Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its cost of equity is rsU=14%. Firm L has $1 million of debt outstanding at a cost of rd=8%. There are no taxes. Assume that the MM assumptions hold. Find V, S, rs, and WACC for Firms U
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Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its
Find V, S, rs, and WACC for Firms U
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- Instructions: Assume the following data for two firms (U = unlevered firm) and (L = levered firm). Assume the two firms are in the same risk class when it comes to business risk. Both firms have EBIT = €1000 000. Firm U has zero debt and its required rate of return (KsU = 12%). Firm L has €2000 000 debt and pays 10% interest rate. Based on the data provided, answer the following questions and show all your computations and interpret your results. Find the value of unlevered (U) and levered (L) firms under zero corporate tax assumption. Find the market value of the firm’s L’s debt and equity. Do 1 and 2 under the assumption of corporate tax = 60%Suppose there is a large probability that L will default on its debt. For the purpose of this example, assume that the value of Ls operations is 4 million (the value of its debt plus equity). Assume also that its debt consists of 1-year, zero coupon bonds with a face value of 2 million. Finally, assume that Ls volatility, , is 0.60 and that the risk-free rate rRF is 6%.Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m): A) Please fill in the following statements. 1) B's return on equity is [B_ROE] 2) B's debt to equity ratio is [B_D_E] 3) A's weighted average cost of capital is [A_WACC], 4) B's weighted average cost of capital is [B_WACC] B) Please answer the following questions. 5) A’s shares carry less risk than B’s shares, true or false (T/F)? [ALessRisk] 6) Assume A is fairly priced, what would be B’s weighted average cost of capital in the absence of arbitrage opportunities? [B_WACC_noarbitrage] B) Please answer the following questions. Suppose now that an investor with a 5% stake in B would like to sell his shares and take a stake in A, but would like to keep his…
- Where do we generally find optimal level of debt? A. where the tax shield is maximized B. the amount of debt such that the YTM is 5.5% or less C. where debt equals equity D. whatever will yield a FICO sore of 700 or better E. consistent with a low investment grade debt ratingA firm's equity beta is 1.2 and its debt is risk free. Given a 0.7 debt to equity ratio, what is the firm's asset beta? (Assume no taxes.)Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £100m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk-free rate. The relevant numbers are provided in the following table (in £ m): Assume A is fairly priced, what would be B’s weighted average cost of capital in the absence of arbitrage opportunities?
- What happens to ROE for Firm U and Firm L if EBIT falls to $1,600? What happens if EBIT falls to $1,200? What is the after-tax cost of debt? What does this imply about the impact of leverage on risk and return?The beta of Company’s X equity is equal to 1. Assuming that the company's debt is risk-free, that X's debt to equity ratio is equal to 1, and that there are no taxes, the beta of company X’s assets is 1 1/2 2 2/3Assume the Capital Asset Pricing Model is true and that all securities should lie along the line created by the equation (the Security Market Line). Greg Noronha has been told the expected return on Merchants Bank is 9.75%, He knows the risk-free rate is 1.9%, the market risk premium is 6.75%, and Merchants' beta is 1.15. Based on the Capital Asset Pricing Model, Merchants Bank is: A. fairly valued. B. undervalued. C. overvalued.
- Suppose that Tesla has a market Beta of 2.01 . They have a debt to equity valve of34%and a tax rate of25%. The risk free rate is3%and the inarket risk premium is4.1%Suppose that Tesla acquives Fivian and their new debt to equity rato is75%. What is Tesla's new market Beta? A. 1.75 B. 1.84 C. 201 D. 250Calculate the union’s cost of equity from the CAPM using its own beta (0.90) estimate and the industry beta (1.25) estimate. How different are your answers? Assume a risk-free rate of 2% and a market risk premium of 7%. Can you be confident that Union Pacific’s true beta is not the industry average?Suppose the Capital Asset Pricing Model (CAPM) is valid in a market. Use CAPM to ex- plain and answer following questions. Note: There is no relationship between each situation. (a) Can security A exist in the market? (Hint: Security market line) If yes, compute risk premium on security A. If not, is this security underpriced or overpriced? Expected return 5% Asset Beta Risk-free Market 12% 1 A 15% 1.3 (b) Can security B exist in the market? (Hint: Security market line) If yes, compute risk premium on security B. If not, is this security underpriced or overpriced? Expected return 6% Asset Beta Risk-free Market 13% 16.5% 1 1.5 Suppose the expected cash flow can be collected from investment in security B is $1000 at time 1. And an investor thinks the beta of security B is 1.8. But the actual beta is given in the above table. Then how much more/less (you also need to select "more" or "less") will he offer for the firm than it is truly worth at time 0? Hint: the present value of the cash…