Project #97290 - Debt Policy Formula 22Q

1.

River Cruises is all-equity-financed.

  

  Current Data        
  Number of shares   100,000              
  Price per share $ 10              
  Market value of shares $ 1,000,000              
  State of the Economy
 
  Slump  Normal Boom
  Profits before interest $ 78,250     131,500     193,000  

  

Suppose it now issues $250,000 of debt at an interest rate of 10% and uses the proceeds to repurchase 25,000 shares. Assume that the firm pays no taxes and that debt finance has no impact on firm value. Refer to the above table to compute the missing data. (Do not round intermediate calculations. Round "Earnings per share" to 3 decimal places. Enter "Return on shares" as a percent rounded to 2 decimal places.)

  

  Outcomes    
  Number of shares             
  Price per share $10             
  Market value of shares $             
  Market value of debt $             
State of the Economy
 
     Slump    Normal    Boom
  Profits before interest $78,250         $131,500         $193,000        
  Interest $         $         $        
  Equity earnings $         $         $        
  Earnings per share $         $         $        
  Return on shares %     %     %    
   

Expected Outcome

 

2.

River Cruises is all-equity-financed with 100,000 shares. It now proposes to issue $300,000 of debt at an interest rate of 12% and use the proceeds to repurchase 30,000 shares at $10 per share. Profits before interest are expected to be $130,000.

 

a.

What is the ratio of price to expected earnings for River Cruises before it borrows the $300,000? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

  Price-earnings ratio   

 

b.

What is the ratio after it borrows? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

 

  Price-earnings ratio   

3.

The common stock and debt of Northern Sludge are valued at $72 million and $28 million, respectively. Investors currently require a return of 16.4% on the common stock and 7.3% on the debt. If Northern Sludge issues an additional $12 million of common stock and uses this money to retire debt, what happens to the 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.)


 

  New return on equity %  

4.

Here is Establishment Industries’ market-value balance sheet (Figures in millions):


 

           
  Net working capital $ 840     Debt $ 700  
  Long-term assets   2,760     Equity   2,900  
 

 

  Value of firm $ 3,600     $ 3,600  
 



 





 

The debt is yielding 5.0%, and the cost of equity is 16.0%. The tax rate is 37%. Investors expect this level of debt to be permanent.


 

a.

What is Establishment’s WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)


 

  WACC %  


 

b.

How would the market-value balance sheet change if Establishment retired all its debt? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 1 decimal place.)


 

New Market-Value Balance Sheet
(figures in millions)
  Net working capital $     Debt $  
  Long-term assets     Equity  
 
 
  Value of firm $     Total $  
 

 

 

 

 

Subject Mathematics
Due By (Pacific Time) 12/05/2015 12:00 pm
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