intermediate finance

FIN 3950 Problem Set #4 Spring 2015

Due: Monday, April 13, 2015, not later than 11:59pm in the D2L Drop Box

Use a single worksheet within the same Excel workbook for each problem (1 file, 2 worksheets). Label

each worksheet tab properly.

1. The AED Corporation is currently financed with 100% common equity. AED stock currently sells for $30/share, equity investors require a 15% return from their equity investment, the riskless rate of

interest is 1.5%, and the stock’s beta is 1.25. 500,000 shares of the stock are outstanding, and the

expected growth rate is 0%. The firm is considering a recapitalization, in which new debt will be

issued and the proceeds used to repurchase shares. Forecasted debt costs are given in the table

below. The firm faces a 34% tax rate, and expected EBIT is $1,000,000. Complete the table below.

Can you identify an optimal capital structure for AED? What is that optimal capital structure?

wD kD βL kC WACC Firm Value

10% 7.5%

20% 8.0%

30% 9.0%

40% 11.0%

50% 13.5%

60% 16.5%

2. The CFB, Inc., is currently financed with 90% common equity. Expected EBIT for CFB is $3,500,000. CFB stock currently sells for $50/share, the riskless rate of interest is 1.0%, and 2,000,000 shares of

the stock are outstanding, and the expected growth rate is 0%. The firm is considering a

recapitalization, in which new debt will be issued and the proceeds used to repurchase shares.

Forecasted debt costs and some other relevant information are given in the table below. The firm

faces a 34% tax rate. Complete the table below. Can you identify an optimal capital structure for

CFB? What is that optimal capital structure?

wD kD βL kC WACC Firm Value

0% -- βU =

10% 6.5% 1.10 10%

15% 7.0%

20% 8.0%

25% 9.5%

30% 11.5%

35% 14.0%