FIN 330 SNHU Corporate Finance Capital Structure Questions

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 of​debt) ​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 is​Temple’s after-tax cost of debt on
the​bond?
The​after-tax cost of debt is
​%. ​(Round to two decimal​places.)
2. (​ Cost of​debt) Sincere Stationery Corporation needs to raise ​$500,000 to improve its manufacturing plant. It has decided to issue a
​$1,000 par value bond with an annual coupon rate of 10.0 percent with interest paid semiannually and a 10​-year maturity. Investors
require a rate of return of 9.0 percent.
a. Compute the market value of the bonds.
b. How many bonds will the firm have to issue to receive the needed​funds?
c. What is the​firm’s after-tax cost of debt if the​firm’s tax rate is 34 ​percent?
a. The market value of the bonds is ​$
. ​(Round to the nearest​cent.)
b. The number of bonds that the company needs to sell is
c. The​firm’s after-tax cost of debt is
bonds. ​(Round up to the nearest​integer.)
​%. ​(Round to two decimal​places.)
3. (​ Related to Checkpoint​14.2) ​(Cost of common​equity) 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 is​Salte’s cost of common​equity?
The​company’s cost of common equity is
​%. ​(Round to two decimal​places.)
4. (​ Cost of preferred​stock) The preferred stock of Walter Industries Inc. currently sells for ​$36.00 a share and pays $2.50 in dividends
annually. What is the​firm’s cost of capital for the preferred​stock?
The​firm’s cost of capital for the preferred stock is
​%. ​(Round to two decimal​places.)
5. (​ Individual or component costs of​capital) You have just been hired to compute the cost of capital for​debt, preferred​stock, and
common stock for the Mindflex Corporation.
a. Cost of​debt: Since​Mindflex’s bonds do not trade very​frequently, you have decided to use 9.00 percent as your cost of​debt, which is
the yield to maturity on a portfolio of bonds with a similar credit rating and maturity as​Mindflex’s outstanding debt. In​addition, Mindflex
faces a corporate tax rate of 34 percent.
b. Cost of common​equity: ​Mindflex’s common stock paid a ​$1.25 dividend last year. In​addition, 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 of​debt: Now​let’s assume that​Mindflex’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 preferred​stock: ​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. The​after-tax cost of debt for the firm is
b. The cost of common equity for the firm is
c. The​after-tax cost of debt for the firm is
d. The cost of the preferred stock for the firm is
​%. (Round to two decimal​places.)
​%. ​(Round to two decimal​places.)
​%. ​(Round to two decimal​places.)
​%. ​(Round to two decimal​places.)
6. (​ Related to Checkpoint​14.1) ​(Weighted average cost of​capital) The target capital structure for QM Industries is 40 percent
common​stock, 10 percent preferred​stock, 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, the​before-tax cost of debt is 8.0 ​percent, and the​firm’s tax rate is 35 ​percent, what is​QM’s weighted
average cost of​capital?
​QM’s weighted average cost of capital is
​%. ​(Round to three decimal​places.)
7. (​ Related to Checkpoint​14.4) ​(Flotation costs and NPV​analysis) 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 ​$50 million in new​debt,
the​firm’s investment banker charges a fee of 200 basis points​(where one basis point is 0.01​percent). If Faraway decides to adjust for
these flotation costs by adding them to the initial​outlay, what will the initial outlay for the project​be?
The flotation cost adjusted initial outlay is ​$
. ​(Round to the nearest​dollar.)
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 ​$75 million to finance an acquisition and sells shares to the​public, how much stock would they have to sell if flotation costs are
expected to be 15 ​percent?
The flotation cost adjusted initial outlay is ​$
. ​(Round to the nearest​dollar.)
9. ​(Related to Checkpoint​15.1) ​(Calculating debt​ratio) Webb​Solutions, Inc. has the following financial​structure: 1.
a. Compute​Webb’s debt ratio and​interest-bearing debt ratio.
b. If the market value of​Webb’s equity is ​$2,000,000 and the value of the​firm’s debt is equal to its book​value, assuming excess cash
is​zero, what is the​debt-to-enterprise-value ratio for​Webb?
c. If you were a bank loan officer who was analyzing whether or not to loan more money to​Webb, which of the ratios calculated in parts a
and b is most relevant to your​analysis?
a. ​Webb’s debt ratio is
​%. ​(Round to one decimal​place.)
​Webb’s​interest-bearing debt ratio is
​%. ​(Round to one decimal​place.)
b. ​Webb’s​debt-to-enterprise-value ratio is
​%. ​(Round to one decimal​place.)
c. If you were a bank loan officer who was analyzing whether or not to loan more money to​Webb, which of the ratios calculated in parts a
and b is most relevant to your​analysis? ​(Select the best choice​below.)
