Consider this case:Globo-Chem Co. currently has a capital structure consisting of 35% debt and 65% equity. However, Globo-Chem Co.'s CFO hassuggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7.5%, and Globo-Chem Co.'s beta is 1.25.If the firm's tax rate is 35%, what will be the beta of an all-equity firm if its operations were exactly the same?Now consider the case of another company:U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 8%, and its tax rateis 35%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%.U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-taxcost of debt to increase to 10%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weightedaverage cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.),The optimal capital structure is the one that_the WACC andthe firm's stock price. Higher debt levelsthe firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to

Levered beta: Indicates how volatile a company's stock returns are when taking its debt levels into…

Answered: the firm's risk. Consequently, higher…

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the firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to

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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Question

Consider this case:
Globo-Chem Co. currently has a capital structure consisting of 35% debt and 65% equity. However, Globo-Chem Co.'s CFO has
suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7.5%, and Globo-
Chem Co.'s beta is 1.25.
If the firm's tax rate is 35%, what will be the beta of an all-equity firm if its operations were exactly the same?
Now consider the case of another company:
U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 8%, and its tax rate
is 35%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%.
U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax
cost of debt to increase to 10%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weighted
average cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.),
The optimal capital structure is the one that_
the WACC and
the firm's stock price. Higher debt levels
the firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to

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Step 2: Calculate the Beta of all Equity Firm G Corp:

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Step 3: Calculate Unlevered Beta of US R Inc:

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Step 4: Calculate Levered Beta of US R Inc with new capital structure:

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Step 5: Calculate WACC:

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Which statement is most correct? * A. Since debt financing raises the firm’s financial risk, increasing debt ratio will increase WACC. B. Since debt financing is cheaper than equity financing, increasing debt ratio will reduce WACC. C. Increasing a firm’s debt ratio will typically reduce the marginal costs of both debt and equity financing; however, it still may raise the firm’s WACC. D. Statements a and c are correct. E. None of the above
Which of the following statements is correct? A. The optimal dividend policy is the one that satisfies management, not shareholders. B. The use of debt financing has no effect on earnings per share (EPS) or stock price. C. Stock price is dependent on the projected EPS and the use of debt, but not on the timing of the earnings stream. D. The riskiness of projected EPS can impact the firm's value. E. Dlvidend policy is one aspect of the firm's financial policy that is determined solely by the shareholders. Reset Selection
Which of these is a main characteristic of debt capital?(a) Investors in debt participate in the ownership of the firm.(b) Investors in debt are paid interest.(c) Debt is more risky for the investor and less risky for the firm.(d) If dividends are not paid, this can lead to foreclosure, legal proceeding and financial distress.
While the use of debt can lower the average cost of capital, there is a point that the debt leverage gets high enough it increases the cost of capital. Group of answer choices True False
Ch. 17. True/False. The optimal amount of debt produces the highest weighted average cost of capital. Group of answer choices True False
Generally speaking, the cost of debt is cheaper than the cost of equity. Does it imply that a firm should increase its debt-to-equity ratio to as high as possible such that its corporate cost of capital can be minimized?

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