The financial manager has determined the following schedules for the cost of funds: Cost of the Ratio Cost of Debt Equity 0% 5% 13% 10 5 13 20 5 13 30 5 13 40 5 14 50 6 15 60 8 16 a. Determine the firm’s optimal capital structure. b. Construct a simple pro forma balance sheet that shows the firm’s opti- mal combination of debt and equity for its current level of assets. Assets $500 Debt — Equity — $500 c. An investment costs $400 and offers annual cash inflows of $133 for five years. Should the firm make the investment? d. If the firm makes this additional investment, how should its balance sheet appear? Assets — Debt — Equity — e. If the firm is operating with its optimal capital structure and a $400 asset yields 20.0 percent, what return will the stockholders earn on their investment in the asset?
The
Cost of the Ratio Cost of Debt Equity
0% 5% 13%
10 5 13
20 5 13
30 5 13
40 5 14
50 6 15
60 8 16
a. Determine the firm’s optimal capital structure.
b. Construct a simple pro forma
Assets $500 Debt —
Equity —
$500
c. An investment costs $400 and offers annual
d. If the firm makes this additional investment, how should its balance sheet appear?
Assets — Debt —
Equity —
e. If the firm is operating with its optimal capital structure and a $400 asset yields 20.0 percent, what return will the stockholders earn on their investment in the asset?
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The management of a conservative firm has adopted a policy of never letting debt exceed 40 percent of total financing. The firm will earn $14,000,000 but distribute 40 percent in dividends, so the firm will have $8,400,000 to add to
- cost of retained earnings? Round your answer to one decimal place.
%
- cost of new common stock? Round your answer to one decimal place.
%
The rate of interest on the firm’s long-term debt is 11 percent and the firm is in the 32 percent income tax bracket. If the firm issues more than $2,900,000, the interest rate will rise to 12 percent. Given this information, what is the
- cost of debt? Round your answer to one decimal place.
%
- cost of debt in excess of $2,900,000? Round your answer to one decimal place.
%
The firm raises funds in increments of $3,700,000 consisting of $1,480,000 in debt and $2,220,000 in equity. This strategy maintains the capital structure of 40 percent debt and 60 percent equity. Develop the marginal cost of capital schedule through $11,000,000. Round your answers for the break-points to the nearest dollar and for the marginal costs to one decimal place.
The marginal cost of capital schedule:
| $0 - $ | |
| cost of debt: % | |
| cost of capital: % |
| $ - $ | |
| cost of debt: % | |
| cost of equity: % | |
| cost of capital: % |
| above $ | |
| cost of debt: % | |
| cost of equity: % | |
| cost of capital: % |
What impact would each of the following have on the marginal cost of capital schedule?
- the firm’s income tax rate increases
If income tax rates were to rise, the effective cost of debt would , and the marginal cost of capital would at all levels.
- the firm retains all of its earnings and the price of the stock is unaffected. Round your answers for the break-point to the nearest dollar and for the marginal costs to one decimal place.
The marginal cost of capital schedule:
$0 - $ cost of debt: % cost of equity: % cost of capital: % $ - $ cost of debt: % cost of equity: % cost of capital: % above $ cost of debt: % cost of equity: % cost of capital: % - $11,000,000 is insufficient to meet attractive investment opportunities
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