Managerial Finance

) Ylusa DD Y rvble,rnl t5-1 , li - 8 t3- 1 i.::

is stai--le and it exoects no growth, so all earnings are paid out as dividends. The debrt r:nn-ci:ts ri r::'r:tlltl bcnrls. a. \,Vl:at is the total market value of the firm's stock, S, and the firrn's total market

YArLrlr Y :

b. What is the firm's weighted a\rerage cost of capitai? c. Suppose the firm can increase its riebt so tirat its capitai structure iras :uyo tiebt,

based on market values (it will issue debt and buy back stock). At this lel,el of debt, its

cost of equity rises to 18.57o anci its interest rate on all debt rviil rise to 12o/o (it rvili har.'e

to call and retund the old debt). What is the WACC under this capital structure? What

is the total value? Horv much debt will it issue, ancl what is the st<ick price after the repurchase? How many shares w-ill remain outstanding after the repurchase?

Lighter Industrial Corporation (LIC) is considering a large-scale recapitalization.

Currentiy, LiC is financeci r,vith 2592o debt andT5oro equity. LiC is considering increasing its level of debt until it is financed with 60% debt and 407o equity. The beta on its cornnlon stock at the current level of debt is I.5, the rrsk-free rate is 6%, the market risk premiurn is 4?o, and LIC t"aces a 409ro federal-plus-state tax rate.

a. What is LIC's cur"rent cost of equity? b. What is LIC's r.rnlevered beta? c. l{rhat will be the neu, beta and new cost of equitv if LIC recapitalizes?

?

a-hani+r t 1

(sr-2) Hama<ia Equation

Easy Probiems 1-6

(1s-1)

Break-even Quantity

(1s-2)

Unievered Beta

(1s-3)

Fremium for Financial Risk

(1s-4)

Value of EquitY after Recapitalization

(1s-s)

Stock Price after Recapitalization

(1s-o Shares Remaining

after Recapitalization

Intermediate Problems 7-8

Es'4 Break-even Point

Shapland Inc. has fixed operating costs of$500,000 and variable costs of S50 per unit. If it seils the product for $75 per unit, what is the break-even quantity?

Counts Accounting has a beta of i.15. The tax rate is 40%, and Counts is financed with 20% debt. What is Counts's unlevered beta?

Ethier Enterprise has an unlevered beta of 1.0. Ethier is financed with 5091o debt and has a

levered beta of 1.6. If the risk-tree rate is 5.5% and tl.re market risk premium is 60lo, horv much is the additional premium that Ethier's shareholders require to be conrpensated for

iinancial risk?

Nichols Corporation's value of operations is equal to $500 rnillion after a recapitalization (the firm hatl no debt before the recap). It raised $200 million in new debt and used this to

buy back stock. Nichols had no short-temr investments before or after the recap. After the

recap, w4 = 409/o. What is S (the value of equity afler the recap)?

{.ee Ntlanufacturing's value of operations is equal to $900 million after a recapitaiization (the firm ha<l no debt before the recap). Lee raised $300 million in new debt and used this

to buv back stock. Lee had no short-term investments before or after the recap. After the

recap, wd = i1-1. The firm had 30 milli<ln shares before the recap. lVhat is P (the stock price after the recap)?

I)t,e Trucking raised $1-50 million in new debt and used this to buy back stock. A{1er the

recap, I)ye's stock price is $7.-50. If Dye had 60 million shares of stock betbre tl.re recap, horv manv shares does it have after the recap?

Schweser Satellites Inc. produces satellite earth stations thaf seli for $100,000 each.'lhe

filn's fixed costs, F, are $2 million, -50 earth stations are produced and sold each year,