be repurchased, the new value of equity, and the new price per share. d. Suppose the tax rate on business income is lowered from 40% to 21%. What is your new optimal capital structure? Why does a lower tax rate have this effect on the use of debt?
Suppose you own a clothing boutique to pass the time in your retirement. This business currently has no debt, no short-term investments, 100,000 shares outstanding, a beta of 1.2, current-year free cash flows of $ 100,000, and expected growth of 4% per year. a. If the current business tax rate is 40%, the risk-free rate is 4%, and the market risk premium is 8%, find the weighted average cost of capital (WACC), value of equity, and price per share for your firm. You know from your MBA finance course that leverage can add value to your firm, so you consider changing your capital structure. The banker gives you interest rate quotes for the following capital structures: wd 12.5% 25% 37.5% 50% rd 5.00% 7.00% 10.00% 12.00% b. Assuming you repurchase shares of stock with the money raised from the debt issuance, for each capital structure, calculate the new cost of equity, WACC, value of operations, and the amount of debt issued. What is the optimal capital structure for your boutique, and why? c. For the optimal capital structure, calculate the number of shares to be repurchased, the new value of equity, and the new price per share. d. Suppose the tax rate on business income is lowered from 40% to 21%. What is your new optimal capital structure? Why does a lower tax rate have this effect on the use of debt?
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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Transcribed Image Text:Suppose you own a clothing boutique to pass the time in your retirement. This business currently has no debt,
no short-term investments, 100,000 shares outstanding, a beta of 1.2, current-year free cash flows of $
100,000, and expected growth of 4% per year. a. If the current business tax rate is 40%, the risk-free rate is
4%, and the market risk premium is 8%, find the weighted average cost of capital (WACC), value of equity, and
price per share for your firm. You know from your MBA finance course that leverage can add value to your firm,
so you consider changing your capital structure. The banker gives you interest rate quotes for the following
capital structures: wd 12.5% 25% 37.5% 50% rd 5.00% 7.00% 10.00% 12.00% b. Assuming you repurchase
shares of stock with the money raised from the debt issuance, for each capital structure, calculate the new cost
of equity, WACC, value of operations, and the amount of debt issued. What is the optimal capital structure for
your boutique, and why? c. For the optimal capital structure, calculate the number of shares to be repurchased,
the new value of equity, and the new price per share. d. Suppose the tax rate on business income is lowered
from 40% to 21%. What is your new optimal capital structure? Why does a lower tax rate have this effect on the
use of debt?
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