Student:GM
Date: 5/29/23
Instructor: SP
Course: FIN-330-X5100 Corporate Finance
23EW5
Assignment: 4-1 MyFinanceLab Homework:
Capital Structure and C
1. ( Cost ofdebt) Temple-Midland, Inc. is issuing a $1,000 par value bond that pays 8.0 percent annual interest and matures in 15 years.
Investors are willing to pay $950 for the bond and Temple faces a tax rate of 35 percent. What isTemple’s after-tax cost of debt on
thebond?
Theafter-tax cost of debt is
%. (Round to two decimalplaces.)
2. ( Cost ofdebt) Sincere Stationery Corporation needs to raise $500,000 to improve its manufacturing plant. It has decided to issue a
$1,000 par value bond with an annual coupon rate of 10.0 percent with interest paid semiannually and a 10-year maturity. Investors
require a rate of return of 9.0 percent.
a. Compute the market value of the bonds.
b. How many bonds will the firm have to issue to receive the neededfunds?
c. What is thefirm’s after-tax cost of debt if thefirm’s tax rate is 34 percent?
a. The market value of the bonds is $
. (Round to the nearestcent.)
b. The number of bonds that the company needs to sell is
c. Thefirm’s after-tax cost of debt is
bonds. (Round up to the nearestinteger.)
%. (Round to two decimalplaces.)
3. ( Related to Checkpoint14.2) (Cost of commonequity) Salte Corporation is issuing new common stock at a market price of $27.00.
Dividends last year were $1.45 and are expected to grow at an annual rate of 6.0 percent forever. What isSalte’s cost of commonequity?
Thecompany’s cost of common equity is
%. (Round to two decimalplaces.)
4. ( Cost of preferredstock) The preferred stock of Walter Industries Inc. currently sells for $36.00 a share and pays $2.50 in dividends
annually. What is thefirm’s cost of capital for the preferredstock?
Thefirm’s cost of capital for the preferred stock is
%. (Round to two decimalplaces.)
5. ( Individual or component costs ofcapital) You have just been hired to compute the cost of capital fordebt, preferredstock, and
common stock for the Mindflex Corporation.
a. Cost ofdebt: SinceMindflex’s bonds do not trade veryfrequently, you have decided to use 9.00 percent as your cost ofdebt, which is
the yield to maturity on a portfolio of bonds with a similar credit rating and maturity asMindflex’s outstanding debt. Inaddition, Mindflex
faces a corporate tax rate of 34 percent.
b. Cost of commonequity: Mindflex’s common stock paid a $1.25 dividend last year. Inaddition, Mindflex’s dividends are growing at a
rate of 6.0 percent per year and this growth rate is expected to continue into the foreseeable future. The price of this stock is currently
$30.00.
c. Cost ofdebt: Nowlet’s assume thatMindflex’s bonds are frequently traded. A Mindflex bond has a $1,000 par value(face value) and a
coupon interest rate of 13.0 percent that is paid semiannually. The bonds are currently selling for $1,125 and will mature in 20 years.
Mindflex’s corporate tax rate is 34 percent.
d. Cost of preferredstock: Mindflex’s preferred stock pays a dividend of 7.0 percent on a $125 par value. However, the market price at
which the preferred shares could be sold is only $90.00.
a. Theafter-tax cost of debt for the firm is
b. The cost of common equity for the firm is
c. Theafter-tax cost of debt for the firm is
d. The cost of the preferred stock for the firm is
%. (Round to two decimalplaces.)
%. (Round to two decimalplaces.)
%. (Round to two decimalplaces.)
%. (Round to two decimalplaces.)
6. ( Related to Checkpoint14.1) (Weighted average cost ofcapital) The target capital structure for QM Industries is 40 percent
commonstock, 10 percent preferredstock, and 50 percent debt. If the cost of common equity for the firm is 18.0 percent, the cost of
preferred stock is 10.0 percent, thebefore-tax cost of debt is 8.0 percent, and thefirm’s tax rate is 35 percent, what isQM’s weighted
average cost ofcapital?
QM’s weighted average cost of capital is
%. (Round to three decimalplaces.)
7. ( Related to Checkpoint14.4) (Flotation costs and NPVanalysis) The Faraway Moving Company is involved in a major plant
expansion that involves the expenditure of $200 million in the coming year. The firm plans on financing the expansion through the
retention of $150 million in firm earnings and by borrowing the remaining $50 million. In return for helping sell the $50 million in newdebt,
thefirm’s investment banker charges a fee of 200 basis points(where one basis point is 0.01percent). If Faraway decides to adjust for
these flotation costs by adding them to the initialoutlay, what will the initial outlay for the projectbe?
The flotation cost adjusted initial outlay is $
. (Round to the nearestdollar.)
