Project #2952 - Financial Managment

It a online finance homework about Capital structure analysis

Break-even Point

Schweser Satellites Inc. produces satellite earth stations that sell for $95,000 each. The firm's fixed costs, F, are $2.5 million, 50 earth stations are produced and sold each year, profits total $500,000; and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $3.5 million to investment and $420,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 19 units, but (3) the sales price on all units will have to be lowered to $90,000 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt.

 

  1. What is the incremental profit?

    To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)? Round your answer to two decimal places.

Capital Structure Analysis

The Rivoli Company has no debt outstanding, and its financial position is given by the following data:

Assets (Market value = book value) $3,000,000
EBIT $500,000
Cost of equity, rs 10%
Stock price, Po $15
Shares outstanding, no 200,000
Tax rate, T (federal-plus-state) 40%

The firm is considering selling bonds and simultaneously repurchasing some of its stock. If it moves to a capital structure with 40% 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 8%. Rivoli is a no-growth firm. Hence, all its earnings are paid out as dividends. Earnings are expected to be constant over time.

 

  1. What effect would this use of leverage have on the value of the firm?
      
    I. Increasing the financial leverage by adding debt results in an increase in the firm's value.
    II. Increasing the financial leverage by adding debt results in a decrease in the firm's value.
    III. Increasing the financial leverage by adding debt has no effect on the firm's value. 

  2. What would be the price of Rivoli's stock? Round your answer to the nearest cent.
    $  per share

  3. What happens to the firm's earnings per share after the recapitalization? Round your answer to the nearest cent.
    The firm   its EPS by $  .

  4. The $500,000 EBIT given previously is actually the expected value from the following probability distribution:
    Probability EBIT
    0.10 - $ 125,000
    0.20 200,000
    0.40 500,000
    0.20 750,000
    0.10 1,225,000

    Determine the times-interest-earned ratio for each probability. Round your answers to two decimal places.
    Probability TIE
    0.10  
    0.20  
    0.40  
    0.20  
    0.10  

    What is the probability of not covering the interest payment at the 40 percent debt level? Round your answer to two decimal places.

    %.

 

 

WACC and Optimal Capital Structure

F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows:

Market Debt-
to-Value 
Ratio (wd)
Market Equity-to-Value 
Ratio (ws)
Market Debt-
to-Equity 
Ratio (D/S)
Before-Tax Cost of Debt (rd)
0.0 1.0 0.00 7.0%  
0.2 0.8 0.25 8.0    
0.4 0.6 0.67 10.0    
0.6 0.4 1.50 12.0    
0.8 0.2 4.00 15.0    

F. Pierce uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 6%, the market risk premium is 7%, and the company's tax rate is 35%. F. Pierce estimates that its beta now (which is "unlevered" since it currently has no debt) is 1.2. Based on this information, what is the firm's optimal capital structure, and what would the weighted average cost of capital be at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places.

DEBT  %
EQUITY  %
WACC  %

 

Miller Model with Corporate and Personal Taxes

An unlevered firm has a value of $850 million. An otherwise identical but levered firm has $270 million in debt. Under the Miller model, what is the value of the levered firm if the corporate tax rate is 34%, the personal tax rate on equity is 25%, and the personal tax rate on debt is 30%? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$   million

 

Miller Mondigliani without Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $7 million of 5% bonds outstanding. Assume that (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $2 million, and (4) the cost of equity to Company U is 10%.

 

  1. What value would MM estimate for each firm? Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.
    Company U $   million
    Company L $   million


  2. What is rs for Firm U? Round your answer to two decimal places.
     %

    What is rs for Firm L? Do not round intermediate calculations. Round your answer to two decimal places.
     %

  3. Find SL. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000.
    $   million

  4. What is the WACC for Firm U? Round your answer to one decimal place.
     %

    What the WACC for Firm L? Round your answer to one decimal place.
     %

  5. Suppose VU = $20 million and VL = $22 million. According to MM, are these values consistent with equilibrium?

 

 

Miller-Mondigliani with Corporate Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $16 million of 7% bonds outstanding. Assume that (1) all of the MM assumptions are met, (2) both firms are subject to a 40% federal-plus-state corporate tax rate, (3) EBIT is $4 million, and (4) the unlevered cost of equity is 10%.

 

  1. What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.
    Company U $   million
    Company L $   million


  2. What is rs for Firm U? Round your answer to one decimal place.
     %

    What is rs for Firm L? Do not round intermediate calculations. Round your answer to one decimal place.
     %

  3. Find SL, and then show that SL + D = VL results in the same value as obtained in part a. Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answers to two decimal places.
    SL = $   million
    SL + D = $   million

  4. What is the WACC for Firm U? Do not round intermediate calculations. Round your answer to two decimal places.
     %
    What is the WACC for Firm L? Do not round intermediate calculations. Round your answer to two decimal places.
     %

Dividend Payout

The Wei Corporation expects next year's net income to be $10 million. The firm's debt ratio is currently 55%. Wei has $9 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei's dividend payout ratio be next year? Round your answer to two decimal places.

 %

 

Stock Repurchase

A firm has 10 million shares outstanding with a market price of $15 per share. The firm has $30 million in extra cash (short-term investments) that it plans to use in a stock repurchase; the firm has no other financial investments or any debt. What is the firm's value of operations after the repurchase? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.

$   million

How many shares will remain after the repurchase? Round your answer to the nearest whole number.

 shares

 

Stock Split

Suppose you own 2,000 common shares of Laurence Incorporated. The EPS is $12.00, the DPS is $3.25, and the stock sells for $90 per share. Laurence announces a 2-for-1 split. Immediately after the split, how many shares will you have?

What will the adjusted EPS and DPS be? Round your answers to the nearest cent.

EPS $  
DPS $  

What would you expect the stock price to be? Round your answer to the nearest cent.

$  

Boehm Corporation has had stable earnings growth of 4% a year for the past 10 years, and in 2012 Boehm paid dividends of $2.4 million on net income of $18.0 million. However, in 2013 earnings are expected to jump to $28.8 million, and Boehm plans to invest $14.4 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2013 Boehm will return to its previous 4% earnings growth rate. Its target debt ratio is 35%.

 

  1. Calculate Boehm's total dividends for 2013 under each of the following policies:
    1. Its 2013 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest dollar.
      $   

    2. It continues the 2012 dividend payout ratio. Round your answer to the nearest dollar.
      $   

    3. It uses a pure residual policy with all distributions in the form of dividends (35% of the $14.4 million investment is financed with debt). Round your answer to the nearest dollar.
      $   

    4. It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. Round your answer to the nearest dollar.
      $  


  2. Which of the preceding policies would you recommend? Restrict your choices to the ones listed.
     

 

Subject Business
Due By (Pacific Time) 03/09/2013 12:00 am
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