Reference no: EM132983600

Questions -

Q1) An unlevered firm has a cost of capital of 12.46 percent and a tax rate of 35 percent. The firm is considering a new capital structure with 35 percent debt. The interest rate on the debt would be 6.68 percent. What would be the firm's levered cost of capital?

Q2) Edwards Construction currently has debt outstanding with a market value of $280,000 and a cost of 6 percent. The company has an EBIT of $16,800 that is expected to continue in perpetuity. Assume there are no taxes.

a. What is the value of the company's equity and the debt-to-value ratio?

b. What is the equity value and the debt-to-value ratio if the company's growth rate is 4 percent?

c. What is the equity value and the debt-to-value ratio if the company's growth rate is 5 percent?

Q3) Castle, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 20 percent lower. The firm is considering a debt issue of $90,000 with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock. There are currently 10,000 shares outstanding. The firm has a tax rate 35 percent. Assume the stock price remains constant.

a-1. Calculate earnings per share (EPS) under each of the three economic scenarios before any debt is issued.

a-2. Calculate the percentage changes in EPS when the economy expands or enters a recession.

b-1. Calculate earnings per share (EPS) under each of the three economic scenarios assuming the company goes through with recapitalization.

b-2. Given the recapitalization, calculate the percentage changes in EPS when the economy expands or enters a recession.