C12.exercises.docVIP

Capital Structure: Basic Concepts 1. 【EBIT and Leverage】 Money, Inc., has no debt outstanding and a total market value of $150,000. Earnings before interest and taxes, EBIT, are projected to be $14,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 30 percent higher. If there is a recession, then EBIT will be 60 percent lower. Money is considering a $60,000 debt issue with a 5 percent interest rate. The proceeds will be used to repurchase shares of stock. There are currently 2,500 shares outstanding. Ignore taxes for this problem. a. Calculate earnings per share, EPS, under each of the three economic scenarios before any debt is issued. Also, calculate the percentage changes in EPS when the economy expands or enters a recession. b. Repeat part (a) assuming that Money goes through with recapitalization. What do you observe? 4. 【Break-Even EBIT】 Rolston Corporation is comparing two different capital structures, an allequity plan (Plan I) and a levered plan (Plan II). Under Plan I, Rolston would have 150,000 shares of stock outstanding. Under Plan II, there would be 60,000 shares of stock outstanding and $1.5 million in debt outstanding. The interest rate on the debt is 10 percent and there are no taxes. a. If EBIT is $200,000, which plan will result in the higher EPS? b. If EBIT is $700,000, which plan will result in the higher EPS? c. What is the break-even EBIT? 5.【 MM and Stock Value】 In Problem 4, use MM Proposition I to ?nd the price per share of equity under each of the two proposed plans. What is the value of the ?rm? 13. 【Calculating WACC】 Shadow Corp. has no debt but can borrow at 8 percent. The ?rm’s WACC is currently 12 percent, and the tax rate is 35 percent. a. What is Shadow’s cost of equity? b. If the ?rm converts to 25 percent debt, what will its cost of equity be? c. If the ?rm converts to 50 percent debt, what will its cost of equity be? d. What is Shadow’s WACC in part (b)? In part (c)? 18. 【Firm