Calculate Octane’s new beta (levered beta) with 40 percent

Calculate Octane’s new beta (levered beta) with 40 percent

Subject: Business    / Finance
Question
QUESTION 2 Calculate Octane’s new beta (levered beta) with 40 percent debt ratio
0.87
1.21
2.24
None of the above

QUESTION 3 Calculate Octane’s cost of common equity – using the CAPM – with 40% debt ratio
17.203%
18.174%
None of the above

QUESTION 4 For this and the next question: Truck Parts Company (TPC) has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company’s EBIT is $13.40 million, and its tax rate is 15%. TPC can change its capital structure by either increasing its debt to $70 million or decreasing it to $30 million. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. Assume zero growth. What will be the value of the firm if the firm decreases its use of leverage? Assume that cost of equity will decrease to 13%.
$71.92 million
$87.6154 million
$102.2442 million
None of the above

QUESTION 5 What will be the value of the firm if it increases its use of leverage? Assume that cost of equity will increase to 16%.
$4.25 million
$95.3936 million
$102.6923 million
None of the above

QUESTION 6 For this and the next question: Gomez Computer Systems has expected EBIT of $200,000, a growth rate of 6%, and faces a tax rate of 40%. In order to support growth, Gomez must reinvest 20 percent of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding. A similar company with no debt has a cost of equity of 11%. According to the MM extension with growth, what is the value of Gomez’s tax shield, VTS?
$87,273
$192,000
$288,000
$300,000

QUESTION 7 According to the MM extension with growth, what is Gomez’s unlevered value, VU?
$1,090,909
$1,600,000
$2,400,000
$4,000,000

QUESTION 8 Your firm has debt worth $200,000, with a yield of 9 percent, and equity worth $300,000. It is growing at a 5 percent rate, and faces a 40 percent tax rate. A similar firm with no debt has a cost of equity of 12 percent. Under the MM extension with growth, what is your firm’s cost of equity, rEL?
9.36%
12.0%
13.2%
14.0%

QUESTION 9 Which of the following statements is true?
A debt-free firm will always have zero operating leverage
The business risk of a firm generally rises as the degree of operating leverage increases
Firms with high break-even levels suffer from high systematic risk exposure

QUESTION 13 For this and the next problem: The Watts Company manufactures ladies’ watches, which are sold through discount stores. Each watch is sold for $25; fixed costs are $140,000 for 30,000 watches or less; variable costs are $15 per watch. What is the firm’s EBIT at a sales level of 30,000 watches?
$160,000
$450,000
None of the above

QUESTION 15 Which type of risk is a direct result of a firm’s decision to use debt?
business risk
financial risK
company-specific risk

QUESTION 16 Spunk Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT). New sales are projected to be 170,000 units, an increase of 45,000 over last year’s level of 125,000 units. Last year’s EBIT was $60,000. Based on a DOL of 2.5, what is this year’s projected EBIT with the increase in sales?
$175,000
$114,000
None of the above is correct

QUESTION 17 REVIEW. What is the original M&M view (no taxes) on capital structure?
The value of the firm rises with the firm’s debt ratio.
The firm’s overall cost of capital drops as the firm uses more and more debt.
The firm’s overall cost of capital is unaffected by the use of debt

QUESTION 18 REVIEW. In 1963, M&M revisited the capital structure argument and considered the effect of corporate taxes. Their conclusion is that:
The value of the firm is unaffected by changes in the firm’s capital structure
The firm’s overall cost of capital drops as the firm’s use of debt increases
The value of the firm increases and then drops as the firm’s use of debt increases

QUESTION 19 REVIEW. What is Miller’s (1977) contribution to the capital structure theory?
Introduced interest tax shield on debt
Considered effects of personal taxes on a firm’s cost of capital
Considered effects of financial distress cost

QUESTION 20 REVIEW. Based on the tradeoff theory of capital structure, at what point is the value of the firm maximized?
At a debt ratio of 100%
When the benefits of leverage is offset by higher interest rates and cost of financial distress
At a debt ratio of 0%

