Corporate Finance
3rd Edition
ISBN: 9780132992473
Author: Jonathan Berk, Peter DeMarzo
Publisher: Prentice Hall
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Question
Chapter 14, Problem 15P
a.
Summary Introduction
To Determine: The interest rate on the debt.
Introduction:
Debt–equity ratio indicates a relative proportion of debt and equity that is used to finance the company’s assets. Basically, the fraction of debt with shareholders’ equity is termed as debt–equity ratio.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Tomorrow Co is financed entirely by equity that is priced to offer a 14% expected return on equity. If the company repurchases 40% of equity and substitutes an equal value of debt yielding 8%, what is the expected return on equity after refinancing? (Ignore taxes and cost of financial distress.)
An all-equity firm has expected earnings of $14,200 and a market value of $82,271. The firm is planning to issue $15,000 of debt at 6.3 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?
Infosystems, Inc. has a debt/equity ratio = 2. The firm has a cost of equity of 12% and a cost of debt of 6%. Calculate the firm’s equity’s beta (β) after the target debt/equity ratio changes to 1.5. Assume that the cost of debt does not change. Ignore taxes and other market imperfections. The risk-free interest rate is 2% and the market risk premium is 7%.
Chapter 14 Solutions
Corporate Finance
Ch. 14.1 - How does the risk and cost of capital of levered...Ch. 14.2 - Why are investors indifferent to the firms capital...Ch. 14.2 - What is a market value balance sheet?Ch. 14.2 - In a perfect capital market, how will a firms...Ch. 14.3 - How do we compute the weighted average cost of...Ch. 14.3 - With perfect capital markets, as a firm increases...Ch. 14.4 - If a change in leverage raises a firm's earnings...Ch. 14.4 - True or False: When a firm issues equity, it...Ch. 14.5 - Consider the questions facing Dan Harris, CFO of...Ch. 14.5 - Prob. 2CC
Ch. 14 - Consider a project with free cash flows in one...Ch. 14 - You are an entrepreneur starting a biotechnology...Ch. 14 - Acort Industries owns assets that will have an 80%...Ch. 14 - Wolfrum Technology (WT) has no debt. Its assets...Ch. 14 - Suppose there are no taxes. Firm ABC has no debt,...Ch. 14 - Suppose Alpha Industries and Omega Technology have...Ch. 14 - Prob. 7PCh. 14 - Prob. 8PCh. 14 - Zetatron is an all-equity firm with 100 million...Ch. 14 - Explain what is wrong with the following argument:...Ch. 14 - Prob. 11PCh. 14 - Hardmon Enterprises is currently an all-equity...Ch. 14 - Prob. 13PCh. 14 - Prob. 14PCh. 14 - Prob. 15PCh. 14 - Hartford Mining has 50 million shares that are...Ch. 14 - Mercer Corp. has 10 million shares outstanding and...Ch. 14 - Prob. 18PCh. 14 - Prob. 19PCh. 14 - Prob. 20PCh. 14 - Prob. 21PCh. 14 - Prob. 22PCh. 14 - Prob. 23P
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- The Rivoli Company has no debt outstanding, and its financial position is given by the following data: What is Rivoli’s intrinsic value of operations (i.e., its unlevered value)? What is its intrinsic stock price? Its earnings per share? Rivoli is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 30% debt based on market values, its cost of equity, rs, will increase to 12% to reflect the increased risk. Bonds can be sold at a cost, rd, of 7%. Based on the new capital structure, what is the new weighted average cost of capital? What is the levered value of the firm? What is the amount of debt? Based on the new capital structure, what is the new stock price? What is the remaining number of shares? What is the new earnings per share?arrow_forwardDavid 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: e. Suppose the expected free cash flow for Year 1 is 250,000 but it is expected to grow faster than 7% during the next 3 years: FCF2 = 290,000 and FCF3 = 320,000, after which it will grow at a constant rate of 7%. The expected interest expense at Year 1 is 128,000, but it is expected to grow over the next couple of years before the capital structure becomes constant: Interest expense at Year 2 will be 152,000, at Year 3 it will be 192,000 and it will grow at 7% thereafter. What is the estimated horizon unlevered value of operations (i.e., the value at Year 3 immediately after the FCF at Year 3)? What is the current unlevered value of operations? What is the horizon value of the tax shield at Year 3? What is the current value of the tax shield? What is the current total value? The tax rate and unlevered cost of equity remain at 25% and 14%, respectively.arrow_forwardSnow Flake Inc is currently all equity financed. The company decides to recapitalize to take advantage of the tax shield of debt. The firm's marginal tax rate is 30%. After a substantial borrowing, firm's cost of equity goes up to 12%. Assuming that firm's asset beta is 0.9, risk free rate is 2%, and EMRP is 5%, the company's post recapitalization debt to capital ratio is closest to: Group of answer choices Search 36% 175% 64% 56% None of the answers is correctarrow_forward
