Reference no: EM132757788
Questions -
Q1. FINANCIAL LEVERAGE EFFECTS - The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neals total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year's EBIT for three possible states of the world: $4. 2 million with a 0.2 probability, $2.8 million with a 0.5 probability, and $700,000 with a 0.3 probability Calculate Neals expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios; then evaluate the results
Debt/ Capital Ratio Interest Rate
0% -
10 9%
50 11
60 14
Q2. HAMADA EQUATION - Cyclone Software Co is trying to establish its optimal capital structure. Its current capital structure consists of 25% debt and 75% equity; however, the CEO believes that the firm should use more debt The risk-free rate, Ige is 5%; the market risk premium, RPw is 6%; and the firms tax rate is 40%.Currently, Cyclone's cost of equity is 14%, which is determined by the CAPM. What would be Cyclones estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?
Q3. RECAPITALIZATION - Tapley Inc. currently has total capital equal to S5 million, has zero debt, is in the 40% federal-plus-state tax bracket, has a net income of $1 million, and distributes 40% of its earnings as dividends
Net income is expected to grow at a constant rate of 5% per year, 200,000 shares of stock are outstanding, and the current WACC is 13.40%. The company is considering a recapitalization where it will issue S1 million in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recaptalization, its before-tax cost of debt will be 11% and its cost of equity will rise to 14.5%
a. What is the stock's current price per share (before the recapitalization)?
b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in part a.