A. The most relevant of the three​debt-related ratios we have calculated is the​first, the debt ratio.
B. None of these three ratios can measure​Webb’s ability to repay the loan.
C. The most relevant of the three​debt-related ratios we have calculated is the​second, the​interest-bearing debt ratio.
D. The most relevant of the three​debt-related ratios we have calculated is the​third, the​debt-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 a​firm’s capital​structure) ​Curley’s Fried Chicken Kitchen operates two southern cooking restaurants in St.​Louis, Missouri,
and has the following financial​structure: 2. The firm is considering an expansion that would involve raising an additional ​$2.0 million.
a. What are the​firm’s debt ratio and​interest-bearing debt ratio in its present capital​structure?
b. If the firm wants to have a debt ratio of 50 ​percent, how much equity does the firm need to raise in order to finance the​expansion?
a. The​firm’s debt ratio is
​%. ​(Round to one decimal​place.)
The​firm’s interest-bearing debt ratio is
​%. ​(Round to one decimal​place.)
b. If the firm wants to have a debt ratio of 50​%, the equity the firm needs to raise is ​$
. ​(Round to the nearest​dollar.)
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 tax​savings) Dharma Supply has earnings before interest and taxes​(EBIT) of ​$500,000​, interest expenses of
​$300,000​, and faces a corporate tax rate of 35 percent.
a. What is Dharma​Supply’s net​income?
b. What would​Dharma’s net income be if it​didn’t have any debt​(and consequently no interest​expense)?
c. What are the​firm’s interest tax​savings?
a. Dharma​Supply’s net income is ​$
. ​(Round to the nearest​dollar.)
b. If it​didn’t have any​debt, Dharma​Supply’s net income is ​$
c. The​firm’s interest tax savings are ​$
. ​(Round to the nearest​dollar.)
. ​(Round to the nearest​dollar.)
12. (​ Related to Checkpoint​15.1) ​(Analyzing coverage​ratios) The income statements for Home​Depot, Inc.​(HD), spanning the
period​2014-2016 (just before the housing​crash, so these are representative​years) are found​here: 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 the​firm’s ability to service its debt obligations has changed over this​period?
a. The times interest earned ratio for 2016 was
times. ​(Round to two decimal​places.)
The times interest earned ratio for 2015 was
times. ​(Round to two decimal​places.)
The times interest earned ratio for 2014 was
times. ​(Round to two decimal​places.)
b. What is your assessment of how the​firm’s ability to service its debt obligations has changed over this​period? ​(Select the best
choice​below.)
A. Home​Depot’s ability to service its debt obligations has been increasing over the years.
B. Home​Depot’s ability to service its debt obligations has been fluctuating over the years.
C. Home​Depot’s ability to service its debt obligations has been steady over the years.
D. Home​Depot’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 and​EPS) You have developed the following pro forma income statement for your​corporation: 4. It represents the most
recent​year’s operations, which ended yesterday. Your supervisor in the​controller’s office has just handed you a memorandum asking for
written responses to the following​questions:
a. If sales should increase by 25 ​percent, by what percent would earnings before interest and taxes and net income​increase?
b. If sales should decrease by 25 ​percent, by what percent would earnings before interest and taxes and net income​decrease?
c. If the firm were to reduce its reliance on debt financing such that interest expense were cut in​half, 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
decimal​places.)
If sales should increase by 25​%, the percentage change in net income is
​%. ​(Round to two
​%. ​(Round to two decimal​places.)
b. If sales should decrease by 25​%, the percentage change in earnings before interest and taxes is
​%. ​(Round to two
decimal​places.)
If sales should decrease by 25​%, the percentage change in net income is
​%. ​(Round to two decimal​places.)
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 decimal​places.)
If sales should increase by 25​% and interest expense should decrease by 50​%, the percentage change in net income is
​%. ​(Round to two decimal​places.)
If sales should decrease by 25​% and interest expense should decrease by 50​%, the percentage change in earnings before interest and
​%. ​(Round to two decimal​places.)
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 decimal​places.)
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
of​Tennessee, Georgia, North​Carolina, and South Carolina. A small group of private investors in the​Atlanta, Georgia area is interested
in financing the startup company and two financing plans have been put forth for​consideration:
• The first​(Plan A) is an​all-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 the​firm’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 the​firm’s prospects suggests that the​long-term EBIT will be above ​$300,000 annually. Taking this
into​consideration, which plan will generate the higher​EPS?
a. The EBIT indifference level associated with the two financing plans is ​$
. ​(Round to the nearest​dollar.)
b. Using EBIT of $300,000​, complete the segment of the income statement for Plan A​below: ​(Round income statement amounts to the
nearest dollar except the EPS to the nearest​cent.)
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 B​below: ​(Round income statement amounts to the
nearest dollar except the EPS to the nearest​cent.)
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 the​drop-down menu.)
A
B
15. (​ Using EBIT-EPS​break-even analysis) Home​Depot, Inc.​(HD), had 1244 million shares of common stock outstanding in​2016,
whereas Lowes​Companies, Inc.​(LOW), had 929 million shares outstanding. Assuming Home​Depot’s 2016 interest expense is ​$919
million, Lowes’ interest expense is ​$552 ​million, and a 35 percent tax rate for both​firms, what is their​break-even level of operating
income (i.e., the level of EBIT where EPS is the same for both​firms)?
The EBIT indifference level is ​$
. ​(Round to the nearest​dollar.)