Question Details

What is the coefficient of variation of expected EPS under the conservative capital structure 



 .	Pennington Airlines currently has a beta of 1.2.  The company- capital structure consists of $7 million of equity and $3 million of debt.  The company is considering changing its capital structure.  Under the proposed plan the company would increase its debt by $2 million and use the proceeds to repurchase common stock.  (So, after the plan is completed, the company will have $5 million of debt and $5 million of equity.)  The company estimates that if it goes ahead with the plan, its bonds will have a nominal yield to maturity of 8.5 percent.  The company- tax rate is 40 percent.  The risk-free rate is 6 percent and the market risk premium is 7 percent.  What is the company- estimated WACC if it goes ahead with the plan?

a.	 8.35%
b.	 9.75%
c.	12.27%
d.	10.90%
e.	11.45%


(The following information applies to the next four problems.)

Copybold Corporation is a start-up firm considering two alternative capital structures, one is conservative and the other aggressive. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy calls for D/A = 0.75. Once the firm selects its target capital structure, it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring and forecasted EBIT in this state is $60,000. The Famine state has a 40 percent chance of occurring and expected EBIT is $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent. The firm will have $400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share.

 .	What is the difference between the EPS forecasts for Feast and Famine under the aggressive capital structure?

a.	$   0
b.	$1.48
c.	$0.62
d.	$0.98
e.	$2.40

 .	What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure?

a.	$1.00
b.	$0.80
c.	$2.20
d.	$0.44
e.	$   0

 .	What is the coefficient of variation of expected EPS under the aggressive capital structure?

a.	1.00
b.	1.18
c.	2.45
d.	2.88
e.	3.76
 .	What is the coefficient of variation of expected EPS under the conservative capital structure ?

a.	0.58
b.	0.39
c.	0.15
d.	0.23
e.	1.00




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