CapStructure
Problems (15-3)
Ethier Enterprise has an unlevered beta of 1.0. Ethier is finance with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that Ethier’s shareholders require to be compensated for financial risk?
- No debt RsU = RF + βU(RM - RF) = 5.5% + 1.0(6%) = 11.5%
- With debt
RsL = RF + βL(RM - RF) = 5.5% + 1.6(6%) = 15.1%
- The additional premium required for financial risk = Rs,L- Rs,U = 15.1%-11.5%+ = 3.6%
Problems (15-10)
Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a Zero-growth firm and pays out all of its earnings as dividends. The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0.
a. What is BEA’s unlevered beta? Use market value D/S when unlevering? βU = = = 0.87
b. What are BEA’s new beta and cost of equity if it has 40% debt? - BEA’s new beta βL = βLใหม่ = (0.87) βLใหม่ = 1.218
- BEA’s cost of equity RsL = RF + βL(RM - RF) = 6% + (1.218)(4%) = 10.872%
c. What are BEA’s WACC and total value of the firm with 40% debt?
- BEA’s WACC WACC = = (9%)(1-0.4)(0.4) + (10.872%)(0.6) = 8.683%
- BEA’s total value of the firm V0 of firm = , g = 0% = = = = $103,188,000
Problems (26-9) International Associates (IA) is about to commence operations as an international trading company. The firm will have book assets of $10 million, and it expects to
Ethier Enterprise has an unlevered beta of 1.0. Ethier is finance with 50% debt and has a levered beta of 1.6. If the risk-free rate is 5.5% and the market risk premium is 6%, how much is the additional premium that Ethier’s shareholders require to be compensated for financial risk?
- No debt RsU = RF + βU(RM - RF) = 5.5% + 1.0(6%) = 11.5%
- With debt
RsL = RF + βL(RM - RF) = 5.5% + 1.6(6%) = 15.1%
- The additional premium required for financial risk = Rs,L- Rs,U = 15.1%-11.5%+ = 3.6%
Problems (15-10)
Beckman Engineering and Associates (BEA) is considering a change in its capital structure. BEA currently has $20 million in debt carrying a rate of 8%, and its stock price is $40 per share with 2 million shares outstanding. BEA is a Zero-growth firm and pays out all of its earnings as dividends. The firm’s EBIT is $14.933 million, and it faces a 40% federal-plus-state tax rate. The market risk premium is 4%, and the risk-free rate is 6%. BEA is considering increasing its debt level to a capital structure with 40% debt, based on market values, and repurchasing shares with the extra money that it borrows. BEA will have to retire the old debt in order to issue new debt, and the rate on the new debt will be 9%. BEA has a beta of 1.0.
a. What is BEA’s unlevered beta? Use market value D/S when unlevering? βU = = = 0.87
b. What are BEA’s new beta and cost of equity if it has 40% debt? - BEA’s new beta βL = βLใหม่ = (0.87) βLใหม่ = 1.218
- BEA’s cost of equity RsL = RF + βL(RM - RF) = 6% + (1.218)(4%) = 10.872%
c. What are BEA’s WACC and total value of the firm with 40% debt?
- BEA’s WACC WACC = = (9%)(1-0.4)(0.4) + (10.872%)(0.6) = 8.683%
- BEA’s total value of the firm V0 of firm = , g = 0% = = = = $103,188,000
Problems (26-9) International Associates (IA) is about to commence operations as an international trading company. The firm will have book assets of $10 million, and it expects to