- The Company KNV is in the construction industry and has outstanding debts valued at €4 million and its equity is valued at €6 million. The shares of KNV have a beta of 1.2 and the market has an expected risk premium of 8% p.a. The risk free rate is 4% p.a. and the KNV is risk free. The company doesn't pay any tax. Required: a) What is the required return on the KNV stock?. b) Estimate the company's cost of capital. c) Suppose the company wants to diversify its business and invest in the manufacturing of building materials. The beta of an unleveraged firm in the building materials sector is 1.1. Estimate the required return on KNV's new venture.arrow_forwardRolex, Inc. has equity with a market value of $20 million and debt with a market value of $20 million. Assume the firm has no default risk and can borrow at the risk-free interest rate. The risk-free interest rate is 5 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost of capital for an otherwise identical all-equity firm? O 7.77% O 9.00% O 10.14% O 8.27%arrow_forwardThe common stock and debt of Northern Sludge are valued at $56 million and $23 million, respectively. Investors currently require a 15% return on the common stock and an 7% return on the debt. If Northern Sludge Issues an additional $5 million of common stock and uses this money to retire debt, what is the new expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Expected stock return %arrow_forward
- Currently, Hotel California has no debt (i.e., leverage=0). The CEO of Hotel California considers increasing leverage (=debt/(debt+equity)) 0.4. Currently, Hotel California’s CAPM beta is 1.5. The cost of debt (??) will be 10%, riskfree rate (??) is 2%, and market return (??) is 13.5%. Assume that the corporate tax rate (τ) is 50%. Your task, as the CFO of Hotel California, is to provide the cost of capital under this proposed capital structure (i.e., 25% leverage). What is the weighted average cost of capital under the proposed capital structure (i.e., 40% leverage)?arrow_forwardWolfrum Technology (WT) has no debt. Its assets will be worth $467 million one year from now if the economy is strong, but only $295 million in one year if the economy is weak. Both events are equally likely. The market value today of its assets is $291 million. a. What is the expected return of WT stock without leverage? b. Suppose the risk-free interest rate is 5%. If WT borrows $139 million today at this rate and uses the proceeds to pay an immediate cash dividend, what will be the market value of its equity just after the dividend is paid, according to MM? c. What is the expected return of WT stock after the dividend is paid in part (b)? a. The unievered expected return of WT stock is (Round to two decimal places)arrow_forwardKyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCold - WACCNew? New Debt/Assets 35% Orig. cost of equity, rs 10.0% New Equity/Assets 65% New cost of equity = rs 11.0% Interest rate new = rd 7.0% Tax rate 40.0% O1.72% O2.06% 1.38% 1.04%arrow_forward
- What is the value of equity and debt?arrow_forward4. North Inc has a perpetual expected EBIT of $200. The interest rate on debt is 12%. Assume that there are no taxes. a. what is the value of North Inc if the debt/equity ratio is .25 and its weighted average cost of capital is 16%? What's the value of North's equity? What is the value of North's debt? What is the firm's cost of equity? b. Suppose the corporate tax is 30% and North has $400 in debt outstanding. If the unlevered cost is 20%, what's the value of North? What is the value of the firm's equity? What is the Wacc?arrow_forwardRolex, Inc. has equity with a market value of $20 million and debt with a market value of $10million. Assume the firm has no default risk and can borrow at the risk-free interest rate. Therisk-free interest rate is 5 percent per year, and the expected return on the market portfolio is11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost ofcapital for an otherwise identical all-equity firm? handwrite pleasearrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Dividend disocunt model (DDM); Author: Edspira;https://www.youtube.com/watch?v=TlH3_iOHX3s;License: Standard YouTube License, CC-BY