Suppose you prefer the original capital structure with a 13% return on the common stock and a WACC of 11.88%. If you have $3,000 to invest, how much should you invest in the stock and bonds of the restructured firm (which have returns of 13.53% and 9%, respectively) to obtain the same return as an investment in the stock of the original firm?

Suppose you prefer the original capital structure with a 13% return on the common stock and a WACC of 11.88%. If you have $3,000 to invest, how much should you invest in the stock and bonds of the restructured firm (which have returns of 13.53% and 9%, respectively) to obtain the same return as an investment in the stock of the original firm?

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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The cost of raising capital through retained earnings is (GREATER THAN / LESS THAN) the cost of raising capital through issuing new common stock. The current risk-free rate of return is 3.80% and the current market risk premium is 5.70%. Blue Hamster Manufacturing Inc. has a beta of 0.87. Using the Capital Asset Pricing Model (CAPM) approach, Blue Hamster’s cost of equity is (9.64 / 8.76 / 11.39 / 9.20) . Fuzzy Button Clothing Company is closely held and, as a result, cannot generate reliable inputs for the CAPM approach. Fuzzy Button’s bonds yield 10.20%, and the firm’s analysts estimate that the firm’s risk premium on its stock relative to its bonds is 4.50%. Using the bond-yield-plus-risk-premium approach, the firm’s cost of equity is (14.70 / 16.17 / 17.64 / 18.38) . The stock of Cute Camel Woodcraft Company is currently selling for $32.45, and the firm expects its dividend to be $1.38 in one year. Analysts project the firm’s growth rate to be constant…
Am. 354.
A firm is worth $50 or $180 with equal probability and is financed with debt that has a face value of $60. It is considering a new project that is equally likely to be worth - $50 or +$40. The cost of capital is 12% for all securities. 1. Calculate the present values of the firm’s debt and equity, assuming that the project is not undertaken. 2. What will happen to the value of the firm if the new project is undertaken?
Hardmon enterprises is currently an all equity firm with an expected return of 16%. Its a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume perfect capital markets. Suppose Hardmon borrows to the point that it’s debt-equity ratio is .50. With this amount of debt, the debt cost of capital is 6%. What will be the expected return of equity after this transaction?
Match the following A premium over and above the risk-free rate. ✓ The computed cost of capital determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure and summing the results A measure of the amount of debt used in the capital structure of the firm Superior growth of a firm may achieve during its early years, before leveling off to a more normal growth ✓ The earnings available to common stockholders divided by the number of common stock shares outstanding ✓ A line or equation that depicts the risk-related return of a security based on risk-free rate plus a market premium related to the beta coefficient of the security A measure of the spread or dispersion of a series of numbers around the expected value A model for determining the value of a share of stock by taking the present value of an expected stream of future dividends. A. Supernormal Growth B. Market Risk Premium C. Financial Leverage D.…
An unlevered firm has expected earnings of $2,401 and a market value of equity of $19,600. The firm is planning to issue $4,000 of debt at 6 percent interest and use the proceeds to repurchase shares at their current market value. Ignore taxes. What will be the cost of equity after the repurchase?
For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure rs: Cost of equities new stock issuance re: Cost of equities retained earnings rd: Cost of debts WACC: Weigthed average costs of capital rs > re rd WACC re rs > WACC rd. WACC > re> rs >rd. rd >rers > WACC
Can you please answer this part c follow up question: c) Suppose the initial £90,000 is raised by borrowing at the risk-free interest rateinstead of issuing equity. What are the cash flows to equity and debt holders, andwhat is the initial value of the levered equity according to Modigliani and Miller’sPropositions? Is the company’s cost of equity the same as before? Overall, can thecompany raise the same amount of capital as before? Explain your reasoning.
EXERCISE AIndicate whether each of the following statements is true or false. Support your answerswith the relevant explanations. 1. Under the conditions of perfect capital markets, the cost of capital of a companyfinanced fully by equity is expected to be equal to that of the same company butfinanced with 50% equity and 50% debt. (Explain your reasoning.)
2. Concatti Corporation hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 10.50%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 4.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?
Diamond Drillers is planning to use retained earnings to finance anticipated capital expenditures. The beta coefficient for this stock is 1.20. The risk-free rate of return interest is 9% and the market risk is estimated at 13%. If a new issue of common stock were used in this model, the flotation costs would be 7%. By using the capital asset pricing model, what is the cost of using retained earnings to finance the capital expenditure?
6. The Cost of Capital: Weighted Average Cost of Capital The firm's target capital structure is the mix of debr, preferred stock, and common equity the firm plans to raise funds for Its future projects. The target proportions of debt, preferred stock, and commonequity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained eamingsis used in the firm's WACC calcuation, However, If the fiem wil have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation. Quantitative Problem: Barton Industries expects that its tarpet capital structure for raising funds in the fubare for its capital budget wll consist of 40% debt, 5% preferred stock, and 55% common equity.Note that the firm's marginal tex rate is 25%. Assume that the firm's cost of debt, fe is 8.9%, the fem's cont of preferred stock, r is 8.1% and…

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