8. ( Flotation costs) The Pandora Internet Radio Company was started in 2000 to provide a personalized radio listening experience over
your computer or iPhone and is privately owned. However, its success could easily lead its owners to take the company public with the
sale of common stock to the public. When companies sell common stock for the first time the flotation cost can be very high. If Pandora
needs $75 million to finance an acquisition and sells shares to thepublic, how much stock would they have to sell if flotation costs are
expected to be 15 percent?
The flotation cost adjusted initial outlay is $
. (Round to the nearestdollar.)
9. (Related to Checkpoint15.1) (Calculating debtratio) WebbSolutions, Inc. has the following financialstructure: 1.
a. ComputeWebb’s debt ratio andinterest-bearing debt ratio.
b. If the market value ofWebb’s equity is $2,000,000 and the value of thefirm’s debt is equal to its bookvalue, assuming excess cash
iszero, what is thedebt-to-enterprise-value ratio forWebb?
c. If you were a bank loan officer who was analyzing whether or not to loan more money toWebb, which of the ratios calculated in parts a
and b is most relevant to youranalysis?
a. Webb’s debt ratio is
%. (Round to one decimalplace.)
Webb’sinterest-bearing debt ratio is
%. (Round to one decimalplace.)
b. Webb’sdebt-to-enterprise-value ratio is
%. (Round to one decimalplace.)
c. If you were a bank loan officer who was analyzing whether or not to loan more money toWebb, which of the ratios calculated in parts a
and b is most relevant to youranalysis? (Select the best choicebelow.)
A. The most relevant of the threedebt-related ratios we have calculated is thefirst, the debt ratio.
B. None of these three ratios can measureWebb’s ability to repay the loan.
C. The most relevant of the threedebt-related ratios we have calculated is thesecond, theinterest-bearing debt ratio.
D. The most relevant of the threedebt-related ratios we have calculated is thethird, thedebt-to-enterprise-value ratio.
1: Data Table
Accounts payable
$500,000
Short-term debt
250,000
Current liabilities
750,000
Shareholders’ equity
500,000
Total
(Click on the icon
$750,000
Long-term debt
in order to copy its contents into a spreadsheet.)
$2,000,000
10. ( Adjusting afirm’s capitalstructure) Curley’s Fried Chicken Kitchen operates two southern cooking restaurants in St.Louis, Missouri,
and has the following financialstructure: 2. The firm is considering an expansion that would involve raising an additional $2.0 million.
a. What are thefirm’s debt ratio andinterest-bearing debt ratio in its present capitalstructure?
b. If the firm wants to have a debt ratio of 50 percent, how much equity does the firm need to raise in order to finance theexpansion?
a. Thefirm’s debt ratio is
%. (Round to one decimalplace.)
Thefirm’s interest-bearing debt ratio is
%. (Round to one decimalplace.)
b. If the firm wants to have a debt ratio of 50%, the equity the firm needs to raise is $
. (Round to the nearestdollar.)
2: Data Table
(Click on the icon
Accounts payable
$100,000
Short-term debt
400,000
Current liabilities
$500,000
Long-term debt
2,000,000
Owner’s equity
1,500,000
Total
$4,000,000
in order to copy its contents into a spreadsheet.)
11. ( Computing interest taxsavings) Dharma Supply has earnings before interest and taxes(EBIT) of $500,000, interest expenses of
$300,000, and faces a corporate tax rate of 35 percent.
a. What is DharmaSupply’s netincome?
b. What wouldDharma’s net income be if itdidn’t have any debt(and consequently no interestexpense)?
c. What are thefirm’s interest taxsavings?
a. DharmaSupply’s net income is $
. (Round to the nearestdollar.)
b. If itdidn’t have anydebt, DharmaSupply’s net income is $
c. Thefirm’s interest tax savings are $
. (Round to the nearestdollar.)
. (Round to the nearestdollar.)
12. ( Related to Checkpoint15.1) (Analyzing coverageratios) The income statements for HomeDepot, Inc.(HD), spanning the
period2014-2016 (just before the housingcrash, so these are representativeyears) are foundhere: 3.
a. Calculate the times interest earned ratio for each of the years for which you have data.
b. What is your assessment of how thefirm’s ability to service its debt obligations has changed over thisperiod?
a. The times interest earned ratio for 2016 was
times. (Round to two decimalplaces.)
The times interest earned ratio for 2015 was
times. (Round to two decimalplaces.)
The times interest earned ratio for 2014 was
times. (Round to two decimalplaces.)
b. What is your assessment of how thefirm’s ability to service its debt obligations has changed over thisperiod? (Select the best
choicebelow.)
A. HomeDepot’s ability to service its debt obligations has been increasing over the years.
B. HomeDepot’s ability to service its debt obligations has been fluctuating over the years.
C. HomeDepot’s ability to service its debt obligations has been steady over the years.
D. HomeDepot’s ability to service its debt obligations has been declining over the years.
3: Data Table
$ thousands
Net operating income(EBIT)
Interest expense
Earnings before taxes
Income taxes
Net income
(Click on the icon
2016
2015
2014
$11,774,000
$10,469,000
$9,166,000
(919,000)
(830,000)
(711,000)
$10,855,000
$9,639,000
$8,455,000
(4,012,000)
(3,631,000)
(3,082,000)
$6,843,000
$6,008,000
$5,373,000
in order to copy its contents into a spreadsheet.)
