QUESTION 1
BMC Inc. currently has $1,000,000 of 8% coupon bonds and 40,000 common shares outstanding. The tax rate is 40%. The firm is considering a large investment of $1,500,000 in a new project. The following options are feasible for raising this capital: ï· Option 1: Sell $1,500,000 worth of common stock at $50 per share. ï· Option 2: Issue $1,000,000 worth of 6% coupon bonds with a 20-year maturity, in addition to $500,000 worth of common stock at $50 per share.
a) Calculate the EBIT indifference point for the 2 options.
b) What is the EPS at the EBIT indifference point? At EBIT levels above the EBIT indifference point, which plan is better?
QUESTION 2
B&B Inc. has a book value of debt of $500,000. The market value of debt is $550,000. Its pre-tax cost of debt is 10%, and its beta is equal to 2. The tax rate is 40%. The firm has an annual EBIT of $200,000. In the market, you observe that T-bills are being sold to yield 1%, and the S&P/TSX Composite Index is expected to yield 6%.
What is B&Bâs weighted average cost of capital? Assume there is no cost of financial distress.
QUESTION 3
An unlevered firm, CEA Inc., has 160,000 common shares issued and outstanding. It has a perpetual constant EBIT of $800,000 and an unlevered beta of 1.5. The firm has corporate tax rate of 40%. The market risk premium is 8% and the risk- free rate is 3%. Assume a world of taxes and costs of financial distress.
a) Calculate the value of the firm.
b) Calculate the WACC for the firm.
c) What is the value of a share in the company and what is the EPS?
d) If the firm issues $1,000,000 of bonds with a coupon rate of 10%, and now the beta of the levered firm is 1.85, what is the value of the firm?
e) What is the WACC for the firm with its new capital structure?
QUESTION 1
BMC Inc. currently has $1,000,000 of 8% coupon bonds and 40,000 common shares outstanding. The tax rate is 40%. The firm is considering a large investment of $1,500,000 in a new project. The following options are feasible for raising this capital: ï· Option 1: Sell $1,500,000 worth of common stock at $50 per share. ï· Option 2: Issue $1,000,000 worth of 6% coupon bonds with a 20-year maturity, in addition to $500,000 worth of common stock at $50 per share.
a) Calculate the EBIT indifference point for the 2 options.
b) What is the EPS at the EBIT indifference point? At EBIT levels above the EBIT indifference point, which plan is better?
QUESTION 2
B&B Inc. has a book value of debt of $500,000. The market value of debt is $550,000. Its pre-tax cost of debt is 10%, and its beta is equal to 2. The tax rate is 40%. The firm has an annual EBIT of $200,000. In the market, you observe that T-bills are being sold to yield 1%, and the S&P/TSX Composite Index is expected to yield 6%.
What is B&Bâs weighted average cost of capital? Assume there is no cost of financial distress.
QUESTION 3
An unlevered firm, CEA Inc., has 160,000 common shares issued and outstanding. It has a perpetual constant EBIT of $800,000 and an unlevered beta of 1.5. The firm has corporate tax rate of 40%. The market risk premium is 8% and the risk- free rate is 3%. Assume a world of taxes and costs of financial distress.
a) Calculate the value of the firm.
b) Calculate the WACC for the firm.
c) What is the value of a share in the company and what is the EPS?
d) If the firm issues $1,000,000 of bonds with a coupon rate of 10%, and now the beta of the levered firm is 1.85, what is the value of the firm?
e) What is the WACC for the firm with its new capital structure?
Related questions
Omega Corp. currently has 200,000 shares of stock outstanding and no debt. However, they are planning on issuing debt in order to buy back stock. Their EBIT is a constant $500,000 regardless of how much debt they issue and they pay all net income out as dividends. Their tax rate is 40%. They have estimated the following costs of debt and costs of equity for various levels of debt.
| EBIT = | 500,000 | Tax Rate | 40% | Share | ||||
| Debt | Rd | Re | Net Inc | Equity Value | Firm Value | % Debt | WACC | Price |
| 0 | 6.00% | 9.00% | 300,000 | 3,333,333 | 3,333,333 | 0.00% | 9.00% | 16.67 |
| 500,000 | 6.30% | 9.40% | 2,990,426 | 3,490,426 | 14.32% | XXXX | ||
| 1,000,000 | 6.80% | 10.00% | ||||||
| 1,500,000 | 7.50% | 11.00% | 41.51% | XXXX | 18.07 | |||
| 2,000,000 | 8.50% | 12.50% | XXXX | 3,584,000 | 8.37% | |||
| 2,500,000 | 10.00% | 14.50% | ||||||
| 3,000,000 | 12.00% | 17.00% | 84,000 | XXXX | 85.86% | 17.47 |
22. What will their Net Income be if they issue $2,000,000 in debt?
a. $158,000 b. $172,000 c. $198,000 d. $216,000
23. What will their WACC be if they issue $1,500,000 in debt?
a. 8.23% b. 8.30% c. 8.36% d. 8.42%
24. What will their Share Price be if they issue $500,000 in debt?
a. $16.94 b. $17.12 c. $17.45 d. $17.72
25. What is the value of the firm�s equity if they issue $3,000,000 worth of debt?
a. 500,000 b. 1,500,000 c. 2,000,000 d. 2,500,000
