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FIN 401 Lecture Notes - Lecture 4: Cash Flow, Capital Structure, Risk Premium

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danotehustla
9 Feb 2018
School
Ryerson University
Department
Finance
Course
FIN 401
Professor
Melissa Toffanin

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Document Summary

Example #1 financing a new business in a pcm. You have the opportunity to run a coffee shop in the lobby of a nearby office building for one year. Your research indicates that an upfront investment of ,000 is required to start. After covering your operating costs (including your wage), you expect to generate a cash flow of ,500 at the end of the year. Returns to equity with and without debt . The effect of leverage on the cost of capital: for any choice of capital structure, the firm"s pre-tax wacc is unchanged and remains equal to the firm"s unlevered cost of capital. The effect of leverage m&m proposition ii. Mm proposition ii: the cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the debt-to-equity ratio (measured using market values) r. We want to choose the capital structure that will maximize stockholder wealth.

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Related Questions

Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before tax cost of debt is 10%, and its tax rate is 35%. It currently has a levered beta of 1.10. the risk free are is 2.5% and the risk premium on the market is 8%. U.s. Robotics Inc. is considering changing its capital structue to 60% debt and 40% equity. Inceasing the firms level of debt will cause its before tax cost of debt to increase to 12%.

1.What is Robotics unlevered beta?

2. Reiever U.S. Robotics beta using the firm's new captial structure.

3. Use Robotics levered beta under the new capital structure to solve for its cost of equity under the new capital struature.

4. What will the firms WACC be if it makes the changes in the capital structure?

Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before tax cost of debt is 10%, and its tax rate is 35%. It currently has a levered beta of 1.10. the risk free are is 2.5% and the risk premium on the market is 8%. U.s. Robotics Inc. is considering changing its capital structue to 60% debt and 40% equity. Inceasing the firms level of debt will cause its before tax cost of debt to increase to 12%. 1.What is Robotics unlevered beta? 2. Reiever U.S. Robotics beta using the firm's new captial structure. 3. Use Robotics levered beta under the new capital structure to solve for its cost of equity under the new capital struature. 4. What will the firms WACC be if it makes the changes in the capital structure?

7. A type of financing that involves one corporation borrowing from another non-financial corporation is called:
a) commercial paper
b) preferred sharing
c) an operating lease
d) a short term line of credit

8. Past the point where the optimal capital structure exists, adding debt to the capital structure:
a)results in higher interest rates for the firm, and higher leverage. The higher leverage results in a riskier firm with a higher cost of equity.
b)Reduces the firms cost of equity
c)violates SEC regulations if the excess debt is considered permanent.
d)results in the excess debt's interest not being tax deductible