Question Details

What will be its estimated stock price after the capital structure change 


 .	A consultant has collected the following information regarding Young Publishing:

Total assets	    $3,000 million	Tax rate	      40%
Operating income (EBIT)	$800 million	Debt ratio	       0%
Interest expense	  $0 million	WACC	      10%
Net income	$480 million	M/B ratio	       1.00×
Share price	 $32.00	EPS = DPS	      $3.20

	The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS).  Young- stock price can be calculated by simply dividing earnings per share by the required return on equity capital, which currently equals the WACC because the company has no debt.

	The consultant believes that the company would be much better off if it were to change its capital structure to 40 percent debt and 60 percent equity.  After meeting with investment bankers, the consultant concludes that the company could issue $1,200 million of debt at a before-tax cost of 7 percent, leaving the company with interest expense of $84 million. The $1,200 million raised from the debt issue would be used to repurchase stock at $32 per share.  The repurchase will have no effect on the firm- EBIT; however, after the repurchase, the cost of equity will increase to 11 percent.  If the firm follows the consultant- advice, What will be its estimated stock price after the capital structure change ?

a.	$32.00
b.	$33.48
c.	$31.29
d.	$32.59
e.	$34.72

 .	Simon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a capital structure that consists of 20 percent debt and 80 percent equity.  (Its D/E ratio is 0.25.)  The risk-free rate is 6 percent and the market risk premium, kM - kRF, is 5 percent. Currently the company- cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40 percent.  What would be Simon- estimated cost of equity if it were to change its capital structure to 50 percent debt and 50 percent equity?

a.	14.35%
b.	30.00%
c.	14.72%
d.	15.60%
e.	13.64%

 .	Aaron Athletics is trying to determine its optimal capital structure. The company- capital structure consists of debt and common stock.  In order to estimate the cost of debt, the company has produced the following table:

Debt-to-total-	Equity-to-total-	Debt-to-equity	 Bond	Before-tax
assets ratio (wd)	assets ratio (wc)	    ratio (D/E)		rating	cost of debt
									
0.10	0.90	0.10/0.90 = 0.11	AA	7.0%
0.20	0.80	0.20/0.80 = 0.25	A	7.2 
0.30	0.70	0.30/0.70 = 0.43	A	8.0
0.40	0.60	0.40/0.60 = 0.67	BB	8.8
0.50	0.50	0.50/0.50 = 1.00	B	9.6

The company- tax rate, T, is 40 percent.

The company uses the CAPM to estimate its cost of common equity, ks.  The risk-free rate is 5 percent and the market risk premium is 6 percent. Aaron estimates that if it had no debt its beta would be 1.0.  (Its “unlevered beta,” bU, equals 1.0.)

On the basis of this information, what is the company- optimal capital structure, and what is the firm- weighted average cost of capital (WACC) at this optimal capital structure?

a.	wc = 0.9; wd = 0.1; WACC = 14.96%
b.	wc = 0.8; wd = 0.2; WACC = 10.96%
c.	wc = 0.7; wd = 0.3; WACC =  7.83%
d.	wc = 0.6; wd = 0.4; WACC = 10.15%
e.	wc = 0.5; wd = 0.5; WACC = 10.18%

 .	Zippy Pasta Corporation (ZPC) has a constant growth rate of 7 percent. The company retains 30 percent of its earnings to fund future growth. ZPC- expected EPS (EPS1) and ks for various capital structures are given below. What is the optimal capital structure for ZPC?

Debt/Total Assets	Expected EPS	ks    
       20%	$2.50	     15.0%
       30	 3.00	     15.5
       40	 3.25	     16.0
       50	 3.75	     17.0
       70	 4.00	     18.0

a.	Debt/Total Assets = 20%
b.	Debt/Total Assets = 30%
c.	Debt/Total Assets = 40%
d.	Debt/Total Assets = 50%
e.	Debt/Total Assets = 70%


 .	Given the following choices, what is the optimal capital structure for Chip Co.?  (Assume that the company- growth rate is 2 percent.)

Dividends		 Cost of 
Debt Ratio		Per Share		Equity (ks)
   0%			  $5.50		  11.5%
  25			   6.00		  12.0
  40			   6.50		  13.0
  50			   7.00		  14.0
  75			   7.50		  15.0

a.	0% debt; 100% equity
b.	25% debt; 75% equity
c.	40% debt; 60% equity
d.	50% debt; 50% equity
e.	75% debt; 25% equity




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