Exercises from Financial Management Book, Chapter14

Only available on StudyMode
  • Download(s) : 111
  • Published : January 8, 2012
Open Document
Text Preview
Solutions to Exercises
Session 2
(Capital Structure)

14-1QBE = [pic]
QBE = [pic]
QBE = 500,000 units.

14-4From the Hamada equation, b = bU[1 + (1 – T)(D/E)], we can calculate bU as bU = b/[1 + (1 – T)(D/E)].

bU = 1.2/[1 + (1 – 0.4)($2,000,000/$8,000,000)]
bU = 1.2/[1 + 0.15]
bU = 1.0435.

14-8Facts as given: Current capital structure: 25% debt, 75% equity; rRF = 5%; rM – rRF = 6%; T = 40%; rs = 14%.

Step 1:Determine the firm’s current beta.

rs= rRF + (rM – rRF)b
14%= 5% + (6%)b
9%= 6%b
1.5= b.

Step 2:Determine the firm’s unlevered beta, bU.

bU= bL/[1 + (1 – T)(D/E)]
= 1.5/[1 + (1 – 0.4)(0.25/0.75)]
= 1.5/1.20
= 1.25.

Step 3:Determine the firm’s beta under the new capital structure.

bL= bU[1 + (1 – T)(D/E)]
= 1.25[1 + (1 – 0.4)(0.5/0.5)]
= 1.25(1.6)
= 2.

Step 4:Determine the firm’s new cost of equity under the changed capital structure.

rs= rRF + (rM – rRF)b
= 5% + (6%)2
= 17%.

14-9a.
a. If net income = $1,000,000 and dividend payout ratio = 40%, then the total amount of dividend paid in Year 0 was 40% x $1,000,000 = $400,000. Therefore, the current dividend per share, D0, = $400,000/200,000 shares = $2.00. D1 = $2.00(1.05) = $2.10. Therefore, P0 = D1/(rs – g) = $2.10/(0.134 – 0.05) = $25.00.

b.Step 1:Calculate EBIT before the recapitalization:

The firm is 100% equity financed, so there is no interest expense. (EBIT = EBT
NI = EBT – Taxes = EBT – EBT(T) = EBT (1-T) ⇨ EBIT = EBT = NI/ (1-T) = $1,000,000/(1 – T) = $1,000,000/0.6 = $1,666,667.

Step 2:Calculate net income after the recapitalization:

EBT = EBIT – Interest expense =...
tracking img