Currently, the firm is all equity funded with 500000 shares valued at $10 per sh

Question

Currently, the firm is all equity funded with 500000 shares valued at $10 per share and the required return on equity is 15.6%. Income tax rate is 40%. Your banker has indicated that the following leverage restructurings are possible

1. Estimate the share prices for the following debt restructures 10%, 20%, and, 30%, respectively:

A $10.44; $10.68; $10.48

B $10.68; $10.48; $10.44

C $10.68; $10.44; $10.48

D $10.48; $10.68; $10.44

E $10.44; $10.48; $10.68

2. Estimate which two debt restructures maximize firm value.

A 0%; 10%

B 20%; 30%

C 30%; 0%

D 10%; 20%

E 0%; 20%

Airplane Company has a cost-plus-fixed fee contract with the air force to build jets. The government will buy any additional equipment that it needs on a justified cost-savings basis.

3.The incremental tax rate for the company is 40%. The company has computed the following labor savings for a new equipment that costs $18,334:

$10,000

The company has an after-tax time value of money of 6% and the federal government has a before-tax time value of money of 5%. Should the equipment be purchased?

A COMPANY-NO; GOVT-YES

B INDETERMINATE

C COMPANY-YES; GOVT-NO

D COMPANY-YES; GOVT-YES

E COMPANY-NO; GOVT-NO

4. Calculate return on equity (ROE) and earnings per share (EPS) if expansion is financed by equity.

A 23.76%; $2.38

B 22%; $2.2

C 29.7%; $2.97

D 25.08%; $2.51

E 33%; $3.3

5. Calculate return on equity (ROE) and earnings per share (EPS) if expansion is financed by debt.

A 22%; $2.2

B 23.76%; $2.38

C 33%; $3.3

D 29.7%; $2.97

E 25.08%; $2.51

6. Calculate return on equity (ROE) and earnings per share (EPS) if expansion is financed by equity and debt equally.

A 25.08%; $2.51

B 22%; $2.2

C 29.7%; $2.97

D 33%; $3.3

E 23.76%; $2.38

Debt Leverage 10.00% 20.00% 30.00% Interest   8.50% 9.00% 9.50% ROE 16.00% 17.00% 19.00%

Explanation / Answer

1. E $10.44; $10.48; $10.68

2. A 0%; 10%

3. E COMPANY-NO; GOVT-NO

4. D 25.08%; $2.51

5. A 22%; $2.2

6. E 23.76%; $2.38

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