13. ( Leverage andEPS) You have developed the following pro forma income statement for yourcorporation: 4. It represents the most
recentyear’s operations, which ended yesterday. Your supervisor in thecontroller’s office has just handed you a memorandum asking for
written responses to the followingquestions:
a. If sales should increase by 25 percent, by what percent would earnings before interest and taxes and net incomeincrease?
b. If sales should decrease by 25 percent, by what percent would earnings before interest and taxes and net incomedecrease?
c. If the firm were to reduce its reliance on debt financing such that interest expense were cut inhalf, how would this affect your answers
to parts a and b?
a. If sales should increase by 25%, the percentage change in earnings before interest and taxes is
decimalplaces.)
If sales should increase by 25%, the percentage change in net income is
%. (Round to two
%. (Round to two decimalplaces.)
b. If sales should decrease by 25%, the percentage change in earnings before interest and taxes is
%. (Round to two
decimalplaces.)
If sales should decrease by 25%, the percentage change in net income is
%. (Round to two decimalplaces.)
c. If sales should increase by 25% and interest expense should decrease by 50%, the percentage change in earnings before interest
and taxes is
%. (Round to two decimalplaces.)
If sales should increase by 25% and interest expense should decrease by 50%, the percentage change in net income is
%. (Round to two decimalplaces.)
If sales should decrease by 25% and interest expense should decrease by 50%, the percentage change in earnings before interest and
%. (Round to two decimalplaces.)
taxes is
If sales should decrease by 25% and interest expense should decrease by 50%, the percentage change in net income is
%. (Round to two decimalplaces.)
4: Data Table
Sales
$
(22,800,000)
Variable costs
Revenue before fixed costs
$
$
$
12,400,000
(6,200,000)
Taxes (50%)
Net income
13,750,000
(1,350,000)
Interest expense
Earnings before taxes
22,950,000
(9,200,000)
Fixed costs
EBIT
45,750,000
$
6,200,000
14. ( EBIT-EPS analysis) Three recent graduates of the computer science program at the University of Tennessee are forming a company
that will write and distribute new application software for the iPhone. Initially, the corporation will operate in the southern region
ofTennessee, Georgia, NorthCarolina, and South Carolina. A small group of private investors in theAtlanta, Georgia area is interested
in financing the startup company and two financing plans have been put forth forconsideration:
• The first(Plan A) is anall-common-equity capital structure. $2.0 million dollars would be raised by selling common stock at $20
per common share.
• Plan B would involve the use of financial leverage. $1.0 million dollars would be raised by selling bonds with an effective interest
rate of 11.0 percent(per annum), and the remaining $1.0 million would be raised by selling common stock at the $20 price per share.
The use of financial leverage is considered to be a permanent part of thefirm’s capitalization, so no fixed maturity date is needed for the
analysis. A 30 percent tax rate is deemed appropriate for the analysis.
a. Find the EBIT indifference level associated with the two financing plans.
b. A detailed financial analysis of thefirm’s prospects suggests that thelong-term EBIT will be above $300,000 annually. Taking this
intoconsideration, which plan will generate the higherEPS?
a. The EBIT indifference level associated with the two financing plans is $
. (Round to the nearestdollar.)
b. Using EBIT of $300,000, complete the segment of the income statement for Plan Abelow: (Round income statement amounts to the
nearest dollar except the EPS to the nearestcent.)
Stock Plan
EBIT
$
Less: Interest Expense
Earnings Before Taxes
$
Less: Taxes at 30%
Net Income
$
Number of Common Shares
EPS
$
Using EBIT of $300,000, complete the segment of the income statement for Plan Bbelow: (Round income statement amounts to the
nearest dollar except the EPS to the nearestcent.)
Bond/Stock Plan
EBIT
$
Less: Interest Expense
Earnings Before Taxes
$
Less: Taxes at 30%
Net Income
$
Number of Common Shares
EPS
$
Plan (1)
(1)
will generate the higher EPS. (Select from thedrop-down menu.)
A
B
15. ( Using EBIT-EPSbreak-even analysis) HomeDepot, Inc.(HD), had 1244 million shares of common stock outstanding in2016,
whereas LowesCompanies, Inc.(LOW), had 929 million shares outstanding. Assuming HomeDepot’s 2016 interest expense is $919
million, Lowes’ interest expense is $552 million, and a 35 percent tax rate for bothfirms, what is theirbreak-even level of operating
income (i.e., the level of EBIT where EPS is the same for bothfirms)?
The EBIT indifference level is $
. (Round to the nearestdollar.)
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