QUESTION 21 Volga Publishing is considering a proposed increase in its debt ratio, which will also increase the company’s interest expense. The plan would involve the company issuing new bonds and using the proceeds to buy back shares of its common stock. The company’s CFO expects that the plan will not change the company’s total assets or operating income. However, the company’s CFO does estimate that it will increase the company’s earnings per share (EPS). Assuming the CFO’s estimates are correct, which of the following statements is most correct?
Since the proposed plan would increase financial risk, the company’s stock price might still fall even though EPS is expected to increase.
If the plan reduces the company’s WACC, the company’s stock price will likely decline.
Since the plan is expected to increase EPS, stock price should definitely increase.
Statements a and c are correct.

QUESTION 22 A firm is considering expanding its production line, which is expected to increase revenues by 20%. The financial manager has estimated, based on the two financing proposals on the table, that the firm’s sales-EPS indifference level is $12 million. As a prudent manager, you wish to maximize the value of stockholder investment. What would guide your decision as to which financing alternative – debt versus equity – should be adopted?
You should choose the debt plan if projected revenues exceed $12 million
You should choose the equity plan if projected revenues are less than $12 million
You should choose the plan that maximizes stock price even if EPS is lower
You should choose the plan that maximizes EPS even if stock price is lower

QUESTION 23 You are considering two financing alternatives for a proposed project at your company. Plan A is an all-equity plan while Plan B is a debt-plus-equity alternative. Suppose the EBIT indifference level for the two plans is $ 5million. Which plan should maximize your firm’s EPS if expected operating income from the project is about $3 million?
Plan A
Uncertain

QUESTION 24 Three recent MBA graduates from Purdue wish to for a company to write and distribute financial analysis software for personal computers. A small group of private investors from Chicago is interested in financing the new company. Two financing proposals are being considered. Plan A is an all-equity capital structure. This plan calls for $3 million to be raised by selling common stock at $20 per share. Plan B would combine equity with financial leverage. This second plan calls for $2 million to be raised by selling bonds at an interest rate of 11 percent. The remaining $1 million would be raised by selling common shares at $20 per share. The use of financial leverage is considered to be a permanent part of the firm’s capitalization. Thus, no fixed maturity date is needed for the analysis. Tax rate is 34%. Find the EBIT indifference level for the two financing plans.
Summary of Input Data
Equity Debt + Equity Equity
$3,000,000 $1,000,000
Stock price: P0 $20 $20
Number of shares: n 150,000 50,000
Debt $0 $2,000,000
Cost of debt: rD NA 11%
Tax rate 34% 34%
Choose a starting EBIT, e.g. $250,000

$330,000
$1,000,000
None of the above

QUESTION 25 For this and the next question: A firm issues 100,000 shares with a total market value of $5,000,000. The firm’s market value of debt is also $5,000,000. The firm is expected to generate $1,500,000 in operating income (i.e. EBIT). Currently, interest charges are $225,000. Tax rate is 40%. Suppose the firm changes its capital structure which causes (1) total debt to rise by 70% (2) Number of shares to drop by 70% (3) Interest expenses to increase by 75%. Assume that both EBIT and share price remain unchanged with this change in capital structure. Calculate current EPS.
$7.65
$22.13
None of the above

QUESTION 26 Continuing .Calculate the new EPS with the change in capital structure.
$5.65
$22.13
None of the above

QUESTION 27 A firm’s cost of equity is 20% and an after-tax cost of debt of 12%. What DEBT-TO-EUITY RATIO should be used in order to keep the firm’s WACC at 15%? Please be careful in solving this problem.
63.50
1.67
1.00
None of the above

QUESTION 28 A firm’s tax rate is 35%. Cost of debt is 10% and required rate of return on equity is 18%. Calculate the firm’s WACC if the firm finances 45% of its assets with debt.
14.00%
18.20%
12.83%
None of the above