Winter\'s Toyland has a debt-equity ratio of 0.65. The pre-tax cost of debt is 8

Question

1. Winter's Toyland has a debt-equity ratio of 0.65. The pre-tax cost of debt is 8.7 percent and the required return on assets is 16.1 percent. What is the cost of equity if you ignore taxes? (Round to the 2nd decimal XX.XX%)
2. Douglass & Frank has a debt-equity ratio of 0.35. The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent? (Round to the 2nd decimal XX.XX%)
3. D. L. Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent. The tax rate is 32 percent. What is the present value of the tax shield?
4. Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 10 percent. Bruce currently has no debt, and its cost of equity is 20 percent. The tax rate is 34 percent. What will the value of Bruce & Co. be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares
5. Becker Industries is considering an all equity capital structure against one with both debt and equity. The all equity capital structure would consist of 26,000 shares of stock. The debt and equity option would consist of 13,000 shares of stock plus $245,000 of debt with an interest rate of 9 percent. What is the break-even level of earnings before interest and taxes between these two options? Ignore taxes

Explanation / Answer

1)

WACC =16.1%
16.1% =1/1.65*re +0.65/1.65*8.7%
re =20.91%
cost of equity = 20.91%

4)

VU = $100,000 (1 - 0.34)/0.20; V = $330,000
VL = $330,000 + 0.34($54,000) = $348,360

5)

for breakeven 245,000 * 0.09 + 13000 x = 26000x

x = 245000 * 0.09 /13000 = 1.6962

Hence breakeven earnings = 1.6962 * 26000 = 37,316.4

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