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Savvy Supermarkets is a chain of grocery stores that is currently financed with 12.5% debt and 87.5% equity. The CEO of Savvy decides that the proportion of debt in the current capital structure is too low because investors in Savvy’s stock demand a higher rate of return. Savvy issues debt and pays out all proceeds as a special dividend to shareholders. The current rate of return on Savvy’s equity is 16%, only slightly higher than the 14% currently expected on the stock market index. Suppose the risk-free rate is 6% and Savvy has 10 million shares outstanding for a price of $18 per share. For answering the following questions, please assume the Modigliani and Miller assumptions are correct and the CAPM is valid.
a. What is the equity beta and the debt beta of Savvy if the debt has an expected return of 6%?
b. What is the cost of capital of Savvy?
c. Suppose the CEO wishes to realize a target expected return of 20% through leveraging and paying the proceeds as special dividend. How much debt should the company issue, assuming that all debt can be issued at an expected return equal to the risk-free rate?
Two credit cards both state an APR of 10%. First National Bank’s card charges 0.8333% compounded monthly. First United Bank’s card charges 5% compounded semiannually (twice a year). Given these APR’s, what are the effective annual rates charged by th..
Bakker Corporation applies manufacturing overhead on the basis of direct labor-hours. At the beginning of the most recent year, the company based its predetermined overhead rate on total estimated overhead of $112,850 and 3,700 estimated direct labor..
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You just won the 800 million dollar lottery. You have the option of taking 500 million as one lump sum or 25.8 million TODAY (year 0) then 25.8 million for the next 30 years. We need to pay taxes. Assume the tax rate is 40 percent for all payments. H..
Let's say you short sell 500 shares of XYZ corporation when its price is $40 per share. The IMR is 45%, The MMR is 25%, and the broke charges 9% per year on borrowed funds. If within three months, the price of XYZ rises to $58 per share; will you be ..
According to the tax effect theory, investors prefer dividends and, as a result, the higher the payout ratio, the higher the value of the firm. According to the dividend preference (bird-in-the-hand) theory, investors prefer cash to paper (stock), so..
The practice of executing unauthorized trades for an investment account by a salesman or broker in order to generate commission from the account. A civil wrong, not arising from a contract, for which a court will provide a remedy. A form of business ..
Turbo Technology Computers is experiencing a period of rapid growth. Earnings and dividends are expected to grow at a rate of 15% during the next two years, at 13% in the third year, and at a constant rate of 6% thereafter. Calculate the dividend yie..
Which of the following is not typically included among the three major components of a financial planning model?
Paterson Products is considering leasing a computerized inventory control system to reduce its average inventories. The annual cost of the system is $46,000. How much, if any, annual savings will the firm realize on the reduced level of average inven..
Teardrop, Inc., wishes to expand its facilities. The company currently has 12 million shares outstanding and no debt. The stock sells for $22 per share, but the book value per share is $33. Calculate the new book value per share. Assume no change is ..
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